Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 14459

PERFORMANCE AUDIT REPORT

INDONESIA

HOUSING SECTOR LOAN(LOAN 2725-IND)

MAY 9, 1995

Operations Evaluation Department

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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Currency Equivalents (annual averages)

Currency Unit = Rupiah (Rp)

1983 US$1.00 Rp 9091984 US$1.00 Rp 10261985 US$1.00 Rp 11111986 US$1.00 Rp 12831987 US$1.00 Rp 16441988 US$1.00 Rp 16861989 US$1.00 Rp 17701990 US$1.00 Rp 18431991 US$1.00 Rp 19501992 US$1.00 Rp 2030

Abbreviations and Acronyms

BAPPENAS (GOI) National Economic Planning BoardBI Bank Indonesia (Central Bank)BKPN National Housing Policy BoardBTN Bank Tabungan Negara (National Savings Bank)GOI Government of IndonesiaHPS Housing Policy StudyHSL Housing Sector LoanHSPS (HSL) Housing Sector Policy StatementKPR (BTN) Mortgage Lending ProgramMENPERA State Ministry of HousingPAR Performance Audit ReportPCR Project Completion ReportPERUMNAS National Urban Development CorporationREI Real Estate IndonesiaREPELITA Five-year Development PlanRSI (Bank) Resident Staff in IndonesiaRSS A core housing unit affordable by low-income households

Fiscal Year

Government: April 1 - March 31

FOR OFFICIAL USE ONLYTHE WORLD BANK

Washington, D.C. 20433U.SA

Office of Director-GeneralOperations Evaluation

May 9, 1995

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Performance Audit Report on IndonesiaHousing Sector Loan (Loan 2725-IND)

Attached is the Performance Audit Report on Indonesia - Housing Sector Loan (Loan 2725-IND) prepared by the Operations Evaluation Department.

The project aimed to increase the housing supply for low and middle income households,reduce subsidies and decrease the housing sector's dependence upon Government funds. It alsosought to stimulate private sector production of housing as well as strengthen the principal stateagencies involved in the sector.

To achieve this, the project financed a time slice (the last two years of Indonesia's FourthNational Development Plan) of the Government's mortgage finance program under the control ofthe National Savings Bank, Bank Tabungan Negara (BTN), the state National Savings BanL Theproject also provided substantial technical assistance to BTN and to the government's housingdeveloper, the National Urban Development Corporation (PERUMNAS), as well as supportingimportant studies of the housing sector through the State Ministry of Housing.

Implementation was free of major problems and project physical investments in housing werecompleted within the original time frame. A one year Loan extension was agreed, however, tocomplete technical assistance programs aimed at important institutional and policy action.

Project performance on the whole was good and most objectives were met. The delivery ofsmaller housing units increased. Private real estate business expanded. Some improvements, mostlyin the area of computerization, were made to the main public sector housing agencies. ButIndonesia's housing sector, which still has one of the most highly subsidized interest rates in theworld, remains dependent upon Government financing. On the other hand, important studiessponsored by the project provided insights into the workings of Indonesia's large and complex housingsystem, and gave useful pointers for future sector reform. On the whole, the project was a goodexample of a sectoral lending operation geared to a realistic policy reform agenda. Further progressdepends on moving beyond the formal system and enhancing market mechanisms, including rentals.

The audit rates the project outcome as satisfactory and its institutional achievements asmodest The sustainability of the project is rated as unlikely because housing remains dependentupon Government highly subsidized financing in a context of ever-tightening budget constraints.

Attachment

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

FOR OFFICIAL USE ONLY

Contents

Preface . 3Basic Data Sheet ............................................................ 5Evaluation Summary.........................................................7

1. Background ..................................................... 15

Introduction ......................................................... 15Macroeconomic Context ................................................ 15Implications of Financial Reforms for the Housing Sector ...................... 16The Housing Sector in Indonesia ......................................... 17Bank Involvement .................................................... 20Government Policy and Bank Strategy ................................... 21

2. The Project ..................................................... 25

"Wholesaling" a Sector Policy Agenda ................................... 25Operational Improvements by the Principal Actors .......................... 26Issues in Project Preparation .......................................... 26Project Appraisal ................................................. 26Project Objectives and Description ..................................... 27

3. Project Implementation and Results .................................... 29

Start Up and Implementation ............................................ 29Financial Performance ................................................. 29Increased Delivery of Smaller Housing Units within theFormal System ................................................... 31Expansion of Private Real Estate Business ................................ 33Dependence of Formal System upon GovernmentFunding - Subsidies ................................................ 33Employment Generation ............................................ 36Institutional Strengthening ........................................... 36Compliance with Operational Directives and Covenants ....................... 38

4. Other Points of Special Interest ....................................... 39

Government and Bank Approaches to Housing Policy and Strategy ............... 39Who were the Project beneficiaries and what were their incomelevels . ........................................................ 40

This report was prepared by Mrs. Alcira Kreimer (Task Manager) and Mr. Roy Gilbert(Consultant) who audited the project in April-May 1994. Administrative assistance wasprovided by Ms. Stacy Ward.

This document has a restricted distribution and may be used by recipients only in the performance of theirofficial duties. Its contents may not otherwise be disclosed without World Bank authorization.

Contents (Cont.)

Arrears Management and Current Status of Mortgage Loan Arrears .............. 41What of the Informal System ......................................... 44

5. Borrower and Bank Performance and Dialogue ............................ 47

6. Conclusions and Lessons Learned ..................................... 49

Annex 1 - Statistical Data .. ............................................... 51

Annex 2 - Comments from the Borrower ....................................... 52

Bibliography .......................................................... 53

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Preface

This is a Project Performance Audit Report (PAR) on the Indonesia: HousingSector Loan (Ln. 2725-IND). The Loan was approved on June 23, 1986 in an amount ofUS$275 million and closed on December 31, 1992.

The PAR is based on the Project Completion Report (PCR) of the projectprgzarc; by the Infrastructure Operations Division of the East Asia and Pacific CountryDepartment III, the Staff Appraisal and the President's Report, the Loan documents, thetranscript of the Executive Directors' meeting at which the project was considered, areview of project files and discussions with Bank stafE An OED audit mission visitedIndonesia in April/May 1994. The mission discussed the performance of the HousingSector Loan with Indonesian government officials (State Ministry of Housing,BAPPENAS and Ministry of Public Works), management and staff of the principalexecuting agencies (Bank Tabungan Negara and PERUMNAS), and representatives ofother key players in the housing sector (Bank Indonesia, Real Estate Developers, BankRSI-Jakarta). The kind cooperation and valuable assistance provided by all theseinterlocutors is gratefully acknowledged.

The PCR provides a satisfactory account of most aspects of the project experience.It discusses the sensitive nature of the project and related implementation issues candidlyand in sufficient detail, although important project information is not included, notablyfinal project costs, the economic justification, and the income profile of projectbeneficiaries. As far as data availability permits, the PAR tries to fill these gaps.

Following standard OED procedures, copies of the draft PAR were sent to therelevant Government officials and agencies concerned for their review and comments.Comments received have been attached to the Report as Annex B.

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Basic Data Sheet

HousING SECTOR LoA (LoA 2725-IND)

Loan Position (Amounts in US$ million)

Appraisal Estimate Actual/Reestimate Actual % ofAppraisal Estimate

Total Project Cost 1208.7 N/A -

Loan Amount (US$m) 275 198 72

Canceled (US$m) - 77.0 -

Economic Rate of Return 15% N/A

Cumulative Estimated and Actual Disbursements

Appraisal Estimate (US$m) 275

Actual (US$m) 198

Actual as % of Estimate 72

Date of Final Disbursement 05/93

Project Dates

Original Actual

Identification 11/83Appraisal 08/85 and 03/86Negotiations 05/86Board Approval 06/23/86Signing - 06/26/86Effectiveness 09/25/86 12/16/86Loan Closing 12/31/91 12/31/92Project Completion - 03/31/93

6

Staff Inputs (staff weeks)

FY84 FY85 FY86 FY87 FY88 FY89 FY90 FY91 FY92 FY93 FY94 Total

Preappraisal 11.8 24.4 23.1 593

Appraisal 36.2 36.2

Negotiation 8.1 8.1

Supervision .2 33.2 27.6 13.2 8.6 10.9 3.1 1.7 9-3 107.9

Other 1.7 6.7 8.3

Totals 11.8 26.1 74.3 33.2 27.6 13.2 8.6 10.9 3.1 1.7 9-3 219.8

Mission Data

Month/ No. of DaysYear Persons in Field

Through Appraisal 08/85 5 13

03/86 8 18

Supervision 11/87 2 19

02/88 4 22

03/89 6 11

08/89 7 11

11/89 5 15

06/90 9 26

10/92 1 15

Other Project Data

Borrower: (Government of Indonesia)Executing Agency: (BTN - Bank Tabungan Negara)

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Evaluation Summary

Introduction

1. Indonesia has one of the largest housing markets in the world. Constantlyincreasing demand for housing is likely to be a key feature of its economic future. Duringthe preparation of the Housing Sector Loan (HSL) project, Indonesia's economic growthwas buoyant. When the project was appraised in 1985/86, falling world oil prices(Indonesia's major commodity export), made macroeconomic adjustment an imperative.Without prejudice to project support for housing sector policy reform, the HSL becamepart of the country's adjustment program.

2. Important financial sector reforms in the 1980s paved the way for the HSL. Theelimination of the credit and interest rate ceilings especially, helped deepen Indonesia'sfinancial sector. As measured by the ratio of broad money (M2) to GDP, the country'sfinancial depth was 50 percent in 1993, placing Indonesia mid-way among its East Asianneighbors. During HSL preparation in 1984, Indonesia's financial depth had been only 21percent. Therefore, housing finance relied almost exclusively upon BTN (Bank TabuganNegara - National Savings Bank) at that time.

3. Although only 32 percent of all Indonesians live in urban areas, the country's verylarge total population (1843 million in 1992) guarantees a sizable housing market in alarge urban network which includes six cities of over one million inhabitants. Housing inIndonesia is delivered through two systems with the following characteristics:

Informal delivery system:

* responsible for 80 percent of supply;* household based with no direct assistance from government;* emphasis upon expansion and improvement of existing dwelling units;* house tenure secure, land tenure insecure;* much substandard housing, infrastructure often inadequate; and* serving the whole range of incomes, particularly at the lower end.

Formal delivery system:

* responsible for 20 percent of supply;* direct government support through BTN, Perumnas and private developers;* subsidized interest mortgage loans available;* emphasis upon production of new single family units;* both house and land tenure secure;* all housing meets official standards, and infrastructure generally adequate;

and

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* moderate and high income households are main beneficiaries.

4. The Housing Sector Loan evaluated here aimed to make improvements in theformal delivery system only. Although responsible for only a fraction of all housingsupplied in Indonesia, its output was substantial in absolute terms, with annual sales inexcess of 70,000 units during the 1987-93 period.

5. In the past, environmental conditions in Indonesian cities were favorable to lowcost housing. Residents could safely draw drinking water from shallow wells on their plotseven in central areas of major cities, for instance. Increasing densities and poor urbaninfrastructure services have recently led to serious environmental crises, particularly inJakarta, where most surface water is contaminated by sea water seepage and effluentcollects in open drainage ditches that pollute surface wells. As measured by key variablesof the U.N./Bank Housing Indicators Program, housing quality in Indonesia is belowaverage at the country's level of GNP per capita. Only two-thirds of structures are builtwith permanent materials, the lowest proportion in East Asia. One third of all urbanhouses in Indonesia lack water connections.

6. The following institutional players of Indonesia's formal housing sector, wereinvolved in the HSL:

* BTN (Bank Tabungan Negara) -the state-owned savings bank responsiblefor implementing the Government's mortgage lending program.

* Bank Indonesia -Indonesia's central bank and the largest single financier ofthis program and banker of its subsidies.

* Pyivate real estate developers - firms that execute housing projects eligible forBTN mortgage lending, and which form the association REI (Real EstateIndonesia).

* Perum Perumnas (Perusahaan Umum Pembangunan PerumahanNasional) -the state developer of low cost housing similarly financedthrough BTN.

* MENPERA (Kantor Menteri Negara Perumahan Rakyat) -the Office of theState Ministry of Housing is responsible for supervising the implementationof housing policy through the formal system of house delivery.

* BKPN (Badan Kebijaksanaan Perumahan Nasional) -National HousingPolicy Board is an inter-ministerial committee for formulating housingpolicy in Indonesia.

9

Bank Involvement and Sector Policy

7. Since the appraisal of the Urban I project (Ln. 1040-IND) in Jakarta, the Bankhelped to finance eleven urban development projects in Indonesia. The Urban I projectitself was responsible for the creation of two of the principal actors of HSL, namely BTNas a mortgage lending bank and Perumnas. The supervision of the Urban IV project (Ln.1972-IND) -the only other Bank financed operation that included housingcomponents -provided a testing ground for some of the components developed underHSL

8. MENPERA drafted a Housing Sector Policy Statement for the HSL Despite itsbroad title, the document dealt only with the formal system of housing delivery. Inparticular, it provided for raising BTN housing loan annual interest rates from the 5-9percent range to 9-15 percent. After the HSL was completed in 1992, the Governmentissued a revised policy document. While more comprehensive, the new document stillfocuses exclusively upon the formal system of delivery.

9. Housing sector policy guidance for the HSL came from a 1984 Bank urban sectorstudy on Indonesia which included a summary of a quick review undertaken the previousyear. Since then, the Bank urban sector strategy for the country has shifted towards urbaninfrastructure rather than housing as such. Bank lending options for housing in Indonesiahave recently been influenced by a 1993 Bank-wide policy document Housing: EnablingMarkets to Work. The new policy recommends that governments no longer focus upon thedirect financing and production of housing-as the Government of Indonesia did under theHSL-but instead should concentrate upon the provision of conditions for the privatesector to deliver suitable housing to the population.

Project Objectives and Description

10. The HSL was innovative in providing a line-of-credit to finance part of an existingmortgage lending program. A priori agreement on the HSL policy agenda was the resultof skillful project preparation in pursuit of a realistic and meaningful set of policy reforms.The HSL project also sought to improve the performance of the principal participants inthe project, making BTN and Perumnas operations more efficient. These agencies'serious organizational problems - BTN's loan arrears and Perumnas' large backlog of unsoldunits-were brought to light by careful project preparation. The HSL included actionsdesigned to help overcome these problems.

11. Project Objectives: (i) expanding housing finance for low and middle incomehouseholds; (ii) reducing overall subsidies and applying the remainder to lowest incomegroups; (iii) reducing housing sector dependence upon Government funds; (iv) stimulatingpublic and private developer production of low-cost housing; (v) generating employment;(vi) strengthening BTN and Perumnas; and (vii) assisting MENPERA in policydevelopment and monitoring.

10

12. Project Descnption: a program consisting of (i) financing mortgage loans to sub-borrowers; (ii) strengthening BTN; (iii) strengthening Perumnas; (iv) studies and technicalassistance.

Implementation Experience

13. Project start-up was relatively trouble-free with only minor delays. Having thepolicy agenda agreed a priori facilitated disbursements and minimized the need forconditionality. The volume of BTN mortgage lending picked up rapidly. All major studieswere implemented as planned. Supervision missions rated the project as being free ofmajor problems. The PAR estimates final projects costs-that were not given in thePCR-to be about US$1.4 billion, somewhat higher than the SAR estimate of US$1.2billion.

14. BTN's financial performance during implementation was mixed. The bank's assetstructure became more liquid, increasing its ability to meet maturing obligations, butreducing its capacity to provide mortgage loans. Key legal covenants of the HSL wereconcerned with BTN's finances. BTN was in compliance with covenanted minimum debtservice and debt to equity ratios. Despite its larger holdings of liquid assets, BTN'scurrent ratio fell to 0.8 during implementation, far below the 1.5 covenanted at appraisal.However, Government guarantees eliminated the prospect of BTN insolvency.

Results

15. Increased delivery of smaller units within the formal systen Thanks to the HSL,smaller, more affordable units-of 36 square meters floorspace or less-made up the vastmajority of housing financed during the HSL years. These important results, which arenot reported in the PCR, do suggest that the project succeeded in targeting benefitstoward lower income groups able to pay for such units. For the most part, these houseswere produced by private sector developers, while Perumnas' output fell continuouslyduring the implementation of HSL

16. Expansion of private real estate business: Private sector housing productionincreased as a direct result of the HSL, as the project intended. In parallel, the numberof firms setting up in the real estate development business grew by more than 65 percentover the 1986-1993 period.

17. Reduced dependence upon Government funding: The HSL project did not succeedin enhancing financial self-reliance. Cutbacks in Government funding by 1992 weretranslated into fewer mortgage loans awarded by BTN. The opportunity cost ofGovernment's subsidized funding of BTN rose from Rp. 3.2 million (US$1,960) per unit in1987 to Rp. 6.2 million (US$3,030) per unit in 1992, implying that subsidies continue at a

11

high level.' Large negative mortgage-to-prime interest rates reported for Indonesia by theU.N./Bank Housing Indicators Program, reveal that the country's formal delivery systemenjoys one of the most highly subsidized interest rates in the world.

18. Institutional strengthening: While executing the HSL, BTN's staff more thandoubled, and personnel costs as a share of total assets increased from 1.3 to 1.5 percent,presumably through higher staff quality. Both BTN Headquarters and large branchesmade considerable headway in automating their administration and operations through theuse of computers. Due to rapid technological progress in this area, however, systems putin place by the HSL had become obsolete and have already been replaced. The earliersolutions provided by the HSL did nevertheless serve as a catalyst in stimulatingcomputerization within BTN. Perumnas continued to experience many difficultiesimposed by fierce competition from private sector developers. During the HSL, its outputcontinued to decline and improvement in Perumnas' marketing performance was onlyslow. Toward the completion of the HSL, however, Perumnas' profitability rose followingincreased sales of houses that afforded greater gross margins for the company. As aresult, Perumnas' was able to report higher profitability in its recent financial statements.

Points of Special Interest

19. Housing policy and strategy: Policy recommendations made by HSL sponsoredstudies included: (i) strengthening community-based finance institutions (e.g. cooperatives,credit unions) to mobilize resources for housing; (ii) accepting commercial banks asretailers of mortgage lending giving them equal access to subsidies; (iii) introduction of up-front price subsidies to replace the present interest rate subsidy that discourages savingsand prevents other players from entering the market for housing finance; (iv) Governmentshould focus its efforts upon enhancing the effectiveness of informal system housingdelivery; (v) Government needs to redirect its housing efforts to lower income groups andeliminate subsidies of middle and upper income housing. Although housing policy inIndonesia was in a state of flux at the time of the audit, there still have to be a number ofdevelopments for policy to incorporate such recommendations. On the Bank's side,

1. According to the Region, the PAR's argument in this paragraph is flawed. Commentators from the Region believethe discussion of subsidies should focus eKclusively upon BT's extra income from the mortgage loan interest hike triggeredby the HSL, and regard this extra income as the equivalent of subsidies saved. This perspective treats BTN as if it were thesubsidizer. Since a key objective of the project was to reduce the reliance of the housing finance system on government funds,however, the audit believes that progress in reforming subsidies needs to be assessed more broadly and measured by the extentthat the housing burder on govammeufuance is auawatcd The audit thus treats the Government as the subsidizer and BTNas the administrator of these subsidies. In the view of the audit, BTN's additional income would be an important variable ofsubsidy reform only if this income were passed on to the Government itself, the originator of formal sector housing subsidiesin Indonesia. BTN could have done this through paying higher interest rates on subsidied funding provided through BankIndonesia liquidity credits, for instance. In practice, though, the terms and conditions of Government equity funding and BankIndonesia liquidity credits to BTN remained unchanged for most of the HSL The immediate result of raising BTN mortgageloan interest charges in 1987 was therefore to increase BTN's own interest spread, with favorable repercussions for the banksown profitability as financial statements demonstrate. Data in the PAR (paras. 3.15-3.20) demonstrate that Governmentsubsidized funding for the BTN housing program rose substantially over the 1987-92 period. For these reasons, continuedsupport for Government efforts at housing reform is important and the policy dialogue needs to recognize the key role of BankIndonesia in particular.

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however, the 1993 "enabling" housing policy document was a radical departure from thestrategy the Bank supported through the HSL in Indonesia, which had relied upon directdelivery of housing via the public sector. In calling for governments to move away fromthe direct delivery of low-cost housing, the new strategy implies a significant shift in policyin a country with a long track record in borrowing from the Bank for urban sectoroperations.

20. Who were the project beneficiaries? To the extent that the HSL led to the greatersupply of smaller, more affordable dwelling units, the project succeeded in its aim toexpand access to housing finance for lower and middle income households. Even so,expensive house enlargements observed during field inspections to BTN financed housingschemes is evidence that many beneficiaries have fairly high incomes. In 1988, prior tothe impact of HSL lending, the median income of households occupying BTN financedhousing was twice the median income of urban households as a whole. New surveys willbe necessary to learn the extent to which the HSL reduced this differential, if at all.These surveys could also verify whether there has been a reduction in governmentemployees' monopoly of BTN loans. In 1988, civil servants and military personnel, whoaccounted for only 18.7 percent of the general population, took 77 percent of all BTNmortgage loans awarded that year. Previously, under both Urban I and Urban IV, theGovernment's treatment of some BTN lending as if it were to finance a housing programspecifically for civil servants and military was highlighted by Bank supervision missions.

21. Arrears management: After allowing arrears to increase in the first years of HSLimplementation, BTN succeeded in reducing them to the equivalent of 2.1 percent ofhousing loan amounts outstanding by 1992. This was a significant achievement, especiallyas poor loan portfolio quality is a problem that is widespread in the Indonesian bankingsystem. .Examples from best practice arrears reduction in BTN's Padang and Surabayabranches gave some ideas about how the improvements were made. Computerizedinformation systems, automatic follow-up of arrears and effective action by BranchManagers on a case-by-case basis were essential ingredients of success. Earlier studiesshowed that, in most cases, arrears were not caused by borrowers' inability to pay, butrather their unwillingness to do so. This experience confirms that vigorous administrativeaction can bring loan portfolio receivables up-to-date.

22. What of the informal delivery system? A lesson of experience of the HSL showsthat more attention should be given the informal delivery system as a legitimate supplierof housing. HSL studies showed that housing solutions provided through the informalsystem are not confined to the realm of illegality. Of housing delivered through theinformal system, a bare 5.3 percent can be considered squatting, while as much as 37percent is occupied by households who have legal title to the land they occupy. Anotherimportant finding of these studies was that 85 percent of all Indonesian urban householdsenhance their housing conditions through building a new unit or improving their existingone by themselves. All these findings point to the need for Government policy torecognize the importance of the informal delivery system and provide support for resourcemobilization for home construction and improvement within it.

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Sustainability

23. HSL achievements in producing more smaller housing units were substantial, butwere sharply curtailed in the early 1990s as subsidized funding from the Government wasreduced. Returning to and sustaining the HSL program at its peak level achieved in 1989would therefore depend upon the resumption and maintenance of Government subsidiesat high former levels, something that contradicts stated Government policy. On the otherhand, the improved performance of mortgage loan repayments under HSL does helpsustainability. But, while interest rates remain subsidized, better arrears management byitself cannot relieve the strong dependence of BTN financing arrangements uponGovernment funding.

Conclusion and Lessons Learned

24. Ratings: The PAR agrees with the PCR findings that the outcome of the projectis satisfactory and its institutional development impact has been modest. The sustainabilityof project benefits has been downgraded from uncertain to unlikely due to fiscalconstraints and the project dependence upon government funding. During its mission, theaudit noted a growing awareness among policymakers of the need to address the issue ofcost recovery in the housing sector in Indonesia.

25. Sector Strategy: The audit endorses the PCR findings that future efforts toimprove the supply of affordable housing in Indonesia must focus upon the informalsystem of delivery and that Government's best efforts be directed towards facilitatingmarket mechanisms for housing finance and production. The experience of the HSLshowed how far one can go in improving the formal delivery system in its present form, asystem whose scope is ultimately constrained by the level of subsidies that can be financedby the Government.

26. Policy: At the sector policy level, the HSL succeeded in shifting priorities towardsmaller units. This was a substantial improvement within the formal delivery system itself.From the perspective of the housing market as a whole in Indonesia, however, its impactis somewhat diminished.

27. Subsidies: Despite the hike in BTN interest rates agreed prior to appraisal, theHSL did not succeed in reducing the dependence of the formal supply system uponsubsidies. If Government policy calls for the continuation of housing subsidies, analternative solution would involve once-off subsidies that reduce the price of housing tobuyers, with the balance of the purchase price being financed by loans at market rates andconditions. Monthly repayments could be at the same level as those presently charged byBTN. This would be a more efficient use of subsidies, and could help reduce distortionsin the financial sector.

28. HSL Studies as an X-ray of Indonesia's Housing Sector: Important studiessponsored by the HSL shed considerable light upon the workings of the large and complex

14

housing market in Indonesia. As well as confirming the dichotomy of the informal/formalhousing delivery systems, HSL studies also pointed out the need for improving theworkings of the housing finance market.

29. Project Preparation The HSL was a good example of a sectoral lending operationattached to a meaningful and realistic policy agenda. Successful a priori agreement onpolicy made project implementation much easier, and free of policy conditionality. In thisrespect, the preparation of the HSL was a model effort, which took into account theproject's important linkages with the financial sector agenda. The seriousness with whichboth sides took the policy commitment is confirmed by the fact that the sector agenda wasnot harmed by the new macro-adjustment role the Loan proceeds acquired shortly afterappraisal.

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1. Background

A. Introduction

1.1 With the number of urban households in Indonesia expected to grow by more than6 percent per annum through to the end of the century, constantly increasing demand forhousing will continue to be a key feature of the country's future development. Upward of500,000 dwelling units have to be added to the housing stock each year. Indonesia'shousing market is a very large one. After all, the country has the fourth largestpopulation in the world. Within this market, there are two distinct systems of housingdelivery. In this report, they are described as an informal delivery system, through whichmost additional housing is supplied, and a formal delivery system, responsible for only aminority of new housing units. Some of the key characteristics of each of these twosystems are summarized in Table 1.1.

Th L1 is Choaemutm of Houing Mrta Deivery Sysims

INFORMAL DELVERY FORMAL DElVERY

Total mke shaerk More than 80 percent Lan than 20 peet

Role of gverment No direct assistance Support through BI, PERUMNAS, and privatc reale demopers

Credit mechanisms Family/commun.ry based (no government subsidies) Subsidized oam from 8IN and employers

House ontuction: Mostly expansion and improvement of existing dwelling Production of new, single family units by PERUMNASthrough households' own efforts o privae developers

Hous tenure Secure Secure

Land Lanure: Insecure Secure

Home structure quality. Varied with much sub-standard housing All boming meets olicially adopted standards

Infrasatrte quality Mostly inadequate Adequate

Income levels serve& Entire range, particularly low incomes Moderate to high incomes

1.2 The Housing Sector Loan evaluated here aimed to make improvements in theformal delivery system only. Even though this system accounted for only a minority ofhousing supplied in Indonesia-less than 20 percent of the'total-it was still responsiblefor a large output in absolute terms. Between 1987 and 1993, annual sales through theformal delivery system were in excess of 70,000 housing units.

B. Macroeconomic Context

1.3 Indonesia's economy was buoyant during the identification and preparation of theHSL. GDP increased by more than 6 percent in 1984, the year prior to appraisal. HSLwas a product of expectations of uninterrupted growth and the ability of rising oil

16

revenues to finance an ample Government subsidy program to support housing supplythrough the formal system. During the HSL appraisal mission in October 1985, however,it became apparent that Indonesia's economy was badly hit by falling world prices for oil,then the country's main export commodity. HSL's project design remained unaltered, butthe Bank Loan funds suddenly acquired a new role: to help sustain the Government'shousing program for Repelita IV (1984/85-1988/89 Five Year Development Plan) whichmight otherwise have been curtailed. Unexpectedly, and with no prejudice to its sectorpolicy agenda, the HSL became part of the Government's macro-program during thecountry's second adjustment period 1986-1988.'

1.4 Through the wide range of measures adopted with good effect, Indonesia'smacroeconomic adjustment was quick and successful. After falling back to 1.9 percent in1985, annual GDP growth rose to more than 6 percent for the remainder of theimplementation of the HSL Constraints on public sector financing persisted, however.

C. Implication of Financial Reforms for the Housing Sector

1.5 Part of Indonesia's adjustment program took effect through a series of financialreforms that had major implications for the housing sector. Among the key measureswere:

* 1983 - elimination of credit and interest rate ceilings (this paved the wayfor the upward adjustment of interest rates on BTN housing loans thattook effect in 1985, before interest rate adjustments in most other sectors).

* 1983 - reduction of state banks' dependence upon Bank Indonesia's (BI)highly subsidized liquidity credits (this forced BTN to search for alternativesources to mobilize resources).

* 1988 - institution of a reform package stimulating more competition in thebanking system, by allowing all banks-including foreign ones-to open morebranches (wider offer of alternative savings products competed with savingsfor housing).

* 1991 - BI's higher risk adjusted capital requirements of banks-in line withinternational standards of the Bank of International Settlements inBasle-to be phased over following two years (meaning tighter control overBTN lending).

* 1992 - approval of a new Banking Law to consolidate above reforms.

2. (World Bank 1993a. p. 148-149).

17

1.6 These reforms helped deepen Indonesia's financial sector. By 1991, there werenearly twice as many banks as there had been in 1983 (the year the HSL was identified).?Since 1988, some 1,200 new companies have set up in the business of financialintermediation." Meanwhile, banking assets grew annually at over 18 percent during the1988-92 period.

1.7 Indonesia's current financial depth has recently been estimated at 50 percent,'placing the country today midway within the range of its East Asian neighbors.' Yet,when the HSL was being prepared in 1984, the country's financial depth was only 21percent. In such a shallow financial system, the almost total dependence of housingfinance upon a single state bank such as BTN was understandable. Financial deepeningfollowing the reforms should allow other players to be more active in the country'spotentially huge market for housing finance. Greater private sector participation would benecessary for new financial products to develop effectively, such as bonds backed by asecondary mortgage market, an idea that is being discussed in Indonesia at the time ofwriting.

1.8 Some pre-reform features of the financial system still persist today, however.Despite the reduction of Bank Indonesia liquidity credits, this subsidized financingcontinues to distort the allocation of credit, according to a recent Bank report.! BIliquidity credits, some of which carry interest rates of only 3 percent per annum, stillconstitute the main item on BTN's balance sheets up to the present time (details. Table3.3).

D. The Housing Sector In Indonesia

1.9 Urban Development Although only 32 percent of Indonesians live in urban areas,the country's very large total population (184.3 million in 1992) guarantees a sizablemarket for urban housing. Indonesia thus boasts an extensive urban network. RecentU.N. estimates for the populations of urban agglomerations in Indonesia in 1995 are asfollows: Jakarta (11.2 million); Bandung (3.0 million); Surabaya (2.8 million); Medan (2.2

3 (Id Ip. 239)

4. (bd).

5. (World Bank 1994a. p. 79).

6. (1Nd) Financial depth is measured as the ratio of broad money (M2) to GDP.

7. (Wd.) For 1990, the fnancial depth of the following East Asian countries wa Japan (117 percent); Thailand(75 percent) Malaysia (67 permat); Indonesia (43 percent); Philippines (34 percent) and Korea (40 percent). Source:(UNCHS/World Bank 1993. Table 1).

& (World Bank 1994a. p.p. 82-83).

18

million); Semarang (1.5 million) and Palembang (1.4 million). Including the capital andmegacity of Jakarta, all these urban agglomerations are on the islands of Java andSumatra.'

1.10 Infonnalformal delivery systems Housing is supplied through these systems in allmajor urban centers in Indonesia in the 80:20 percent shares mentioned previously.Informal delivery must have been less prominent in the past, as only 69.8 percent of thenation's housing stock was found in 1988 to be informally supplied, judged by its notmeeting minimum structural and infrastructure standards. Nevertheless, formal housingsupply supported by housing loans with below-market interest rate-almost exclusivelythrough BTN-expanded considerably in Indonesia since the mid-1970s. Even so, receivingsuch a loan is only a remote possibility for the majority of the population. It wasestimated in 1988 that only 2.4 percent of all owner-occupier households in Indonesiancities became homeowners by means of a BTN loan.*

1.11 Owner occupied versus rental housing Some 56 percent of all urban households inIndonesia own the houses they occupy, a relatively high proportion by internationalstandards (comparisons: Table A.1 in annex). For those who wish to procure it, homeownership is fairly easy to acquire in Indonesia. Unlike regulations for Land ownershipwhich can be complex, rules for home ownership are fairly straightforward, and allow ahousehold to obtain reasonably secure tenure of a low-cost unit inexpensively. Althoughrenters constitute only 26 percent of all urban households, rental housing is nevertheless asolution for a larger proportion of low income households, especially those living in urbankampungs.11

1.12 Environmental conditions In the past, these were very favorable for low-costhousing in Indonesia's cities, both informally and formally supplied. Residents couldusually draw ground water from shallow wells on their own plots even in central areas oflarge cities, for instance. Amenable soil conditions eased drainage, making simple on-sitesolutions for collection and treatment of effluent possible. These initially benignconditions have given way to serious urban environmental crises in major cities, especiallyJakarta. The soil's carrying capacity for housing has reached saturation point in manyplaces, as populations have grown and become more dense and basic infrastructureremains inadequate. In Jakarta, for instance, it is well known that seepage of sea waterhas contaminated surface wells throughout much of the city as a result of excessive

9. Population data taken from (United Nations 1993 - Table AHl).

10. (Struyk 199o. pp. so and 59).

H1. Urban kapaw are mbed income "compounds" or neighborhoods loated i central and peripheral asethroughout Indoasia's ctis, usually behind properties roting main roads, as well as along railway lines and canal bank. Mostae not slums or ghettos in the westcrn sese, since many km g residents enjoy some legal title to their homes and some haemiddc to high incomes. For a detailed discussion of the role of rental housing in Indonesia, including the ubiquitous ?ak andGubuk row units, ce: (Hoffman, M. 1992).

19

drawing of fresh water from them.

1.13 Housing quality By the standards of internationally used housing indicators, thequality of Indonesia's urban housing stock is below that of its East Asian neighbors, buthigher than other countries with a similar GNP per capita (comparisons. Table A.1 inAnner). Indonesian housing provides less floorspace than that of its neighbors. On theother hand, there is less overcrowding in Indonesia than in other Asian countries,measured by the number of persons per room. Most significantly, only two thirds ofIndonesia's housing stock is made up of permanent structures, compared with more than80 percent in all comparison countries. As already mentioned, urban infrastructureservices in Indonesia are poor. Only 66 percent of houses have water connections, fewerthan all East Asian countries except the Philippines.

1.14 Institutional arrangements By definition, organized institutional arrangements areconfined to the formal system of housing delivery. The main players, all of whom wereinvolved in the HSL project, include:

* BTN-the state-owned savings bank responsible for implementing theGovernment's mortgage lending program. BTN's mortgage lendingactivities began in 1975 under the Urban I project (details: para. 1.17) atthe behest of the Bank.

* Bank Indonesia -Indonesia's central bank and the largest single financier ofthe Government's subsidized mortgage lending program, which was activelyinvolved in the HSL project.

* Private real estate developers-firms that execute housing projects eligible forBTN mortgage lending, and which form the association REI (Real EstateIndonesia).

* Perum Peumnas (Pemusahaan Umum Pembangunan PerunahanNasional) - the State Developer of low cost housing similarly financedthrough BTN. Under the purview of the Ministry of Public Works,Perumnas was established in 1974 through the Bank financed Urban Iproject (details: para. 1.17).

* MENPERA (Kantor Mentei Negara Perumahan Rakyat) -the Office of theState Ministry of Housing is responsible for supervising the implementationof housing policy through the formal system.

* BKPN (Badan Kebijaksanaan Perumahan Nasional) -National HousingPolicy Board is an inter-ministerial committee for formulating housingpolicy in Indonesia.

*

20

1.15 There are other important agencies involved in the formal system of housingdelivery, but which were not directly involved in the HSL project. They include (a) PTPapan Sejahtera -a mixed state/private agency supported by IFC, now fully privatized, thatis responsible for providing high income mortgage loans for house purchase but only on asmall scale; (b) local authorities, especially Kabupaten and Kotamadya at the city level,who are responsible for the release of urban land for housing development; and (c) BPN,formerly Agraria (National Land Agency) -responsible for formal titling of residentialdevelopments.

E. Bank Involvement

1.16 Since the appraisal of the Urban I project in 1973, the Bank has consistentlysupported the Government's urban development program, if not always its housing aspect.To date, the Bank has financed eleven urban development projects, six of which havebeen completed and audited by OED. Only two of these projects had explicit housingcomponents, however. These were sites and service schemes supported by Urban I (Loan1040-IND) in Jakarta and by Urban IV (Loan 1972-IND) in five more locationsthroughout the country. Urban IV also provided technical assistance to BTN andPerumnas for staff development and the introduction of computer systems. Thesupervision of Urban IV project provided a testing ground for some of the componentsdeveloped under HSL

1.17 Of these earlier experiences, the most important Bank initiative in Indonesia'shousing sector came under Urban L Upon the recommendation of the Bank, the Urban Iproject provided for the creation of a new agency, then called in English the "NationalUrban Development Corporation" (NUDC), which later became more widely known by itsBahasa Indonesia acronym of Perum Perumnas or simply Perumnas. OED's audit of thatproject concluded that the creation of Perumnas was an important direct result of theUrban I operation. Correctly noting in the early 1970s that Indonesia's financial systemlacked a mortgage-backed instrument to finance house purchase, the Urban I projectmade another important innovation. It assigned the responsibility to BTN to introduce amortgage lending system to Indonesia. At that time BTN was only a traditional savingsbank with no previous experience in housing finance. Thus, two of the key players of theHSL project evaluated here were themselves the products of the first urban developmentoperation supported by the Bank in Indonesia more than a decade earlier. Supervision ofthe later Urban IV project provided important learning experience for the Bank ofimplementing housing components through these two agencies.

12. World Bank (1983), Indonesia Jakarta Urban Dewdopna Project (Loan 1040-IND) Project Performance AuditReport, Operations Evaluation Department, June 30, 1983. Report No. 4620.

13. The audit noted, bowever, that Urban I gave inadequate technical support for the accessary institution buildingof the mortgage sytem which was completely untried in Indonesia at that time. Jid

21

1.18 There are two reasons for the intermittent nature of Bank involvement in thehousing sector in Indonesia between Urban I in 1973 and the HSL in 1986. The Bank didnot feel comfortable with Government policy giving priority to civil servants in allocatingBTN financed housing. The Bank also favored lower dwelling unit standards than thosepreferred by the Government so that lower and middle income beneficiaries would havegreater access to housing. Nevertheless, significant policy development in 1985 (details:pam. 2.1) enabled Government and Bank to agree an agenda for the HSL

1.19 Despite Government expressions of interest and a request to the Bank for asecond loan as recently as December 1993, a follow-on HSL-II project was notforthcoming at the time of the audit. As early as March 1988, though-only eighteenmonths after HSL-I itself became effective-Bank missions held discussions about apossible HSL-I. In the view of the Bank, a second project was justified because itplanned to eliminate the interest rate subsidy and to allow other banks, apart from BTN,to participate in house finance. With Government supporting such policies, HSL-IIpreparation went as far as appraisal, reaching agreements on a timetable for endinginterest rate subsidies and arrangements for five other banks -themselves appraised by theBank-to participate in house financing. The Government's position changed after theHSL-II appraisal, however. Through the Ministry of Finance and Bank Indonesia, theBank learned that interest rate subsidies would continue in a housing finance system stillto be dominated by BTN in Indonesia. Given the Government's apparent lack of interestin supporting a market-based strategy for housing finance, work on HSL-II wasdiscontinued. According to the Bank, the HSL-I strategy of increasing mortgage lendingby doubling the size of a single agency (i.e. BTN) had exhausted its limits. The next stagewould involve broad participation and more intensive competition among state and privatebanks in Indonesia's deepening financial system. At the time of the audit, this approachhad yet to be incorporated into Government policy for the sector.

F. Government Policy and Bank Strategy

1.20 For HSL preparation, MENPERA drafted a Housing Sector Policy Statement(HSPS)." It stated Government policy on only one aspect of the sector, however,namely the formal system of delivery. It provided guidelines for the mortgage financeprogram of Repelita IV until 1989, which the HSL was to support. The principalinnovation was raising interest rates on BTN's housing loans from the 5-9 percent range to9-15 percent and increasing down-payment requirements of borrowers. The HSPS'sobjectives were identical to those of the HSL itself (details: para. 28). The Statement'ssilence on broader policy aspects affecting the informal system of housing was notaccidental. It followed strict line responsibilities of the ministries in Jakarta. Buildingstandards and the provision of urban infrastructure, not discussed by the HSPS, are withinthe domain of the Ministry of Public Works, for instance. The question of which financial

14. This was based upon MENPERA's policy directive Surat Kepuauan No. 08/KPMS/1985, a summary Englishtranslation of which was included as Annex 10 of the HSL-SAR.

22

intermediaries should participate in housing finance, also not analyzed, is a matter for theMinistry of Finance and Bank Indonesia.' In this sense, the HSPS was a clear andthorough statement that helped guide the HSL, but it only covered housing from a strictlydepartmental point of view, as formally perceived by one Government department. Evenso, the State Minister of Housing was the Government interlocutor for the sector, and aninfluential one.

1.21 After the HSL, BKPN updated Indonesia's housing policy through issuing a newNational Housing Policy and Strategy (NHPS) in 1992." The policy covers many aspectsof the formal delivery system, especially highlighting the need for new lending instrumentsto finance home improvement and rental housing. The appreciation of the document by awider audience beyond Indonesia itself has no doubt been constrained by its not yet beingavailable in an English language version.

1.22 For its part, the Bank's approach to Indonesia's housing sector at the time HSLwas prepared was guided by a country urban sector study of 1984, which included asummary of a quick housing study undertaken the previous year.' Although this studyacknowledged that the great majority of housing in Indonesia was supplied through theinformal system, the report recommended that Bank support be focused upon improvingthe performance of Perumnas, the state developer within the formal system." It alsorecommended the upward adjustment of interest rates on BTN mortgage loans." The1984 report was thus the precursor of the HSL

1.23 Since 1984, Bank urban sector strategy in Indonesia has focused upon urbaninfrastructure rather than housing per se." On the other hand, financial sector reform,which has direct implications for housing finance, has been a central and recurrent themeof Bank country economic memoranda on the country.

1.24 In the absence of a country-specific housing strategy, the Bank's new housingpolicy document - issued in 1993 after HSL was completed - guides the sector lending

is. Bank Indonesia was, of coune, heavly invoKed in the issues and decisons concerning mortgage lending rates.

16. Badan Kebijakanaan Perumahan Nasional (BKPN) Kebijakanasn dam Sonai Nasional Pamahap Edisi IJakarta, September 1992.

17. (World Bank - 1984).

18. Ibid. pp. 92-94.

19. Ibi pp. 193-196.

20. See, for example. (World Bank 1994b). This dociment does not indude proposals epcitly for owing withisits sectoral agenda.

23

strategy in Indonesia, as it does in other countries.' The new policy's "enabling"approach recommends that governments no longer focus upon the direct production ofhousing, as they had under HSL and earlier projects in Indonesia. Instead, governmentsshould induce reforms and simplify regulations to make the delivery of housing and theprovision housing finance more efficient through greater competition between public andprivate sector actors. Although this policy was not conceived specifically for theIndonesian context, it does represent an important policy shift affecting future Banklending for housing in Indonesia. The older approaches, represented by Urban I, UrbanIV and the HSL itself, are now outdated.

1.25 At the time of the audit, the Bank's new and very recent housing sector strategyhad yet to be tried in Indonesia. The new strategy implies a significant shift in policy in acountry with a long track record in borrowing from the Bank for urban sector operations.It poses a major challenge for all involved. If continued Bank lending for housing inIndonesia remains an objective, both Government and Bank would have to closely re-examine the parameters of earlier lending (including that of the HSL) to adjust and adaptthem to current policy standards.

21. (Word Bank. 1993b).

24

25

2. The Project

A. *Wholesaling a Sector Policy Agenda

2.1 The HSL was an innovative form of Bank lending for urban development inIndonesia. Earlier urban projects had "retailed" Bank Loan proceeds to finance particularphysical projects identified beforehand in chosen cities. In contrast, the HSL provided fora line-of-credit to BTN to help finance part of its existing mortgage lending program(KPR). Specific physical development projects eligible for HSL funding were notidentified in advance. Instead, all parties to the HSL project agreed on basic programparameters beforehand, notably the size of the houses to be financed and the terms of thehousing loans to be made. In this way, Bank Loan proceeds were "wholesaled." Followinglengthy discussions during HSL preparation, the Government agreed to make thefollowing changes to its policy.

* reduce housing subsidies by aligning BTN lending terms more closely withthose prevailing in Indonesia's financial markets (annual interest rates wereincreased from the 5-9 percent range to 9-15 percent and average down-payment amounts were also increased).

* explicitly redirect BTN's mortgage lending in favor of lower income groups.

* encourage private developers to produce low-cost housing by allowing themto supply smaller units (that were formerly the exclusive prerogative ofPerumnas).

In addition, both BTN and Perumnas undertook to improve their efficiency andeffectiveness in accordance with institutional action programs agreed within the scope ofthe HSL

2.2 An important feature of the HSL experience was that the Government and theBank agreed the HSL sector policy agenda before project appraisal. This result reflectedskilled project preparation in pursuit of a realistic and meaningful set of policy reformsacceptable to both Government and Bank. Subsequent approval of the HSL itself wasformal recognition by the Bank of the important housing policy progress made by theGovernment. This a priori policy reform therefore avoided policy conditionality todisbursements during implementation that is characteristic of much lending in the sector.

26

B. Operational Improvements by the Principal Actors

2.3 The HSL sought to improve policy-making by MENPERA and to increaseefficiency by the two principal Government agencies involved in formal system housingdelivery, BTN and Perumnas. The project assigned the most prominent implementationrole to BTN. Since changes in the policy agenda were already achieved, BTN and, to alesser extent, Perumnas, had the responsibility of putting the new policies into effect. TheHSL provided technical assistance to help all three agencies achieve their goals. Specificperformance targets were agreed with BTN in terms of explicit financial ratios to achieve(details: paras. 3.6-3.9). Reduction of severe arrears in the repayment of BTN loans alsofeatured strongly in the HSL design. HSL assistance to Perumnas focused appropriatelyupon improving that agency's weak marketing capabilities, especially in helping it toreduce a large backlog of unsold units that came to light during the supervision of UrbanIV.

C. Issues in Project Preparation

2.4 Government's initial reluctance at project identification to make BTN mortgageloans more expensive to borrowers by raising interest rates as the Bank suggested, ensuredthat the policy dialogue during preparation was an intensive one. Staff of the Bank'sResident Mission in Jakarta played an important role in these discussions. Preparationmissions' persistence in pursuing the desired changes at a time when the Government wasbeginning an overall reform of the financial system (details- para. 1.5) bore fruit. At anunexpected meeting with the State Minister of Housing during the pre-appraisal mission,the Government informed the Bank of its decision to raise BTN interest rates. Thissignaled the go-ahead for the appraisal of the HSL and spurred the final preparation ofthe project.

2.5 During preparation, the Bank was fully aware of the organizational weaknesses ofboth BTN and Perumnas. Some staff even advised that problems with BTN were so greatto preclude an operation on the scale of the proposed HSL with such an agency. Missionstudies of BTN finances were thus particularly thorough. The serious problemsidentified -such as BTN mortgage loan arrears, and Perumnas backlog of unsoldunits -were made very transparent by preparation work. The HSL design itself attemptedto incorporate some solutions to the problems identified. Wisely, the project design didnot promise miracles and project objectives were not pitched unrealistically high.

D. Project Appraisal

2.6 With agreement on the HSL policy already secured, project appraisal could focusupon fine tuning arrangements for implementation. In particular, the mission was able toconcentrate upon the details of HSL's proposed technical assistance as well as thestructure of the proposed housing policies study (HIPS).

27

2.7 HSL funding acquired a new significance during appraisal. Tightening publicfinances following eroding oil prices meant HSL Loan proceeds became necessary tofinance the Government's housing program for the remainder of Repelita IV The urgentfunding requirements, notwithstanding a 31 percent devaluation of the Rupiah shortlybefore the HSL appraisal mission, gave project appraisal a higher priority. On the otherhand, a number of technical factors delayed processing. The status of BTN's financialstatements was always a cause of concern. It took some time to clarify which statementshad been audited and which financial reports were final. Factors such as thesenevertheless gave HSL staff on the Government and Bank sides more time to considerongoing macroeconomic changes in Indonesia. The 45 percent devaluation of the rupiahin September 1986 came too late for the HSL Loan amount to be reduced. Predictably,US$75 million of the US$275 million Loan had to be canceled shortly intoimplementation.

E Project Objectives and Description

2.8 The objectives of the HSL were a relevant and realistic set of aims based upon thepolicy agenda agreed beforehand. They were the direct outcome of a prolonged andintensive policy dialogue between the Government and the Bank during preparation. Asper the Loan Agreement (Schedule 2), these objectives were to:

(i) expand access to housing finance for low and middle incomehouseholds;

(ii) reduce overall subsidies by the Borrower and apply the remainingsubsidies to the lowest income groups;

(iii) reduce the reliance of the housing finance sector on funds from theBorrower and introduce new instruments for resource mobilization;

(iv) stimulate the production of more low-cost housing by public andprivate developers;

(v) generate employment at low foreign exchange cost;

(vi) strengthen the key institutions in the housing sector, namely BTNand Perumnas; and

(vii) assist the Borrower's Office of the State Minister for Housing indeveloping and monitoring housing sector policies and programs.

2.9 Separate project components were not built around each of these objectives.Instead, the HSL aimed to fulfill its objectives through implementing the following

28

program, described in detail in the Loan Agreement (Schedule 2):

Part A: Financing of the development of housing sub-projects through theprovision of mortgage loans to Sub-borrowers.

Part B: Strengthening of BTN's operational performance and managementthrough technical support and acquisition of related equipment.

Part C: Strengthening of Perumnas' operational performance andmanagement through technical support and acquisition of relatedequipment.

Part D: (1) study of urban housing market focusing upon demand patternsand supply constraints; (2) post-construction evaluation of low-cost housingprojects; (3) study of land titling problems; (4) technical assistance toMENPERA for policy analysis.

210 Project design was straightforward, being grafted on to the Government's existinghousing program. Nearly all project costs -99.5 percent of the total -were incurred throughfinancing the mortgage lending program. Although only 0.5 percent of project costs wereaccounted for by technical assistance and studies, these were 100 percent Bank financed.Involving expenditures of US$6.1 million, they constituted a significant effort to shed newlight upon the workings of Indonesia's vast and complex urban housing markets.

29

3. Project Implementation and Results

A. Start up and Implementation

3.1 The HSL's agreed policy package boded well for a rapid project start-up. Minordelays occurred because of slow appointments procedures for consultants to implementnew management systems within BTN. Even so, loan effectiveness was declared inDecember 1986, only three months later than planned.

3.2 Thanks to the HSL, BTN mortgage lending in Indonesia expanded significantly.By 1989, BTN's annual award of housing loans exceeded 100,000. This was more thantwice the level achieved prior to the HSL (details- Table 3.2). These loans helpedphysically transform the urban peripheries of Indonesia's main cities, through stimulatingthe construction of new low and middle income housing estates of single family homes byPerumnas and private developers. All major studies foreseen under the project werecompleted as planned. The PCR does not include a re-estimate of the project economicrate of return (ERR). Using imputed rental values of completed units to measure projectbenefits, the SAR estimated the project ERR to be 15 percent. The audit was unable tofind a more up-to-date ERR estimate, nor did it appear that the surveys of rental datathroughout Indonesia - needed as inputs to ERR calculations - had been undertakenrecently. Given the buoyant demand for low-income housing in Indonesia, however, thereis no reason to expect the final project ERR to be significantly lower than the appraisalestimate.

3.3 Supervision missions rated the project to be free of major problems throughoutimplementation. Overall, the mortgage lending component of the project wasimplemented more smoothly than the more innovative studies and technical assistance.Delays in implementing the latter required the extension of Loan closing by one year.The HSL was thus implemented in six years, against an appraisal plan of five. BTNmortgage lending, during the years that HSL was implemented, accounted for 99.5 percentof the total costs of the project. Measuring costs in this way, as was done in the SAR, thePAR estimates final project costs as US$1,428.3 million (Rp.2,326.9 billion), somewhathigher than the appraisal estimate of US$1,202.6 million (Rp.1,322.8 billion).

B. Financial Performance

3.4 BTN's financial performance during implementation was mixed. Its level of lendingincreased sharply, but profitability was only modest and declining. BTN's liquidity ratio,defined as current assets: total assets, increased during implementation from 16.2 percentin 1985 to 30.1 percent in 1992. Although this trend has placed BTN on a more soundfinancial footing, it means that only 59 percent of BTN's assets are now made up of

30

housing loans, against 85 percent at the time of appraisal. In better matching its assets toits liabilities, BTN's own capacity to finance housing has been reduced.

3.5 To obtain a better term balance of its liabilities, a bank specializing in long-termloans for housing like BTN will always be under pressure to hold more liquid assets Toachieve this, the bank would have to diversify in offering more short-term products. Animportant lesson of the HSL therefore could be that long-term assets in the form ofmortgaged housing loans should be held by many financial intermediaries, each with avaried portfolio of loans at different terms. Eventually, housing loan products would beavailable throughout Indonesia's financial market BTN itself could also diversify its ownoperations through providing a broader range of banking services.

3.6 In order to help stimulate BTN to improve its financial performance, HSL legaldocuments required BTN to meet specific financial ratios and report progress regularly tothe Bank The fulfillment of most of these conditions indicates that compliance with legalcovenants was, for the most part, satisfactory. Details are given below.

3.7 Debt service ratio. understood as net revenuesdebt service requirements, the HSLrequired BTN to maintain a minimum ratio of 1.2 (HSL-PA 4.02(a)). Throughoutimplementation, BTN surpassed this requirement in observing a ratio in the 1.4-1.7 range.The satisfactory result depended a lot, of course, upon the availability of low cost BankIndonesia liquidity credits to BTN.

3.8 Curent ratio: defined as cumnt assetswcurrent liabilities, this was covenanted to benot less than 1.5 (HSL-PA 4.03(a)). BTN's short-term solvency, as measured by this ratio,unfortunately deteriorated sharply. BTN's current ratio fell from 1.5 at appraisal to the0.8-0.9 range during the implementation of the HSL, reflecting BTN's weak capacity tomeet unanticipated calls on its current deposits. With Government guarantees backingit, BTN is unlikely to become insolvent in practice, of course. The low current rationevertheless reflects how BTN still remains isolated and protected from real financialmarket conditions prevailing in Indonesia today.

3.9 Debt to equity ratio: was agreed not to exceed 6:1 (HSL-PA 4.04(a)), when BTN'sdebt to equity ratio at appraisal was little more than 3:1. Such a low ratio made it seemunlikely that BTN would become too highly leveraged, but increased borrowing (from theBank and BI), with only modest additions to BTN's subscribed capital, did raise the debtto equity ratio to more than 5:1 by 1992. Ilis was still not a very high level for adevelopment bank, however. Nor does this trend indicate a weakening of BTN's capitalstructure, since most of its borrowing remains in the form of Bank Indonesia liquiditycredits, which are quasi equity. Should Government policy dictate, their repayment terms

22. It should be mentioned that there ar a number of adoministrative restrictions to prevent savers withdrawing theirfunds immediately.

31

could no doubt be easily renegotiated if the need should arise.

3.10 In the future opening up of Indonesia's housing sector, the market's assessment ofBTN's financial performance will be strongly influenced by the quality of its loan portfolio,which has unfortunately been marred by the problem of extensive arrears in repayments.Because of its importance to the HSL, the issue of arrears management and results isdiscussed at a point of special interest later in this report (paras. 4.9-4.14). Despite theproblems noted, BTN was nevertheless able to successfully float five-year bonds on threeoccasions during the implementation of the HSL

C. Increased Delivery of Smaller Housing Units within the Formal System

3.11 Thanks to the HSL, formal housing delivery in Indonesia shifted sharply in favor ofsmaller more affordable units, defined as those with 36 square meters of floorspace or less.During the HSL years (1987-93), 87 percent of all housing financed by BTN consisted ofsmaller housing units (details: Table 3.1). Prior to the HSL, only 39 percent of BTNfinanced housing was made up of such smaller units. By examining data upon the share ofall BTN financing going to smaller houses, the PAR hopes to shed some light upon thetargeting of the housing program toward lower income households, an important aspect ofthe project not covered by the PCR. Currently, 36 square meter units are eligible forBTN housing loans of up to Rp. 13.0 million (US$6,100), equivalent to 90 percent of thecost of the house. For such a house the borrower household's maximum income is Rp. 0.9million (US$418) per month, evidently not the lowest income group. Neither is it thehighest income group. The HSL achievement in stimulating the production of thesesmaller houses should not be under-estimated, however. The audit mission learned thatsome parliamentarians in Jakarta had complained that BTN was unfair in not providingmortgage loans to higher income groups.

Table 3.1 - BTN financed housing in Indonesia 1985-1993

Smaller Units 36m2 and less) Larger Units ( ore than 36m2) Totalnumber % of total number % of total number

betore HSL:1985 11.659 25% 35.576 75% 46.2351986 40,589 47% 46.051 53% 86,540

sub-total(1985-86) 62.248 39% 81.627 61% 132.875

after HSL:1987 45467 70% 19,486 30% 64.9531988 78.970 88% 11.116 12% 90.0861989 98.565 87% 15,033 13% 113.5981990 52.421 89% 6,655 11% 59.0761991 45 331 94% 3,094 6% 48.4251992 43.813 91% 4,472 9% 48.2851993 61.010 92% 5,193 8% 66.203

sub-total (1987-93) , 426,577 87% 66.048 13% 480.626Source. BTNNotes include both Perumns and Prvate houstng and 'Packet B* as well as 'Packet A' mortga* loans

32

3.12 The HSL project succeeded in stimulating the delivery of more low cost housing bypublic and private developers. Actual production figures are difficult to ascertain,however, as private developers report only houses that they sell, not houses that theybuild, some of which might remain unsold. Assuming that private developers' unsold unitsare not a major factor, however, BTN data on housing loans awarded by size of unit andby type of developer, can plot underlying trends in the production of smaller units (lessthan 36 square meters), as illustrated in Fig. 3.1.

Fig. 3.1 Annual Sales of Low-cost Housing in Indonesia 1985-93

8000070000

Ia 2so 2

6 0000

4 0000

2000010000 - -

0 Private developers

1951986 1991Prurmas

Source BTN 1992 imNote unuts of 36rn2 or-les

3.13 Perumnas' output of smaller units peaked prior to the effectiveness of the HSLThe project's noteworthy impact was upon the delivery of these units by privatedevelopers, which soared ahead in 1987 and 1988 as soon as HSL Loan funding becameavailable. Initial gains were not sustained, however, as output declined sharply in 1990and thereafter. The continued fall of Perumnas' output reflects the difficultiesexperienced by the state developer over this period (details: paras. 3.26-3.28). It is tooearly to say whether upturns in 1993 are the beginning of a new trend towards recovery byboth private and public developers. If recent decisions are an indicator, the production ofsmaller units through the formal system is unlikely to recover to the peak levels achievedunder the HSL Significantly, BTN introduced a new product, namely the Packet CMedium Cost House Loan" in May 1993. There is no restriction on the size of house thistype of loan may be used to finance, nor is there a maximum income level for eligibleborrowers. At the time of the audit, the ceiling for Packet C lending was Rp. 50 million

33

(US$23,700) and interest was levied at 26 percent per annum.

D. Expansion of Private Real Estate Business

3.14 By stimulating greater output of small houses by private developers, the HSLencouraged new businesses to set up in the real estate sector in Indonesia (detais. Fig3.2). This was an important and positive result of the project. Prior to the HSL in 1986,the professional association Real Estate Indonesia (REI) had 605 members. It latest rollcount is of some 1,000 members. Especially in the slumped market conditions at the timeof the audit, that such a large number of firms continue in business is a positive result.Competition has forced the state developer Perumnas to try and make its operations moreefficient, although it has lost market share at the same time.

Fig. 3.2 Indonesia: Private Developers 1986-93(No. of firms affiliated to RB)

E.~~~ Depeden. of Formal Syste upo G. vernmen Fun. ... Su..sidies.

1000.

800-

600

300 Z

200.

1986 1987 1988 1989 1990 1991 1992 1993S.a.. R=d Essevsee

E. Dependence of Formal System upon Government Funding - Subsidies

3.15 In trying to reduce this dependence, the HSL was not successful. BTN receivedmuch less Government funding at the completion of the HSL (in 1992) than it did whenthe project began in 1986 (details. Table 3.2), but the fall was accompanied by aproportional cutback in the number of new housing loans approved by BTN (details: Table3.1). Subsidized BI liquidity credits, temporarily relieved from financing BTN while theHSL was being disbursed, again became an important source of funding. Non-

34

governmental sources of funding have yielded only modest results. BTN bond floatationin 1989, 1990 and 1991, for instance, did raise some Rp. 50 billion in each year. Theyhave since been discontinued as BTN continues to look to the Government as its principalsource of funding. Such dependence is reciprocated insofar as the Government continuesto see BTN as its principal housing policy instrument

Table 3.2 - Government Sources of Funds for BTN 1986-92

(in billions of ru am)1986 1987 1988 1989 1990 1991 1992

Government Equrry 6685 6301 7750 86.66 1013 1026 8820Bank Indonesia Liquidity Credits 14416 161 50 24.91 74.90 51 49 10940 7258World Bank (HSL) . 414 0.00 140.97 61 74 0.25 2.29 1.27Total: 211.16 224.51 243.38 223.3 61.87 121.95 162.05Source PCR Annex 1(b - BTN data

3.16 The evolution of BTN's balance sheet during the implementation of the HSL overthe 1987-1992 period shows that BTN's housing loans continue to rely upon financialbacking from the Government (Table 3.3). At Rp. 1,851 billion in 1992, total Governmentholdings of BTN equity and long-term debt were 19 percent higher in real terms than in1987 as the HSL was beginning. Only debt outstanding to the World Bank has begun todiminish with the repayment of the HSL itself. As a share of BTN total liabilities,Government holdings have fallen, however. The reduction was mainly the result BTN'sgreater holdings of short time liabilities in the form of call money and time deposits, notof increased bond issues. An indication of a successful reduction of dependence uponGovernment funding would be BTN's ability to substitute Government long-term loans bylong-term loans from other sources, something that has yet to happen on a significantscale.

3.17 BTN's balance sheet can also provide an indication of the opportunity cost ofGovernment backing of the formal housing finance system, if not a measure of the actuallevel of subsidies paid.. By providing low-interest or interest-free loans to BTN,Government forgoes the opportunity to earn market rates of interest on its money. Themarket rate of interest is represented by the rate on twelve month time deposits (Table3.3). The interest foregone is estimated in Table 3.3 by subtracting the interest actuallyearned from the interest that would have been earned on each of the three Governmentbacked balance sheet items.

35

Table 3.3 Government Funded Liabilities on BTN's Balance Sheet 1987-1992

(btlions of ruptans)

Balance Sheet ften: 1987 1988 1989 1990 1991 1992

Government Equity . 306.0 383.5 470.1 480.1 490.1 600

Bank Indonesia Liquidity Credits 887.9 912.3 891.0 899.1 948.9 974

World Bank Loan (HSL) 112.2 253.2 314.9 315.1 286.8 276

Total: 1306.1 1149.0 1676.0 1694.3 1725.8 1851.3

Government share of all iabilies 71% 69% 57% 60% 46% 47%

Time deposit interest 19.1% 20.2% 19.7% 21.2% 234% 19.6%

Government Opportunity Cost:

Government Equity 584 77.5 92.6 101.8 114.7 1176

Bank Indonesia Liquidity Credits 143.0 156.9 148.8 163.6 193.6 1618

World Bank Loan (HSL) 8.5 22.0 25 8 30.6 34.1 2 4

Total: 209.9 256A 267.2 296.0 342.4 301.1

Source: Uabilites - BTN Annual Reports

Time deposit Interest (12 month accounts with pnvate banks) - World Bank 1994 Table 6.8

Notes. Subsidy element is estimated as interest foregone given folowing earnings: Govemment equity 0%.

Bank Indonesa Liquidity Credit a 3%; and World Bank Loan (on-lert from Goverrment) a 11.5%.

3.18 Adding the three amounts of interest foregone represents an estimate of theannual opportunity cost of the Government support of the BTN program, which has risensubstantially over the 1987-1992 period. Standing at Rp. 301.8 billion (US$146.4 million)at the closure of the HSL, this represents an average cost of Rp. 6.2 million (US$3,030)per housing unit financed under the program in 1992. This is much more than the Rp. 3.2million (US$1,960) per housing unit in 1987. Market interest rates were similar in bothyears, making such a comparison particularly revealing. lese results suggest that, fromthe point of view of Government funding, subsidies to deliver housing through the formalsupply system have not fallen as a result of the HSL They also imply that, on average,higher cost units are being financed under the program, contrary to the HSL objective ofexpanding the access of low and middle income households to housing finance. Aware ofthis, Bank Indonesia recently increased interest rates on liquidity credits used to financelarger housing units to 7-9 percent per annum. Obviously, such changes cannot beimposed overnight upon BTN lest they wipe out BTN's operating margins.

3.19 The foregoing analysis implies that Government subsidies continue. A positiveresult, however, is that the continuing subsidies are more likely to go to lower incomebeneficiaries as the HSL intended. This is because of the growing share of smaller units

36

in BTN's mortgage finance program that was discussed earlier (paras. 3.11-3.13).

3.20 Other studies have tried to estimate the value of subsidies awarded through BTNby directly measuring the interest foregone by BTN itself in granting below-market interestloans. The present value of such subsidies for loans awarded in the year 1987 wasestimated at Rp. 117 billion (US$70.9 million)" Clearly, Indonesia's subsidy program forformally delivered housing is a very large one. According to UNCHS/World Bank HousingIndicators, Indonesia has one of the most highly subsidized mortgage lending interestsrates in the world. In 1990, only Ghana, Venezuela, Turkey, Ecuador, Hungary andPoland had more highly subsidized rates than Indonesia's out of 51 countries reportingsuch data.

F. Employment Generation

3.21 Little new information was forthcoming about job creation through houseconstruction, an important HSL objective. In an earlier study, Jammal estimated anemployment multiplier of 105 jobs for each billion rupiah invested in housing in Indonesiain 1987.' If this held during the implementation of the HSL, one could expect that216,650 jobs would have been created during the building of the houses financing throughBTN's Rp. 1,857 billion lending (PCR Table 4(ii)) over the 1987-91 period? As theHSL hoped, the foreign exchange cost of this achievement was probably small, given thepredominantly local inputs used in Indonesia's construction sector.

G. Institutional Strengthening

3.22 BTN. During the HSL, BTN more than doubled in size. It had a staff of 3,846 atproject completion in 1992; up from 1,733 during HSL appraisal in 1985. Personnel costs,which had been a 13 percent of total assets in 1985, rose to 1.5 percent by 1992. Thiswas only a modest increase for an agency engaged upon training and improving the skilllevels of its staff. The HSL-SAR (para. 2.3) had been critical of the weak human resourcebase of BTN where only 5.8 percent of the staff were university graduates. Up to datefigures of the present situation were, unfortunately, not available to the audit mission.BTN's growth did not entail economies of scale in its administration. By 1992, BTN'sadministrative costs were 3.8 percent of total assets, significantly higher than the 2.8percent reported at appraisal in 1985.

23. Sauyk (1990. p. 10).

24. (UNCHS/Wodd Bank 1993 Table 3).

2s. (Ja., Y. 1967).

26. Thi estimate assumes that BTN financn correspodAs to 90 percent of the cot of construction and that theemployment multiplier was not eroded by inflation over the period.

37

3.23 Computerization of BTN operations was nevertheless given a significant boost bythe HSL Reasonably at the time the proposal was made, HSL technical solutionsinvolved mini-computers accessed by a number of terminals within each BTN branch tohelp manage branch finance and operations. Systems were put in place, introducingcomputerization to a number of BTN branches for the first time. The rapid technologicaladvances of micro-computers and networking especially, which could not have beenforeseen by the HSL, soon made the mini-computer technology obsolete. Although thesystems introduced by the HSL have already all been replaced, they did nevertheless serveas a catalyst that demonstrated the power and flexibility of computer-based systems forBTN branches.

3.24 The Surabaya branch, for instance, is using an up-to-date network of micro-computers to manage savings and loan accounts, with special emphasis on tracking arrears.The system has yet to be fully developed, since it still does not produce consolidatedreports for branch management. It also has not yet helped speed up deposit taking fromthe public, which is still painfully slow process for an bank that is seeking to mobilize moreresources. Another branch visited by the audit mission, at Padang in Sumatra, was alsobusy developing a microcomputer network to help manage its day-to-day operations andfinances. In both cases, the hardware is in place. Future challenges are being metthrough intensive systems development Although the solutions being developed are notthose of the HSL itself the project did serve as a catalyst to set in motion a series ofimprovements.

3.25 Computing in BTN's headquarters has also made considerable progress. Today,BTN's Information Technology Department has a staff of 62, engaged in developingsystems to improve and speed BTN's administration. Since 1992, new satellite linksalready provide on-line service links between 6 branches. The plan is to install 500-600work-stations in 42 branches throughout the country, using microcomputer networks as thebasis of the branch systems, of the type already in operation in Surabaya and Padang.

3.26 Perumnas. The state developer experienced difficulties during the implementationof the HSL Its output of housing units continued to decline over the 1987-1992 period(details: Table 3.1). Perumnas' past poor marketing performance could have improvedinsofar as the agency concentrated its operations in nine strategic urban areas." Thishelped Perumnas avoid the trap of building unmarketable housing schemes in remotecities in response to political pressure from local authorities. Even so, the backlog ofunsold units remained at 10,000, a similar number to that identified by the HSL appraisalmission. Marketing of new units has improved only slowly. According to the auditor'sreport on Perumnas 1991/92 Financial Statements, actual income from the sale of houseswas only 78 percent of that budgeted.

27. The wcm Jakarta, Medan, Surabaya, Bandung, Semarang, Solo Ujung Pandang East KaHmantan and Padang.

38

3.27 Among the reasons given in the Annual Report for Perumnas' difficulties were: (a)ineffective communications between Perumnas headquarters and branch offices; (b)lengthy processing by BTN; and (c) construction delays due to frequent changes inspecifications while building was under way. In addition, the report blames the high costof interest on BTN loans (that the HSL thought was too low!) as discouraging buyers ofPerumnas' houses. Judging from the growing sales of privately built houses, BTNmortgage terms do not seem to have been a constraint upon demand.' The HSLexperience shows how Perumnas experienced great difficulties in responding to intensivecompetition from private developers, even as the formal delivery system expanded.

3.28 Perumnas has nevertheless made efforts to improve its administration, notablythrough the computerization of routine administrative activities. The agency now has amanagement information system based upon a network of microcomputers at itsheadquarters. Toward the completion of the HSL, however, Perumnas' profitability rosefollowing increased sales of houses that afforded greater gross margins for the company.As a result, Perumnas was able to report higher profitability in recent financial statements.

H. Compliance with Operational Directives and Covenants

3.29 As for any project, a very large number of Bank Operational Directives (OD),Operational Manual Statements (OMS), Operational Policy Notes (OPN), and guidelineswere applicable to the preparation, appraisal, and implementation of the project.Compliance with these administrative, legal and procedural requirements can be taken forgranted as these were required for Board approval and effectiveness.

330 Apart from the standard covenants of a typical loan/credit agreement there were afew specific covenants geared to helping BTN improve its financial performance.Compliance with legal covenants was, for the most part, satisfactory. Details concerningfinancial performance are provided in Section 3.B. Specific aspects related to (i) debtservice ratio are discussed in para. 3.7; (ii) current ratio issues are discussed in para. 3.8;and (iii) debt to equity ratio issues are discussed in para. 3.9.

28. It must be admitted, however, that we do not have compIete information about the number of unsold housingunits on the books of private developers.

39

4. Other Points of Special Interest

A. Government and Bank Approaches to Housing Policy and Strategy

4.1 The HSL was about helping the Government introduce changes in housing sectorpolicies. To that end, policy studies sponsored by the HSL came up with a number ofimportant conclusions and recommendations concerning housing finance in particular.Among these:"

* Community-based finance institutions, such as cooperatives, credit unions,and rotating savings groups, should be strengthened to mobilize moresavings for housing, especially to finance home improvements.

* Commercial banks in Indonesia are suitable intermediaries through whichto retail mortgage lending, provided that they will be able to freelyestablish their own terms of lending and have equal access to subsidies asother market players.

* More formal resources will be mobilized for housing if the present interestrate subsidy on housing loans is replaced by an up-front, once-off pricesubsidy. This would allow lending on market terms -from private and publicsources-to finance the balance due. Below market rates of interest inhibitfunds mobilization for housing by discouraging savings.

4.2 The HSL's Housing Policies Study (HPS) was one of the most comprehensivestudies of the Indonesian housing sector yet undertaken. Both its design and realizationbenefitted from the inputs of specialized high caliber staff and consultants. The HPS wasbased upon a sample survey of 8,000 urban households throughout Indonesia and hasbecome a standard reference on the subject today. The HPS recommendations wereforthright:3

* Government must direct more of its efforts toward enhancing theeffectiveness of those processes that already provide most of the housing inurban areas.

* Government must redirect its housing efforts to lower-income groups andeliminate the subsidization of middle and upper income housing.

29. For ful details, a HSL-PCR Pat II, Eaosure A. pp. 39-63.

30. (Struyk 1990. pp. 10-11).

40

4.3 Government has given careful attention to recommendations such as these and hasrecently reformulated its housing policy." Although the new National Housing Policyand Strategy (NHPS) is the most broad ranging sector policy document on housing to beproduced by the Government, it is still not ready to embrace key proposals for reform tohave come out of studies sponsored by the HSL Government policy is still largely boundby limits of the formal system of delivery. Despite its broad preamble concerning everycitizen's right to a decent house and healthy environment in Indonesia, the "Housing andSettlements" Law No. 4 of 1992 introduces many improvements and clarifications, butonly to the development of housing BTN-style.

4.4 At the end of the HSL project, while the Government was contemplating furtherpolicy changes that the HSL studies called for, the Bank itself was reforming its ownlending strategy for housing not only in Indonesia, but worldwide. The result was theBank's sector policy paper entitled Enabling Markets to Work (details: para. 1.24). Itsmain message was that governments should withdraw from the direct provision of housingand instead concentrate on removing obstacles to the free working of the housing market,leaving housing finance and delivery primarily as a private sector responsibility.

4.5 A marked change from the earlier Bank approach of building up public sectorhousing institutions (such as BTN and Perumnas), the Bank's new housing sector policydeprives the Bank of the strategic justification for an HSL-type investment. At the timeof the audit Government housing policy in Indonesia had yet to incorporate an enablingstrategy into its proposal for a second HSL, which the Bank itself has so far not been ableto approve.

B. Who Were the Project Beneficiaries and What Were Their Income Levels?

4.6 The HSL project aimed to expand access to housing finance for low and middleincome households. Insofar as BTN's program shifted to providing smaller moreaffordable units in greater numbers (details: Table 3.3), the HSL succeeded in this aim.Prior to the HSL, the median income levels of the occupants of BTN financed housinghad been nearly twice the median income level for the population as whole.' Newsurveys will be necessary to update the relative income levels of BTN borrowers and thoseof the general population.

31. Government of Indonesia. Badan Kebijaksanaan Perunimahan Nasional (BKPN) Kebijkaksanaan dan Smat*Nasional Panahan Edisi II Jakarta, September 1992. Although formally adopted by the Government's housing policy boardBKPN, at the time of writing, it is not clear cactly how the policy will be adopted during Repdia VI.

32. Undang Republik Indonesia Nomor 4 Tahun 1994 euang Peanahan dan PemAiman Kantor Menteri NegaraPerumahan Rakyat, Jakarta.

33. Original occupants of BTN housing had median monthly income of Rp. 280,000 against Rp. 150,000 for urbanhomeowners in general. (Struyk 1990 p. 297).

41

4.7 In the meantime, field inspections continue to show that BTN financed housing,especially by private developers, is not occupied by predominantly low income groups.Where lot sizes permit, many occupants quickly enlarge their original units into substantialhomes as private developer housing projects are now evolving into replicas of suburbanmiddle income housing schemes found in many European countries. When plots arecompletely covered, expansion can continue through the building of a second story. Inthis sense, the HSL helped transform the physical urban form, especially on the peripheryof many Indonesian cities. Field visits readily reveal that communities living on these sitesare not among Indonesia's poorest Perumnas housing schemes visited by the auditmissions catered to lower income beneficiaries than private developer housing did,confirming the findings of more detailed studies.

4.8 The experience of the HSL indicates that BTN housing loans serves as aGovernment housing program for its employees. Although civil servants, militarypersonnel and employees of state owned enterprise make up only 1&7 percent of thegeneral population in Indonesia, they accounted for 77 percent of all BTN housing loansawarded in 1988, for instance. Thus persists an old bone of contention betweenGovernment and Bank which nearly brought the implementation of the Urban I project toa halt in 1976.0 Governments in most countries provide some housing assistance tosome of their employees. In Indonesia, the form of the Government assistance throughinterest rate subsidies distorts financial markets by keeping other players, who are unableto compete on present BTN terms, out of the housing segment of the market IfGovernment departments or state owned enterprises provided lump sum subsidies on priceto their employees instead, housing finance could expand within market parameters, andmore funding could be mobilized.

C. Arrears Management and Current Status of Mortgage Loan Arrears

4.9 Prior to the HSL, BTN had a poor record in collecting housing loan repaymentsdue from its borrowers. MENPERA sources estimated that nearly 50 percent of allBTN's outstanding loans were in arrears in 1988. Poor loan portfolio quality is not amonopoly of BTN, however. A recent Bank study noted a deterioration across all banksin Indonesia since 1990, resulting in 15 percent of all bank loans being classified in that

34. HPS findinp for 1989 were that the median monthly household income of Perumnas' benefciaries was Rp.235,000, against Rp. 325,000 per month for households living in private developer projects (Struyk 1990 p. 297).

35. This was due to the dispute between Government and Bank staff over who should occupy the recently completedKleader sites and services in Jakarti. The Government wanted civil servants, while the Bank felt that all low-incomebeneficiaries should be entitled.

36. (StruyL 1990. p. 330).

42

year." Recent press reports indicate that 21.2 percent of all outstanding loans at statebanks in Indonesia were non-performing.'

4.10 In the case of BTN, however, loan arrears were recognized early on as being amajor problem undermining the credit-worthiness of the institution. There was clearly aneed to regain the lost credibility of the BTN mortgage loan product and to avoid the riskof increasing default by borrowers. For these reasons, through its "Draft Statement ofGeneral and Operational Policies" BTN undertook to reduce arrears to a level not toexceed 2 percent of its outstanding portfolio of mortgage loans (HSL-SAR Anner 4 p.52).BTN also undertook to set aside a provision for risk or bad debts equal to at least 1% ofits outstanding portfolio.

4.11 Early in HSL implementation, arrears on outstanding BTN housing loans-whenrepayments are two months or more overdue-exceeded the target agreed under the HSL,peaking to nearly 7 percent in 1989 (Fig. 4.1). BTN's later performance improved notably,however, so the latest figures for 1993 indicate arrears on 2.1 percent of outstandingloans, only slightly above the SAR target Wisely, BTN has increased provisions for lossand bad debt. By HSL Loan closing in 1992, these provisions stood at 2.5 percent ofoutstanding loans, well above the one percent minimum agreed at HSL appraisal.

Fig 4.1 BTN Housing Loan Arrears 1988-1993(as percentage of outstanding loan amounts)

7.0%6

6.0% - - --- t ------------------ -

5.0% . .---------

3.0%1 ----------- -------------

0.0%---

3.0%-------------------------------------- ----HSL target...g... Actual arrears

1.%---------------------------------

0.0% 1

1988 1989 1990 1991 1992 1993TSoure: BTN

37. (World Bank. 1994a p. 80). Classifed loans rated according to the length of time loan payments we overdue,and the inancial condition of the borrower. There are three categories (i) substandard; (ii) doubtful; and (i) loss. Thedeclining quality of the loan portfolio led to an increase in the market's risk premium of holding assets in the Indonesianfinancial system from 03 percent in 1990 to 2.8 percent in 1992. (World Bank 1994 p. 80)

38. Jakarta Pos February 21, 1994.

43

4.12 Although there is still room for improvement, BTN made a remarkable recovery incollections on its housing loan accounts. Such results can help restore waning credibilityby borrowers that they have to repay BTN housing loans. Keeping loan accountrepayments up-to-date is essentially a responsibility of BTN Branches. For that reason,the audit mission visited two branches, Padang in Sumatra and Surabaya in East Java, tolearn how loan arrears were reduced in branches that offered examples of best practice.'Arrears data from these branches is summarized in Table 4.1.

Table 4.1 - BTN Housing Loan Arrears - Padang and Surabaya Branches 1987-1994

Padang SurabayaDelinquent loans Amount delinquent Delinque nt loans Amount delinquent

year No % of total Rp. m % of total No % of total Rp m % of total1987 5.018 44.6 1,033 2.9 41,810 na 3,127 na1988 5.305 42.5 1,026 2.5 35,569 na 14.137 na1989 4.477 31.2 1,085 2.2 23,683 na 13.762 na1990 4.207 26.1 1,411 2.6 19.059 na 9141 na1991 1.722 12.6 370 0.8 12876 na 3.381 na1992 3.132 22.3 406 0.9- 7L553 na 3.169 na1993 2.438 15.7 339 0.6 11,784 na 2.171 na1994* 4.252 26.1 661 1.2 19,347 na 3.965 naSource. BTN Branch data, accounts receivable information systemNotesBTN consders arrears to wc when loan repayments are two months or more overdue' data for 1994 refer to Januarv.A or1

4.13 Both the Padang and Surabaya branches reported significant reductions in arrearsin recent years. In the case of Padang, barely one percent of outstanding loans is nowdelinquent Both branches have effective computerized information systems that helptrack arrears and automatically produce correspondence to borrowers who are behind intheir payments. Most importantly, the respective branch managers follow through cases ofseriously delinquent loans, initiating mortgage foreclosure procedures where necessary.Even though HSL supervision missions were repeatedly informed that such action was notpossible, the audit mission was informed of cases of foreclosures recently executed bythese branches. Vigorous administrative action can reduce arrears accumulated byborrowers who can afford to pay.

39. Figums for December 1993 show that of the 12 the major BTN branches (with more than Rp. 10 billion inhousing loans outstanding) the bet performers in arrears colections, as shown by the proportion of all outstanding housingloans in good order wer= Padang (99.13 percent); Bandung (98.4 percent); and Surabaya (98.2 percent). The worst performerswere: Medan (8&6 perceat) Palanbang (94.0 perMcnt), and Ujung Pandang (95.6 percent).

44

4.14 Earlier studies in Indonesia have shown that housing loan delinquency is notsignificantly related to the income level of the borrower, implying that most delinquentborrowers choose not to when they can afford to pay.' This being the case, the questionof loan arrears is therefore more the result of inadequate administration in collections,than in borrowers facing affordability constraints. The HSL targets were (belatedly)achieved, and it is thanks to the project that much more is known today about the arrearssituation in BTN's mortgage lending portfolio and its causes.

D. What of the Informal System?

4.15 Changes to Housing Policy and its executing agencies have led to noteworthyimprovements within the formal system of housing delivery in Indonesia. But, asmentioned earlier (paa. 1.10), this formal system only accounts for some 20 percent ofhousing delivery in the country. The informal system of delivery is responsible for 80percent of housing supplied. Even so, this informal system was opaque to the HSL andremains so as far as recent policy initiatives (Le. NHPS) by the Government areconcerned. Important questions to be addressed by the on-going policy sector policydialogue are how should Government housing policy address this informal system and whatsupport can the Bank provide in future lending operations? As Indonesia's financialsector continues to open up and deepen, these questions are especially relevant to ahousing delivery system now recognized as being responsive to consumer demand and ableto shelter the majority of Indonesia's urban population with serviceable housing."'

4.16 The lessons of the experience of the HSL call for much more attention to be givento the informal system. HSL sponsored studies have made clear that this informal kystemdoes not operate in the realm of illegality. It incorporates community based savings tohelp finance home improvements. As many as 37 percent of households living indwellings delivered through the informal system have legal title to the land they occupyand are owners of their houses. A mere 53 percent can be considered as squatterswithout any form of legal support to the houses and land they occupy.'

4.17 An important fact brought to light by the HSL is that 85 percent of all Indonesianurban households improve their housing conditions either through building their ownhouse or by improving their existing one.' Moving to newer better housing, such as thatprovided through BTN financed schemes, is not the way that urban households in

40. Housing kn delinqucacy was found to be associated withL (i) bonrower being a dvil servant; (ii) dimatisfactionwith the dwelling unit; (iii) bonrowers in smaller cities (Struyk 1990 pp. 330-331, 452-44).

41. (StruyL 1990. p. 9).

42. Aid p. 94.

43. Abid. p. 210.

45

Indonesia typically obtain better housing. Home improvement and better infrastructureservices in situ are the means by which most people enjoy improved housing conditions.Such improvements take place within the informal delivery system, which still remainsbeyond the purview of housing policy as presently conceived. Urban upgrading wasrecognized as an important process by the kampung improvement program, but only at avery low level of household income. As incomes rise in Indonesia's cities, so the processof home improvement for many households extends beyond introducing basic amenitiesonly. At the same time, the urban poor that remain still find their housing solutionsmostly through their own efforts of gradual improvements within the informal system ofdelivery. By highlighting these facts, HSL studies highlighted many aspects of housing thatthe Government's evolving sector policy has yet to address.

46

47

5. Borrower and Bank Performance and Dialogue

5.1 Both Borrower and Bank were engaged in an intensive policy dialogue over thetwenty-one-month period that preceded project appraisal. At the outset, differences onhousing sector policy were wide. While the Borrower was committed to consolidatingBTN both financially and institutionally, it was reluctant to endorse the "substantial"increases in mortgage lending rates that Bank identification missions saw as inevitable.After considerable and sometimes protracted consultations in Jakarta and Washington,concessions were made by both sides during the ongoing discussions. Project preparationwas into its eighteenth month before BTN accepted that it could seek financial viabilitywhile focusing upon the housing needs of lower income groups at the same time. For itspart, the Bank detected considerable resistance to the highest interest rate it proposed (18percent) and agreed to apply it to only a minority of cases.

5.2 Bank management nevertheless reckoned that HSL had to be seen as only the firstin a series of housing projects under which further reforms would be achieved. Althoughthe expectation of a follow-on operation was to be frustrated, the Borrower/Bank policydialogue succeeded in taking housing sector reform in Indonesia one important stepfurther. Among the reasons for the success were:

* Borrower and Bank positions were made clear to each other, even whendivergent;

* dialogue focused upon a few key issues, namely mortgage lending rates,loan allocation and target groups and institutional development;

* the Bank's resident mission in Jakarta ensued a continuous contact withsenior Government authorities between identification missions fielded fromWashington.

53 This early success is today somewhat overshadowed by the different paths thatGovernment housing policy and Bank sector strategy have since taken. It was not clear tothe audit mission that Government officials in the housing sector were fully informedabout the changes in Bank strategy invoked by the Bank's 1993 housing policy paper. Iflack of information in Jakarta really is a problem, it would call for a more active dialoguebetween the Government and the Bank on the new directions that housing policy mighttake. Should such a dialogue resume, it would be important for representatives of theMinistry of Finance and Bank Indonesia to participate in addition to the strictly sectoralauthorities. Once again, Bank Indonesia would have a central role in the housing sectordebate as it had during the preparation of the HSL when mortgage loan interest rateswere discussed. Financial aspects of housing, particularly the respective roles of the publicand private sectors in Indonesia and the method of providing subsidies, are likely toremain at the center of a dialogue that hopefully will be taken up again in the near future.

48

49

6. Conclusions and Lessons Learned

6.1 Sustainability: HSL achievements in producing more smaller housing units weresubstantial, but were sharply curtailed in the early 1990s as subsidized funding from theGovernment was reduced. Returning to and sustaining the HSL program at its peak levelachieved in 1989 would therefore depend upon the resumption and maintenance ofGovernment subsidies at their former levels, something that contradicts statedGovernment policy. On the other hand, the improved performance of mortgage loanrepayments under HSL does help sustainability. But, while interest rates remain so highlysubsidized, better arrears management by itself cannot relieve the strong dependence ofBTN financing arrangements upon Government funding.

6.2 Ratings: The PAR agrees with the PCR findings that the outcome of the projectis satisfactory and its institutional development impact has been modest. The sustainabilityof project benefits has been downgraded from uncertain to unlikely due to fiscalconstraints and the projects high dependence upon government funding. During itsmission, the audit noted a growing awareness among policymakers of the need to addressthe issue of cost recovery in the housing sector in Indonesia.

63 Sector Strategy: The audit endorses the PCR findings that future efforts toimprove the supply of affordable housing in Indonesia must focus upon the informalsystem of delivery and that the Government's best efforts be directed towards facilitatingmarket mechanisms for housing finance and production. It is also important find newways of providing infrastructure to further encourage households to expand and improvetheir homes in situ. The experience of the HSL showed how far one can go in improvingthe formal system, whose scope is ultimately constrained by the level of subsidies that canbe financed by the Government. It is necessary to go beyond the formal system to havean broad impact upon the delivery of housing in Indonesia as a whole.

6.4 Policy: At the sector policy level, the HSL succeeded in shifting priorities towardsmaller units. Although this was a substantial improvement within the formal system itself,its impact upon the overall supply of housing in Indonesia was less significant. The HSLtook these policy changes as far as they can go. Future policy discussion needs to beabout more radical reforms that embrace Government efforts to encouraging the informalsystem of delivery, particularly in removing barriers to its effective functioning. There is aneed for policy to address rental housing, for instance, which meets one third of thehousing supply of low income households.

6.5 Subsidies. Despite the hike in BTN interest rates agreed prior to appraisal, theHSL did not succeed in reducing the dependence of the formal supply system uponsubsidies. The HSL experience showed how subsidizing through below-market interestrates distorts resource mobilization and ties the Government up in very long-term

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commitments, from which it might be difficult to extricate itself. Once-off subsidiesreducing the price of housingfinanced at market rates would be a much more efficient use of subsidies, and reducedistortions in the financial sector.

6.6 HSL Studies as an X-ray of Indonesia's Housing Sector: Important studies weresponsored by the HSL that help shed considerable light upon the workings of the largeand complex housing market in Indonesia. As well as confirming the dichotomy of theinformal/formal housing delivery systems, HSL studies also pointed out the need forimproving the workings of the housing finance market. Most importantly, they showedthat most urban households in Indonesia obtain better quality housing through buildingnew dwelling units by themselves or by improving their existing house.

6.7 Project Preparation: The HSL was a good example of a sectoral lending operationattached to a meaningful and realistic policy agenda. Successful a priori agreement onpolicy made project implementation much easier, and free of policy conditionality. In thisrespect, the preparation of the HSL was a model effort, which took into account theproject's important linkages with the financial sector agenda. The seriousness with whichboth sides took the policy commitment is confirmed by the fact that the sector agenda wasnot harmed by the new macro-adjustment role the Loan proceeds acquired shortly afterappraisal.

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Annex 1 - Statistical data

Table A1.1 Housing Indicators: Selected Countries 1990

Country(1): Floor area per Persons per Households per Permanent(2) Water(3) Journey(4) to OwnerSverson (rn2 room dw*ling uitt structures f%) connection (%) work (minutes) occupancy(%

moonia 10.17 1.28 1.14 67 66 40 58Asianneighbors.-Korea 18.80 1.48 1.90 97 100 37 40Philippines 1200 3.00 1.10 80 66 30 48Malaysia 18.58 1.67 1.03 86 94 34 59Singapore 20.00 1.40 1.02 99 100 30 90Thailand 16.48 2.01 1.01 97 76 91 68with imilarGNP/capita

Ept12.00 1.50 1.47 94 71 .40 3Zimbabwe 7.00 2.28 1.51 83 97 56 45Cte divoire 7.90 2.22 1.11 88 33 38 21Senegai 8.10 2.30 1.00 84 49 35 57with highGNP/capitaJapan 15.79 0.77 0.80 100 100 40 40Netherlands 23.80 0.63 1.13 100 100 18 9U.S.A. 68.65 0.39 1.00 100 _ _100 29 61

Soce- UNCHS/Wodd Bank Moung fincaoaNoe:(1) Data refer to the principal city (ually the capital) of the respective cointrie(2) the slurs of all dwellng ut wtich Is ilMl to last twenty ymrs or mor.(3) the share of all dwelling uris that has water connecan to the plot occupied(4) the verae lenath of tme of a onwy ca omwmute duinc rush haur by all modes of tma t

52

Annex 2

COMMENTS FROM THE BORROWER

KANTOR MENTERI NEGARAPERUMAHAN RAKYAT

Our Reference : 25/UN.01 01/A.IV/III/95 Narch 23, 1995

Mr. Yves AlbouyChief Infrastructure and Energy DivisionOperations Evaluation DepartmentThe World Bank1818 H Street, N.WWashington, D.C.20433U.S.A

me Housing Sector Loan (Loan 2725-IND)Draft Performance Audit Report.

Dear Mr. Albouy,

After studying the content of the Performance Audit Report(PAR), in principle, the Government of Indonesia, agreed uponthe evaluation that has been made.On this occasion I would like the Bank to consider to givehousing sector loan for Indonesia Six-Five Year Plan (PelitaVI).For this reason I would appreciate if the Bank can send acomplete mission for this purpose-

Looking forward to hear from you soon.

Si' rel

Reskatant gorJ inz FinanceOffice of Thi S e inister for Housing

Aut1herlMd RepresentativeHousing Sector Loan (Loan 2725-IND)

C.C1. H.E.- Ir. Akbar Tandjung,

The State Minister for HousingRepublic of Indonesia;

2. Mr. Widisdo Sukarman,SE,MBA,President DirectorPT.Bank Tabungan Negara (Persero);

President Director Perum Perumnas.4. File.

JL Kabon Sirih No. 31, Jakena Pusot Telp. 326583 - 327430 -324401 Telex 67257 Menpera IA.

53

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United Nations Centre for Human Settlements/World Bank 1993. Housing IndicatorsProgram VoL II Indicator Tables Revised edition October 1993.

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IMAGING

Report No: 14459Type: PPAR