The World Bank€¦ · BNI Bank Negara Indonesia BNPB Badan Nasional Penanggulangan Bencana (National Disaster Management Authority) BRI Bank Rakyat Indonesia ... As the largest economy

Document of

The World Bank

FOR OFFICIAL USE ONLY Report No: PGD115

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

PROGRAM DOCUMENT FOR A

PROPOSED LOAN

IN THE AMOUNT OF US$ 300 MILLION TO

THE REPUBLIC OF INDONESIA

FOR THE

INDONESIA FIRST FINANCIAL SECTOR REFORM DEVELOPMENT POLICY FINANCING

February 24, 2020

Finance, Competitiveness And Innovation Global Practice 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 of February 10, 2020) Currency Unit: Rupiah (IDR)

US$ 1.00 = IDR 13,710

ABBREVIATIONS AND ACRONYMS

ADB Asian Development Bank

API Application Program Interface

ASEAN Association of Southeast Asian Nations

ATMs Automated Teller Machines

Bappenas Badan Perencanaan Pembangunan Nasional (National Development Planning Agency)

BI Bank Indonesia

BKF Badan Kebijakan Fiskal (Fiscal Policy Unit)

BPBD Badan Penanggulangan Bencana Daerah (Subnational local disaster management agencies)

BPK Audit Board (Badan Pemeriksa Keuangan)

BNI Bank Negara Indonesia

BNPB Badan Nasional Penanggulangan Bencana (National Disaster Management Authority)

BRI Bank Rakyat Indonesia

BTN Bank Tabungan Negara

CAR Capital Adequacy Ratio

CMEA Coordinating Ministry of Economic Affairs

CMSF Capital Market Strengthening Facility

CPF Country Partnership Framework

CPI Consumer Price Index

DAK Dana Alokasi Khusus (Special Allocation Fund)

DFS Digital Financial Services

DPL Development Policy Loan

DPO Development Policy Operation

DRFI Disaster Relief Financing and Insurance

D-SIBs Domestic Systemically Important Banks

E&S Environmental and Social

EAP East Asia Pacific

ESG Environmental, Social, and Governance

FCs Financial Conglomerates

FDI Foreign Direct Investment

FIRM Financial Sector and Investment Climate Reform and Modernization

FMIS Financial Management Information System

FSAP Financial Sector Assessment Program

FSB Financial Stability Board

G2P Government to Person

GAC Global Affairs Canada

GDP Gross Domestic Product

GDPR General Data Protection Regulation

GNP Gross National Product

GoI Government of Indonesia

GRiF Global Risk Financing Facility

GRS Grievance Redress Service

HCI Human Capital Index

IBRD International Bank for Reconstruction and Development

ICP Indonesian Crude Oil Price

ID4D Identification for Development

IDR Indonesian Rupiah

IDRAR Indonesia Resilience and Reconstruction

IDRIP Indonesia Disaster Resilience Initiatives Project

IFC International Finance Corporation

IFSSP Indonesia Financial Sector Strengthening Program

IGGF Indonesia Infrastructure Guarantee Fund

IMF International Monetary Fund

InfraSAP Infrastructure Sector Assessment Program

IPS Indonesia’s Payment System

ISD Integrated Supervision Department

JICA Japan International Cooperation Agency

KEM-PPKF Kerangka Ekonomi Makro dan Pokok-pokok Kebijakan Fiskal (Macroeconomic Framework and Fiscal Policy Principles)

KSSK Komite Stabilitas Sistem Keuangan (Financial System Stability Coordinating Forum)

KUR Kredit Usaha Rakyat (People’s Business Credit)

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Regional Vice President: Victoria Kwakwa

Acting Country Director: Rolande Pryce

Regional Practice Group Director: Hassan Zaman

Practice Manager: Irina Astrakhan

Task Team Leader: Francesco Strobbe

POJK Peraturan Otoritas Jasa Keuangan (Indonesia Financial Service Authority Regulation)

PPKSK Pencegahan dan Penanganan Krisis Sistem Keuangan (Financial Safety Net)

QR code Quick Response Code

QRIS QR Code Indonesia Standard

SAI Supreme Audit Institution

SCD Systematic Country Diagnostic

SCV Single Customer View

SEADRIF Southeast Asia Disaster Risk Insurance Facility

SECO State Secretariat for Economic Affairs

SMEs Small and Medium-sized Enterprises

SNG Sub-National Governments

SNKI Strategi Nasional Keuangan Inklusi (National Strategy for Financial Inclusion)

SN-PPPK Strategi Nasional Pengembangan dan Pendalaman Pasar Keuangan (National Strategy for Financial Market Deepening)

SOBs State‐Owned Banks

SOEs State‐owned enterprises

SPVs Special Purpose Vehicles

TA Technical Assistance

USAID United States Agency for International Development

VAT Value Added Tax

WB World Bank

WBG World Bank Group

LDP Letter of Development Policy

LKD Layanan Keuangan Digital (Digital Financial Services)

LPS Lembaga Penjamin Simpanan (Indonesia Deposit Insurance Corporation)

LPG Liquified Petroleum gas

MCICP Multi-Country Investment Climate Program

MOF Ministry of Finance

MOLHR Ministry of Law and Human Rights

MSMEs Micro, Small and Medium-sized Enterprises

MTEF Medium-Term Expenditure Framework

NIMs Net-Interest Margins

NPG National Payment Gateway

NPLs Non-performing Loans

NSFI National Strategy for Financial Inclusion

OECD Organisation for Economic Co-operation and Development

OJK Otoritas Jasa Keuangan (Indonesia Financial Service Authority)

OTC Over the Counter

PBL Policy Based Loan

PDAMs Perusahaan Daerah Air Minum (local water supply companies)

PEFA Public Expenditure and Financial Accountability

PIK Pusat Informasi dan Komunikasi (Information and Communication Center)

PPP Public Private Partnership

https://www.seco.admin.ch/seco/en/home.html

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REPUBLIC OF INDONESIA

INDONESIA FIRST FINANCIAL SECTOR REFORM DEVELOPMENT POLICY FINANCING

TABLE OF CONTENTS

SUMMARY OF PROPOSED FINANCING AND PROGRAM .......................................................................3

1. INTRODUCTION AND COUNTRY CONTEXT ...................................................................................5

2. MACROECONOMIC POLICY FRAMEWORK ....................................................................................8

2.1. RECENT ECONOMIC DEVELOPMENTS ................................................................................. 8

2.2. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY .............................................. 12

3. GOVERNMENT PROGRAM ........................................................................................................ 15

4. PROPOSED OPERATION ............................................................................................................ 17

4.1. LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION ............................... 17

4.2. PRIOR ACTIONS, RESULTS AND ANALYTICAL UNDERPINNINGS ....................................... 24

4.3. LINK TO CPF, OTHER BANK OPERATIONS AND THE WBG STRATEGY ............................... 41

4.4. CONSULTATIONS AND COLLABORATION WITH DEVELOPMENT PARTNERS .................... 41

5. OTHER DESIGN AND APPRAISAL ISSUES .................................................................................... 42

5.1. POVERTY AND SOCIAL IMPACT ......................................................................................... 42

5.2. ENVIRONMENTAL ASPECTS .............................................................................................. 44

5.3. PFM, DISBURSEMENT AND AUDITING ASPECTS ............................................................... 45

5.4. MONITORING, EVALUATION AND ACCOUNTABILITY ....................................................... 47

6. SUMMARY OF RISKS AND MITIGATION ..................................................................................... 48

ANNEX 1: POLICY AND RESULTS MATRIX .......................................................................................... 50

ANNEX 2: LETTER OF DEVELOPMENT POLICY ..................................................................................... 54

ANNEX 3: ENVIRONMENT AND POVERTY/SOCIAL ANALYSIS TABLE .................................................. 60

ANNEX 4: ADDITIONAL BACKGROUND ON THE DISASTER RISK FINANCE MECHANISM PROPOSED UNDER REFORM #9 ......................................................................................................................... 62

ANNEX 5: KEY FINANCIAL SECTOR STATISTICS .................................................................................. 66

The Indonesia Financial Sector Reform Development Policy Financing (P170940) was prepared by a World Bank Group team led by Francesco Strobbe and comprising of Ketut Ariadi Kusuma, I Gede Putra Arsana, Dara Lengkong, Bertine Kamphuis, Safriza Sofyan, Neni Lestari, Siti Budi Wardhani, Cynthia Clarita Kusharto, Fajar Pane, Erly Sapulete-Tatontos, Yuliana Irene, Novira Kusdarti, Benedikt Lukas Signer, Cindy Paladines, Derek H. C. Chen, Indira Maulani Hapsari, Evarist F Baimu, Ria Dharmawan, Rowena Gorospe, Alejandro Alcala Gerez, Theodore Manggala Amarendra, Fernando Dancausa, Rahajeng Pratiwi, Sailesh Tiwari, Francis Addeah Darko, Ismael Ahmad Fontan, Jonathan Marskell, James Neumann, Katia D’Hulster,

Marco Nicoli, Michael J Fuchs, Shankar Narayanan, Devika Bahadur, Tatiana Didier Brandao, Thomas E Walton, Dhruw Sharma, Ana Maria Aviles. Comments and inputs were also gratefully received from Yongmei Zhou (Program Leader), Theo Thomas, Ashley Taylor and Dorsati Madani (OPCS), Ganesh Rasagam, Anderson Caputo Silva, Erik Feyen and Aurora Ferrari (FCI), Frederico Gil Sander, Ralph Van Doorn and Jaffar Al Rikabi (MTI), Changqing Sun (SPJ), Anja Robakowski-Van Stralen (EFI). The team gratefully acknowledges the excellent collaboration of the Government of Indonesia, and the comments of peer reviewers: Fiona Stewart (Lead Financial Sector Specialist, GFCLT), Harish Natarajan (Lead Financial Sector Specialist, GFCFI) and Cedric Mousset (Lead Financial Sector Specialist, GFCFS). The team benefitted from guidance from Rodrigo A. Chaves (Former Country Director, EACIF), Rolande Pryce (Acting Country Director, EACIF), Hassan Zaman (Regional Director, EEADR), Alfonso Garcia Mora (Global Director, EFNDR) and Irina Astrakhan (Practice Manager, EEAF1).

The World Bank Indonesia First Financial Sector Reform Development Policy Financing (P170940)

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SUMMARY OF PROPOSED FINANCING AND PROGRAM

BASIC INFORMATION

Project ID Programmatic If programmatic, position in series

P170940 Yes 1st in a series of 3

Proposed Development Objective(s)

The program development objective of this programmatic operation is to support financial sector reforms that will assist the Government of Indonesia (GoI) in achieving a deep, efficient and resilient financial sector. The proposed operation is the first in a series of three programmatic operations. This programmatic DPL series is structured around the following three pillars and set of objectives: • Pillar A: Increasing the Depth of the Financial Sector. Pillar objectives: to expand the size of the financial sector by increasing outreach, broadening financial market products and mobilizing long-term savings. • Pillar B: Improving the Efficiency of the Financial Sector. Pillar objectives: to lower the costs for individuals and enterprises by strengthening the insolvency and creditor rights framework, protecting consumers and personal data and promoting interoperability of payment systems. • Pillar C: Strengthening the Resilience of the Financial Sector. Pillar objectives: to strengthen the capacity of the sector to withstand financial and non-financial shocks by strengthening the resolution framework, implementing sustainable finance practices and establishing disaster risk finance mechanisms.

Organizations

Borrower: REPUBLIC OF INDONESIA

Implementing Agency: FISCAL POLICY AGENCY, MINISTRY OF FINANCE

PROJECT FINANCING DATA (US$, Millions) SUMMARY

Total Financing 300.00 DETAILS

International Bank for Reconstruction and Development (IBRD) 300.00


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INSTITUTIONAL DATA

Climate Change and Disaster Screening

This operation has been screened for short and long-term climate change and disaster risks

Overall Risk Rating

Moderate .

Results

Indicator Name Baseline Target

1 - Reduction in the percentage of adults stating distance is the foremost barrier to opening a transaction account (FI account and mobile money) (%)

19.3 [2017] 10.2 [2022]

2 - Average transactions by beneficiaries through social assistance (KKS) accounts per year

0.8 [2019] 2 [2022]

3 - Outstanding IDR-denominated private debt securities (IDR trillion)

412 [2018] 711 [2022]

4 - Reduced portion of short-term investments (cash, bank deposits) in pension fund portfolios (%)

19.3 [2017] 16 [2022]

5 - Number of insolvency cases opened by the court, evidencing greater access by firms

304 [2018] 334 [2022]

6 - Number of financial product marketing violations detected per year

200 [2018] 400 [2022]

7 – Number of payment services providers (bank and non-bank financial institutions) facilitating QR payments

8 [2018] 40 [2022]

8 - Number of days for LPS to pay out insured depositors in closed commercial banks

90 [2018] 7 [2022]

9 - Number of bank resolution plans finalized by LPS 0 [2019] All systemic banks [2022]

10 – Commercial banks complying with sustainable finance practices (%)

0 [2019] 75 [2022]

11 - Utilization of the pooling fund for disaster response financing. Pooling Fund not established [2019]

Pooling fund utilized in disaster response [2022]

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IBRD PROGRAM DOCUMENT FOR A PROPOSED

INDONESIA FIRST FINANCIAL SECTOR REFORM DEVELOPMENT POLICY LOAN (DPL)

TO THE REPUBLIC OF INDONESIA

1. INTRODUCTION AND COUNTRY CONTEXT

1. This Program Document proposes a First Financial Sector Reform Development Policy Operation (DPO) for the Republic of Indonesia in the amount of US$300 million. The proposed operation is the first in a programmatic series of three IBRD loans and is intended to support a reform program aimed at (i) increasing the depth, (ii) improving the efficiency and (iii) strengthening the resilience of the financial sector. 2. Indonesia, the world's largest island country located between the Indian and the Pacific Ocean, aspires to become an upper middle-income country by 2025 and the 5th largest global economy in the world by 2030. A country with a diverse population and a complex landscape, Indonesia is the world’s fourth most populous nation with approximately 265 million people living in over 6,000 inhabited islands. Indonesia has made remarkable development progress over the last 20 years and has emerged as a middle-income economy with macroeconomic and political stability. As the largest economy in South East Asia and 16th largest in the world, Indonesia has maintained an average GDP growth of 5% p.a. in the last 5 years. Growth has been sustained primarily by private consumption, thanks to a large and growing domestic market with a middle class estimated to account for 20 percent of the Indonesia’s population and for 43 percent of total household consumption.

3. Indonesia’s macroeconomic fundamentals remain strong, with robust economic growth, stable inflation, low unemployment, and narrow fiscal deficits. The Indonesian economy has weathered well the recent challenging external environment largely due to significant improvements in Indonesia’ macro-economic framework since 2010, including the implementation of prudent macroeconomic policies and structural reforms. Robust GDP growth and strong economic fundamentals have enabled Indonesia to absorb the impact of the recent decline in commodity prices and the current economic and financial uncertainties. The economy withstood the 2013 Taper Tantrum, and since then it has weathered well sharp declines in commodity prices and bouts of global financial markets instability. All major credit rating agencies have upgraded Indonesia’s rating to creditworthy since May 20171, corroborating the country’s improved economic environment, fiscal management, and overall credit worthiness.

4. Indonesia has also made solid progress in reducing poverty and inequality. The poverty rate fell to a single digit for the first time on record to 9.8 percent in March 2018. It has continued to decline, registering 9.4 percent in March 2019. Inequality, which had been increasing throughout the 2000s, has also been on a distinct, albeit somewhat modest, downward trend since 2015. The Gini coefficient for consumption, currently at 38.9, is 2.2 points below the peak in 2014. The expansion of social assistance programs, both in terms of coverage as well as generosity, together with the significant rationalization of poorly targeted energy subsidies has contributed positively to recent poverty and inequality trends.

1 Standard and Poor’s (BBB), Fitch (BBB), Moody’s (Baa2), and the Japan Credit Rating Agency (BBB).


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5. But there are several challenges to sustaining and deepening this progress. First, the pace of poverty reduction has started to stall, suggesting that it may be getting progressively harder to reach and uplift the remaining poor, who are more likely to be entrenched in chronic forms of poverty associated with lagging and remote rural regions, or social groups. Second, protecting economic gains for those who escape poverty remains a challenge: the income of approximately 20 percent of the entire population hovers marginally above the national poverty line, keeping them exposed to the risk of falling into poverty following a financial or non-financial shock. Third, despite not being in poverty or vulnerability, almost half of the population is yet to achieve the economic security and lifestyle of the middle class. Securing a robust pathway to the middle class for this “aspiring middle class” group is vital to the realization of Indonesia’s aspirations of becoming an upper middle-income country. Going the last mile on eliminating poverty, continuing to address the economic vulnerabilities of the population, and unlocking the productive potential of the economy to make the pathway to the middle class available to all Indonesians represent the three main challenges facing the country. 6. To maintain economic growth and generate higher quality jobs in greater numbers and at a faster pace – which is crucial to addressing these challenges – Indonesia needs to close three key gaps. An infrastructure gap, estimated at over $1.5 trillion; a human capital gap, which places Indonesia in the third quartile of the HCI with some of the highest stunting rates in the world at over 30 percent; and an institutional gap, which leads to restrictive and unpredictable regulation and lack of capacity, coordination and leadership in delivering public services and implementing public policies to enhance inclusive growth. Closing these three gaps, while maintaining the foundations of macroeconomic stability, will require collecting more and spending better, improving the decentralization framework and service delivery at local levels, promoting openness and competition within a stable regulatory environment and deepening and broadening the financial sector.

7. A sound and well-functioning financial sector is critical to sustain Indonesia’s growth and to achieve the Government’s shared prosperity goals. Financing the infrastructure gap and broadening opportunities for individuals and firms require an acceleration of financial sector deepening, efficiency, and inclusion without compromising macro- and micro-prudential standards. The authorities recognize this necessitates stronger coordination between agencies to formulate a coherent policy framework and evaluate its impact as well as to monitor financial risks across sectors and for the broader economy. An ambitious agenda to promote financial sector deepening and to strengthen financial oversight and crisis management has been pursued by the Government of Indonesia in the recent years.2 However, to date, the Indonesian financial sector is not yet sufficiently able to fund development needs or boost inclusive economic growth.

8. With a level of financial sector assets of 71 percent of GDP (as of 2018), Indonesia compares poorly to other ASEAN countries.3 The financial sector is relatively shallow, dominated by banks which are part of financial conglomerates, with a substantial presence of the State and a narrow domestic

2 In 2011, OJK was established as an integrated regulator to oversee the entire financial sector and is now implementing its Financial Services Sector Master Plan. The authorities launched the National Financial Inclusion Strategy in 2016 and various initiatives to boost access to transaction accounts, microcredit, and lending to individuals and small and medium-sized enterprises (SMEs). 3 As of 2017, Philippines was at 99.2%, Vietnam at 218%, Malaysia at 264%.


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institutional investor base4. Bank intermediation efficiency is relatively low, which holds back financial development and, ultimately, inclusive and sustainable economic growth. Net-interest margins have been structurally higher in Indonesia than in peers.5 The small size of the banking sector, weaknesses in the institutional environment, high market power, and operational inefficiencies contribute to weak intermediation efficiency. Financial inclusion of both households and SMEs trail peers.6 Although money markets have become more active, they remain shallow and segmented. Capital markets do not yet provide sufficient funding, nor do they represent a competitive alternative to banks. In the absence of a domestic investor base that is willing and able to provide longer-term financing, the role of foreign funding is important, but it exposes Indonesia to a volatile external environment and requires vigilance regarding external refinancing risks. The challenges of managing the associated risks and boosting investor demand are compounded by the absence of active hedging markets. 9. This operation builds on the achievements from previous DPOs. The 2012 Financial Sector and Investment Climate Reform and Modernization (FIRM1) DPL focused on reinforcing financial sector stability (e.g. with the establishment of the OJK Board of Commissioners), promoting financial sector diversification, enhancing financial inclusion (e.g. with the launch of the National Strategy for Financial Inclusion - NSFI), and supporting investment climate regulatory reform. This was followed by the (stand-alone) Financial Sector Reform Modernization (FIRM2) DPL in 2014 that continued supporting the previous FIRM1 DPL’s financial sector reform areas, e.g. by operationalizing the Financial System Stability Coordinating Forum (KSSK) and by making further advances on consumer protection, basic saving accounts and financial literacy following the issuance of the NSFI. The proposed DPO builds on those achievements by supporting reforms that further expand the role of key counterparts (such as OJK) in the sector and strengthen the coordination among the members of the KSSK (i.e. MoF, BI, OJK, LPS) given their joint responsibility in promoting cross-cutting reforms that support a deeper, more efficient and resilient financial sector. 10. This DPO series presents an opportunity to leverage on Indonesia’s progress on financial sector development; however, technical and institutional risks need to be taken into consideration. The new government will have a valuable opportunity to push for reforms that boost inclusive growth and entrench stability. Financial sector reform is among the priorities of the new administration, that firmly supports this operation. Combined with continued progress on infrastructure, the business environment, and human capital investment, it will contribute to higher and more inclusive growth. The implementation of the reforms supported by this DPO series is complex, requiring collaboration with and among a large number of implementing agencies. The proposed reforms require intense technical work to guarantee their completion and the sustainability of their results. Wherever possible, this operation therefore seeks complementarities with ongoing technical assistance provided by the international development partners.

4 As of September 2019, there were 110 commercial banks whose total assets represented 53.3 percent of GDP (or 76.3 percent of total financial sector assets). Out of 1688 banks (including commercial and rural banks), the top 10 banks hold around 62% of the total banks’ assets. Among these, the four state-owned banks (Mandiri, BNI, BRI, BTN) hold 40.3% of assets. On the NBFIs’ side Indonesia’s mutual fund assets are equivalent to 3.5 percent of GDP (September 2019), below the median value for Indonesia’s peer countries of 21.4 percent of GDP. The insurance companies represent 8.3 percent of GDP, while the median value of peer countries’ is 20.2. Indonesia’s pension fund assets are equal to 1.8 percent of GDP while the median value for peer countries is 4.4 percent of GDP. 5 See paragraph 37. 6 See paragraph 40.


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2. MACROECONOMIC POLICY FRAMEWORK

2.1. RECENT ECONOMIC DEVELOPMENTS

11. Indonesia’s fundamentals continue to be sound. After 6 years of adjusting to lower commodity prices, economic growth strengthened in 2018 to 5.2 percent, the highest in 5 years, on the back of solid domestic demand (Table 1). Private consumption edged up to a 4-year high on the back of low inflation and strong labor market conditions. Similarly, investment growth surged to a 6-year high in 2018 due to favorable domestic financing conditions and relatively robust commodity prices, particularly during the first half of the year. Government consumption growth more than doubled partly due to strong social assistance spending. In contrast to 2017, net exports contracted in line with weaker external conditions and strong capital goods imports. On the production side, the service sector continues to dominate growth. Labor market conditions also remained strong in 2018 with the employment rate reaching a two-decade high, matched by the unemployment rate falling to a 20-year low of 5.3 percent. Reflecting sound economic conditions, the poverty rate fell to a record low of 9.8 percent in 2018. 12. Recent economic growth tapered in line with unfavorable external conditions. For the first 3 quarters of 2019, the economy grew on average 5.0 percent yoy. Domestic demand continued to be the main driver of growth with the pickup in the private consumption growth being offset by weaker investment growth in light of election related political uncertainty. Government consumption growth has slowed compared to 2018, largely driven by lower subsidy spending7. Meanwhile, due to unfavorable external conditions, export and imports have been falling, with imports contracting faster8, cushioning growth.

13. Indonesia’s economy is also driven by extraction of natural resources and hence put large pressure to the country’s natural capital. It is still closely tied to commodities, such as coal, natural gas, palm oil, timber and rubber, despite economic diversification. Productivity of palm oil is driven by increases in the areas rather than yields, and forest estates are planted or mined without licenses and are degraded after being used. These practices deplete Indonesia’s natural capital and have been associated with deforestation and forest fire which cost Indonesia over USD 5 billion in 2019.

14. Indonesia’s external sector also weakened amid the persistent global uncertainties, particularly from continued slower global trade growth. Despite external headwinds, the current account deficit narrowed to 2.7 percent of GDP for the first three quarters of 20199 from 2.9 percent in 2018, as both export and imports volumes contracted. The capital and financial account surplus increased to 2.9 percent in 2019 from 2.4 percent in 2018, driven by higher foreign direct investment (FDI) and portfolio inflows. Portfolio inflows up to Q3 2019 amounted to US$ 14.6 billion. In line with the stable capital flows, the Rupiah has been stable hovering around IDR 14,100 per US$ for most of the year, which coupled with

7 The energy subsidy bill shrank due to lower commodity prices and the stronger Rupiah. 8 This is partly due to several Government policies to manage imports in order to narrow the current account deficit. These policies consists of: 1) Tax increase on selected imported consumption goods; 2) The Biodiesel 20 (B20) policy, a 20 percent blend of palm oil and 80 percent petroleum diesel, for all diesel fuel sold domestically; and 3) Domestic Market Obligation (DMO) on crude oil production where the Government mandates oil and gas contractors to offer their share of crude oil production to PT. Pertamina before any considerations for exports. 9 The analysis for the Balance of Payments in 2019 will use data for the first three quarters data in 2019.


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lower inflation, provided space to Bank Indonesia to ease monetary policy to support growth. After appropriately tightening in 2018, Bank Indonesia cut its benchmark rate four times by a cumulative 100 basis points to 5 percent in October 2019, to support growth. Correspondingly, international reserves continued to be robust, reaching USD 126.7 billion in October 2019, the highest in 20 months, sufficient to finance of 7.4 months of imports. This was considerably higher than that of US$ 120.7 billion in December last year (Table 1).

Table 1. Key Macroeconomic Indicators

2016

Actual 2017

Actual 2018

Actual 2019 Proj.

2020 Proj.

2021 Proj.

2022 Proj.

Real economy

Real GDP (% change) 5.0 5.1 5.2 5.0 5.1 5.2 5.2

Private Consumption (% change) 5.0 5.0 5.1 5.2 5.1 5.2 5.2

Government Consumption (% change) -0.1 2.1 4.8 3.5 3.7 4.2 4.5

Gross Fixed Investment (% change) 4.5 6.2 6.7 4.5 5.0 5.3 5.5

Exports (% change) -1.7 8.9 6.5 -1.0 1.5 2.5 3.5

Imports (% change) -2.4 8.1 12.0 -6.0 0.5 1.8 3.0

Unemployment Rate (%) 5.6 5.5 5.4 4.2 4.2 4.3 3.4

CPI (year-average, %) 3.5 3.8 3.2 3.1 3.5 3.5 3.0

Fiscal accounts of Central Government, percent of GDP

Revenues 12.5 12.3 13.1 12.4 12.8 13.2 13.3

of which tax revenue 10.4 9.9 10.3 9.8 10.4 10.8 11.0

Expenditures 15.0 14.8 14.8 14.6 14.8 15.2 15.4

Fiscal Balance -2.5 -2.5 -1.8 -2.1 -2.1 -2.0 -2.0

Central Government Debt 28.3 29.4 29.8 30.1 30.2 30.1 30.2

Selected monetary accounts

Policy Interest Rate 4.6 3.3 2.5 … … … …

Credit growth (% change) 7.9 8.2 11.8 … … … …

M2 (% change) 10.0 8.3 6.3 … … … …

Balance of Payments, percent of GDP unless indicated otherwise

Current Account Balance -1.8 -1.6 -2.9 -2.7 -2.7 -2.6 -2.4

Exports, Goods and Services 18.0 19.1 20.3 18.6 17.8 17.4 17.4

Imports, Goods and Services -17.1 -18.0 -20.9 -18.9 -18.3 -18.0 -18.0

Net Foreign Direct Investment 1.7 1.8 1.3 1.8 1.8 1.9 1.9

Gross Reserves (months of imports of goods and services)

7.6 7.2 6.8 … … … …

Terms of Trade 1.5 0.3 -5.0 -4.1 -0.5 -0.5 -0.8

Exchange Rate (IDR per US$, average) 13,308 13,381 14,250 … … … …

GDP nominal in US$ (billions) 933 1,002 1,041 1,122 1,208 1,308 1,415

Source: Ministry of Finance, Bank Indonesia, World Bank staff projections for 2019-2022


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15. Continued prudent and coordinated monetary and exchange rate policies are complemented by conservative fiscal policy, which helped sustain economic growth. Bank Indonesia’s monetary policy is aimed to minimize the volatility of Rupiah ensuring stable capital inflows to finance the current account deficit, and keeping the inflation within its target range, in line with its inflation targeting framework. Government revenues surged 18.8 percent in 2018 compared to 7.1 percent in 2017, the highest growth since 2011, largely due to ongoing revenue reforms and better compliance. This led to an increase in the tax ratio to 10.3 percent in 2018. Expenditures was contained at 14.8 percent of GDP, with immediate disaster expenditure due to the three natural disasters in late 2018 being executed within the approved budget envelope using contingency funds. With higher revenue collections and managed expenditures, fiscal deficit fell to a six-year low at 1.8 percent of GDP in 2018. The conservative fiscal policy and enhanced fiscal credibility was also acknowledged through an investment-grade sovereign credit rating by four major credit ratings agencies. 16. In 2019, Government revenues and expenditures moderated, due to high base effects of strong revenue and expenditure realizations from last year as well as large cyclical downturn. After reaching an eleven-year high of 23.0 percent yoy last year, supported by a cyclical upturn in commodity prices and the impact of tax reforms, growth of total Government revenue collection posted a modest 1.7 percent year-to-October this year, driven by the very substantial high base effect, impact of a streamlined tax refunds and a cyclical downturn with lower commodities prices and contracting imports, which weighed on both tax and non-tax revenues. Total Government expenditure growth was also weaker, reaching less than half of the five-year high increase seen in 2018. Growth was driven by personnel spending but offset by contracting capital and subsidy spending, with energy subsidies excluding arrear payments shrank by 15.9 percent in 2019 compared to last year’s 39.0 percent increase, partly due lower commodity prices and the appreciation of the Rupiah. The Government also allocated IDR 15 trillion for disaster mitigation and reconstruction expenditures and issued a regulation to accelerate the disbursements of DAK (Special Allocation Fund) transfers to subnational governments and give them more flexibility for post-disaster responses in 2018 and 2019.10 17. The 2020 budget sets an optimistic revenue and expenditure growth amid weakening global economic activities. The Government targets a total revenue of 13.9 percent of GDP, a 1.2 percentage points higher than the 2019 Government outlook. Tax revenues is targeted to grow by 13.5 percent yoy, higher than the predicted tax revenue growth of 8.2 percent in 2019, driven by higher value added tax (VAT) collections, excises and non-oil and gas income tax revenues, suggesting the expected impact of tax administration and tax policies reforms are underway.11 Expenditures are expected to grow modestly than in 2019, but with improved quality of spending through expansion of capital and social expenditures and lower energy subsidy expenditures. Infrastructure spending is projected to grow 5.9 percent, mostly goes to development of tourism destinations. Energy subsidy spending also foresee a decline by 12.1 percent yoy in 2020 after an expected decline of 7.1 percent in 2019. This was due to the reduction in the overall

10 MoF regulation No. 145/2018 concerning distribution and use of transfers to regions and Village Funds for FY 2018 and FY 2019 to support the acceleration of post-earthquake rehabilitation and reconstruction. 11 This is despite the introduction of new tax incentives to attract investment. These consists of super deduction for supporting vocational and R&D activities, a mini tax holiday for new investment up to IDR 500 billion, and investment allowances for human capital-intensive industries, as well as the subsidized income tax for certain sectors such as geothermal, foreign Government bonds. Also, VAT exemptions will be enacted for transportation rental services (ships, aircrafts, and train) to improve competitiveness


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subsidy bill, owing to three initiatives: 1) the reduction in the amount of diesel subsidy by half from IDR 2000 to IDR 1000 per liter; 2) the LPG subsidy distribution system, which will be targeted allowing only poor and vulnerable households to benefit (closed distribution); and 3) the electricity subsidy that will remove subsidies to non-poor households or most of the 900VA subscribers in 2020 and will be given only to poor households as listed in the unified poverty database.12 Overall, the 2020 Government approved Budget projects a narrower deficit target of 1.8 percent of GDP compared to 2019 and still below the legal threshold of 3 percent. 18. Fiscal risks and contingent liabilities are manageable, but SOE debt has recently started to trend up and warrant closer monitoring. Exposure to explicit contingent liabilities in the form of loan guarantees to SOEs amounted to IDR 107.6 trillion (0.55 percent of GDP) for the first half of 2019, well below the guarantee ceiling of 6.0 percent of GDP, and guarantees to Public Private Partnership (PPP) projects in 2019 amounted to IDR 9.8 trillion, which is mitigated by the Indonesia Infrastructure Guarantee Fund (IGGF) for guarantee risks. However, total non-financial state-owned enterprise debt amounted to USD 72.1 billion or 6.4 percent of GDP in the first half of 2019, increasing by 0.2 percentage points since 2018.13 Indonesia is also exposed to fiscal risks from natural disasters. It is important to monitor other contingent liabilities, such as those from companies owned by sub-national governments (SNGs), such as the local water supply companies (PDAMs), many of which are loss making.

19. Several tax reforms are underway, including those under the Omnibus Law, in addition to recent reforms support by the 2019 Third Fiscal Reform DPL. The Government is finalizing an Omnibus law draft to be submitted to the parliament in 2020, which consists of: (1) gradual reduction of the statutory corporate income tax rate to 20 percent by 2021; (2) reduction of taxes on interest from government bonds issued abroad to zero; (3) change of provision in the VAT Law to implement digital economy taxation; (4) a shift to a territorial taxation system applied to non-residents;14 (5) change in the penalties applied to self-corrections of VAT forms. The impact of these changes has not yet been included in the macro projections. The Government has issued a regulation to increase tobacco excise tax rates. The new regulation sets the excise tariff and the minimum retail price for the different kinds of tobacco products, which will result in the average cigarette excise tax rate reaching 21.2 percent and the minimum retail price increasing by an average of 37.0 percent in 2020. A draft regulation to the Parliament has also been tabled to levy a national plastic bags excise. This is in addition to tax reforms supported by the Fiscal Reform DPL series to improve compliance and broader the tax base, including strengthening e-invoicing for VAT and electronic filing of corporate income tax, the establishment of a new compliance risk management unit at the Ministry of Finance, measures to expand the income tax base by encouraging eligible SMEs to move into the general income tax regime, and measures against base erosion and profit shifting by international investors in Indonesia.15

12 The actual amount in the 2020 Budget will go up by 4.7 percent because of expected increased electrification rates mainly due to the reduction of fuel subsidy bill for diesel, kerosene and LPG. 13 Bank Indonesia does not use SOEs’ financial statements to produce the debt data for non-financial SOEs and considers the data not yet complete. 14 For those staying in Indonesia for fewer than 183 days, or for foreign expats, a maximum of 4 years. 15 https://projects.worldbank.org/en/projects-operations/project-detail/P167297.

https://projects.worldbank.org/en/projects-operations/project-detail/P167297


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2.2. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY

20. Indonesia’s economic growth is expected to pick up in the medium term, despite continuing global economic uncertainties, with domestic demand continue to be the key driver of growth. Economic growth is forecast to gradually strengthen to an average of 5.2 percent in 2021 and 2022. Domestic demand is expected to gradually continue to drive growth in the near-term, offsetting a weaker external sector. Private consumption growth is projected to stay robust, although easing modestly in 2020 on account of the higher inflation from the removal of electricity tariff subsidies for a substantial number of households next year. Investment growth is expected to edge up in the medium term, supported by reduced political uncertainties post-election, lower borrowing costs and improved business sentiment due to proposed reforms. Risks to the growth outlook are tilted towards the downside, with protracted trade tensions posing additional risks to international trade flows and China’s growth outlook.

21. As external headwinds are expected to continue, Indonesia’s external sector is projected to weaken. The current account deficit is expected to gradually narrow to 2.4 percent of GDP in 2022. This reflects impacts from continued measures from the Government to manage imports and slower investment growth. These measures may in fact have some unintended consequences considering Indonesia’s need to expand exports, which requires facilitating imports. External financing needs over the forecasting horizon are expected to be financed primarily by foreign direct investment (Table 2).

Table 2. BoP Financing requirements and sources (US$ million)

2016

Actual 2017

Actual 2018

Actual 2019 Proj.

2020 Proj.

2021 Proj.

2022 Proj.

Current account deficit 16,952 16,196 30,484 30,208 32,010 33,195 33,045

Scheduled debt amortization

5,193 5,007 7,448 10,567 9,372 10,909 10,933

Total financing needs 22,145 21,203 37,932 40,775 41,381 44,104 43,979

Total financing sources 22,145 21,203 37,932 40,775 41,381 44,104 43,979

Net FDI inflows 16,136 18,502 13,304 20,061 21,969 24,072 25,963

Project loan disbursements 1,847 2,033 1,097 3,667 5,592 6,101 6,151

Portfolio flows excluding Eurobonds (net)

8,476 9,995 -1,198 3,766 3,894 4,034 4,142

Private sector loans (net) -5,282 2,064 10,304 11,091 11,890 12,771 13,448

Budget financing 13,292 12,677 16,106 11,548 9,273 10,117 10,200

(o/w) Securities, other program loans

12,992 11,977 15,806 10,548 8,973 9,817 9,900

(o/w) WB DPLs 300 700 300 1,000 300 300 300

Other external financing(1) -234 -12,482 -8,812 -7,919 -8,497 -9,126 -9,610

Use of FX reserves -12,089 -11,586 7,131 -1,439 -2,739 -3,864 -6,315

Note: Change in reserves: “-“ denotes an accumulation; “+” denotes a reduction. (1) Other external financing includes errors and omissions for actual data. Source: BPS; Ministry of Finance; BI; World Bank staff projections for 2019-2022


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22. Monetary policy is projected to continue to ease to support growth, while fiscal policies are expected to remain conservative, but both policies will be responsive to the possible impact of the global economic uncertainties. Global monetary easing and some moderations in trade tensions are expected to prompt capital flows to emerging countries, including Indonesia, that will support Rupiah, and providing space for monetary policy to boost growth.

23. The Government is projected to implement fiscal consolidation measures, which are expected to lead to a lower fiscal deficit over the medium term. Revenue is projected to recover thanks to a partial cyclical recovery of income tax and VAT, the subsiding impact of the tax refunds and the impact of past tax policy and administration reforms. Excise revenue is projected to increase as tobacco excise reforms are implemented. On the expenditure side, energy subsidy reforms are projected to reduce the subsidy bill, generating space for higher social assistance and capital investment and increased transfers to subnational governments. Staff project the primary fiscal deficit to average at 0.3 percent of GDP and the fiscal deficit to average at 2.0 percent of GDP for the years 2020-22, which is consistent with a stable level of central government debt (Table 3).

Table 3. Medium-term fiscal framework (central government), including the tax reforms (Percent of GDP)

2016

Actual 2017

Actual 2018

Actual 2019 Proj.

2020 Proj.

2021 Proj.

2022 Proj.

Revenue 12.5 12.3 13.1 12.4 12.8 13.2 13.3 Tax Revenue 10.4 9.9 10.3 9.8 10.4 10.8 11.0

Income Tax 5.4 4.8 5.1 4.9 5.1 5.3 5.5 Sales Tax (VAT) 3.3 3.5 3.6 3.3 3.6 3.8 3.8 Excises 1.2 1.1 1.1 1.2 1.3 1.3 1.3 International Trade Tax 0.3 0.3 0.3 0.3 0.2 0.2 0.2 Other taxes 0.1 0.0 0.0 0.0 0.0 0.0 0.0

Non-Tax Receipts 2.1 2.3 2.7 2.6 2.4 2.4 2.3 Grants 0.1 0.1 0.1 0.0 0.0 0.0 0.0

Total expenditure 15.0 14.8 14.8 14.6 14.8 15.2 15.4 Primary Expenditure 13.6 13.2 13.1 12.8 13.1 13.4 13.5

Central Government Expenditure 7.8 7.7 8.0 7.7 7.9 7.9 7.9 Personnel 2.5 2.3 2.3 2.4 2.4 2.4 2.4 Material 2.1 2.1 2.3 2.1 2.1 2.1 2.1 Capital 1.4 1.5 1.2 1.1 1.3 1.3 1.3 Subsidy 1.4 1.2 1.5 1.1 1.0 1.0 1.0

Energy 0.9 0.7 1.0 0.7 0.6 0.6 0.6 Non-energy 0.5 0.5 0.4 0.4 0.4 0.4 0.4

Grant expenditure 0.1 0.0 0.0 0.0 0.0 0.0 0.0 Social assistance 0.4 0.4 0.6 0.6 0.8 0.8 0.8 Others 0.0 0.1 0.1 0.3 0.3 0.3 0.3

Transfers to sub-national 5.7 5.5 5.1 5.1 5.2 5.5 5.6 Interest 1.5 1.6 1.7 1.7 1.7 1.8 1.8

Primary fiscal balance -1.0 -0.9 0.0 -0.4 -0.4 -0.2 -0.2 Overall fiscal balance -2.5 -2.5 -1.8 -2.1 -2.1 -2.0 -2.0 Net financing 2.5 2.5 1.8 2.1 2.1 2.0 2.0

Investment in financial assets -0.6 -0.5 -0.4 -0.5 0.0 0.0 0.0 Net borrowing 3.0 3.0 2.1 2.6 2.1 2.0 2.0

Net local currency borrowing … … … 2.3 1.8 1.8 1.7 Net foreign currency borrowing … … … 0.3 0.2 0.2 0.3

Central government debt 28.3 29.4 29.8 30.1 30.2 30.1 30.2 Source: Government of Indonesia (2018c, 2019), World Bank staff projections for 2019-22.


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24. The medium-term fiscal policy remains sustainable as debt level remained less than half of the legal threshold, with low share of foreign exchange-dominated debt. In the medium term, the baseline scenario projects the level of debt to tick up slightly from 29.8 percent of GDP at end-2018 to 30.2 percent of GDP by 2022 with a stable fiscal deficit of around 2 percent of GDP. A permanent 30 percent exchange rate depreciation shock would increase the debt-to-GDP ratio to 33.5 percent of GDP in 2020 after which it would decline again. A temporary, negative GDP growth shock of 1 percentage points (reducing growth to level not seen in the last 17 years) compared to the baseline, leading to a proportional revenue decline, would put debt on a moderately increasing path peaking at 31.5 percent of GDP in 2022. A temporary, positive expenditure shock of 1 percent of GDP lasting two years, perhaps due a large natural disaster and subsequent reconstruction efforts, would increase the level of debt peaking at 32.2 percent of GDP in the 2022 (Figure 1).

Figure 1. Projected central government debt-to-GDP ratio under baseline and shocks (Percent of GDP)

Source: Ministry of Finance, Bank Indonesia, World Bank staff calculations

25. Risks to growth are severely tilted to the downside stemming from weakening commodity prices, China’s economic slowdown, and prolonged trade tensions, which can also trigger another emerging market selloff. Further escalation of trade tensions is likely to continue weighing heavily on China and regional economies that partake in regional supply chains, which will consequently impact Indonesia’s economic growth through weaker exports and lower commodity prices. The latter will weigh on Government revenue collection. Moreover, with Indonesia’s shallow financial sector and already-low level of exports and FDI, pressure from increasing capital outflows could exert pressure on the currency. This will increase borrowing costs and weaken investment. The weaker currency could also dampen consumer confidence and increase inflation, leading to slower consumption growth. 26. However, a strong policy framework, improving macro-financial conditions and structural reforms help Indonesia to reduce the impacts from these risks. Foreign reserves remained robust equivalent to finance 7.4 months of imports of goods and services at the end of October 2019. Despite intervening to minimize volatility, Bank Indonesia had been conserving reserves throughout 2019 by allowing market-driven depreciation rather than defending a fixed level of the exchange rate and responding to the easing monetary policy by the U.S. Federal Reserve to maintain interest rate differentials. Likewise, fiscal policy has been consistently prudent, despite ambitious budget target:

20

25

30

35

2016 2017 2018 2019 2020 2021 2022

Baseline

30% exchange rate shock

1pp GDP growth/revenue shock

1% of GDP expenditure shock


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deficits have remained low and government debt is less than half of the legal threshold of 60 percent of GDP, of which 58 percent is denominated in local currency. At the same time, macro-financial conditions improved from the easing global financing conditions. Bank Indonesia has also taken additional measures by relaxing some lending requirements and recently lowering the reserve requirement ratio to ease liquidity16. Moreover, the Government has taken actions to embark on structural reforms, particularly to attract more investments and increase its competitiveness, through streamlining regulations and employing tax reforms.

27. The macroeconomic policy framework is considered adequate for the proposed operation. The Government is committed to sustain growth amid the heightened global uncertainties. The continued conservative fiscal policies with a narrow fiscal deficit, low level of debt has reinforced prudent monetary and exchange rate policies to help abating the impact of external headwinds. Ongoing fiscal reforms will also contribute to maintaining a conducive and stable fiscal framework. Monetary policy continues to be responsive to the exchange rate and liquidity pressures, while maintaining inflation within the target range. The policy mix has been consistent with macroeconomic stability and the management of risks that may arise. Structural policies to support growth such as simplified business regulations through assigning the investment agency to coordinate with technical ministries to simplify business licensing is expected to attract more investment, including FDI. This will provide another avenue for Indonesia to achieve higher sustained growth.

3. GOVERNMENT PROGRAM

28. The GoI has recognized the need for further deepening and broadening the financial sector to reduce vulnerabilities to volatile global financial market conditions, and maintain financial stability, which are critical for sustainable economic growth. The Indonesian financial sector authorities, including the OJK, BI, LPS, MoF, Bappenas and CMEA have developed and launched a number of strategies aimed towards promoting sustainable financial sector development. Significant efforts have been made to implement these strategies, particularly through issuance of key laws and regulations, putting in place relevant institutional set-up and various capacity building efforts. Evidently, the GoI recognizes the huge and challenging agenda that lies ahead, one that requires strong and continuing commitment, collaboration and coordination amongst the various stakeholders and development partners. 29. National strategies in the areas of capital markets development, financial inclusion, payment systems and disaster risk finance are key elements of the financial sector development agenda pursued by GoI. These strategies can be conceptually mapped to the thematic drivers of financial deepening, financial efficiency and financial resilience:

• Financial deepening: the main GoI’s approach to capital markets development is elaborated in the National Strategy for Financial Market Deepening (SN-PPPK) 2018-2024. This strategy contains a detailed and comprehensive plan of action for developing seven financial markets17 by focusing on (i) the sources of economic financing and risk management (which includes

16 Bank Indonesia (2019) through https://www.bi.go.id/en/ruang-media/siaran-pers/Pages/SP_218219.aspx 17 These include government bond market, corporate bond market, money market, foreign exchange market, stock market, structured products market and Islamic financial market.


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capital providers, instruments and intermediaries); (ii) market infrastructure development (which includes capital users, financial market infrastructure and benchmark rate and standardization); and (iii) policy coordination, regulatory harmonization and education (which includes regulatory framework and coordination and education). A critical cross-market development strategy is also defined with the objective to expand the investor base, harmonize tax regulations, support investor protection and education and regulate transaction system operators. The approach of the strategy is in line with international best practices and supported by relevant donor-funded programs.

• Financial deepening: the National Strategy for Financial Inclusion (NSFI) underpins the GoI’s efforts in further expanding access to financial services. Launched in November 2016, it included the ambitious target of 75% percent adult access to financial services at formal financial institutions by the end of 2019. While the target is unlikely to be achieved by the end of 2019, the NSFI has the merit of guiding ministries/institutions, provincial governments, regencies/municipalities, and other related agencies towards the common goal of improving access to financial services through their respective collective and integrated efforts. Such integrated implementation requires a well-functioning institutional set-up, particularly for the NSFI secretariat and related working groups. Key areas of engagement identified by the strategy and benefitting from the support of the development community consist of: (i) Financial Education.; (ii) Public Property Rights; (iii) Financial Distribution Channels and Intermediary Facilities; (iv) Delivery of Government financial services; (v) Consumer Protection. Cross-cutting foundations consist of (i) Favorable policies and regulations to promote financial inclusion (ii) Supportive inter-operable financial information technology and infrastructure; (iii) Effective implementation organization and mechanism.

• Financial efficiency: following the launch of the Bali Fintech Agenda in 2018, the authorities recently approved a blueprint for payment system reform and launched a national payment gateway to facilitate the interconnection and interoperability of the retail payment systems. The so-called Indonesia’s Payment System (IPS) 2025 Visions is a major step towards a modern payment system and is designed to ensure that the current trend of digitalization develops within a conducive digital economic and financial ecosystem. The five IPS 2025 Visions18 will materialize through five initiatives to be implemented directly by Bank Indonesia in pursuance of the central bank’s duties and jurisdiction, as well as implemented through productive collaboration and coordination with relevant government ministries and institutions and also the industry. The initiatives are: 1) digital open banking and interlink bank-fintech; 2) development of retail payments; 3) development of wholesale payments and financial market infrastructure; 4) data; and 5) regulation, supervision, and reporting.

• Financial resilience: GoI is also pursuing a comprehensive approach to better manage fiscal and financial risks due to frequent and large climate shocks and natural disasters. The

18 The IPS 2025 Visions are: (i) reinforcing the integration of national digital economy and finance; (ii) accelerating digital transformation within the banking industry through the implementation of open-banking standard; (iii) assuring interlink between Fin-Tech and banks to contain the escalation of shadow-banking risk through the regulation of the use of digital technology; (iv) striking the balance among innovation, consumer protection, integrity, and stability as well as fair competition; (v) safeguarding national interest on cross-border use of digital economy and finance.


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Ministry of Finance launched the National Disaster Risk Financing and Insurance Strategy during the WB-IMF Annual Meetings in October 2018. This strategy includes several complementary financial mechanisms and instruments, including insurance of key public assets, including administrative buildings, hospitals, schools and bridges. In December 2018, Indonesia, together with Cambodia, Japan, Lao PDR, Myanmar, and Singapore agreed to establish the Southeast Asia Disaster Risk Insurance Facility (SEADRIF), a regional platform to provide ASEAN countries with financial solutions and technical advice to increase their financial resilience to climate and disaster risks.

4. PROPOSED OPERATION

4.1. LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION

30. The program development objective of this programmatic operation is to support financial sector reforms that will assist the Government of Indonesia (GoI) in achieving a deep, efficient and resilient financial sector. The proposed operation is the first in a series of three programmatic operations. 31. This programmatic DPL series is structured around the following three pillars and set of objectives:

• Pillar A: Increasing the Depth of the Financial Sector. Pillar objectives: to expand the size of the financial sector by increasing outreach, broadening financial market products and mobilizing long-term savings.

• Pillar B: Improving the Efficiency of the Financial Sector. Pillar objectives: to lower the costs for individuals and enterprises by strengthening the insolvency and creditor rights framework, protecting consumers and personal data and promoting interoperability of payment systems.

• Pillar C: Strengthening the Resilience of the Financial Sector. Pillar objectives: to strengthen the capacity of the sector to withstand financial and non-financial shocks by strengthening the resolution framework, implementing sustainable finance practices and establishing disaster risk finance mechanisms.

32. The program of reforms proposed under this DPL series spans across several key areas of financial sector development. The three thematic pillars of financial depth, efficiency and resilience integrate, in a consistent and cross-cutting manner, reform areas related to financial inclusion, infrastructure and access (i.e. reform areas #1, 4, 5 and 6), long-term finance (i.e. reform areas # 2 and 3), financial stability (i.e. reform area #7) and climate and risk management (i.e. reform areas #8 and 9). The fact that reforms on the financial inclusion and deepening space outnumber the reforms on the financial stability side reflects the current priorities in terms of financial sector development in Indonesia. Two critical areas currently not explicitly covered under the proposed program are related to banking competition and to integrated supervision of financial conglomerates. The former requires the completion of an ongoing analytical study to provide evidence-based policy recommendations. The latter is currently part of the policy dialogue of the World Bank with OJK for the provision of technical assistance on the relevant regulatory and supervisory framework. Both areas are further described below. 33. Indonesia’s economy relies mostly on traditional intermediation channels. Banks dominate the financial sector while the non‐bank financial sector, especially institutional investors, is thus relatively


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small.19 The banking sector functions mainly through a primary role of transforming (shorter‐term) deposits into (longer‐term) loans. Capital markets are a main source of equity financing for corporations; however, on the debt side the story is quite different as the corporate bond market size is still very small. Bank loans are still by far the main source for debt capital for corporations. Apart from equity investment, the portfolio holdings of Indonesia’s main institutional investors (insurance companies, pension funds, and mutual funds) are concentrated in government debt and short-term instruments (e.g. bank deposits), thus reflecting the overall level of underdevelopment of the non-government and corporate long-term debt markets. 34. The banking system in Indonesia is characterized by a large state presence. There are four sizable state‐owned banks (SOBs), two of which are the top two banks in the country in terms of loan volumes. Jointly, these four SOBs accounted for 41 percent of total banking assets and 43 percent of total loans as of June 2019. There are also 27 regional development banks, accounting for another 9 percent of total banking assets and 8 percent of total bank loans as of June 2019. SOBs along with regional development banks play a key role in the financing of micro and small enterprises. State‐owned enterprises (SOEs) account for a relatively small share of bank deposits and of bank loans but have a sizable presence in capital markets. They accounted for 54 percent of outstanding bonds in June 2019 and 24 percent of equity market capitalization. 35. Financial stability indicators confirm the soundness of the sector and indicate that the system would be able to withstand volatility in financial markets.20 The banking system overall remains sound and well-capitalized with a capital adequacy ratio (CAR) at 22.97% in 2019, well above the regulatory requirements, as well as the regional median.21 The ratio of non-performing loans (NPLs) at 2.5% is comparable with other countries while some signals of possible liquidity pressures are emerging as the loan-to-funding ratio reached 92.8 percent in Q2 2019.

36. Developing a deeper financial system while preserving financial stability is a key priority for Indonesia. Albeit stable, the Indonesian banking system is relatively shallow. Although credit to the private sector has been growing since 1999 (when Indonesia faced the consequences of the 1997 Asian financial crisis), it is still relatively low at about 36 percent of GDP as of December 2018. This is one of the lowest levels among its peer countries, which exhibit as a group a median of 48 percent of GDP. Domestic bank deposits are at 38 percent of GDP, well below the regional median of 64 percent. The Indonesian capital market is also shallow. Equity market capitalization is 41 percent of GDP in 2018 (against a regional median of 72 percent); private debt securities outstanding are about 2.5 percent of GDP (against a regional median of 45 percent); and the government securities market stands at 13 percent of GDP (against a regional median of 28 percent). Foreigners have a marked presence in the financial system, being relatively large investors in both equity markets (holding 51 percent of the free float of) and government debt (holding 40 percent of government bonds). They have a more limited role in corporate debt markets. Such large presence may impose some constraints on monetary and exchange rate policies.

19 For example, banks accounted for 77.6 percent of the assets of financial institutions in September 2019. In contrast, insurance companies accounted for 11.8 percent and pension funds for 2.6 percent. Other NBFIs represented the remaining 8 percent. 20 Please refer to Annex 5 for a summary of key financial sector statistics. 21 CAR differences exist among the 10 largest banks: some of them (including state owned banks) fall below the CAR average industry, but they still maintain a significant gap from the minimum CAR requirement.


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37. Not only the financial system is too small, but it is also costly. Banks’ credit intermediation is a critical factor for sustainable and inclusive growth but remains too costly in Indonesia. Historically, Indonesian banks have been highly profitable with net-interest margins (NIMs) well above peers. The analysis undertaken in the context of the 2017 FSAP finds that Indonesian banks had an average net interest margin of 4.6 percent over the period 2010 -2015, significantly higher when compared to the worldwide average of 2.97 percent. The FSAP analysis also reveals that more than three-quarters of the difference in net interest margins observed in Indonesia compared to the worldwide average can be explained by: (a) the small size of Indonesia banks, (b) relatively weak institutions (governance, regulatory effectiveness and the rule of law), and (c) higher operating costs. There is reason to be concerned about the high cost of banking services in Indonesia as measured by net interest margins, as the banking sector rather than contributing to the efficient allocation of scarce resources may be consuming excessive resources. Structural factors within the banking sector could cause weak competition and deserve a deeper analysis that the World Bank is undertaking. 22 38. Competition in the delivery of banking services is core to containing costs and thereby to harnessing the role of the financial sector in allocating scarce resources to their optimal uses and to enhancing outreach to marginal users. The preliminary findings of the analysis of competition in the Indonesian banking sector reveal that the market is geographically segmented. Private banks concentrate their business in the Java region with on average 85% of their loans and deposits concentrated in this region. SOBs have 67% of their loans and 74% of their deposits in the Java region, while the business of the regional development banks occurs almost exclusively in their respective regions. The market is also segmented as regards customer base. SOBs and regional development banks account for an overall share of 64% of loans to MSMEs, with a stronger presence in the smaller segments.23 While SOBs provide greater outreach in the provision of banking services both geographically and in terms of servicing MSMEs, a segment crucial to Indonesia’s economic growth prospects, this outreach is costly. SOBs and regional development banks have higher net interest margins than private banks. Although state banks fulfill specific mandates and perform functions not performed by private banks, concerns relate to the efficiency with which these services are provided – i.e. the state banks’ cost-efficiency and ability to innovate in the delivery of financial services. 39. Several strands of analysis are under preparation in exploring competition in the Indonesian banking system. These include: (a) flow of funds analysis of the sources and uses of funds and the impact of any sector-wide financial imbalances; (b) bank-by-bank analysis to compare the different cost components reflected in the spreads charged by various (groups of) banks; (c) geographical analysis of the differences in costs of providing banking services in urban and rural locations and the extent to which banks cross-subsidize across banking locations; (d) analysis of the role of state banks and the extent to which they operate on a level playing field with private banks, and whether alternative products and

22 The banking competition study that the World Bank is undertaking in cooperation with OJK and the Ministry of Finance is at an initial stage and therefore no specific recommendations could be provided for the first operation of this DPL series. Access to critical data at the individual bank level to conduct a spread decomposition analysis has been requested to the Indonesian authorities. The analysis of these data could underpin important recommendations that would be part of the policy dialogue of the World Bank with the national counterparts in the coming months and could potentially support reforms under the next operations of this DPL series. 23 In particular, they provide a dominant share of 92% of all bank loans to micro enterprises and 83% of the loans to small enterprises. This market capture of the MSME segment arguably builds on their utilization of the partial credit guarantee scheme and interest rate subsidies provided under the KUR program.


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delivery channels might be less costly in terms of distortions to competition in the provision of financial services; and (e) the extent to which regulatory oversight of the banking sector might impact competition in the banking system. Given the importance of strengthening the provision of financial services to the MSME sector, a survey is being conducted of the services provided by banks to MSMEs which will support the analysis of banking competition. Given the potential scope for Fintech-based banking solutions in a country with the population size and geographic diversity of Indonesia, it will also be important to consider whether the regulatory and supervisory framework provides a level playing field for competition among bank and non-bank financial service providers, thereby allowing the Fintech industry to develop responsibly and safely, without damaging disruptions to the functioning of existing markets along the way. 40. The shallowness and the inefficiencies of the financial sector correspond with low access to the formal financial system by the population. Household access to the formal financial sector as measured by the percentage of adults holding a transactional account has increased from 36% in 2014 to 49% in 2017 (Global Findex 2017). While this is the largest account ownership increase of any developing economy in the EAP region, Indonesia still has one of the largest unbanked population in the world.24

Indonesia presents a reverse gender gap and a high income gap in account ownership.25 Ninety-five million adults in Indonesia (and two thirds of the poorest adults) do not have an account at a financial institution. This means a limited possibility to invest in their future and to protect themselves from unexpected shocks. Among the reasons for financial exclusions, lack of money, distance and costs are on top.26 41. Although several financial sector related laws and regulations include provisions on data protection, there is no Data Protection Law. The adoption of a data protection framework is relevant to allow for the development of Indonesia’s digital financial services and digital economy plans at large. Personal data is increasingly being collected and used by the financial and other sectors and by government as part of their service delivery. While this creates opportunities for innovation and efficiencies that underpin the digital economy, it also presents some risks such as identity theft, unfair consumer discrimination, financial loss resulting from data breaches and other negative consequences to consumers and individuals at large. A law and regulations for general data protection and privacy aligned with international best practices should seek to minimize these risks by establishing responsibilities of data controllers and processors, the rights of data subjects, and independent oversight, including by providing legal clarity regarding the use of personal information for specific purposes. This framework will contribute to create trust in the provision of digital services.

42. The GoI’s support to MSMEs is based on the long-standing credit guarantee program (“KUR”), whose effectiveness needs to be carefully analyzed. Established by the Government in 2007 with the

24 According to the 2017 Global Findex, China (225 million), India (190 million), Pakistan (100 million) and Indonesia (95 million) have over 1/3 of the approximately 1.7 billion adults remained unbanked worldwide. 25 While globally women are less likely than men to have a bank account, Indonesia is one of the few countries with a reverse gender gap: i.e. women are 5 pp more likely than men to have an account, but equally likely to have an inactive account. However, the poor are 20 pp less likely than the rich to have an account, an income gap 7 pp larger than the world average. 26 According to the 2017 Global Findex, 72% of Indonesian adults cited not having enough money as a barrier, but only 18% cited this as their only barrier, similar to the developing world average of 20%. A third of Indonesian unbanked adults said distance was a barrier—even though 69% of these adults have a mobile phone. 1-in-4 Indonesian adults cited lack of documentation as a barrier but 80% of these adults have a National ID. 32% reported the cost to open and maintain an account. Only 2% of unbanked Indonesian adults report not needing an account.


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objective to enhance MSMEs’ access to bank loans through the provision of subsidized, partial credit guarantees (covering 70 to 80 percent of the loss), by 2014 KUR has grown to be the GoI’s dominant mechanism to support MSMEs.27 From 2015, the focus of KUR changed from facilitating access to loans for first time MSME borrowers through the provision of partial credit guarantees, to the provision of loans at subsidized interest rates to MSMEs regardless of their previous access to finance. The number of eligible sectors has also increased. At the same time, the determination of the guarantee fee is now more market based. The new KUR program featured prominently in the Government’s economic reform packages announced in late 2015.28 This redesign requires a careful cost-benefit analysis and the World Bank is currently undergoing an impact evaluation to measure the actual impact of the program on the final beneficiaries. 43. While the Indonesian authorities have made significant progress towards strengthening the overall framework for crisis management and resolution, there remain some areas where improvements are needed. The Law Number 9/2016 on Prevention and Resolution of Financial System Crisis (“PPKSK Law”) provides a strong legal and institutional framework for crisis management, especially amongst the four key financial sector authorities.29 This framework is intended to facilitate more coordinated monitoring and maintenance of financial system stability, resolution of financial system crisis, and resolution of problems of systemic banks, during normal and financial system crisis conditions. The PPKSK Law, together with the LPS Law, also set out LPS’s statutory mandate as both the deposit insurance agency and resolution authority; thereby enabling LPS to undertake crisis management and resolution measures. Nevertheless, the legal framework needs to be strengthened to clarify further the mandates and statutory objectives of the authorities, particularly to give more prominence to financial stability objectives. There is also a need to boost LPS’s capacity towards implementing crisis management and resolution measures, both ex-ante and ex-post.

44. Financial conglomerates (FCs) might pose risks to financial stability and require adequate oversight. The financial sector is dominated by FCs, accounting for over 80 percent of banking sector assets and almost 60 percent of financial system assets.30 Most FCs have a horizontal structure with a non-regulated holding company controlling the group. Article 5 of the OJK Act defines the establishment of “an integrated regulation and supervision system for all activities of the financial sector” as one of the main functions of OJK. However, the legal and regulatory framework present some gaps.31 A silo-based

27 Between 2009 and 2014, the 34 participating banks concluded around 12.5 million loan contracts with MSMEs and disbursed IDR 179 trillion in KUR-supported loans. The majority of the program—85 percent of total KUR-backed disbursements—was channeled through three state-owned commercial banks: BRI, Mandiri, and BNI. BRI alone disbursed IDR 117 trillion between 2009 and 2014, or 65 percent of the whole KUR program. The Nonperforming Loan (NPL) ratio of these supported loans was 3.3 percent. 28 In 2016, the total loan amount disbursed through the KUR program was IDR 94.4 trillion. Government targets for 2017 are set even higher, coming close to IDR 110 trillion. When compared to the total outstanding stock of loans to micro (IDR 182 trillion by end 2016) and small (IDR 241 trillion) businesses, it is clear that the KUR program is of central importance for the entire market segment. 29 Namely Ministry of Finance, Bank Indonesia (BI), the Financial Services Authority (OJK) and the Deposit Insurance Corporation (LPS). 30 Most of the FC (39) have banking as their main activity, while insurance is the main activity of 8 FC and securities of 2 FCs. 12 FC are so diversified that they need fully-fledged conglomerate supervision. 31 For example, the OJK Law and the Banking Act do not define FCs and do not provide OJK with supervisory powers over non-operating holding companies which are heading some FCs.


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governance arrangement, that foresees three Chief Executives appointed to the Board of Commissioners, each with specific responsibilities for the banking sector, the NBFI sector and the capital markets sector, is embedded in the OJK Act. This governance structure has been interpreted strictly and is mirrored in OJK’s organizational chart. To overcome the constraints of the governance structure, OJK has developed an approach to integrated supervision of FCs based on the “Lead-Entity concept”.32 According to OJK, the abolishment of the Integrated Supervision Department (ISD) in 201933 and the reallocation of the supervisors to the different functional areas have not changed its supervisory approach and scope. On the contrary this has helped to make the process not only more effective but also efficient. Yet some risks associated with blurring and conglomeration might require the establishment of an enhanced integrated supervision approach going forward to allow for a comprehensive view of the risks in the financial system.

45. This program builds on some key recommendations from the 2017 FSAP. The FSAP had identified a series of inter-related financial development priorities related to promote deepening and inclusion and strengthen oversight and crisis management. On the former, recommendations pointed at a more coordinated approach addressing root causes of weak intermediation efficiency by focusing on cross-cutting financial sector fundamentals such as legal, tax and regulatory frameworks to enhance capital markets, insolvency and credit rights regimes, and the impact of digital financial services. On the latter, recommendations focused on the need for a comprehensive harmonization and modernization of the regulatory and supervisory framework, with a specific focus on integrated supervision; the need to improve the crisis management framework with a public funding mechanism in case of systemic resolution to be incorporated in the law and the need to strengthen the corporate governance framework of financial conglomerates.

46. Recommendations from the 2018 InfraSAP are also addressed through the proposed program of reforms. The InfraSAP report indicates principal constraints for the domestic financial sector to engage in long-term infrastructure finance, i.e. the limited ability of the banking sector given the short-term funding, issues surrounding exposure limits, and the low funding capacity of the contractual savings sector. Foreign investment is, hence, necessary but involves currency and interest rate management challenges. The report provides recommendations relating to improving ability for the market to provide long-term financing. These recommendations include, but are not limited to: review pension and social security funds’ early withdrawal parameters, pension portability and default investment choices; amend existing policies on liability management, performance measurement and risk management; introduction of a framework to encourage the issuance of bonds by project companies operating as SPVs (project bonds); encourage structured instruments by harmonizing regulations governing sale and transfer of assets and tax treatments; and creating tax level playing fields among capital market products; and develop interest rate and currency swaps and derivatives markets over the long-term.

32 The Lead entity is the principal regulated financial institution of a FC or a lead financial institution appointed by the controlling or ultimate shareholders of the financial conglomerate. The Lead-Entity concept was indicated as an “interim approach” in the OJK’s Integrated Supervision Roadmap 2017-2019. The Roadmap clearly stated that “the Lead-Entity concept […] needs to be enhanced due to its shortcomings relative to international best practices.” The OJK document indicates that the Lead-Entity approach is not always legally enforceable due to the lack of direct ownership linkage between the Lead Entity and its sister companies. 33 The ISD was established in September 2016 and dismantled in January 2019. This is the result of a business re-engineering process that was conducted within OJK and that allows it to adequately carry out the mandate of the OJK Act.


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47. Improved resilience to natural disasters and climate change is also critical for achieving Indonesia’s development goals and requires the establishment of adequate disaster risk finance mechanisms. Indonesia is exposed to various types of natural disasters that are projected to intensify with climate change. Hydrological disasters such as floods and landslides, as well as meteorological disasters such as storms make up almost 70 percent of major disaster events since 2000. Floods and landslides are also responsible for 65 percent of total lives lost and 76 percent of total number of displaced people during the same period. Furthermore, climatological hazards, such as droughts and involuntary spread of manmade fires for land clearing exacerbated by droughts, also contributed significant economic loss to Indonesia. With the second longest coastline in the world, Indonesia also faces a high risk of sea-level increase and coastal inundation that may affect up to 42 million people living in low laying coastal zones, which includes both rural and urban areas. For the central government, the cost of replacing or restoring public infrastructure, most of which are uninsured, is likely to increase with climate change, thus placing a significant burden on public expenditure. At the same time, changes in rainfall and temperature patterns are also associated with potentially higher public health risks from climate-sensitive diseases. Building resilience to natural disasters and climate change, through improved infrastructure, health and social spending, complemented by the establishment of adequate financial mechanisms based on a national-level risk financing strategy, will help vulnerable populations better prepare for shocks and withstand the impacts both from short-term extreme weather events, and from slow-onset climate-related hazards, such as sea-level rise. 48. There are significant interdependences between financial deepening, efficiency and resilience that mutually reinforce each other. The present DPO proposes a set of reforms that simultaneously tackle important cross-cutting issues related to these three areas of financial sector development and require coordination among key financial sector’s government agencies. Deeper capital markets can impose competitive pressure on the banking sector to innovate, become more efficient, and sustainably reach out to new segments. The status quo of the Indonesian banking sector, currently overcrowded with a long tail of small, relatively weakly performing banks inhibits banks from reaping scale economies and becoming more efficient which contributes to higher intermediation costs. At the same time, financial deepening and inclusion would help mobilize domestic resources to finance the economy, lessen the reliance on volatile external financing and strengthen the capacity of the system to absorb shocks. Similarly, interventions aimed at increasing the efficiency of the system (such as the one on insolvency and creditor rights) have also an impact on financial stability by improving NPL management and lowering the risk of corporate distress and cascading corporate failures. The reforms proposed under this DPL are of course interconnected also with other critical areas of reform (such as the structural factors affecting banking competition or the supervision of financial conglomerates) that, as explained, are currently excluded from this operation. Yet, this would not compromise the achievement of the specific objectives of this DPO. 49. The design and preparation of the program considers the lessons learned from previous DPOs. The Implementation Completion Reports for the Indonesia Financial Sector and Investment Climate Reform and Modernization DPL (P130150) of 2012 and for the Financial Sector Reform and Modernization DPL (P145550) of 2014 suggest that (i) a sectoral , as opposed to multisectoral, DPL approach bears more focus and significant results; (ii) having extensive analytical work completed prior to the DPL is critical for building consensus among technocrats and policymakers on specific reforms well in advance of the DPL; (iii) the presence of a strong government counterpart to serve as coordinator is an important success


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factor in a loan involving multiple institutions; and (iv) a programmatic series with a multi-year results framework entails a longer-term mapping of reforms and can deliver more meaningful outcomes that are in better alignment with the GoI’s own strategic plan. The design of the proposed DPL takes these important lessons into account.

4.2. PRIOR ACTIONS, RESULTS AND ANALYTICAL UNDERPINNINGS

50. The first pillar of the DPL focuses on increasing the depth of the financial sector. The pillar has the objective to expand the size of the financial sector by increasing outreach, broadening financial market products, and mobilizing long-term savings. It includes the following reforms: Reform Area 1: Increasing outreach of financial services 51. Rationale: Expanding the efficient and commercially viable provision of financial services through agents will contribute to increased opportunities for accessing financial services, especially for women. Indonesia has two separate agent network programs: one for banking agents and one for e-money agents.34 A recent assessment of the two programs showed two main shortcomings: (i) inadequate incentives35 and (ii) inter-institutional problems.36 These generate sub-optimal agent performance, overlaps and inconsistencies between the two regulations37 and confusion in the market (i.e. among financial service providers, agents, and consumers). On the other hand, increased outreach can be further advanced by digitizing G2P social assistance payments.38 Indonesia has upwards of 89 national G2P social assistance programs targeting the poor. GoI has made an important push to begin achieving fully integrated digital social assistance payments.39 However, at present, non-cash G2P social assistance payments are disbursed only through state-owned banks through a combo card-based system. This system has several drawbacks40, including limiting the access options for the beneficiaries that are not

34 The first, called Laku Pandai is regulated by OJK and included more than 800 thousand agents as of 2018. The second, called LKD, is regulated by BI and included 300 thousand agents as of 2018. 35 Detailed regulations constrain business choices on how to organize agency networks. This may raise the cost of agent servicing and management. 36 Coordination problems between BI and OJK in terms of policy objectives which reflected in the regulations (Laku Pandai and LKD). 37 For example: requirement to apply for service provision; definition of both programs; agent categorization; and exclusivity. 38 For the purpose of this document, “G2P payments” is only intended to refer to social assistance payments made by the GoI. Other Government-to-Person payments such as civil servant salaries, pensions, tax refunds etc. are not within the scope of this document. 39 Particularly through the issuance of Presidential Regulation 82, 2016 on the national financial inclusion strategy and Presidential Regulation 63, 2017 on non-cash social assistance distribution. In 2017 the GoI shifted its conditional cash transfer (PKH) program and its rice subsidy program (BPNT) to non-cash disbursement mechanisms, using bank accounts that integrate into one single KKS. With the card instrument, the GoI aims to achieve proper targeting of the programs (called the 6Ts), to improve the effectiveness and efficiency of social assistance. Until 2019, the digitized PKH program has reached 10 million families while BPNT has reached 15.6 million families. The government plans to expand the digitation of subsidy program to another 25.7 million families that received LPG and electricity subsidies. 40 Four main drawbacks: (i) the ‘combo-card’ is designed to deliver benefits only and is not designed as a financial inclusion tool with little prospect of contributing to wider service offerings that could further accelerate development; (ii) the card-based system is expensive to deploy to micro-merchants (who must often acquire a matching POS device). This cost undermines the wider reach of the effort and makes a sustainable business case, to sustain these services, much more challenging; (iii) the control by four state-owned banks limits innovation or competition for the provision of these vital services; removing the assets or


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free to choose the most convenient provider. As the large majority of social assistance payments are made under the name of the woman in the households, their digitization would have a significant impact also on enhancing the financial inclusion of women. 52. Proposed reforms: This DPL series supports key reforms to increase outreach of financial services by (i) optimizing agent service operations and (ii) digitizing G2P social assistance payments. DPL 1 and 2 therefore support (i) the adoption of a joint policy framework between BI and OJK for implementing the two agent network programs and (ii) the revision of Laku Pandai and LKD regulations to address inconsistencies between the two regulations. The proposed reforms will require BI and OJK to closely coordinate and harmonize the procedures of these two major agent network programs that were so far run independently from each other. The revision should aim at making policies from BI and OJK mutually consistent and inspired to the same general principles. 41 While a unification of the two programs under the same policy is not realistic, the harmonization of the respective policy frameworks should aim at strengthening the incentive structure supporting the agent business. On the other hand, by shifting the social assistance distribution to electronic payment mechanisms, the government aims to improve efficiency, transparency, and accountability while at the same time promoting financial inclusion. DPL 3 will then also support the revision of the current G2P regulations with the aim of expanding the distribution channels of non-cash social assistance beyond state-owned banks. 53. Expected results: Harmonizing the two agent network regulations will provide clear directions to the industry in terms of advancing the agent banking networks. More flexibility will allow the industry to develop stronger business cases. This in turn will promote the introduction of more agents in the market, bringing more access points closer to consumers. As one third of respondents indicated distance as a primary reason for not having an account, it can be expected that, by reducing the distance, the number of accounts would increase. The G2P effort instead aims to move beyond digital delivery of benefits over a single channel to delivery over multiple channels and providing customer choice by leveraging - to the extent possible - existing financial, telecommunications and identification infrastructure to improve delivery of funds for government payment programs. For citizens, benefits should include more predictable payments accessible through products that best meets their needs. This would in turn contribute to empowering women through their right to choose the better form of access and usage of the social assistance accounts made under their name.

54. Ongoing technical support & related FSAP recommendation: The proposed reforms are supported by an ongoing TA project in promoting financial access and inclusion (P166791) funded by the Swiss State Secretariat for Economic Affairs (SECO)’ Indonesia Financial Sector Strengthening Program (IFSSP) Trust Fund that will promote the ownership and usage of transaction accounts either through physical or digital channels as well as a Social Assistance Strengthening TA (P160590) in the area of strengthening social program delivery mechanisms. The FSAP recommendation related to Financial Inclusion and Digital Financial Services requires a stronger BI-OJK coordination and collaboration over the digital financial services (DFS) oversight.

creativity of a wider set of providers who are also part of the wider payment system. 41 Some basic principles include: (i) Achieve consistency of objectives; (ii) Promote competition and protect market integrity; (iii) Protect user interests and ensure sound market conduct; (iv) Adopt functional, risk-based and proportional approaches to regulation, supervision, and oversight; (v) Support inter-institutional cooperation (with no prejudice to the statutory or legal or other powers of the institutions)


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• Prior action: BI and OJK have adopted a joint policy framework on agent networks to support the implementation of agent network programs (namely Laku Pandai and LKD).

• Trigger DPL2: BI and OJK have harmonized Laku Pandai and LKD programs in line with policy framework and as evidenced through [revised regulations and implementing measures no. and date].

• Trigger DPL3: Non-cash social assistance distribution channels have been expanded as evidenced through [revised regulation no. and date].

• Result Indicator: Reduction in the percentage of adults stating distance is the foremost barrier to opening a transaction account (FI account and mobile money): Baseline (2017): 19.3%; Target (2022): 10.2%; Average transactions by beneficiaries through social assistance (KKS) accounts per year. Baseline (2019): 0.8; Target (2022): 2.

Reform Area 2: Broadening financial market products 55. Rationale: Indonesia’s capital markets are thin and fragmented. Other than the equity and the government bond markets which both attract all types of investors including non-residents, the rest of the market is relatively underdeveloped. This presents challenges in funding certain strategic sectors, such as infrastructure, which require a wide variety of fixed income instruments and structured products. While the authorities have made efforts to introduce various capital market instruments, there are further reforms that need to be made to facilitate a more effective market. First, much of the attention in the past was given to policies to promote the public market; however, to facilitate faster issuance process and more structured instruments – which tend to be riskier – there needs to be a regulatory recognition of private placement of bonds or issuance of bonds to only qualified investors. Further, as the authorities are establishing a regulatory framework to facilitate introduction of new instruments (e.g. infrastructure funds, project bonds), it is important that the tax environment is conducive for those instruments. Currently, some instruments suffer from an inefficient taxation regime; for example, withholding taxes for the same instrument (e.g. bonds) are not the same for all investors, causing a fragmented market and inhibiting liquidity as the investors prefer different instruments or structures due to different tax treatments or rates. Finally, a lack of liquid market for risk hedging (derivatives) inhibits a flow of foreign investment into local currency financing. While the portion of non-resident investors in the IDR government securities is relatively high (38%), their interest for long-term, local currency, and non-sovereign credit has been very limited given the combined risks. Hedging instruments (derivatives) help unbundle these risks and provide investors with the types of risks they prefer, and therefore can broaden the scope for mobilizing long-term IDR financing. 56. Proposed reforms: Three main reforms are being proposed under this line. The first is a reform that would enable a cost-effective issuance of financial instruments, particularly debt securities, without adding accumulated risks to the system.42 This is represented by a regulation that facilitates safe issuance of debt securities in private placement market, strictly to professional investors. The second reform intends to establish a tax level playing field among capital market products and investors, which in turn would provide fungibility across different segments of the financial market. The third area of reform is aimed at the development of over the counter (OTC) derivatives market for risk hedging to facilitate long-term IDR financing for corporate and non-sovereign credit.

42 The financial instruments include infrastructure funds, subnational bonds, and debt securities issued in private placement with certain criteria – these are in addition to instruments which had been allowed earlier, such as listed equities and bonds, asset backed securities, real estate investment trust, mutual funds, etc


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Expected results: The ultimate result intended from these reforms is to have broader and deeper financial markets, represented by the size of IDR-denominated debt securities. Broader and deeper markets would be achieved through increased use of capital market instruments and increased participation of investors, both domestic and foreign, in the Indonesian capital markets. In addition, easier access to capital markets and level playing field would stimulate more issuances and investments into the market. Last but not least, a wider issuer and investor base, including foreign investors, would be enabled by the availability of risk mitigation instruments. The development of a risk hedging market would bolster risk diffusion and risk transfers between investors and market segments (e.g. domestic investors and off-shore investors), so that risks are taken by those who are most capable to bear them. 57. Ongoing technical support & related FSAP/InfraSAP recommendations: The proposed reforms are supported by an ongoing TA project on long-term finance (P166792) funded by the SECO Global Capital Market Strengthening Facility (CMSF) and the Indonesia Infrastructure Finance Development – Financing Support Pillar funded by GAC Canada. Among others, the related FSAP recommendations on Capital Markets included: (i) Review the overall tax framework for financial products; and (ii) Develop interest rate swaps and FX derivatives market. Similarly, the related InfraSAP recommendations included: MOF, BI, and OJK to issue a joint strategy for development of risk management instruments, to include interest rate swap and derivatives markets.

• Prior action: OJK has established standard reporting and improved monitoring of issuances of debt securities in the private placement market, as evidenced by Regulation No. 30/POJK.04/2019.

• Trigger DPL2: MOF has simplified taxes of capital market instruments and established a tax level-playing field for those instruments as evidenced through [regulation no. and date].

• Trigger DPL3: BI and OJK have enabled the development of over-the-counter derivatives market in compliance with G20 commitments as evidenced through [regulation no. and date].

• Result Indicator: Outstanding IDR-denominated private debt securities to GDP (IDR trillion); Baseline (2018): 412; Target (2022): 711.

Reform Area 3: Mobilizing long-term savings 58. Rationale: Indonesian pension funds and insurance companies are contributing less to growth than what they should be capable of. OECD data (2017) indicated that funded pension plans held assets of 1.8 percent of GDP, well below the non-OECD average of 10.9 percent of GDP, let alone the OECD average of 55.3 percent. That same report showed that Indonesian pension funds held one of the highest allocations to “cash and deposits” (27 percent) among the non-OECD countries surveyed. Insurance company investment represents a further opportunity – with low penetration and a relatively high share of assets in cash and deposits. This risk-averse type of investment behavior stems partially from a conservative legal and regulatory regime that should be updated. 59. Proposed reforms: The proposed reforms include revisions to existing regulations. The first reform focuses on facilitating more long-term oriented investment by pension funds and insurance companies (both conventional and Islamic-focused) through the introduction of three new regulations, i.e. OJK regulations 27/POJK.05/2018, 28/POJK.05/2018 and 29/POJK.05/2018. The new regulations provide more alternatives for long-term investments, appropriate for pension funds and insurance companies which


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have long-term liabilities, thus potentially reducing asset-liability mismatches.43 The second reform looks at the risk management framework for defined benefit pension funds to include a long-term funding risk, inducing the pension funds to focus on the ability to fund their long-term liability instead of short-term returns. For defined contribution pension funds, the reform will introduce default age-relevant investment options to encourage longer term investment for younger participants. Finally, the third reform proposes a combination of improved tax policies and procedures to incentivize pension and social security participants to contribute and disincentivize withdrawals from pension and old age savings. 60. Expected results: These reforms will fundamentally change the current regulatory stance into one that is open to broader investment options in the pursuit of long-term return. The most immediate results envisioned include an increase of longer-term investments and an accompanying decrease in the proportion of short-term investment (cash and equivalent) held by pension funds and insurance companies. The shift between cash/deposits to longer-term instruments would not be sudden or immediate and in a size so large in that creates a shock in the banking system. The policies require gradual implementation within the institutional investors – i.e. through risk management policies of the institutional investors, thus avoiding the risk of unintended consequences on the short-term funding cost of the banking sector. Ultimately, it is expected that the policy changes will lead to an increased pool of savings in the pension and insurance industries, and eventually increase their contribution to long-term investments. 61. Ongoing support & related FSAP recommendations: The ongoing reforms in the sector are supported by a TA project on long-term finance (P166792) funded by the SECO Global Capital Market Strengthening Facility (CMSF). The project leverages on previous work and engagement undertaken under the Indonesia Infrastructure Finance Development – Financing Support Pillar (P158784) funded by GAC Canada. The related FSAP recommendations on Capital Markets included: “Eliminate distortions in institutional investors’ regulations to enhance their potential role in capital markets”. The related InfraSAP recommendations included: (i) an amendment of policies on long-term investment by institutional investors, including with respect to asset liability management, performance measurement, and risk management; and, (ii) an action plan to increase the incentives for long-term savings by amending policies associated with early withdrawals through tax penalties and/or phased withdrawal policies, and introducing age-relevant default investment choice in defined contribution schemes.

• Prior action: OJK has expanded the number of long-term instruments to be eligible for investments by pension funds and insurance companies, as evidenced by OJK Regulations Nos. 27/POJK.05/2018, 28/POJK.05/2018 and 29/POJK.05/2018.

• Trigger DPL2: OJK has: (a) amended risk management [requirements/rules] of pension funds; and (b) introduced age-relevant default investment choice for defined contribution funds as evidenced through [regulation no. and date].

• Trigger DPL3: MOF has incentivized contributions to and disincentivized withdrawal from pension and old-age savings as evidenced through [revised tax policies and procedures no. and date].

• Result Indicator: Reduced portion of short-term investments (cash, bank deposits) in pension fund portfolios (%); Baseline (2017): 19.3; Target (2022): 16.

43 Since the regulations were issued, in December 2018, one infrastructure fund was listed where some institutional investors invest. No municipal/subnational bond is issued yet. By looking at the indicator of reduced portion of short-term investments (cash, bank deposits) in pension fund portfolios, between December 2017 and June 2018, the portion of cash/equivalent in the pension portfolio declined from 19.3% to 17.1%. The 2018 regulations cannot alone claim all the credit, but this shows the overall direction of the policies.


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62. The second pillar of the DPL focuses on improving the efficiency of the financial sector. The pillar has the objective to lower the costs for individuals and enterprises by strengthening the insolvency and creditor rights framework, protecting consumers and personal data and promoting interoperability of payment systems. It includes the following reforms: Reform Area 4: Strengthening insolvency and creditor rights

63. Rationale: The main challenge of Indonesia’s insolvency system is the implementation of the legal framework, which remains largely adequate. The 2004 Bankruptcy Law complies with many international standards, although adjustments are needed to address several shortcomings arisen in 15 years of practice. The implementation gap is large: creditor's legal protections are not consistently applied in practice and frequent abuses of creditors’ rights (especially of international creditors) are reported. This lack of legal enforceability is explained by the lack of a body of skilled professionals that, if adequately supervised, would reduce abuses and deviations from the rules included in the legal framework. Unfortunately, insolvency practitioners in Indonesia remain only partially regulated and barely supervised. An enhanced supervision regime and remuneration framework for insolvency practitioners will improve the performance of these professionals, which in turn will improve the treatment that creditors will receive in an insolvency scenario. Combined with an Amendment of the Bankruptcy Law that improves reorganization provisions and protects creditors’ rights, reform of supervision and remuneration of insolvency practitioners will lead to an increase in banks’ recovery rates and a reduction on NPLs, which in turn will lead to an improvement of access to finance. Improved performance by insolvency practitioners and increased transparency in the process will also lead to more efficient and affordable access to restructurings, which will lead to more companies filing for insolvency procedures, eventually avoiding bankruptcy/liquidation and shutting down informally. 64. Proposed reforms: The first reform establishes a clearer and more effective supervision regime for insolvency administrators by the Directorate General of Legal Administrative Affairs through Regulation 37/2018, and defines the Structure and Decision-Making mechanism of the Joint Committee44 through Minister of Law and Human Rights Decree No. M. HH.-03.AH.06.06 Year 2019. The second reform amends Regulation 11/2016 and improves the existing system of remuneration of receivers and administrators to (i) include a maximum cap on their fees, (ii) reduce the current applicable rates, (iii) allow the court to adjust the IPs remuneration, and (iv) enable creditors to review and challenge the final remuneration. The Revision of the Bankruptcy Law, under the third DPL, includes (i) the requirement that the plan protects the interests of dissenting creditors and ensures that they are treated fairly; (ii) the improvement of the current system of appointment of Administrators; (iii) the simplification of the conditions for debtors to obtain a cancellation of their residual debts after the liquidation of their assets; (iv) a clear list of priorities that determines which creditors enjoy preferential treatment in case the assets of the debtor are not sufficient to receive payment.45

44 Joint Committee is a committee established by the Minister of Law and Human Rights to oversee the insolvency practitioners’ activities and conduct. It consists of Ministry of Law and Human Rights officials, Supreme Court officials and professional associations. 45 The amendment of the Bankruptcy Law has been included in the long-term National Legislation Program (Prolgenas) 2020 – 2024. Starting in January 2019, the draft will be submitted to the DG Legislation in the Ministry of Law for the inter-ministerial discussion and then submitted to State Secretary. The submission to Parliament is on track for 2021.


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65. Expected results: It could be assumed that the new regulations will imply a 10% increase in the number of insolvency cases (both restructuring (PKPU) and liquidation cases) that are opened by the court every year. Considering there were 304 insolvency cases filed in 2018 in Central Jakarta and Surabaya, we could estimate that the new regulations, by making the process more transparent and affordable, would bring up the number of cases filed from 304 in 2018 to 334 in 2022, which would imply 30 more insolvency cases during such period. These results would be further complemented and supported by the enactment of the amendments to the bankruptcy law foreseen under DPL 3.

66. Ongoing support & related FSAP recommendation: The WBG—through the IFC Advisory Program (Investment Climate, Competition and Competitive Sectors, 602983)—supports the MOLHR on this resolving insolvency reform agenda. It is funded through the SECO’s Multi-Country Investment Climate Program (MCICP). The related FSAP recommendations on insolvency and creditor rights included: (i) Provide clearer and more effective regulation for the monitoring of insolvency practitioners. (ii) Re-design insolvency practitioner remuneration framework; (iii) Reform the Bankruptcy Law to enhance creditor rights and transparency.

• Prior action: MOLHR has enhanced supervision of insolvency practitioners as evidenced by MOLHR Regulation No. 37/2018 and Decree No. M.HH-03.AH.06.06/2019.

• Trigger DPL2: MOLHR has improved the remuneration system of receivers and administrators as evidenced through [regulation no. and date].

• Trigger DPL3: The Borrower has submitted to Parliament the Amendment to the Bankruptcy Law to enhance creditor rights as evidenced through [submission letter no. & date].

• Result Indicator: Number of insolvency cases opened by the court, evidencing greater access by firms. Baseline (2018): 304; Target (2022): 334 (10% increase).

Reform Area 5: Protecting consumers and personal data, and enhancing transparency 67. Rationale: Only 29 percent of the population in Indonesia has sufficient financial capability to make responsible financial decisions.46 Except in the capital markets sector, the current oversight regime for financial service providers is focused primarily on prudential aspects, with little attention paid to the business conduct of providers. This results in financial markets that pose potential risks to consumers, while also diminishing the benefits of financial inclusion. In addition, Indonesia does not have a comprehensive legal framework on personal data protection and privacy with general applicability. With the rapid growth in Indonesia’s digital economy and increasing use of data for service delivery in the financial and many other sectors – and the associated risks to privacy and security of this data, such as misuse, abuse and leaks – Indonesia should urgently introduce fundamental legal and regulatory safeguards that information is collected, managed, stored, used and disclosed appropriately. Furthermore, a data protection regime that is aligned with other jurisdictions – such as other ASEAN Member States and the European Union – will provide clarity for industries and firms that depend on cross-border flows of information, including the financial sector and e-commerce. 68. Proposed Reforms: This DPL supports key reforms to promote a more robust consumer protection practice in Indonesia, specifically through (i) submission to parliament of a bill on general data protection

46 Based on OJK’s National Survey on Financial Literacy and Inclusion (2017).


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and privacy of personal data;47 (ii) the issuance of regulation establishing specialized market conduct supervision; and (iii) the operationalization of market conduct supervisory activities. In terms of data protection, the Ministry of Communications and Information Technology (Kominfo) has developed a draft bill on general data protection and privacy of personal data which includes a proposal to establish an independent data protection commission. 69. Expected results: The data protection reforms are expected to define and provide legal clarity on how personal data is collected, managed, used and shared, which will provide safeguards to people’s privacy and help build confidence and trust in Government and the financial and other sectors as responsible data processors and controllers. Once enacted, the law on general data protection and privacy of personal data and its implementing regulations should draw on and contextualize best practices, such as the Organization for Economic Cooperation and Development (OECD) Privacy Framework48 and the European Union’s General Data Protection Regulation (GDPR).49 The current consumer protection regime is slightly behind the market development, especially in the area of supervision. OJK issued its core consumer protection regulation in 2013, followed by BI in 2014. Active supervision and enforcement are needed to maintain consumer trust and confidence when using financial products and services. The consumer protection reforms supported by this DPL are expected to contribute to the quality dimension of financial inclusion through an increased number of supervisory activities undertaken by dedicated market conduct supervisors that will lead to a higher number of market misconduct cases, such as financial product marketing violations, be detected. 70. Ongoing Support: The consumer protection reforms are supported by an ongoing TA project in promoting financial access and inclusion (P166791) funded by the SECO IFFSP Trust Fund especially in the quality of financial services reform area that focuses on supporting the development of robust consumer protection practices in Indonesia. The data protection reforms are partly supported by the new TA program on Digital Technologies for Inclusive Development in Indonesia (P171927) and, considering the strong links between data protection and digital ID, the ongoing TA program with the Ministry of Home Affairs and Ministry of Communications and Information Technology on identification for development (ID4D) in Indonesia (P166294).

• Prior action: KOMINFO has introduced a new legal framework on general data protection and privacy through the submission of the draft law on Protection of Personal Data to the Parliament, as confirmed by Nota Dinas No. ND-61/KF/2020 from the Fiscal Policy Agency, Ministry of Finance.

• Trigger DPL2: OJK has enabled specialized market conduct supervision to financial services institutions in accordance with OJK law as evidenced through [PDK regulation no. and date]. BI has enabled specialized market conduct supervision as evidenced through [BI regulation no. and date].

• Trigger DPL3: OJK and BI have operationalized market conduct supervision as evidenced through the development of initial risk assessment processes and procedures for financial consumer protection

• Result Indicator: Number of financial product marketing violations detected per year. Baseline (2018): 200; Target (2022): 400.

47 As the prior action focuses on the submission of the law to Parliament, there is an implicit risk of a possible reversal of its content during the Parliamentary process. The World Bank stands ready to support Kominfo with further technical advice during the process that will lead to the enactment of the law as well as for the formulation of the implementing regulations. 48 OECD, 2013. The OECD Privacy Framework. Available at: http://www.oecd.org/sti/ieconomy/oecd_privacy_framework.pdf. 49 In general, the law is inspired by the international framework on Data Protection and Privacy namely the Convention 108, the OECD principles, the Asia Pacific Economic Cooperation (APEC) privacy framework and the EU’s framework including the GDPR

http://www.oecd.org/sti/ieconomy/oecd_privacy_framework.pdf


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Reform Area 6: Promoting interoperability 71. Rationale: 35% of Indonesian adults (71% of account owners) made or received digital payments as of 2017, a 12 pp increase since 2014. This was driven in part by digital utility payments. However, 30% of accounts remain inactive, twice as many as in 2014. Digital technology could be leveraged to further increase account use, given that 77% of adults (145 million) have a mobile phone, including 62 million unbanked. In turn, increased usage of digital payment instruments is a building block for broader access to financial services. In this context, interoperability is key as it can considerably increase the convenience of both customers and merchants in making and receiving digital payments. Interoperability of retail payment instruments in Indonesia remains limited (i.e. multiple POS devices at merchant locations, non-interoperable ATMs).50 In addition to instruments provided by traditional players, fintech companies are also starting to take a role in the provision of retail payments services. As such, interoperability can also promote competition, reduce fixed costs, and enable economies of scale that help ensure the financial viability of the service. 72. Proposed reforms: the issuance of quick response (QR) codes standards is a key starting point to broaden acceptance and advance interoperability of digital payment instruments in Indonesia. In line with BI’s plans for the implementation of the payment system’s blueprint, the next critical step will be the setting of Application Program Interface (APIs) standards for the industry to enable banks and Fintech companies alike to expand and enhance their offering of payments and related financial services as well as the introduction of the faster payments infrastructure. The pace of implementation of the payment system’s blueprint needs to be defined by technical working groups that are being established by BI. In order not to pre-empt the role of the working groups, the wording for triggers for DPL2 and DPL3 will be refined during the subsequent operations once the technical working groups will be operational. 73. Expected Results: In line with the rationale presented above, the reforms supported by this DPL are expected to contribute to the development of a wider range of retail payment instruments and increased usage of digital payments as demonstrated by an increase in the number of payment service providers (bank and non-bank financial institutions) facilitating QR payments. Standardization of QR codes will allow one code to be used by various payment providers at every merchant; hence providing integrated and inexpensive mobile payment options. Standardization of APIs will allow fintech firms and financial institutions to develop new products to better serve their customers, potentially paving the way to greater competition, lower prices, and a wider range of customer-centric services. 74. Ongoing support & related FSAP recommendation: The reforms are supported by an ongoing TA project on promoting financial access and inclusion (P166791) funded by the SECO IFSSP Trust Fund. The related FSAP recommendation referred to the need to intensify “ongoing efforts to establish a National Payment Gateway (NPG) to bring full interoperability for e-money and payment cards”.

50 A POS is an electronic device used to process card payments at retail locations. It generally reads the information off a customer’s credit or debit card and checks whether the funds in a customer’s bank account are sufficient.


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• Prior action: In order to advance interoperability of digital payment instruments, BI has issued QR Indonesia Standard (QRIS) for adoption by financial service providers as evidenced by BI Regulation No. 21/18/PADG/2019.

• Trigger DPL2: Application Programming Interface (API) standardization could be introduced, subject to the implementation timeline of the National Payment System Blueprint to be defined by dedicated working groups.

• Trigger DPL3: Faster Payments infrastructure could be introduced, subject to the implementation timeline of the National Payment System Blueprint to be defined by dedicated working groups.

• Result Indicator: Number of payment service providers (bank and non-bank financial institutions) facilitating QR payments. Baseline (2018): 8; Target (2022): 40.

75. The third pillar of the DPL focuses on strengthening the resilience of the financial sector. The pillar has the objective to strengthen the resilience of the financial sector against financial and non-financial shocks through strengthening the resolution framework, implementing sustainable finance practices and establishing disaster risk finance mechanisms. It includes the following reforms: Reform Area 7: Strengthening the framework for resolution of troubled, non-viable banks 76. Rationale: In Indonesia, the Deposit Insurance Corporation (LPS) is tasked with both deposit payouts as well as banking resolution. To strengthen both functions, the Indonesian authorities are enhancing the deposit insurance payout system and have introduced a bank resolution framework for systemic banks, to move closer towards international standards and practices.51 Some of these international standards were introduced after the global financial crisis to ensure the resolution of any bank in an orderly manner without severe systemic disruption or exposing taxpayers to the risk of loss. Amongst others, the Financial Stability Board (FSB) Key Attributes require the periodic drafting of resolution and recovery plans for systemic banks to ensure timely identification of resolution strategies, and the availability of dedicated resolution funding. Moreover, to strengthen speed and accuracy of deposits payouts in case of bank liquidation, the LPS is developing the concept for Single Customer View (SCV) reporting.52 The SCV provides a consolidated (aggregated) view of a depositor’s assets and liabilities on a specific date and enable deposit insurers to compensate insured deposits within the shortest time. 77. Proposed reforms: The first reform supports the issuance of an LPS regulation on the SCV which will enable LPS to enhance the timeliness and accuracy of its deposit payout function by gaining access to banks’ records. The second reform supports the establishment of a separate resolution fund that will be funded by a levy from the banking industry, which would be accessible in the event of a financial crisis as declared by the President and LPS implementation of the Bank Restructuring Program. It also supports the issuance of an LPS regulation on resolution planning and resolvability assessments that considers the experience from the currently ongoing pilot exercise on implementing resolution planning and resolvability assessments for three systemic banks. The third-year trigger supports implementation of the SCV Reporting by all commercial banks, and an adjustment of LPS’ operational structure to implement the revised deposit insurance and resolution frameworks.

51 These include the International Association of Deposit Insurers (IADI) Core Principles and the Financial Stability Board (FSB) Key Attributes. 52 SCV represents banks’ reporting on minimum prescribed data on depositors and their aggregate insured deposits, in accordance with rules for calculation of insurance amount and regulatory provisions for usage by deposit insurance authority, within a defined timeframe.


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78. Expected results: All actions supported by this DPL are expected to contribute to financial stability by helping enhance the mechanisms for insured deposit payouts and resolution of any troubled, non-viable banks. The SCV reporting system will help maintaining depositor confidence and avoiding disruptions to financial activities in the event of a bank failure. Implementation of SCV reporting will require all deposit insurance member banks to improve their customer information files and core systems and would require removal of all impediments to fast and efficient reimbursement processes. The resolution fund would put into place a pre-funded arrangement wherein the banking industry is levied to build up the fund, thereby mitigating to a certain extent the risks of disruption and taxpayers’ losses. Nonetheless, the fund would need to be complemented by a public funding mechanism with robust safeguards, given that some systemic bank resolutions could require public funding or the provision of guarantees where industry-based funding is insufficient or would be destabilizing at the time. Furthermore, the regulation on resolution planning and resolvability assessments will require systemic banks to prepare their own resolution plans and the resolution authority (i.e. LPS) to assess whether or not the banks are resolvable under those plans. 79. Ongoing support & related FSAP recommendation: The reforms are supported by ongoing TA project on Strengthening LPS, funded by the SECO IFSSP Trust Fund. The related FSAP recommendations on crisis management and resolution included: (i) Introduce regulations to require banks to calculate complete and accurate SCV balances for all insured deposits; (ii) Establish a funding mechanism via the LPS to facilitate the resolution of systemically important banks under the PPKSK Law; and (iii) Develop resolution options and implementation guidelines for banks, and resolvability assessment and resolution planning frameworks for D-SIBs.

• Prior action. LPS has enhanced the timeliness and accuracy of its insured deposit payout function through the development of the single customer view (SCV) based data reporting by member banks, as evidenced through issuance of LPS Regulation No. 5/2019.

• Trigger DPL2: The Borrower has established the resolution fund and LPS has established the regulatory framework resolution planning and resolvability assessments as evidenced through [GR No. and LPS Regulation No. ]

• Trigger DPL3: (i) LPS has adjusted its operational structure to implement the revised deposit insurance and resolution frameworks and (ii) Reporting on Single Customer View has been implemented by all commercial banks.

• Result Indicator: Number of days for LPS to pay out insured depositors in closed commercial banks. Baseline (2019):90 days; Target (2022): minimum 90% of eligible depositors to be repaid within 7 working days; Number of bank resolution plans finalized by LPS. Baseline (2019): 0; Target (2022): all systemic banks.

Reform Area 8: Implementing sustainable finance practices 80. Rationale: Sustainable finance practices refer to practices that integrate environmental, social, and governance (ESG) risks and criteria in business and financing (lending or investment) decisions. Indonesia’s demographics and geographic location significantly shape its environmental and social (E&S) risk profile. Home to large energy (coal, oil, natural gas, and geothermal energy) and natural resources, Indonesia is facing E&S challenges in the use of fossil fuel for energy, deforestation, and impacts of mining. Efforts to mitigate and adapt to climate change are critical for Indonesia, being the world’s largest archipelagic country, as it is extremely vulnerable to natural disasters exacerbated by the climate change. Indonesia has a goal to reduce greenhouse gas emissions both by 2020 and 2030 under the Paris Agreement while


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maintaining strong economic growths. Financial services industry plays an integral role in all market sectors and therefore it is inherently susceptible to climate change risks. For example, the insurance sector could suffer significant losses from natural disasters exacerbated by climate change; the banking sector is inherently exposed to losses by clients and borrowers; and so are capital market investors exposed to losses by their investments due to climate change-related events.53 81. Proposed reforms: The reforms are focused on introducing supervisory tools required to monitor the implementation of sustainable finance practices that were introduced through OJK Regulation (POJK) 51/2017 on Implementation of Sustainable Finance Practices for Financial Services Institutions, Issuers, and Public Companies. The OJK regulation, introduced in July 2017, covers principles of sustainable finance, the timeline for their implementation and requirements for FIs to implement the following priorities: (i) to develop green financing products/services, and/or increase their green portfolio; (ii) adjust their structure organization; (iii) incorporate E&S aspects in their risk management and business/investment decisions. All FIs must publish a sustainability report annually to ensure the transparency and accountability of the policy implementation in their respective institutions. Pursuant to the timeline under the OJK regulation, the largest banks in Indonesia started to implement it in 2019. To ensure compliance and provide guidance for banks to implement it, OJK issued the Technical Guidelines for Banks on the Implementation of POJK on Sustainable Finance in late 2018. For OJK to monitor and evaluate the progress of the implementation, OJK has started to develop the framework for OJK banking supervisors to monitor and supervise the implementation of the initiative by the banks since early 2019. Therefore, the first reform supported by this DPO focuses on strengthening the institutional capacity of banks and supervisors in dealing with sustainable finance by issuing guidelines for banking supervisors to enable the implementation and supervision of sustainable finance practices by banks. The second and third reforms focuses respectively on the monitoring of the implementation of sustainable finance principles through the sustainability reports to be provided to OJK by the largest banks (i.e. Buku III and IV categories according to the Indonesian classification) first and then by all commercial banks. The triggers are necessary to ensure the gradual implementation and related monitoring of sustainable finance practices by all banks according to international best practices, in parallel with an ongoing technical assistance dialogue.

82. Expected results: The result intended from these reforms is that a substantial majority of entities supervised by OJK are in compliance with the requirements for sustainable finance practices. The proposed reforms would allow OJK to supervise the financial institutions and other entities on their sustainable finance practices to enable such compliance. In turn, this would lower supervised entities’ exposure to losses arising from environmental and natural disasters. Systemically, compliance to sustainable finance practices will ultimately encourage broader compliance of ESG standards in the real sector, which in turn reduces the likelihood and severity of environmental and natural disasters. 83. Ongoing support: The reforms are supported by TA performed through the IFC Sustainable Finance Program, as a continuation of the support from the Sustainable Banking Network.

53 A recent assessment on environmental safeguard practices at an infrastructure financing lender suggest a weakness in the application of good practices, exposing the institution and its clients to losses arising from environmental damages


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• Prior action: OJK has strengthened the institutional capacity of banks and supervisors in implementing OJK Regulation No. 51/POJK.03/2017 on sustainable finance practices by issuing internal guidelines for banking supervisors.

• Trigger DPL2: OJK has monitored the implementation of sustainable finance principles in major banks (BUKU III and IV), as evidenced through [banks’ Sustainability Reports to OJK].

• Trigger DPL3: OJK has monitored the implementation of sustainable finance principles in all banks, as evidenced through [banks’ Sustainability Reports to OJK].

• Result Indicator: Commercial banks complying with sustainable finance practices (%). Baseline (2018): 0; Target (2022): 75.

Reform Area 9: Establishing disaster risk finance mechanisms 84. Rationale: Improved fiscal resilience to natural disasters and climate change has become critical for Indonesia to achieve its development goals. The central government currently spends between US$ 300 and $500 million (0.03-0.05 percent of GDP) annually on post-disaster reconstruction. The cost of disaster and climate shocks, including for social support, housing reconstruction, and replacing or restoring public infrastructure, is likely to increase with climate change, thus placing a significant burden on public expenditure. The current set up does not efficiently finance the uncertain cost from disaster. It relies on a fixed contingent allocation and supplementary budget requests, not allowing the government to efficiently manage the financial risk. As the government is implementing its new Disaster Risk Financing and Insurance Strategy (adopted in October 2018) this includes combining various funding sources into an efficient risk layering strategy, including market-based risk transfer. The government also faces challenges with timely and adequate response, for example, due to delays in budget allocation, execution, and institutional coordination. 85. Proposed reforms54: To improve coordination, efficiency, and governance of post-disaster expenditures (including international assistance), the Government decided to develop a dedicated disaster risk finance mechanism (a ‘pooling fund’) to protect the budget against disaster shocks. The Government has then taken steps to establish the legal framework for a disaster mitigation pooling fund, by including this financial mechanism as a priority topic in the 2020 fiscal planning document submitted to Parliament (KEM PPKF 2020) and reflecting it in Article 45 of the Law No 19 of 2020 regarding the State Budget for the 2020 Fiscal Year. The present DPL also supports two further reforms in this area during the second and third operation of the series: the former will focus on the actual establishment of the pooling fund through a Presidential Decree and the adoption of appropriate regulations and procedures by MOF for its governance and management. Following this, the pooling fund is expected to be fully operational. The latter will support the adoption of a policy to set up pre-arranged disbursement channels directly linked to the pooling fund management for more effective disaster response. The establishment of the pooling fund is the key reform anchoring the implementation of the Government’s financial protection policy in broader fiscal management and financial planning, building on international good practice, e.g. from Mexico and the experience with self-insurance funds in Australia and New Zealand. The pooling fund has also been integrated in the mid-term development plan (RPJMN), allowing the Government to proceed with its establishment and the allocation of funds to it.

54 Please refer to annex 4 for additional background, governance and implementation arrangements of the proposed disaster risk finance mechanism.


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86. Expected results: Improved pre-arranged financing for response to disasters and climate shocks by providing the government a more stable and efficient funding source. The pooling fund can accrue unspent budget allocations for disaster response as reserves for worse years. It can further adopt an efficient risk financing strategy for the government by receiving donor contributions and contracting sovereign risk insurance policies. It also improves the efficiency, transparency, and accountability in the use of state budget funds for post-disaster expenditures through improved up-front planning and budgeting. This will eventually link the funding source directly to pre-arranged disbursement mechanisms, increasing the speed and transparency of disaster response. Last, it will allow the government to better link risk financing to incentives and investment for all phases of disaster risk management, including preparedness and prevention. Bringing the funding of all disasters and climate shocks under a single mechanism helps diversify the risk and more efficiently manage the expected increasing cost of shocks due to climate change and growing asset exposure. 87. Ongoing support: An ongoing TA program funded by SECO and by the Global Risk Financing Facility (GRiF) trust fund supports MOF in the implementation of the DRFI strategy. This TA as well as a new operation under preparation will work with the government to ensure the fund is established in line with good practice public financial management and governance rules. The TA also supports additional areas under the DRF strategy as requested by DOF, including the public asset insurance program, data innovation and risk analytics, household and agricultural insurance, as well as capacity building and insurance training.

• Prior action: The Borrower has taken steps to establish the legal framework for a disaster mitigation pooling fund by including it in the 2020 Budget Law as evidenced by Article 45, Law of the Republic of Indonesia No 20 of 2019 regarding the State Budget Fiscal Year 2020.

• Trigger DPL2: The Borrower has established a pooling fund and adopted appropriate operating procedures for its management as evidenced through [PerPres no. and Date and MoF Decree PMK no. and date].

• Trigger DPL3: MOF has adopted a policy to set up pre-arranged disbursement channels linked directly to the pooling fund management for more effective disaster response as evidenced through [MoF Decree PMK no. and date].

• Result Indicator: Utilization of the pooling fund for disaster response financing. Baseline (2019): Pooling Fund not established; Target (2022): Pooling fund utilized in disaster response.


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Table 4: DPF Prior Actions and Analytical Underpinnings

Prior Actions Analytical Underpinnings

Pillar A: Increasing the depth of the financial sector

PA1 (Access & Usage). BI and OJK have adopted a joint policy framework on agent networks to support the implementation of agent network programs (namely Laku Pandai and LKD).

The study on harmonization of Laku Pandai and LKD program (2018) showed two major shortcomings of the programs: (i) inadequate incentives and (ii) inter-institutional problems. This generate sub-optimal agent performance in the market, overlapping and inconsistencies between two regulations, and confusion in the market (financial service providers, agents, and consumers). The study recommends stages of key reforms to optimize agent service operation, specifically in (i) the development of common policy vision/framework for Laku Pandai and LKD; (ii) the revision of Laku Pandai and LKD regulations based on the common framework; and (iii) the joint effort between BI and OJK to monitor the progress and implementation.

PA2 (Financial Market Products): OJK has established standard reporting and improved monitoring of issuances of debt securities in the private placement market, as evidenced by Regulation No. 30/POJK.04/2019.

The Capital Market Technical Note of the Indonesia Financial Sector Assessment Program (FSAP; 2017) identified the need to improve the primary issuance framework for corporate bonds. The framework for primary market corporate debt issuance has so far been based on public offerings, which are feasible only for large or well-known companies. There were no tiered schemes for issuances targeted only at sophisticated investors which facilitates issuances by mid- and small-sized companies. Private placements were rarely conducted as they are not recognized by the capital market authority. Introducing a recognized private placement regime for corporate bond issuance would complement the established public offering regime.

PA3 (Long-term savings): OJK has expanded the number of long-term instruments to be eligible for investments by pension funds and insurance companies, as evidenced by OJK Regulations Nos. 27/POJK.05/2018, 28/POJK.05/2018 and 29/POJK.05/2018.

The Capital Market Technical Note of the Indonesia Financial Sector Assessment Program (FSAP; 2017) stated that policies to stimulate growth of the institutional investor base are critical to improve conditions for long-term financing and the development of capital markets. Among others, the regulatory features that drive pension investments to short-term products or that restrict their ability to use certain products to manage their portfolio. The Infrastructure Sector Assessment Program (InfraSAP; 2018) – Finance Chapter also identified that regulations governing institutional investor investment should be aligned in order to allow them to invest in new types of instruments aimed at facilitating long-term investment especially in infrastructure (e.g. DINFRA/infrastructure funds).


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Pillar B: Improving the efficiency of the financial sector

PA4 (Insolvency & Creditor Rights): MOLHR has enhanced supervision of insolvency practitioners as evidenced by MOLHR Regulation No. 37/2018 and Decree No. M.HH-03.AH.06.06/2019.

World Bank. 2016. Improvement of the Investment Climate of Indonesia: Report on Insolvency & Debt Resolution, May 2016 (updated September 2016 to include Annex II on selected issues related to the regulation of curators). Unpublished Confidential Report. The Report finds that Insolvency Practitioners in Indonesia remain only partially regulated and identifies a number of challenges that may open the door to abuses. The Report identifies the need for clearer and more effective regulation for the monitoring of insolvency practitioners. The trigger responds to this need though regulatory reform that establishes an adequate supervision regime for insolvency administrators.

PA5 (Consumer and Data Protection): KOMINFO has introduced a new legal framework on general data protection and privacy through the submission of the draft law on Protection of Personal Data to the Parliament, as confirmed by Nota Dinas No. ND-61/KF/2020 from the Fiscal Policy Agency, Ministry of Finance.

Assessment of Indonesia’s Bill on the Protection of Personal Data (2019). This is a preliminary desk-based assessment of the draft law conducted by the World Bank. The assessment indicates that the Bill establishes a general framework for the protection of personal data and privacy that would help establish trust in digital ID systems, be enshrining core data protection principles applicable to both public and private sectors. Diagnostic review on consumer protection and financial literacy (2018). The assessment highlighted several challenges faced by OJK and BI in implementing the current consumer protection framework which includes: (i) the absence of separation of its prudential and consumer protection arrangements; (ii) the need to enhance consumer protection regulatory regime for innovative products and distribution; and (iii) the need to improve internal complaint resolution process and procedures.

PA6 (Interoperability): In order to advance interoperability of digital payment instruments, BI has issued QR Indonesia Standard (QRIS) for adoption by financial service providers as evidenced by BI Regulation No. 21/18/PADG/2019.

FIRST Initiative: Enhancing Payment Systems’ Interoperability and Regulatory, and Oversight Framework. The TA program objective was to support BI in developing a suitable legal, regulatory, and oversight framework in order to enhance the efficiency of the payment system. The program provided input to the draft legislative provision of payments and settlement system act, advisory input to the payment system oversight framework following the principles for financial market infrastructures, advisory input to e-money regulation and national payment gateway, as well as assessment on international remittance service against the CPSS-World Bank general principles.


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Pillar C: Strengthening the resilience of the financial sector

PA7 (Resolution Framework): LPS has enhanced the timeliness and accuracy of its insured deposit payout function through the development of the single customer view (SCV) based data reporting by member banks, as evidenced through issuance of LPS Regulation No. 5/2019.

Under the Financial Safety Net (“PPKSK”) Law there is provision for government regulation to be made to enable LPS to levy the banking industry for the purpose of establishing and maintaining a resolution fund for systemic bank resolution situations. The 2017 FSAP highlighted that the design of such resolution fund needs to take into account the following considerations: purposes for which funding may be applied, preconditions for use of resolution funding, potential scale of funding required, target size and balance between the pre-funding by levy to banking industry and post-funding by Government initial funding and ex-post banking industry levy. At the same time, the 2017 FSAP also pointed out the importance of SCV in ensuring accurate information of depositors and timely payouts to insured depositors; thereby necessitating the issuance of a regulation requiring banks to calculate complete and accurate SCV deposits and depositors data.

PA8 (Sustainable Finance): OJK has strengthened the institutional capacity of banks and supervisors in implementing OJK Regulation No. 51/POJK.03/2017 on sustainable finance practices by issuing internal guidelines for banking supervisors.

Indonesia – Sustainable Banking Network Country Progress Report (Adendum; 2018) identified that while significant progress was made on the umbrella policy in 2017, more specific and practical guidance is required to assist financial institutions with managing specific environmental, social, and governance (ESG) risks of their activities. OJK should also develop further internal capabilities and define appropriate metrics to properly measure the level of implementation.

PA9 (Disaster Risk Finance): The Borrower has taken steps to establish the legal framework for a disaster mitigation pooling fund by including it in the 2020 Budget Law as evidenced by Article 45, Law of the Republic of Indonesia No 20 of 2019 regarding the State Budget Fiscal Year 2020.

Supporting the development of the Government’s DRF Strategy (2018). This World Bank ASA, which has been provided to MOF since 2017, has supported the government in analyzing its current approach to risk financing and determining policy actions to move towards a more pro-active approach to financial risk management. Key recommendations include, implementing a risk layering strategy to more cost-efficiently meet post-disaster funding needs and linking this to pre-arranged disbursement channels for effective and targeted delivery of aid. World Bank, Financial Protection Against Natural Disasters: An Operational Framework for Disaster Risk Financing (DRF) and Insurance, 2014. This study summarizes global experience on DRF. Key lessons for efficient risk financing include: i) combining different financial instruments can minimize the cost of mobilizing post-disaster resources; ii) different instruments should be targeted for specific purposes, e.g. fast liquidity or longer reconstruction; iii) improving links between funding sources directly to contingency plans is key for effective response; and iv) data is key for fine-tuning financial instruments.


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4.3. LINK TO CPF, OTHER BANK OPERATIONS AND THE WBG STRATEGY

88. The proposed DPO is fully aligned with the World Bank’s Country Partnership Framework (CPF) for Indonesia. The FY16-20 WBG CPF for Indonesia draws on the Systematic Country Diagnostic (SCD) which identified three pathways for the elimination of extreme poverty and increasing shared prosperity: i.e. creation of better jobs, improving equality of opportunity, and helping Indonesia manage its vast endowment of natural resources in a sustainable way. The proposed DPO supports the FY2016-20 WBG Country Partnership Framework through two supporting beams (Supporting Beam I: “Leveraging the Private Sector - Investment, Business Climate and Functioning of Markets” and Supporting Beam II: “Shared Prosperity, Equality and Inclusion”. The recent CPF Performance and Learning Review (PLR) confirmed the relevance of the financial sector technical assistance program that is supporting most of the proposed reforms under this DPO. In parallel, a more prominent role for financial sector activities is envisaged as part of the preparation process of the next CPF. 89. Each of the proposed actions and reforms under this DPO are supported by technical assistance projects that are ongoing or under preparation. The current SECO-funded Indonesia Financial Sector Strengthening Program Phase II (IFSSP II – P166790, P166791) Trust Fund is supporting DPL reforms in the areas of access and usage of financial services (Reform Area #1); protecting consumers and enhancing transparency (Reform Area #5); promoting interoperability (Reform Area #6) and strengthening the framework for resolution of troubled banks (Reform Area #7). The SECO Global Capital Market Strengthening Facility (CMSF – P166792) and the Indonesia Infrastructure Finance Development – Financing Support Pillar funded by GAC Canada (P158784) are jointly supporting the reforms on broadening financial market products (Reform Area #2) and on mobilizing long-term savings (Reform Area #3). An IFC Advisory Program (Investment Climate, Competition and Competitive Sectors, 602983) funded by SECO’s Multi-Country Investment Climate Program (MCICP) supports the MOLHR on the resolving insolvency reform agenda (Reform Area #4). The sustainable finance reforms (Reform Area #8) is supported by TA performed through the IFC Sustainable Finance Program, as a continuation of the support from the Sustainable Banking Network. Finally, the reform on disaster risk finance (Reform Area #9) is supported by SECO Global Trust Fund on Disaster Risk Finance.

4.4. CONSULTATIONS AND COLLABORATION WITH DEVELOPMENT PARTNERS

90. The Government has conducted consultations with internal and external stakeholders on the reform program. Given the number of government’s agencies involved in the proposed reform program and the related coordination challenges, the Government, through the Ministry of Finance, has already conducted several rounds of consultations on the proposed matrix of reforms. The consultations involved technical level officials of the Ministry of Finance, Bank Indonesia, OJK, Deposit Insurance (LPS) and Ministry of Law and Human Rights (MoLHR), Bappenas and Kominfo. 91. Consultations with the relevant industry’s stakeholders have also been conducted for selected reforms. On agent banking, consultations with agent service providers have been conducted by GoI through workshops and capacity building events that included established players such the largest banks as well as fintech players and potential new entrants. Similarly, for the G2P digitization, informal consultation workshops have been conducted as the process is still at an infant stage. The QRIS standards


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were developed together with the payment system providers (QR service providers) and piloted together (in two waves), before issuing the regulation. On the resolution framework, extensive consultations have been conducted by LPS with the banking industry for the SCV regulation as well as for the establishment of resolution fund. The ongoing resolution planning pilot exercise also entails intensive consultations with the three participating banks, concerning the overall objective and approach of resolution planning and resolvability assessment. Finally, for the reforms related to capital markets and institutional investors, the OJK’s rule-making rules require a consultation period where draft regulations are published for industry/public comment (minimum 30 days). Oftentimes, focus group discussions are organized before the drafts are published. 92. The World Bank has also conducted consultations with relevant development partners. In particular, the support to reforms underpinned by ongoing technical assistance has been discussed with SECO and with the Bill & Melinda Gates Foundation, who are among the key development partners supporting financial sector development in Indonesia. The Asian Development Bank (ADB) has completed its third Policy Based Loan (PBL) on Financial Market Development and Inclusion Program for Indonesia. This $500 mill PBL was approved in March 2019 and supported reform priorities of the government and the Financial Services Authority (OJK) to further develop and make the finance sector more inclusive by (i) strengthening the regulatory structure for financial stability, (ii) deepening the financial market and (iii) enhancing financial inclusion. Those reforms are complementary to the reforms proposed under the current operation. Moreover, ADB is now preparing a new DPL on Fintech & Financial Inclusion for FY21.

5. OTHER DESIGN AND APPRAISAL ISSUES

5.1. POVERTY AND SOCIAL IMPACT

93. The prior actions associated with the planned reforms are likely to have no adverse poverty and social impacts. If anything, the direct and indirect impacts of the actions are likely to be broadly positive. The link between financial sector stability and poverty is well known in Indonesia. During the 1997-1998 Asian financial crises, the employment rate in the formal sector employment fell steeply, negative economic growth (at around 13 per cent in 1998) were recorded and food prices rose substantially, causing the poverty rate to increase from 17.5 per cent in 1996 to 24.2 per cent in 1998. The Government has made important strides in establishing economic stability since the crises. These proposed policy actions aimed at increasing financial depth, improving financial efficiency and strengthening financial resilience further bolster the government’s efforts. Overall, the policy actions are expected to contribute to creating a favorable economic environment that will stimulate growth and thus have positive social effects and help reduce poverty. 94. Pillar A – Increasing the depth of the financial sector. As per the Global Findex (2017), only 49 percent adults in Indonesia have a transaction account with a formal financial institution, making it the world’s fourth largest unbanked population. The policy actions under this pillar are in general, expected to help increase the availability of funds and access opportunities through increased outreach, financial market products and long-term saving; help improve financial inclusion by supporting access to and usage of transaction accounts and create a broader and deeper financial market; and help increase the pool of savings in the pension and insurance industries, and eventually increase their contribution to long-term investments in Indonesia. These policy actions will therefore expand the access to financial services for


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the poor, vulnerable groups thereby strengthening their ability to manage risks. The policy actions in this area will also allow Indonesia’s large aspiring middle class, especially women and small entrepreneurs, to benefit from an expanded set of economic opportunities.

95. The importance of access to financial services to the poor is clearly reflected in the Government’s national poverty reduction strategy, which includes a cluster of programs that aim to stimulate job opportunities for poor and vulnerable households by encouraging small and micro-entrepreneurs. The National Strategy for Financial Inclusion (SNKI) has also raised the profile of the financial inclusion agenda with the President being appointed as the head of the national steering committee. A key element of the National Strategy for Financial Inclusion is the development of Digital Financial Services (DFS), which has the potential to overcome geographical challenges, decrease costs and promote inclusion. To address some of the challenges to the inclusion agenda, in partnership with banks and nonbank PSPs, the authorities could launch a nationwide campaign to spread awareness on LKD, LP and financial services. Promoting interoperability, regulation for agents and collaboration with stakeholders would all provide the supporting environment for financial inclusion which in turn will be instrumental in expanding the pathway to the middle class for one in two Indonesians who have escaped poverty and vulnerability but still lack full economic security. 96. Opening up the scope of investment options, especially for pension funds can pose risks, but mitigating measures are included within the reform program. Pension funds in Indonesia are a mix between defined benefit and defined contribution. For defined benefit programs, the pension sponsor would ultimately be responsible for covering the shortfall in case of bad out-turns on risky investments. This would be relevant, for example, in case of government sponsored funds (civil service, military) in which case the government would be the ultimate party responsible. For defined contribution programs, the participants would bear the risk of investment downturns. No explicit or implicit guarantee exists for direct contributions program, except arguably for the old-age savings under the social security funds as there’s a requirement for the social security agency to provide a minimum nominal return. So, on the face of it, if long term investments were to sour, this could impose direct and indirect risks to participants in both types of programs. But these risks are mitigated by two factors. First, opening up the scope of investment options to include longer term securities is not necessarily increasing risk exposure. Longer term investments may mean more risk under normal circumstances. But for pension funds, whose liabilities are long term, it would be riskier to have to rely entirely on shorter term assets/instruments to cover those liabilities. Second, the existing investment regulations already have several mitigants in place that would apply just as well to the longer-term vehicles. These include diversification measures that put limits on types of instruments and issuers and restrict the investment domain to regulated instruments such as securities, regulated funds etc. 97. Pillar B - Improving the efficiency of the financial sector. The policy actions under this pillar are expected to channel savings into the most productive investment opportunities in a less costly, faster, safer and more transparent way. Hence ultimately, they are expected to result in to lower the costs for individuals and enterprises through consumer protection, reliable insolvency framework, improved creditor rights and adequate financial infrastructure. Regulations for improved consumer protection are expected to boost the functioning of the financial markets while increasing consumer confidence. The policy actions will therefore help in poverty reduction by promoting the job creation through business growth.


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98. Pillar C - Strengthening the resilience of the financial sector. The policy actions are expected to help consumers and investors to withstand financial and non-financial shocks; contribute to financial stability by helping ensure effective resolution of any troubled, non-viable banks, without severe disruption and taxpayers’ losses and contribute to resilience of the financial sector to non-financial shocks through the establishment of disaster risk finance mechanisms. The policy actions therefore contribute to creating a robust and stable financial system, which is a pre-requisite for economic growth, job creation, and ultimately poverty reduction and upward economic mobility for all Indonesians.

5.2. ENVIRONMENTAL ASPECTS

99. As indicated in the Environment and Poverty/Social Analysis Table in Annex 3, two of the prior actions will have positive effects on the environment. Embedding sustainability in the practices of the financial services industry via Reform Area #8, with emphasis on climate change, will contribute to disaster prevention, disaster risk mitigation, climate change adaptation, and environmental management in Indonesia. Reform Area #9 has the potential to lead to significant positive effects on the natural and human/built environment. This is because the DRFI Strategy recognizes that disaster management financing is needed for three periods – non-disaster, emergency response, and rehabilitation/reconstruction. Within the non-disaster period, pre-disaster financing is to be used, inter alia, for disaster risk mitigation activities or programs, disaster prevention programs, and education on disasters. Whether the potential for positive effects is realized or not will depend in part on the extent to which adoption of the DRFI Strategy leads to pre-disaster financing, and in part on other activities and programs of national and regional governments. The latter may include climate change resilience, disaster-resistant infrastructure, upgraded building codes, and early warning systems. None of the other prior actions will have positive or negative effects on environment, forest, or other natural resources. They will not result in construction, development or operation of facilities that could generate solid or liquid wastes or air emissions, conversion of natural habitat, damage to cultural heritage, loss of biodiversity, or changes in management policies or practices affecting forests or other natural resources.

100. Indonesia’s regulatory framework provides for disaster risk mitigation. Law No. 24 of 2007 concerning Disaster Management that is cited in the DRFI Strategy states that the Government’s responsibilities include: (i) mitigation of disaster risks and integration between disaster risk mitigation and development program, and (ii) protecting communities from the impacts of disasters. Government Regulation no. 22 of 2008 concerning Financing and Management Disaster Grants specifies that the Central and Regional Budgets must provide funds for three periods – pre-disaster, emergency response, and post-disaster. However, the DRFI Strategy lists among disaster management challenges the lack of a comprehensive regulation to govern pre-disaster financing. This is a gap to be remedied in the funding and scaling up of the Strategy and the development of an operations manual for the funding program that are part of the reforms proposed under this DPL.

101. Since the enactment of Law No. 24 of 2007, the Government has substantially strengthened Indonesia’s capacity to manage disasters. The National Disaster Management Authority (BNPB) was established in 2008, with a goal to coordinate the activities of relevant line ministries and agencies in all stages of disaster management – pre-disaster, during disaster, and post-disaster. Subnational local disaster management agencies (BPBDs) have been set up in all 34 provinces and in 90 percent of the 480


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cities and regencies, in keeping with the principle of placing ownership of disaster management at the local level. Since 2004, Indonesia has made substantial investments in hydrometeorological and geophysical monitoring stations and early warning systems. Indonesia has developed good building codes and standards to mitigate risk of seismic damage. The Government is embarking on an Indonesia Resilience and Reconstruction (IDRAR) Program to further strengthen disaster preparedness and emergency response systems and enhance post-disaster rehabilitation and reconstruction programs. BNPB has developed substantial capacity to perform its coordinating functions and currently has a staff of more than 500 persons. Capacity of the BPBDs varies, from substantial in large cities such as Medan to weak in small jurisdictions. The Government has just accepted an IBRD loan of $160 million for the Indonesia Disaster Resilience Initiatives Project (IDRIP), with BNPB as the executing agency, to build disaster preparedness and emergency management capacity in BNPB and selected BNPDs and communities, strengthen geophysical monitoring systems and early warning services, and provide implementation support. Other development partners have been providing capacity-building and technical advice in this sector, including JICA, USAID, Germany, and France.

5.3. PFM, DISBURSEMENT AND AUDITING ASPECTS

102. The Public Financial Management system in Indonesia has shown significant improvements over time. The latest Public Expenditure and Financial Accountability (PEFA) report (2017)55 concludes that Indonesia has established a strong legal and regulatory framework that aligns with most international standards on Public Financial Management (PFM). Overall, the average PEFA performance score is slightly below “B”, which is above the basic level of performance broadly consistent with good international practices. 9 out of 31 PEFA performance indicators received “A” score, which is the highest performance according to PEFA standards, although the effectiveness of the PFM systems in place and the monitoring of performance can still be strengthened. 103. PFM in Indonesia has important strengths, primarily associated with the development of instruments that have allowed prudent fiscal management and control of budget execution. The recent introduction of fiscal rules to support major development initiatives has been effectively followed. The roll-out of the financial management information system (FMIS), together with the implementation of strict cash consolidation management rules, a well-defined treasury management system at the central government level, consistency between the accounting and budgetary classifications, and the convergence of national accounting with international accounting standards for the public sector, have created a solid platform for automation and integration of PFM processes for the improved quality of financial reporting and oversight.

104. However, there are still some weaknesses related to the strategic allocation of resources, the accountability of budget implementation and the efficient delivery of public services. These are areas where reform efforts are taking place, but where these efforts have yet to realize full performance. Among the most important of these ongoing efforts are: (i) improving budget credibility by strengthening the budget forecast, establishing consistent budgeting framework, and increasing revenue mobilization and compliance of tax and non-tax collection; (ii) improving the system capacity to deliver infrastructure outcomes by harmonizing the selection, implementation and monitoring of capital expenditure with

55 World Bank (2018c).


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formal guidelines and oversight, efficient management of public assets, as well as consolidation and monitoring of public procurement operations; (iii) the inclusion in the budget of performance information, linking resource planning in the most appropriate manner for better service delivery; (iv) promoting effective reporting of subnational budget execution; and (iv) strengthening internal audit and external audit, and control measures. 105. The PEFA assessment also notes that the Aggregate Fiscal Discipline in Indonesia is supported by a number of strong points: a clearly defined fiscal strategy; the capability to prepare robust projections of macroeconomic and fiscal performance; the proper reporting of revenue and expenditure operations outside the budget; and sufficient control over fiscal risks and commitments to maintain expenditures during budget execution. However, this generally positive aggregate fiscal discipline outcome is partially limited by weaknesses in budget reliability; insufficient linkages between investment expenditures and recurrent expenditures; and inconsistent implementation of the MTEF.

106. The Strategic Allocation of Resources is supported by the existence of budget rules and circulars that assign predictable budgeting ceilings as well as the timely approval of the annual budget law. However, the difficulty of aligning planning and budgeting and weaknesses in the management of public investment leaves an adverse impact. Robust foundations have been laid for the efficient service delivery but requires better consolidation and integration of performance information to achieve the goal of delivering the right level of services at the right cost.

107. The Badan Pemeriksa Keuangan (BPK), as Indonesia’s Supreme Audit Institution (SAI), has a mandate to conduct financial audits of all central government entities, as well as local government agencies. BPK expressed an unqualified opinion in the last two years to central government financial reports. The audit reports include audit reviews on: (i) the internal control system; (ii) compliance with laws and regulations; and (iii) the status of follow-up audit findings and recommendations. Besides government entities, BPK conducts audits on Bank Indonesia (Central Bank), State Own Enterprises (SOE) and other entities that manage state finances. BPK audits include financial audits, performance audits and audits for special purposes.

108. BPK audit reports on the central government’s financial statements are submitted to parliament within two months after the issuance of the unaudited financial statements. Audit reports on line ministries are submitted semi-annually, three months after the end of the semester, together with a summary (IHPS). Article 21 in Law No. 15/2004 on State Financial Oversight requires parliament to review the follow-up of BPK’s audit reports through hearings with the relevant ministries. The role of reviewing the follow-up of BPK’s audit reports is distributed among the relevant parliamentary commissions, which conduct scrutiny and discussions on the audit reports as part of their regular hearings scheduled with the counterpart ministries. The depth of each hearing may differ depending on the urgency of the issues raised in the audit report and the capacity of each commission.

109. The PEFA assessment also demonstrates that Indonesia shows good performance on indicators about comprehensiveness and transparency of PFM. The “A” score for PI-9 on Public Access to Fiscal Information shows that the fiscal transparency is at the highest standard, as information on government budget made available to the public in printed form through press releases, advertorials for media or through MoF website. However, one element of public access to fiscal information needs to improve to


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ensure full and timely access to the BPK’s audit reports, including publication of full reports on the BPK’s website. Good step already taken in 2015 with the establishment of the Information and Communication Center (PIK) where public can obtain audit reports upon request. Summaries of audit reports also included in the BPK’s biannual semester reports. This is still part of ongoing reform in BPK to fulfill the requirement for the SAIs to have their reports easily accessible and publicly available.

110. BI’s financial statements have received a clean audit opinion. The IMF has not conducted a safeguards assessment covering Bank Indonesia's (BI) framework of reporting and controls since 2002. BPK has expressed an unqualified (clean) opinion on the latest financial statements of BI for FY 2018. Several DPLs, including the Second and Third Fiscal Reform DPLs, were disbursed successfully in 2018 and 2019.

111. The loan disbursement will follow the standard Bank procedures for DPLs. 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 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 the General Conditions for IBRD Financing: Development Policy Financing (2018)(General Conditions). If any portion of the loan is used to finance ineligible expenditures as so defined in the General Conditions, 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.

5.4. MONITORING, EVALUATION AND ACCOUNTABILITY

112. Progress on the results indicators will be monitored and evaluated by the Recipient. The Fiscal Policy Unit (BKF) under the Ministry of Finance will be the executing agency for the proposed operation while BI, OJK, LPS, MoLHR, Bappenas56 and Kominfo will act as implementing agencies. The BKF team is well-coordinated, and given their experience in implementing DPOs with the World Bank, they are increasingly well prepared to obtain and share data to monitor implementation against the agreed results indicators. The World Bank closely follows this progress through supervision activities. 113. Grievance Redress. Communities and individuals who believe that they are adversely affected by specific country policies supported as prior actions or tranche release conditions under a World Bank Development Policy Operation may submit complaints to the responsible country authorities, appropriate

56 Bappenas will play a coordinator role among other agencies (such as Ministry of Social Affairs, Coordinating Ministry of Human Development and Culture, Ministry of Energy and Mineral Resources) to ensure that the trigger for DPL3 under reform area #1 is completed on time.


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local/national grievance redress mechanisms, or the WB’s Grievance Redress Service (GRS). The GRS ensures that complaints received are promptly reviewed in order to address pertinent concerns. Affected communities and individuals may submit their complaint to the WB’s independent Inspection Panel which determines whether harm occurred, or could occur, as a result of WB non-compliance with its policies and procedures. Complaints may be submitted at any time after concerns have been brought directly to the World Bank's attention, and Bank Management has been given an opportunity to respond. For information on how to submit complaints to the World Bank’s corporate Grievance Redress Service (GRS), please visit http://www.worldbank.org/GRS. For information on how to submit complaints to the World Bank Inspection Panel, please visit www.inspectionpanel.org.

6. SUMMARY OF RISKS AND MITIGATION

114. The overall risk rating for the operation is ‘moderate’ with two main sources of risk indicated as “substantial”. The two substantial risks are (i) technical design and (ii) institutional capacity for implementation and sustainability. Measures to mitigate these risks are outlined below. The potential benefits of the proposed operation outweigh the residual risks and warrant IBRD’s assistance.

Risk categories

1. Political and governance Moderate

2. Macroeconomic Moderate

3. Sector strategies and policies Moderate 4. Technical design of program Substantial

5. Institutional capacity for implementation and sustainability Substantial

6. Fiduciary Moderate

7. Environment and social Low

8. Stakeholders Moderate

9. Others

Overall Moderate

115. The risk of the technical design of the operation is substantial. The design requires the coordination of several different counterparts and, given the relatively tight timeline for the completion of critical reforms, a deep commitment from all the relevant stakeholders to abide to the agreed milestones is required. The influence of the Ministry of Finance as executing agency on some of the implementing agencies, such as OJK, might be limited and therefore requires a solid policy dialogue with each implementing agency to make sure there is full alignment on the achievement of the proposed reforms.

116. The risk related to institutional capacity is substantial. Institutional capacity needs continuous support through the ongoing TA to make sure that the agreed reforms can be completed on time and according to the required quality standards. The ongoing TA program underpinning each of the proposed reforms is an important mitigating factor against the risks related to institutional capacity for implementation and sustainability.


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Table 5: Summary Risk Ratings

Risk Categories Rating

1. Political and Governance ⚫ Moderate

2. Macroeconomic ⚫ Moderate

3. Sector Strategies and Policies ⚫ Moderate

4. Technical Design of Project or Program ⚫ Substantial

5. Institutional Capacity for Implementation and Sustainability ⚫ Substantial

6. Fiduciary ⚫ Moderate

7. Environment and Social ⚫ Low

8. Stakeholders ⚫ Moderate

9. Other

Overall ⚫ Moderate


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.

ANNEX 1: POLICY AND RESULTS MATRIX

Reform area and lead counterpart

Prior Action (November 2019) Trigger (Nov 2020) Trigger (Nov 2021) Results Indicator (2022)

Pillar A: Increasing the Depth of the Financial Sector

Reform area #1: Increasing access and usage Counterparts: BI, OJK, Bappenas

PA1. BI and OJK have adopted a joint policy framework on agent networks to support the implementation of agent network programs (namely Laku Pandai and LKD).

BI and OJK have harmonized Laku Pandai and LKD programs in line with policy framework and as evidenced through [revised regulations no. and date]

Non-cash social assistance distribution channels have been expanded as evidenced through [revised regulation no. and date]

Reduction in the percentage of adults stating distance is the foremost barrier to opening a transaction account (FI account and mobile money): Baseline (2017): 19.3%; Target (2022): 10.2%; Average transactions by beneficiaries through social assistance (KKS) accounts per year. Baseline (2019): 0.8; Target (2022): 2

Reform area #2: Broadening financial markets products Counterparts: OJK, MOF, BI

PA2. OJK has established standard reporting and improved monitoring of issuances of debt securities in the private placement market, as evidenced by Regulation No. 30/POJK.04/2019.

MOF has simplified taxes of capital market instruments and established a tax level-playing field for those instruments as evidenced through [regulation no. and date].

BI and OJK have enabled the development of over-the-counter derivatives market in compliance with G20 commitments as evidenced through [regulation no. and date]

Outstanding IDR-denominated private debt securities (IDR trillion); Baseline (2018): 412; Target (2022): 711


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Reform area #3: Mobilizing long-term savings Counterparts: OJK, MOF

PA3. OJK has expanded the number of long-term instruments to be eligible for investments by pension funds and insurance companies, as evidenced by OJK Regulations Nos. 27/POJK.05/2018, 28/POJK.05/2018 and 29/POJK.05/2018.

OJK has: (a) amended risk management [requirements/rules] of pension funds; and (b) introduced age-relevant default investment choice for defined contribution funds as evidenced through [regulation no. and date].

MOF has incentivized contributions to and disincentivized withdrawals from pension and old-age savings as evidenced through [revised tax policies and procedures no. and date].

Reduced portion of short-term investments (cash, bank deposits) in pension fund portfolios (%); Baseline (2017): 19.3; Target (2022): 16

Pillar B: Improving the Efficiency of the Financial Sector

Reform area #4: Strengthening insolvency and creditor rights framework Counterpart: MOLHR

PA4. MOLHR has enhanced supervision of insolvency practitioners as evidenced by MOLHR Regulation No. 37/2018 and Decree No. M.HH-03.AH.06.06/2019.

MOLHR has improved the remuneration system of receivers and administrators as evidenced through [regulation no. and date]

The Borrower has submitted to Parliament the Amendment to the Bankruptcy Law to enhance creditor rights as evidenced through [submission letter no. & date].

Number of insolvency cases opened by the court, evidencing greater access by firms. Baseline (2018): 304 Target (2022): 334 (10% increase).

Reform area #5: Protecting consumers and personal data and enhancing transparency Counterparts: OJK, BI, Kominfo

PA5. KOMINFO has introduced a new legal framework on general data protection and privacy through the submission of the draft law on Protection of Personal Data to the Parliament, as confirmed by Nota Dinas No. ND-61/KF/2020 from the Fiscal Policy Agency, Ministry of Finance.

OJK has enabled specialized market conduct supervision to financial services institutions in accordance with OJK law as evidenced through [PDK regulation of enforcement of market conduct supervision]. BI has enabled specialized market conduct supervision as evidenced through [BI regulation no. and date]

OJK and BI have operationalized market conduct supervision as evidenced through the development of initial risk assessment processes and procedures for financial consumer protection

Number of financial product marketing violations detected per year. Baseline (2018): 200; Target (2022): 400.


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Reform area 6: Promoting interoperability of payment systems Counterpart: BI

PA6. In order to advance interoperability of digital payment instruments, BI has issued QR Indonesia Standard (QRIS) for adoption by financial service providers as evidenced by BI Regulation No. 21/18/PADG/2019.

Application Programming Interface (API) standardization could be introduced, subject to the implementation timeline of the National Payment System Blueprint to be defined by dedicated working groups.

Faster Payments infrastructure could be introduced, subject to the implementation timeline of the National Payment System Blueprint to be defined by dedicated working groups.

Number of payment service providers (bank and non-bank financial institutions) facilitating QR payments. Baseline (2018): 8; Target (2022): 40

Pillar C: Strengthening the Resilience of the Financial Sector

Reform area #7: Strengthening the framework for resolution of troubled, non-viable banks Counterparts: LPS and MOF

PA7. LPS has enhanced the timeliness and accuracy of its insured deposit payout function through the development of the single customer view (SCV) based data reporting by member banks, as evidenced through issuance of LPS Regulation No. 5/2019.

The Borrower has established the resolution fund and LPS has established the regulatory framework for resolution planning and resolvability assessments as evidenced through [GR No. and LPS Regulation No. ]

(i) LPS has adjusted its operational structure to implement the revised deposit insurance and resolution frameworks and (ii) Reporting on Single Customer View has been implemented by all commercial banks

Number of days for LPS to pay out insured depositors in closed commercial banks. Baseline (2019):90 days; Target (2022): minimum 90% of eligible depositors to be repaid within 7 working days Number of bank resolution plans finalized by LPS. Baseline (2019): 0; Target (2022): all systemic banks.


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Reform area #8: Implementing sustainable finance practices Counterpart: OJK

PA8: OJK has strengthened the institutional capacity of banks and supervisors in implementing OJK Regulation No. 51/POJK.03/2017 on sustainable finance practices by issuing internal guidelines for banking supervisors.

OJK has monitored the implementation of sustainable finance principles in (BUKU III and IV) banks, as evidenced through [banks’ Sustainability Reports to OJK].

OJK has monitored the implementation of sustainable finance principles in all commercial banks, as evidenced through [banks’ Sustainability Reports to OJK].

Commercial banks complying with sustainable finance practices (%). Baseline (2018): 0; Target (2022): 75

Reform area #9: Establishing Disaster Risk Finance Mechanisms Counterpart: MOF

PA9. The Borrower has taken steps to establish the legal framework for a disaster mitigation pooling fund by including it in the 2020 Budget Law as evidenced by Article 45, Law of the Republic of Indonesia No 20 of 2019 regarding the State Budget Fiscal Year 2020.

The Borrower has established a pooling fund and adopted appropriate operating procedures for its management as evidenced through [PerPres no. and Date and MoF Decree PMK no. and date].

MOF has adopted a policy to set up pre-arranged disbursement channels linked directly to the pooling fund management for more effective disaster response as evidenced through [MoF Decree PMK no. and date]

Utilization of the pooling fund for disaster response financing. Baseline (2019): Pooling Fund not established; Target (2022): Pooling fund utilized in disaster response.


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ANNEX 2: LETTER OF DEVELOPMENT POLICY


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ANNEX 3: ENVIRONMENT AND POVERTY/SOCIAL ANALYSIS TABLE

Prior Actions Significant positive or negative

environment effects

Significant poverty, social or distributional effects positive or

negative

Pillar A: Increasing the Depth of the Financial Sector

PA1 (Access & Usage): BI and OJK have adopted a joint policy framework on agent networks to support the implementation of agent network programs (namely Laku Pandai and LKD).

No Yes, positive

PA2 (Financial Market Products): OJK has established standard reporting and improved monitoring of issuances of debt securities in the private placement market, as evidenced by Regulation No. 30/POJK.04/2019.

No No

PA3 (Long-term savings): OJK has expanded the number of long-term instruments to be eligible for investments by pension funds and insurance companies, as evidenced by OJK Regulations Nos. 27/POJK.05/2018, 28/POJK.05/2018 and 29/POJK.05/2018.

No No

Pillar B: Improving the Efficiency of the Financial Sector

PA4 (Insolvency): MOLHR has enhanced supervision of insolvency practitioners as evidenced by MOLHR Regulation No. 37/2018 and Decree No. M.HH-03.AH.06.06/2019.

No No


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PA5 (Consumer Protection): KOMINFO has introduced a new legal framework on general data protection and privacy through the submission of the draft law on Protection of Personal Data to the Parliament, as confirmed by Nota Dinas No. ND-61/KF/2020 from the Fiscal Policy Agency, Ministry of Finance.

No Yes, positive

PA6 (Interoperability): In order to advance interoperability of digital payment instruments, BI has issued QR Indonesia Standard (QRIS) for adoption by financial service providers as evidenced by BI Regulation No. 21/18/PADG/2019.

No Yes, positive

Pillar C: Strengthening the Resilience of the Financial Sector

PA7 (Resolution framework): LPS has enhanced the timeliness and accuracy of its insured deposit payout function through the development of the single customer view (SCV) based data reporting by member banks, as evidenced through issuance of LPS Regulation No. 5/2019.

No No

PA8 (Sustainable finance): OJK has strengthened the institutional capacity of banks and supervisors in implementing OJK Regulation No. 51/POJK.03/2017 on sustainable finance practices by issuing internal guidelines for banking supervisors.

Yes, positive No

PA9 (Disaster Risk Finance): The Borrower has taken steps to establish the legal framework for a disaster mitigation pooling fund by including it in the 2020 Budget Law as evidenced by Article 45, Law of the Republic of Indonesia No 20 of 2019 regarding the State Budget Fiscal Year 2020.

Yes, positive Yes, positive


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ANNEX 4: ADDITIONAL BACKGROUND ON THE DISASTER RISK FINANCE MECHANISM PROPOSED UNDER REFORM #9

I. Background & rationale

1. Disasters shocks– including climate shocks and geophysical events - cause significant fiscal risks to the Government at both the national and subnational level. Throughout the years the Government has relied on the national state budget and international assistance to cover disaster losses. The state budget has limited flexibility to absorb significant unexpected expenditures. The National Disaster Risk Financing and Insurance Strategy estimates that from 2005-2017 the government every year on averaged faced estimated direct economic cost of IDR 22.8 billion (US$1.6 billion) from disasters. Over this period, on average each year the government set aside dedicated funds in a contingency budget line in the amount of IDR 3.1 trillion (US$219 million), leaving on average a post-disaster funding gap of IDR 19.75 trillion (US$1.4 billion). From 2002 to 2015, Indonesia suffered an average reported damage of US$367 million annually due to flooding,57 with a total of estimated US$5.2 billion, discounting associated socioeconomic losses. This number is expected to increase, and an analysis of 92 cities across Indonesia indicate that the number of reported floods almost tripled from 50 to 146 from 2006 to 2017.58 This can be significantly exceeded for major catastrophes as was shown by the costs from earthquakes in Lombok and a tsunami in Sulawesi in 2018. When the government has to reallocate core development spending to fulfill obligations due to natural disasters or seek supplementary budgets this can impede the achievement of development targets and slow down rehabilitation. 2. The economic impact can be much more pronounced at the local level. Subnational governments often lack the financial resources to respond effectively in the aftermath of natural disasters due to their limited size and economic base. While the US$4.5 billion economic impact of the 2004 earthquake in the province of Aceh was approximately one percent of national GDP, this represented 54 percent of the provincial GDP. Likewise, the 2006 earthquake in the province of Yogyakarta caused losses estimated at 30 percent of regional GDP.59 Recent World Bank analysis found that in Indonesia district government spending is quite sensitive to natural disasters. District governments, for example, reallocate spending away from general administration to sectors such as health and infrastructure following floods.60 3. The negative impact from disasters on the population and economy are amplified when the Government does not have effective disbursement mechanisms in place to channel funds for response and reconstruction in a well targeted, efficient, and transparent manner. The government may also face challenges with timely and adequate response, for example, due to delays in budget allocation, execution, and institutional coordination. This situation not only leads to increased human suffering, it can also increase the direct cost to the government (e.g. cost of maintaining shelters due to delayed reconstruction of damaged houses); loss in revenue (e.g. loss of tax revenue from continued disruption of economic activities); and long term negative growth impacts (e.g. reduced human capital due to disruption in

57 International Disaster Database EM-DAT, 2018. 58 Data Informasi Bencana Indonesia (DIBI), 2018. 59 World Bank (2011), Indonesia: Advancing a National Disaster Risk Financing Strategy--Options for Consideration 60 World Bank (2018). The reallocation of district-level spending and natural disasters: evidence from Indonesia, Policy Research Working Paper no. WPS 8359


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schools).61 Past experience shows that living cost grants allocated by the Ministry of Social Affairs for displaced persons after the Aceh Tsunami and the Yogyakarta Earthquake were only received up to 4 months after the disaster. Similarly, it took approximately 11 months to distribute the full allocations for housing reconstruction grants following three disasters in 2006 and 2009.62 Analysis is currently being carried out to review and quantify disaster related budget expenditures over the past five years and identify the most significant bottlenecks in targeting and transparency of post-disaster aid. 4. To strengthen financial resilience, Indonesia formally launched its National Disaster Risk Finance and Insurance (DRFI) Strategy during the WB-IMF Annual Meetings in October 2018, under the leadership of the Minister of Finance and the Vice President. The strategy was prepared over the course of 2018 with close technical support by the World Bank. The overarching mission of the strategy is to protect state finances and the population through sustainable and efficient risk financing mechanisms that meet disaster-related expenditures in a planned and timely manner, and that deliver well-targeted and transparent assistance following shocks. Key priorities are: (i) Protecting state and regional assets; (ii) Protecting households and communities affected by disasters, particularly low income communal groups: (iii) Recovering social life and communities affected by disasters; (iv) Strengthening the roles of regional governments, the private sector, and communities in financing disaster risks; (v) Empowering local insurance companies; and (vi) Protecting the state budget.

5. Strengthening the resilience of the state budget to climate shocks and improving the efficiency of post-disaster spending is a key priority under this strategy. Based on international experience, e.g. from Mexico and self-insurance funds in Australia, the government identified as a first priority the establishment of a dedicated budgetary mechanism (‘Pooling Fund’) to manage a budgetary allocation for disasters, leveraging financial instruments including from development partners and international financial markets, and linked to pre-arranged disbursement channels. Such a dedicated funding mechanism can respond to all shocks – whether climate induced such as flooding or geophysical events such as earthquakes. Pooling this risk into a single mechanism increases the efficiency of financial management and helps the government effectively adapt to increasing future risk due to rapid asset growth and climate change.

II. Governance and operational features

6. The Government decided to develop a dedicated funding mechanism (a ‘pooling fund’) for disaster and climate shocks to improve overall coordination and governance of post-disaster expenditures (including international assistance). The pooling fund is expected to help improve disaster financing by (i) enabling the government to accrue unspent budget allocations for disaster response to save for future years and build reserves; (ii) improving efficiency in the use of funds from the state budget for post-disaster expenditures through improved up front planning and budgeting; (iii) leveraging additional financial instruments by linking them directly to the pooling funds with clear and pre-greed operating procedures (e.g. development partner contingent financing or market based risk transfer); (iv) connecting the pooling fund to clear pre-arranged disbursement channels and rules, thereby increased speed and transparency of post-disaster spending and providing predictability to implementing agencies on the

61 World Bank (2015), The Indirect Cost of Natural Disasters and an Economic Definition of Macroeconomic Resilience, Policy Research Working Paper no. WPS 7357 62 World Bank (2011), Indonesia: Advancing a National Disaster Risk Financing Strategy--Options for Consideration


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availability of funds; and (v) increasing the ability to link risk financing to incentives and investment for all phases of disaster risk management, including preparedness and prevention. 7. The governance, institutional and operational details of the fund are to be developed over the coming year. The reform supported under this operation is to provide the mandate to the Government to proceed with the establishment of the pooling fund and allocate future budget resources towards it. The institutional and operational arrangements will be decided and adopted through a Presidential and Ministerial Decrees. Oversight of the MOF will be key in the institutional design of the pooling fund to ensure sound financial management and integration in the budget planning process by MOF. Any budget allocations to the pooling fund will be subject to normal budgetary review. 8. Funding levels for the fund are to be decided by MOF during the fund’s implementation period. The appropriate allocation of resources to the pooling fund needs to be carefully balanced to ensure sufficient resources for shock response while minimizing the cost of carry. During the establishment of the fund financial and actuarial analysis will help determine appropriate funding levels. MOF has indicated that this should aim to meet average annual costs to help protect against unexpected funding needs. The pooling fund is not intended to accumulate large multi-year reserves.

9. The establishment of a dedicated financing vehicle allows MOF to manage the cost of disasters more efficiently. The pooling fund can develop a risk financing strategy to protect itself against extreme years, for example through contingent credit lines from development partners or market-based risk transfer. The fund can also become the central coordination mechanism for post-disaster international aid. This will ensure that any international post-disaster funding flow through a pre-arranged and efficient mechanism and can quickly reach the most affected communities.

10. The pooling fund can also serve as a dedicated risk financing implementation support unit for the government. For example, once the pooling fund and its managing unit are established this can support other priority areas under the national DRF strategy. For example, the scale up of the public asset insurance program will require an automated damage reporting and compensation/claims handling systems. This is a function that the pooling fund could carry out on behalf of the MOF. In the medium term the pooling fund could retain the first layer of losses from the public asset insurance program, efficiently managing the insurance deductible for more frequent events, with risk pooled across the country, and efficient damage reporting and claims management procedures. III. Implementation arrangements and progress

11. The reform under this operation is the first step, creating the mandate in the government planning documents to establish a pooling fund. Following this, a presidential decree will set out the institutional and governance arrangements. MOF will carry out the technical and institutional work to establish the pooling fund and adopt the appropriate regulation and procedures for its management. This will be supported under the second reforms in this series. The third reform will support the adoption of a policy to set up disbursement channels linked to the pooling fund management for more effective disaster response. While the fund is expected to be operational before this third reform, this will further refine it to move from approving individual expenditures towards pre-arranged systems that can rapidly disburse funds in line with standard operating procedures, e.g. through an adaptive social protection system.


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12. The establishment of the pooling fund has been integrated in the 2020 Fiscal Planning Document (KEM-PPKF) approved by Parliament and reflected in the Law No 19 of 2020 regarding State Budget. This is then further reflected in the draft mid-term development plan (RPJMN) 2020-2024 which provides for the implementation of the DRF strategies and the pooling fund as a key activity. The RPJMN is currently published in draft format and is expected to be adopted in January. 13. The World Bank will support the establishment of the fund through a combination of lending operations and implementation support technical assistance. An operation is under preparation to support the establishment of the pooling fund. This will ensure that the fund is established in line with good practice public financial management and governance rules. For example, through regulations which clearly define procurement processes and eligible expenditures for pooling fund resources; beneficiaries of such resources; and oversight, control, and audit processes.


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ANNEX 5: KEY FINANCIAL SECTOR STATISTICS

Stability

2016 2017 2018 Sept. 2019

Capital Adequacy

Risk Weighted CAR (%) 22.93 23.18 22.97 23.28

Bank Capital to Assets (%) 15.64 15.78 15.74 16.20

Banking Liquidity

Private Credit to Deposit (%) 90.70 90.04 94.78 94.34

Liquid Assets/ Deposits & ST Funding (%) 22.64 24.06 19.90 20.31

Assets Quality

NPL Ratio (%) 2.93 2.59 2.37 2.66

Provision to NPL (%) 115.09 123.34 125.16 118.10 Source: OJK

Efficiency

2016 2017 2018 Sept. 2019

3-Bank Concentration Index (%) 37.81 37.76 38.17 38.61

NIM (%) 5.63 5.32 5.14 4.90

Lending-Deposit Spread (%) 7.60 7.20 6.38 6.30

Non-interest Income/Total Income (%) 42.14 39.26 40.91 49.65

Overhead Costs/ Total Assets (%) 7.07 6.13 5.94 7.07

ROA (%) 2.23 2.45 2.55 2.48

ROE (%) 12.33 13.49 14.08 13.53

Credit to Gov. & SOEs/ GDP (%) 2.28 2.29 2.90 3.02 Sources: OJK, BI

Depth

2016 2017 2018 Sept. 2019

Bank

Assets/GDP (%) 55.16 55.29 55.29 55.00

Credit/GDP (%) 35.55 35.10 35.91 35.59

Deposits/GDP (%) 38.28 37.85 16.78 36.48

NBFI

Insurance Assets/GDP (%) 7.51 8.33 8.15 8.38

Pension Fund Assets/GDP (%) 1.92 1.92 1.82 1.85

Capital Market

Mutual Fund Assets/GDP (%) 2.73 3.37 3.41 3.48

Equity Market Cap./GDP (%) 46.37 51.90 47.34 45.62

Government Debt/GDP (%) 16.83 17.69 17.77 17.71

Domestic Corporate Debt/GDP (%) 3.50 6.16 - -

International Corporate Debt/GDP (%) 4.60 5.21 - -

Government Bond/GDP (%) 14.29 15.45 15.94 16.95

Domestic Corporate Bond/ GDP (%) 2.51 2.85 2.78 2.88

International Corporate Bond/GDP (%) 3.13 3.47 4.25 - Sources: OJK, BI, AsianBondOnline, Finstats


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Access

2016 2017 2018 Sept. 2019

Access

ATM Per 1,000 km2 54 56 56 56

Branches Per 1,000 km2 16 16 16 16

Usage

Deposit Accounts Per 1,000 Adults 1057 1565 1589 1599

Credit Accounts Per 1,000 Adults 222 222 230 238

Findex

Transaction Account by All Adults - 49 - -

Mobile Account by All Adults - 3.1 - - Sources: BI, Findex

Financial Industry as of December 2018

Financial Sector Institution Financial sector assets/ GDP (%)

Number of financial institutions

Bank 55.29 1712

Insurance 8.15 151

Finance Company 3.40 185

Pension Fund 1.82 232

MFI 0.01 183

Pawnshop 0.36 91

Venture Capital 0.08 65

Infrastructure Finance Companies 0.49 2

Other Financial Institutions 1.18 26

Total 70.78 2647 Sources: OJK, BI

Documents

The World Bank€¦ · BNI Bank Negara Indonesia BNPB Badan Nasional Penanggulangan Bencana (National Disaster Management Authority) BRI Bank Rakyat Indonesia ... As the largest economy