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Report and Recommendation of the President to the Board of Directors

Project Number: 48134-006 June 2016

Proposed Policy-Based Loan for Subprogram 2 Republic of Indonesia: Stepping Up Investments for Growth Acceleration Program Distribution of this document is restricted until it has been approved by the Board of Directors. Following such approval, ADB will disclose the document to the public in accordance with ADB’s Public Communications Policy 2011.

CURRENCY EQUIVALENTS (as of 23 May 2016)

Currency unit – rupiah (Rp)

Rp1.00 = $0.00007

$1.00 = Rp13,646

ABBREVIATIONS

ADB – Asian Development Bank AEC – ASEAN Economic Community BKPM – Badan Koordinasi Penanaman Modal

(Indonesia Investment Coordinating Board) FDI – foreign direct investment GDP – gross domestic product KPPIP – Kementerian Koordinator Bidang Perekonomian

(Committee for Infrastructure Priorities Development Acceleration)

LIBOR – London interbank offered rate LKPP – Lembaga Kebijakan Pengadaan Barang/Jasa Pemerintah

(National Public Procurement Agency) MOF – Ministry of Finance OSS – one stop service PDF – Project Development Fund PPP – public–private partnership RPJMN – Rencana Pembangunan Jangka Menengah Nasional

(National Medium-Term Development Plan) TA – technical assistance VGF – viability gap funding

GLOSSARY

Availability-based PPP

– Periodic formula-based payments by the government contracting agency to the business entity for making the infrastructure available in accordance with the quality and/or other criteria specified in the PPP agreement. The payments commence upon completion of construction and/or readiness of the infrastructure facility for operation. Only competitively bid out PPP projects are eligible for availability payments. Availability payments are not provided for PPP projects that receive viability support.

e-procurement – Electronic procurement. This is the business-to-business, business-to-consumer, or business-to-government purchase and sale of supplies, work, and services through the internet as well as other information and networking systems, such as electronic data interchange and enterprise resource planning.

Incremental capital output ratio

– This is is the ratio of investment to growth, which is equal to 1 divided by the marginal product of capital. The higher the incremental capital output ratio, the lower the productivity of

capital or the marginal efficiency of capital. NEET – A young person who is not in education, employment, or

training. PPP – Public–private partnership. This is a government service or

private business venture that is funded and operated through a partnership between the government and one or more private sector companies.

Regulatory impact assessment

– This is both a process and record of the steps carried out by the regulator in preparing new legislation or regulations. The regulator will provide a regulatory impact statement on major proposals. The statement will assess the impact of the proposal on the business community and record stakeholder consultations.

Reverse auction

– A repetitive process involving an electronic device for the presentation of new prices, revised down-wards, and/or new values concerning certain elements of tenders, which occurs after an initial full evaluation of the tenders, enabling them to be ranked using automatic evaluation methods.

Viability Gap Funding

– This is the non-remunerated grant made by the public sector (central government and/or state government) for financial support to PPPs, with the objective of making a project commercially viable

NOTE

In this report, “$” refers to US dollars.

Vice-President S. Groff, Operations 2 Director General J. Nugent, Southeast Asia Department (SERD) Directors K. Bird, Public Management, Financial Sector and Trade Division,

SERD S. Tabor, Indonesia Resident Mission (IRM), SERD Team leader R. Hattari, Public Management Economist, SERD Team members A. Haydarov, Infrastructure Economist, IRM, SERD S. Ismail, Financial Sector Specialist, SERD

P. Jayawardana, Young Professional, SERD R. Lacson, Operations Assistant, SERD N. Mardiniah, Safeguards Officer (Resettlement), IRM, SERD C. Roos, Senior Operations Assistant, IRM, SERD D. Simanjuntak, Senior Project Officer, IRM, SERD O. Suyatmo, Senior Procurement Officer, IRM, SERD

S. Zaidansyah, Senior Counsel, Office of the General Counsel Peer reviewers G. Bhatta, Technical Advisor (Governance), Sustainable Development

and Climate Change Department A. Burrell, Principal Public–Private Partnership Specialist, Office of Public–Private Partnership

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page

PROGRAM AT A GLANCE

I. THE PROPOSAL 1

II. THE PROGRAM 1

A. Rationale 1

B. Impact and Outcome 6

C. Outputs 7

D. Development Financing Needs 8 E. Implementation Arrangements 9

III. DUE DILIGENCE 9

A. Economic 9

B. Governance 9

C. Poverty and Social 10

D. Safeguards 10

E. Risks and Mitigating Measures Error! Bookmark not defined.10

IV. ASSURANCES 10

V. RECOMMENDATION 10 APPENDIXES

1. Design and Monitoring Framework 11

2. List of Linked Documents 13

3. Development Policy Letter 14

4. Policy Matrix 19

I. THE PROPOSAL 1. I submit for your approval the following report and recommendation on a proposed policy-based loan to the Republic of Indonesia for subprogram 2 of the Stepping Up Investments for Growth Acceleration Program. 2. The proposed subprogram 2 supports the government’s main reform priorities in raising domestic and foreign direct investment (FDI) in the economy, and represents a medium- to long-term partnership between the Asian Development Bank (ADB) and the government. Subprogram 2 continues and deepens the reforms begun under subprogram 1 of the programmatic approach approved in September 2014.1 The government’s priority areas include (i) creating a more predictable and open business environment, including through (ii) faster and more transparent public investment procurement which in turn will help create (iii) an efficient market for infrastructure through public–private partnerships (PPPs).2

II. THE PROGRAM A. Rationale 3. The development problem. The Indonesian economy is at a major crossroads. Economic growth decelerated from its peak of 6.4% in 2010 to 4.8% in 2015. This is mainly because the commodity price boom ended and macro policies were tightened to lower inflation and the current account deficit. Reliance on commodities has exposed structural weaknesses in the economy, including inefficient investment allocation and underinvestment in infrastructure. These structural weaknesses are reflected in the adjustment to a lower economic growth path, with the economy expected to grow by about 4.9%–5.3% in 2016, significantly below the bottom of the government’s target range of 7.0%–9.0%, stated in the National Medium-Term Development Plan (RPJMN), 2015–2019.3 The economic slowdown, combined with volatility in global financial and commodity markets, has strained fiscal management—with tax revenue collections declining by 2.1% in the first quarter of 2016 compared with the same period in 2015. Given commitments to social and infrastructure spending in the 2016 budget, the fiscal deficit is expected to be higher than the projected deficit of 2.1% of gross domestic product (GDP). 4. Against this backdrop of slower economic growth, structural adjustment, and increased fiscal pressures, the government is challenged in promoting inclusive growth. Since 2000, Indonesia has experienced one of the largest increases in inequality of all Southeast Asian economies. The Gini index, used to measure household income inequality, increased from 0.30 in 2000 to 0.40 in 2015 and is explained in part by insufficient job creation. For example, the rate of job creation is insufficient to reduce Indonesia’s 12.2 million youth not in employment, education, or training—the highest rate in Southeast Asia (Figure 1). Uneven economic growth across provinces has also contributed to widening of regional income disparities, with several provinces in eastern Indonesia significantly lagging Java and Bali in per capita income. For example, Jakarta’s 2014 nominal per capita income ($14,816) is 13 times higher than that of East Nusa Tenggara ($1,154).

1 ADB. 2014. Report and Recommendation of the President to the Board of Directors: Proposed Programmatic

Approach and Policy-Based Loan for Subprogram 1 to the Republic of Indonesia for Stepping Up Investments for Growth Acceleration Program. Manila.

2 The design and monitoring framework is in Appendix 1.

3 The government’s 2016 national budget projects 5.3% growth. ADB. 2016. Asian Development Outlook 2016.

Manila projects 5.2%. The World Bank’s Indonesia quarterly report in March 2016 projects 5.1%, and the International Monetary Fund 2016 Article IV Staff report projects 4.9%.

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5. Therefore, increasing investment in job-creating industries is a vital government priority. The share of investment to GDP rose slightly to 26.2% in 2014, up from 25.1% in 2010. There is also a strong willingness to embrace FDI. Excluding financial services, Indonesia was ranked the 14th largest recipient of FDI in the world in 2014. Yet investment is inefficient and expensive compared with the income it generates, and too much of it is wasted. For example, a common measure of investment efficiency is the incremental capital output ratio. In 2014, this ratio was high, at 5.5, meaning that $5.5 spent on investment produces only $1.0 of income (Figure 2). The incremental capital output ratio in neighboring countries is about 3.0–4.0.4 6. Indonesia’s difficult business climate is one of the reasons for this high-cost and inefficient allocation of investment. According to the World Bank’s 2016 Doing Business Report,5 Indonesia is ranked 109th out of 189 countries in ease of doing business. While this is an improvement of 11 places over the 2015 report, it compares unfavorably with many of its regional neighbors: Malaysia (18th), the Philippines (103th), Thailand (49th), and Viet Nam (90th). A cumbersome business licensing regime has contributed to this high-cost business environment. Indonesia still retains significant equity restrictions on FDI in the services sector.

ICOR = incremental capital output ratio; GDP = gross domestic product; OECD = Organisation for Economic Co-operation and Development. a As a percentage of youth population. Youth refers to 15–24 year olds.

Sources: Asian Development Bank estimates; World Bank Development Indicator database; and Eurostat.

7. The adjustment to a lower economic growth path is also the result of years of underinvestment in the availability and quality of infrastructure in Indonesia compared with most of its neighbors. The World Economic Forum’s Global Competitiveness Report 2015–2016 ranks Indonesia 62nd out of 140 countries on the quality of its overall infrastructure—well below Malaysia (24th) and Thailand (44th).6 This is the result of low public infrastructure investment spending (average of 1.5% of GDP from 2008 to 2012); inadequate private participation in infrastructure investment (average of 0.6% of GDP from 2008 to 2012); and an inefficient public procurement system, where 45.0% of budget disbursements are made in the last 2 months of the fiscal year, creating a drag on public infrastructure delivery. Indonesia’s annual infrastructure investment needs are estimated at 6.2% of GDP (3.9% of GDP in transport, 1.0% of GDP in energy, 1.0% of GDP in telecommunications, and 0.4% of GDP in water and sanitation).7

4 Sector Assessment (Summary): Industry and Trade (accessible from the list of linked documents in Appendix 2).

5 World Bank. 2016. Doing Business 2016: Measuring Regulatory Quality and Efficiency. Washington, DC.

6 World Economic Forum. 2015. The Global Competitiveness Report. Geneva.

7 ADB estimates with data are taken from Indonesia’s national account.

Figure 1: Rates of Youth Not in Employment, Education, or Training – International

Comparison a

Figure 2: Investment Rate (% of GDP) and Incremental Capital Output Ratio

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8. Binding constraints. The government has recognized the set of challenges it needs to deal with to increase investment in job-creating industries, including (i) addressing the proliferation of high-cost business regulations that deters investors, (ii) accelerating infrastructure delivery through increased participation of the private sector, and (iii) resolving inefficiencies in the public procurement system to speed up delivery of infrastructure projects. 9. High-cost business regulatory environment. A proliferation of regulations (both at national and subnational levels), cumbersome licensing procedures, and remaining restrictions on foreign investment, particularly in services, have created a high-cost business environment. The average number of regulations issued by both national and subnational governments increased from 453 per year during 1999–2003 to 1,789 per year in 2010–2014. Starting a business in Indonesia requires an investor to obtain 10 approvals, and the process takes 48 days compared with three approvals and 6 days in Malaysia. Indonesia would benefit from adopting international good regulatory practice, such as mandatory regulatory impact assessments for significant regulatory proposals. Tax administration also imposes significant business compliance costs on investors, such as the predominance of manual tax return filing and tax payment procedures. Moreover, the negative investment list has placed binding ceilings on direct foreign equity investment in the services sector, impeding growth prospects in these sectors and Indonesia’s progress in meeting its ASEAN Economic Community (AEC) goals.8 10. Inefficient market for infrastructure investment. Increasing public infrastructure spending is critical to address the country’s infrastructure deficit and for crowding-in private participation in infrastructure. A poor institutional, policy, and regulatory framework for promoting private participation in infrastructure investment projects, and the lack of long-term financing for infrastructure investments have also contributed to an inefficient market for infrastructure in Indonesia. Four main policy impediments affect private participation in infrastructure investments in Indonesia. First, until 2014 the government did not have a PPP unit and a project development facility for financing feasibility studies and transaction advisory services, which are both important for facilitating private participation in public infrastructure projects. As a result of this undeveloped institutional framework, the government does not have capacities to develop and implement a robust pipeline of PPP infrastructure projects. Second, financial and fiscal risks arising from PPP infrastructure projects need to be managed and budgeted for, such as the government providing grants–known as viability gap funding (VGF)–to the PPP entity to ensure the commercial viability of the PPP project. Performance-based payments–known as availability-based PPP contracts–are also necessary to ensure quality projects. Third, a major constraint to private participation in infrastructure investments is the absence of a long-term asset class that can provide long-term financing for public infrastructure through the capital market. Fourth, the land acquisition process needs to be made more timely, transparent, and fair to allow for more private sector participation in public infrastructure projects. 11. Inefficient public procurement system. Inefficiencies in public procurement are reflected in the concentration of public infrastructure procurement (45%) toward the end of each fiscal year because of lengthy procurement approval processes.9 Improving transparency and the professionalism of procurement officers, as well as promoting competition in public procurement, are necessary to accelerate the delivery of infrastructure investments. The government will need to adopt international standards in public procurement practices, such as e-procurement systems, and introduce international competitive bidding documents to enable foreign firms to compete in the domestic market on a level playing field.

8 The AEC aims to create a single market in the Association of Southeast Asian Nations.

9 Data are taken from the National Public Procurement Agency Monitoring and Evaluation system.

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12. Government reform agenda. To raise the economic growth rate above the 2016 range of 4.9%–5.3%, the government recognizes that it needs to pursue structural reforms to allocate investment more efficiently to job-creating industries. The new RPJMN, 2015–2019 cites income inequality reduction as one of its main priorities. Employment creation can help reduce income inequality. To achieve it, the RPJMN calls for an increased effort and resources for education, skills development, finance sector development, energy sector development, and investment in infrastructure; and mandates continued reform of the investment and business climate. The RPJMN identifies initiatives to simplify investment procedures and regulatory reform, liberalize FDI, increase budget spending on public infrastructure, increase private participation in infrastructure projects, resolve land acquisition impediments, and improve public procurement. Consistent with this focus, since September 2015 the government has announced 12 economic reform packages aimed at simplifying business and logistics regulations and procedures, and removing nontariff barriers to trade. It also considers achieving its AEC goals a catalyst for further domestic investment climate reforms. 13. ADB’s experience. ADB has supported reforms in the investment climate through several loan programs, technical assistance (TA), and knowledge products (Figure 3). In 2001, the focus was on state-owned enterprises reform and small and medium-sized enterprise development, but this has shifted to improving public infrastructure policy and connectivity across Indonesia. Since 2014, ADB has focused on sector reforms—with the goal of improving the investment climate using an integrated sector approach. ADB’s Board of Directors approved the Stepping Up Investments for Growth Acceleration programmatic approach and subprogram 1 loan in September 2014, and established a structured medium- to long-term engagement on investment climate reforms with the new government (footnote 1). ADB has provided a series of TA projects to support the implementation of reforms under the program.10 Through subprogram 2, ADB will continue to work with the government to create a predictable and open business climate, build an efficient market for infrastructure by strengthening the government’s PPP program and diversified modalities of infrastructure financing, and improve public procurement for faster delivery of infrastructure projects. The program supplements ADB’s financial market development and inclusion program, approved by the Board in September 2015, which addresses impediments to capital market development and long-term financing of infrastructure.11 The inclusive energy program, also approved by ADB in 2015, supports a better investment climate by addressing Indonesia’s energy deficit. 12 In 2016, together with the government, ADB is preparing an education sector reform program that aims to improve the quality of education and address the youth skills mismatch in the labor market. ADB is also preparing an engineering project that aims to improve the quality and timely start-up of public infrastructure projects, which could be a catalyst for lifting public infrastructure spending.13 ADB’s Office of PPP is discussing with the government the provision of advisory services to the North Sumatra provincial government to develop Rawasaring, a 100-kilometer brownfield road.

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ADB. 2014. Project Preparatory Technical Assistance to the Republic of Indonesia for Stepping Up Investments for Growth Acceleration Program. Manila (TA 8661-INO); ADB. 2014. Technical Assistance to the Republic of Indonesia for Strengthening the Local Government Bond Market. Manila (TA 8753-INO); and ADB. 2015. Technical Assistance to the Republic of Indonesia for Tax Revenue Administration Modernization and Policy Improvement in Local Governments. Manila (TA 8877-INO).

11 ADB. 2015. Report and Recommendation of the President to the Board of Directors: Proposed Programmatic Approach and Policy-Based Loan for Subprogram 1 to the Republic of Indonesia for Financial Market Development and Inclusion Program. Manila.

12 ADB. 2015. Report and Recommendation of the President to the Board of Directors: Proposed Programmatic Approach and Policy-Based Loan for Subprogram 1 to the Republic of Indonesia for Sustainable and Inclusive Energy Program. Manila.

13 ADB. 2015. Concept Paper: Proposed Technical Assistance Loan to Indonesia for Accelerating Infrastructure Delivery through Better Engineering Services Project. Manila.

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It is also planning to assist the Committee for Infrastructure Priorities Development Acceleration (KPPIP) in prioritizing projects for PPP development. 14. Lessons from the experience. A “One ADB” approach—where all departments provide highly coordinated support to the government’s economic reforms—improves program effectiveness and creates reform impact. This includes support for a medium-term policy reform framework, sustained capacity development TA, knowledge products, and an integrated sector approach to improving the investment climate with program- and project-specific support. A second lesson is the need to engage with local governments in a decentralized system and to provide sustained capacity development TA to enable local governments to pilot test reforms. As a result of progress in these two areas, ADB support is shifting to policy dialogue and reforms at both the national and subnational levels, and taking an integrated sector approach to improving the investment climate.

Source: Asian Development Bank

15. ADB’s value added to the program design and implementation. Key policy reforms under subprogram 1 included raising foreign equity ceilings in land transportation, shipping, and management of ports; establishing KPPIP to screen, monitor, and evaluate 30 national strategic projects for selection under the PPP program; establishing a dedicated office to formulate land acquisition policy; and initiating the development of e-procurement. Reforms proposed under subprogram 2 focuses on operationalizing reforms and securing budget allocations. This includes further liberalizing foreign ownership in the services sector; operationalizing the KPPIP and the National One Stop Service (OSS) Center for large investors; establishing the PPP Unit at the Ministry of Finance (MOF), and the Project Development Fund (PDF) under the PPP Unit; and implementing e-procurement systems in the national government and pilot testing in selected local governments.

16. ADB has provided direct support to the completion of reforms proposed under subprogram 2. The project preparatory TA (footnote 10) provided advisory support to the Coordinating Ministry for Economic Affairs (the executing agency) and Indonesia Investment Coordinating Board (BKPM) on business climate reforms based on the TA-funded assessment of the ease of doing business in five local governments, including Jakarta and Surabaya. These efforts provided input to the government’s most recent economic reform packages coordinated

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through the executing agency. The TA on municipal bonds (footnote 10) provided capacity development support to the West Java provincial government on debt management and issuance of municipal bonds. ADB’s TA on tax administration (footnote 10), funded by the Government of Switzerland, provided policy and capacity development support to the Jakarta local government to strengthen its tax administration systems. Also under the project preparatory TA (footnote 10), ADB assisted the Jakarta local government to establish an e-procurement platform for competitive bidding on supplier contracts.

17. The results have been impressive. In November 2015, the OSS center issued almost 9,600 licenses. Under the strengthened PPP program, three PPP projects have been prepared and one contract signed. Total public procurement delivery through e-procurement increased from Rp2.8 trillion ($212 million) in 2013 to Rp580.9 trillion ($4.4 billion) in 2015. Under the public e-procurement system, close to 43,500 items are listed in the e-catalog. 18. Development partner coordination. Development partner coordination is strong in the investment, trade, PPP, and public procurement reform areas. German development cooperation through KfW provided parallel financing in the amount of a $245 million loan for subprogram 1 and is considering parallel financing for subprogram 2 with an indicative amount of €200 million ($224.6 million equivalent). Both the ADB and KfW teams have worked closely with the Government of Indonesia in formulating the program. The Government of Switzerland has also provided cofinancing through a $5 million grant for ADB’s local tax administration reform project (footnote 10). The Government of Australia, the Government of the United States, and the World Bank are providing separate and coordinated support to the government on investment climate and PPP reforms.14 19. Policy-based loan, budget support, and changes to the programmatic approach—additional subprogram. ADB will continue its programmatic support to increase investment. This approach uses policy-based lending in conjunction with extensive policy dialogue in recognition of the long-term horizon required for investment climate reforms. In addition, subprogram 2 contains significant additional reforms not originally contemplated in subprogram 1, such as the national regulatory reform program. Demonstrating this long-term commitment to investment climate reforms, the government has requested an additional subprogram 3 for consideration in 2018, with increased focus on its national regulatory reform program, institutional reforms for good regulatory practice, and its PPP program; and aligns the program with the RPJMN, 2015–2019. 20. Economic impact of the program. The three outputs of the program combined are expected to raise public and private investments. Potential economic gains are to be achieved through efficiency gains: (i) a lower regulatory burden on businesses and a more open FDI regime; (ii) project costs within budget and timely completion of PPP projects, and an increase in the overall level of infrastructure investments, which would not have occurred without the PPP program; and (iii) improved public procurement in terms of lower bid prices and timely procurement (para. 31). B. Impact and Outcome 21. The impact will be increased investment as a share of GDP, in alignment with the RPJMN, 2015–2019. The outcome will be public and private sector investments increased. At the inception of the programmatic approach in 2014, the government agreed to 22 indicative

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Development Coordination (accessible from the list of the linked documents in Appendix 2).

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policy actions as a basis for subprogram 2. At the government’s request, ADB agreed to sharpen the focus of subprogram 2 and to rationalize some of the measures by concentrating on key reforms. Through the process, eight completed indicative actions under subprogram 2 were combined into four actions, six new policy actions were added, five completed actions were dropped, and one ongoing action was dropped from the program as no follow-up actions would be necessary.15 Subprogram 2 now contains 18 reform actions (10 expected prior actions representing high-impact reforms and eight milestones), which the government completed from October 2014 to June 2016. The change in the policy matrix is reflected in the revised design and monitoring framework (Appendix 1). Subprogram 3 contains 18 policy actions of which 8 are expected prior actions. C. Outputs 22. Output 1: More predictable and open business environment. This output builds on accomplishments under subprogram 1 to ease restrictions on domestic and foreign investments in three important ways. First, through a series of announcements of economic reform packages, the government began a national regulatory reform program. Over 147 business, logistics, and trade regulations were either simplified or eliminated. To assist with identifying and prioritizing regulations for review and reform, selected ministries and agencies including the Ministry of Trade established deregulation units with designated staff. Second, the government has issued Presidential Regulation that sets out the revised negative investment list, further liberalizing foreign investment by allowing at least 67% foreign ownership in investments in the services sector—covering the creative industries (100% in film studios, movie production, and distribution), tourism-related industries (100% in hotels and restaurants), and other recreation enterprises. This is a major reform to the services sector, which will promote new investments and jobs. It also accomplishes the government’s AEC commitments to liberalize foreign equity restrictions. Third, the government reformed licensing procedures. A major reform under subprogram 2 was the 22 line ministries delegating licensing approval authority to BKPM’s OSS center—significantly reducing transaction costs for investors. By the end of 2015, the OSS center had issued over 9,000 licenses to large investors. Another related reform was BKPM reducing the administrative time to obtain the eight mandatory national licenses from 23 days to 3 hours, and the Jakarta local government reducing the time it takes to obtain local trading licenses and enterprise registration certificates to 3 hours. 23. For subprogram 3, the government will implement good regulatory practices by institutionalizing a systematic regulatory review program. This will include setting up an interministerial steering committee to oversee the implementation of good regulatory practices and pilot testing regulatory impact assessment programs in selected ministries or agencies. 24. Output 2: Creating an efficient market for infrastructure through public–private partnerships. Output 2 builds on efforts to develop a robust pipeline of PPP projects by strengthening the institutional, policy, and regulatory framework for PPPs; and expanding the financing modalities for long-term financing of infrastructure. These accomplishments included the following. First, building on subprogram 1, the government operationalized the KPPIP to screen strategic projects for the PPP program. Second, the government strengthened its PPP structure by establishing the PPP Unit in the MOF to complement the existing PPP directorate in the National Development Planning Agency (BAPPENAS), which is responsible for PPP planning. The new MOF PPP Unit has a PDF to facilitate and prepare PPP projects. Third, the

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Reconciliation of the Original Subprogram 2 to the Revised Subprogram 2 (accessible from the list of linked documents in Appendix 2).

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government has expanded PPPs to social infrastructure, such as in the health and education sectors. An availability based scheme for PPP projects was also introduced. These reforms have resulted in the signing of the two availability-based PPP contracts for a telecommunication project. The government has also completed the competitive bidding process for a water supply PPP project, with the support of the PPP Unit. In addition, the government has implemented measures to reduce the fiscal and financial risks of PPP projects. The budget allocation for VGF in the 2016 budget has been increased to Rp1.1 trillion ($86 million) from Rp814 billion ($62 million) in the 2015 budget. The MOF has also approved VGF for three main national water supply PPP projects. The government has enhanced transparency, efficiency, and predictability in the land acquisition process for infrastructure projects by allowing the private sector to fund land acquisition on the government’s behalf. It has also introduced time-bound procedures for the preparation and implementation of land acquisition, and required land compensation payments to be made within 7 days after validation of claims. Finally, the government has continued to expand financing modalities for the public share of capital expenditure of PPP projects, including increasing issuances of sukuk (Sharia compliance bond), the MOF consolidating its infrastructure financing facilities, and capacity development of West Java local government on debt management in preparation for issuing municipal bonds.

25. Under subprogram 3, the government will continue to strengthen the PPP policy framework by enabling local governments to use availability-based PPP schemes, enhancing the PDF mechanism, and clarifying the treatment of unsolicited PPP proposal. MOF will also streamline the approval process for VGF and ensure adequate budget allocation for VGF. 26. Output 3: Faster and more transparent public procurement. Continuing from subprogram 1, the government mandated the use of an e-procurement system for all public procurement of goods and services, which increased total public procurement delivery through e-procurement from Rp2.8 trillion ($213 million) in 2013 to Rp580.9 trillion ($4.4 billion) in 2015. The National Public Procurement Agency (LKPP), with the Jakarta local government, introduced an electronic platform for transparent competitive bidding for procurement of local goods and services. It also opened up foreign firms’ direct participation in competitive bidding for large public infrastructure projects by introducing international competitive bidding documents for procurement of goods and services. 27. For subprogram 3, the LKPP will continue to strengthen the public procurement legal framework to incorporate procurement audit, and will enhance the e-procurement system to include reverse auction of goods. LKPP will also assist the Jakarta local government in pilot testing an electronic platform for a transparent bidding process. D. Development Financing Needs 28. The government has requested a policy-based loan of $500 million from ADB’s ordinary capital resources to help finance subprogram 2. The loan will have a 15-year term, including a grace period of 3 years, an annual interest rate determined in accordance with ADB’s London interbank offered rate (LIBOR)-based lending facility, a commitment charge of 0.15% per year, and such other terms and conditions set forth in the draft loan agreement. Based on this, the average loan maturity is 9.25 years, and no maturity premium is payable to ADB. The loan proceeds will be used to finance the full exchange cost (excluding local taxes and duties) of items produced and procured in ADB members, excluding ineligible items and imports financed by other bilateral and multilateral sources. The proceeds of the policy-based loan will be disbursed to Indonesia in accordance with ADB’s guidelines on simplifying disbursement

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requirements for program loans. 16 The German development cooperation through KfW is considering parallel financing of subprogram 2. 29. In the 2016 budget, the net development financing needs are $19.6 billion. With the continuing economic slowdown in 2016, which has negatively affected tax revenue collections, the government has increased overseas development assistance loans from $3.9 billion to $5.4 billion in the revised 2016 budget. The size of the loan primarily reflects the government’s financing needs, the strength of the reform program, and the implementation costs (para. 31).

E. Implementation Arrangements 30. The Coordinating Ministry for Economic Affairs, the executing agency, will be responsible for coordinating the government’s economic reform packages. The MOF; BKPM; the Ministry of Agrarian and Spatial Planning; PT Sarana Multi Infrastruktur (Persero), a state-owned infrastructure financing company; and LKPP will be the implementing agencies. The implementation of program policy actions will be monitored through a steering committee chaired by a deputy minister of the executing agency, and will consist of senior representatives from the implementing agencies. The implementation period is September 2014–June 2016 for subprogram 2, and July 2016–June 2018 for subprogram 3.

III. DUE DILIGENCE A. Economic 31. The program will have positive economy-wide effects. The program impact assessment estimates the potential net quantifiable benefits of the program at $6.9 billion, under conservative discounting assumptions, which well exceed the program’s estimated costs. 17 Of this, about $2.5 billion flows to the economy as a result of increased trade and foreign investment inflows caused by better regulation, improved ease of doing business, and streamlined tax collection measures at national and subnational levels, particularly with respect to starting up a business. A further $1.3 billion is expected to come from better preparation of PPP projects, improved public debt management capacity at subnational level, and a better land acquisition process. A better public procurement process would also strengthen the governance outlook in Indonesia, and this is expected to have a net present benefit of $3.4 billion. The reforms will entail costs about $500 million. B. Governance 32. The government has made considerable progress in improving the legal and regulatory framework for public financial management. Since the enactment of laws on state finance, state treasury, and state audit in 2003–2004, most regulations underpinning these laws have been promulgated. In 2012, the number of government agencies that received an unqualified audit opinion from the external audit agency increased to 65%, from about 40% in 2009. ADB has reinforced this momentum with continuing support to improve technical capacity and controls. As a result of the government’s continuing commitment to reduce corruption, the capacity of the Corruption Eradication Commission has improved markedly. ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the government.

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ADB. 1998. Simplification of Disbursement Procedures and Related Requirements for Program Loans. Manila. 17

Program Impact Assessment (accessible from the list of linked documents in Appendix 2).

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C. Poverty and Social 33. The reforms supported under the program will contribute to reduced income inequality and poverty reduction. A more conducive investment climate will lead to more and better investment in job-creating industries. Better infrastructure will contribute to poverty reduction through higher growth and by improved connectivity of more remote areas to markets. Given the macro nature of the program’s reforms, no gender benefits are directly observed. D. Safeguards 34. The program does not trigger ADB’s safeguard policies and is classified category C for impacts on the environment, involuntary resettlement, and indigenous peoples. E. Risks and Mitigating Measures 35. Major risks and mitigating measures are described in detail in the risk assessment and risk management plan.18 The expected net benefits and impacts of the program are expected to outweigh the risks. At the macroeconomic level, medium-level risks include the continuation of the global economic slowdown, which affects budget allocations for infrastructure. Development partners are providing coordinated support to the government to safeguard budget revenues and expenditures. At the microeconomic level, there are medium-term risks that local governments will resist regulatory reforms and vested interests may resist structural reforms. ADB will continue to assist the government in improving the regulation making process and facilitating stakeholder consultations.

IV. ASSURANCES 36. The government has assured ADB that implementation of subprogram 2 shall conform to all applicable ADB policies, including those concerning anticorruption measures, safeguards, gender, procurement, consulting services, and disbursement as described in detail in the loan documents.

V. RECOMMENDATION

37. I am satisfied that the proposed policy-based loan would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve

(i) a change in the programmatic approach to include an additional subprogram, as further described in para. 19; and

(ii) the loan of $500,000,000 to the Republic of Indonesia for subprogram 2 of the Stepping Up Investments for Growth Acceleration Program, from ADB’s ordinary capital resources, with interest to be determined in accordance with ADB’s London interbank offered rate (LIBOR)-based lending facility; for a term of 15 years, including a grace period of 3 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft loan agreement presented to the Board.

Takehiko Nakao President

6 June 2016

18

Risk Assessment and Risk Management Plan (accessible from the list of linked documents in Appendix 2).

Appendix 1 11

DESIGN AND MONITORING FRAMEWORK

Impact the Program is Aligned with Investment increased as a share of GDP (National Medium-Term Development Plan, 2015–2019)

a

Results Chain Performance Indicators with Targets

and Baselines Data Sources and

Reporting Mechanisms Risks Outcome By 2019: Public and private sector investments increased

a. Private sector investment commitment in infrastructure through PPPs averages $4.5 billion per year (1990–2012 baseline average: $2.4 billion)

a. World Bank’s private participation in infrastructure database

Continuation of the global economic slowdown adversely affects Indonesia’s economic growth rate and creates a shortfall in fiscal revenue

b. Public sector infrastructure investments increased to at least 3.8% of GDP (2008–2011 annual average baseline: 2.4%)

b. Central Bureau of Statistics and development partner reports

c. Stock of foreign direct investment as a share of GDP increased to 35% (2013 baseline: 26.58%)

c. United Nations Conference on Trade and Development

Outputs 1. More predictable and open business environment

Subprogram 2 (2016): (i) the government reformed 147 regulations (2014 baseline: 0); (ii) national one-stop service issued more than 9,596 licenses (2014 baseline: 0); (iii) 40% of individual registered taxpayers submitted their tax return online (2013 baseline: 0); (iv) processing time to obtain eight mandatory business licenses for a company in an industrial zone is reduced to 3 days (2013 baseline: 23 days); (v) the time taken to obtain Business Trade Licenses and Company Registration Certificates in Jakarta is reduced to 3 hours (2015 baseline: 28 days).

CMEA, BKPM, and MOF Vested interests resist structural reforms Policy inconsistencies between central and local policies

Subprogram 3 (2018): (i) the government reformed 180 regulations (2016 baseline: 147); (ii) national one-stop service issued more than 15,000 licenses (2015 baseline: 9,596); (iii) 60% of individual registered taxpayers submitted their tax return online (2015 baseline: 40%); (iv) one local government will introduce an online system for tax on the acquisition of land and/or buildings.

CMEA, BKPM, and MOF

2. Creating an efficient market for infrastructure through PPPs

Subprogram 2 (2016): (i) MOF established a PPP unit (2014 baseline: 0); (ii) three national PDF-supported projects are awarded (2014 baseline: 0); (iii) three PPP projects received agreement for viability gap funding (2014 baseline: 0); (iv) one availability-based PPP contract is signed

MOF’s PPP unit report, MOF, and BPN

Revenue shortfall leads to a reduction in budget allocation for public infrastructure

12 Appendix 1

Results Chain Performance Indicators with Targets

and Baselines Data Sources and

Reporting Mechanisms Risks (2014 baseline: 0); (v) notice on development plan for land acquisition takes 3 days (2014 baseline: 20); (vi) three national infrastructure projects are financed by sovereign sukuk (Sharia compliance bond).

spending and MOF’s PDF Weak capacity of the MOF PPP unit to bring to market bankable PPP projects

Subprogram 3 (2018): (i) six national PDF-supported projects will be awarded (2015 baseline: 3); (ii) six PPP projects received agreement for viability gap funding (2015 baseline: 3); (iii) MOF PPP unit will sign memorandum of understanding with two local governments (2015 baseline: 1); (iv) four national infrastructure projects will be financed by sovereign sukuk.

MOF’s PPP unit report, and MOF

3. Faster and more transparent public procurement

Subprogram 2 (2016): (i) the government revised regulation on public procurement to strengthen the role of procurement units and mainstream e-procurement (2014 baseline: 0); (ii) total public procurement package is increased to Rp580.9 trillion (2013 baseline: Rp2.8 trillion); (iii) LKPP assisted one local government in developing a local competitive catalogue (2014 baseline: 0); (iv) LKPP developed tools for public procurement benchmarking (2014 baseline: 0).

LKPP Fraud and corruption in public procurement limit value for money capacity Delay in implementation of e-procurement platform at local government affects public procurement efficiency

Subprogram 3 (2018): (i) LKPP will enable procurement auction in its e-procurement system (2016 baseline: 0); (ii) one local government will pilot test competitive catalog (2016 baseline: 0); (iii) LKPP will conduct procurement benchmarking in at least five central government agencies and five local governments (2016 baseline: 0).

LKPP

Key Activities with Milestones Not applicable. Please refer to the Policy Matrix in Appendix 4. Inputs Asian Development Bank: $500,000,000 Assumptions for Partner Financing German development cooperation through KfW: €200,000,000 or its equivalent in US dollars

b (indicative)

BKPM = Badan Koordinasi Penanaman Modal (Indonesia Investment Coordinating Board), BPN = Badan Pertanahan Nasional (National Land Agency), CMEA = Coordinating Ministry of Economic Affairs; GDP = gross domestic product, LKPP = Lembaga Kebijakan Pengadaan Barang/Jasa Pemerintah (National Public Procurement Agency), MOF = Ministry of Finance, PDF = Project Development Fund, PPP = public–private partnership. a

Government of Indonesia. 2015. Rencana Pembangunan Jangka Menengah Nasional (National Medium-Term Development Plan), 2015–2019. Jakarta.

b Numbers are indicative and subject to the government’s request, and approval by the Asian Development Bank and German development cooperation through KfW.

Source: Asian Development Bank.

Appendix 2 13

LIST OF LINKED DOCUMENTS http://www.adb.org/Documents/RRPs/?id=48134-006-3

1. Loan Agreement

2. Sector Assessment (Summary): Industry and Trade

3. Contribution to the ADB Results Framework

4. Development Coordination

5. Country Economic Indicators

6. International Monetary Fund Assessment Letter

7. Summary Poverty Reduction and Social Strategy

8. Risk Assessment and Risk Management Plan

9. List of Ineligible Items

Supplementary Documents

10. Public Financial Management Assessment

11. Public–Private Partnership in Infrastructure

12. Program Impact Assessment

13. Reconciliation of the Original Subprogram 2 to the Revised Subprogram 2

http://www.adb.org/Documents/RRPs/?id=48134-006-3

14 Appendix 3

Appendix 3 15

16 Appendix 3

Appendix 3 17

18 Appendix 3

Appendix 4 19

POLICY MATRIX

Subprogram 2 October 2014 – June 2016

(expected prior actions are in bold)

Indicative Subprogram 3 July 2016 – July 2018


Medium-term Framework and expected results

(2019 – 2023) Output 1: More predictable and open business environment 1.1. Improved regulatory reform process ADB TA, Stepping Up Investment for Growth Acceleration Program (SIGAP) (TA-8661)

The Government implemented measures to ease investment restrictions. Accomplishment included:

1. The Government commenced a national regulatory reform program which included: (i) the establishment of the deregulation unit in the Ministry of Trade; and (ii) the streamlining of 147 business and trade regulations.

2. The Government revised the negative investment list further liberalizing foreign investment by allowing for (i) at least 67% foreign ownership in investments in the services sector covering most of the creative and tourism related industries; and (ii) 100% foreign ownerships in film studios, movie production and distribution.

The Government will strengthen the business regulatory environment by institutionalizing the regulatory impact assessments (RIA) and further liberalize foreign investments. These measures will include:

1. The Government will set up an inter-ministerial task force to oversee RIA program and monitor and evaluate regulations on a regular basis.

2. The Government will pilot RIA programs in selected ministries/agencies. Actions include issuing ministerial/agencies decree that will establish a RIA team and introducing RIA action plan.

Institutionalization of

RIA at national level.

1.2. Reduced the cost of doing business ADB TA, Stepping Up Investment for Growth Acceleration Program (SIGAP) (TA-8661) ADB TA on Tax Revenue

The Government implemented measures to reduce the transaction costs in doing business. Accomplishments included:

3. The Government simplified the process for obtaining business licenses of 22 line ministries and agencies by delegating their licensing authority to BKPM’s National One Stop Service (OSS) Center.

4. The Government has lowered the regulatory cost of setting up a business by (i) BKPM reducing the processing time to obtain the 8 mandatory business licenses from 23 days to 3 hours for large investors; and

The Government continues to streamline business procedures to start business, improve land registration and local tax payment. These measures will include:

3. The Government will merge Business Trade Licenses (SIUP) and Company Registration Certificates (TDP) to simplify the procedure to set up business.

Indonesia’s rank in

the World Bank Group Doing Business Survey in 2023 is reduced to be below 50.

20 Appendix 4






(2019 – 2023) Administration Modernization and Policy Improvement in Local Governments (TA-8877)

(ii) the Jakarta local government reducing the time for SMEs to obtain Business Trade Licenses (SIUP) and Company Registration Certificates (TDP) to 3 hours.

5. The Government has reduced the administration costs to businesses in making tax payments by: (i) the Ministry of Finance (MOF) implementing the electronic tax filing and tax payment system; and (ii) the Jakarta local government increasing local tax payment facilities from 1 bank to 11 banks.

4. The Jakarta local government will improve the

time to set up a business by integrating construction permits to local one-stop-service for business license.

5. The Government will introduce an online land

registration system which will expedite land registration process at subnational level.

6. The Jakarta local government will introduce an

online system for Tax on Acquisition of Land and / or Buildings (BPHTB).

Output 2: Creating an Efficient Market for Infrastructure through Public-Private Partnerships 2.1 Institutional and policy framework strengthened ADB TA, Stepping Up Investment for Growth Acceleration Program (SIGAP) (TA-8661)

The Government implemented measures to strengthen the PPP institutional, legal and regulatory frameworks in order to advance its PPP program. Accomplishments included:

6. To develop a robust PPP pipeline, the Government allocated

Rp146.7 billion ($11.1 million) in 2015 and 2016 to operationalize the Committee for Acceleration of Priority Infrastructure Delivery (KPPIP), which is responsible for screening, monitoring, and evaluating 30 strategic projects for potential investments including through PPP scheme.

7. The Government strengthened its PPP framework by: (i) establishing a PPP Unit in MOF and a Project Development Fund (PDF) to facilitate preparation and transaction of PPP projects; (ii) enabling PPPs in social infrastructure, such as in the health and education sectors, and (iii) introducing availability based scheme for PPP projects.

8. National Public Procurement Agency (LKPP) issued implementation procedures for procurement of PPP projects and recruitment of consultants for preparation and transaction

The Government continues to improve regulatory and institutional frameworks for private participation in infrastructure. These measures will include:

7. The Government will initiate drafting of a legal framework for private participation in infrastructure including PPPs.

8. The Government will strengthen the PPP policy framework by: (i) enabling local governments to use availability-based PPP schemes, (ii) enhancing the PDF mechanism, and (iii) clarifying the treatment of unsolicited PPP proposals.

9. MOF PPP unit will enhance local government

capacities in planning and preparing local PPP infrastructure projects.

At least 3 national PPP projects tendered annually.

Construction started or progressed in at least 5 national PPP projects prepared with PDF support

Three local

governments PPPs prepared with PDF support.

Appendix 4 21






(2019 – 2023) of PPP projects.

9. The Government awarded two availability-based telecommunication PPP contracts. In addition, the Government has completed the competitive bidding process for a water supply PPP project.

2.2. Fiscal and financial risks addressed. ADB TA, Stepping Up Investment for Growth Acceleration Program (SIGAP) (TA-8661)

The government implemented measures to support sustainable funding for Government support for bankability and preparation of PPP projects, improve land acquisition process for PPP projects, and improved the procurement of PPP projects. Accomplishments include:

10. The Government allocated Rp 814 billion ($62 million) in the 2015 budget and Rp.1.1 trillion ($86 million) in the 2016 budget to finance Viability Gap Funding (VGF), and approved VGF for three water supply PPP projects.

11. The Government enhanced transparency, efficiency and

predictability in the land acquisition process for infrastructure projects by: (i) allowing the private sector to fund land acquisition on the government’s behalf, (ii) introducing time-bounded procedures for preparation and implementation of land acquisition, and (iii) requiring land compensation payments made within 7 days after validation of claims.

The government continues to address the fiscal and financial risks. These measures will include:

10. MOF will streamline the approval process for VGF and ensure adequate budget allocation for VGF.

11. The Government will improve land certification program.

PPP projects reach financial close timely.

The average time for land acquisition for PPP projects process is reduced by 30%.

2.3. Infrastructure financing modalities expanded ADB TA on Strengthening the Local Government Bond Market (TA-8753) ADB TA, Stepping

In order to develop and expand long term financing of infrastructure projects, the Government continues to build local government capabilities to issue subnational bonds, expand the use of Islamic finance, and consolidated infrastructure financing facilities. Accomplishments included:

12. The West Java local government, in preparation of issuing subnational bonds to finance local infrastructure projects: (i) established a debt management unit; and (ii) trained and certified 14 staff members as debt and risk managers, of which four are women.

The government continues to introduce new financial instrument to finance infrastructure projects. These measures will include

12. The Government will facilitate the use of long-term financing of PPPs through project bonds.

More financial instruments for long-term infrastructure finance are introduced in the market.

22 Appendix 4






(2019 – 2023) Up Investment for Growth Acceleration Program (SIGAP) (TA-8661)

13. The Government increased sukuk infrastructure project financing from Rp. 1.6 trillion in 2014 to Rp. 13.7 trillion in 2016.

14. In order to improve efficiency, MOF consolidated its infrastructure financing facilities by transferring assets of Government Investment Agency (PIP) under MOF to PT Sarana Multi Infrastruktur (SMI), a state owned infrastructure financing company.

13. The Government will continue to increase the number of sukuk infrastructure projects.

14. The Government will strengthen its infrastructure financing support by converting PT SMI into Indonesia Development Financing Institution.

Output 3: Faster and more transparent public procurement 3.1. Adoption of ICT for public procurement process. ADB TA Aligning ADB and Country Systems for Improved Project Performance (TA-8548) ADB RETA - INO Subproject: Strengthening e-Purchasing Capacity as Catalyst to Accelerate Infrastructure Development (RETA 6455)

The Government implemented measures to improve public procurement governance in order to expedite infrastructure delivery. Accomplishments included.

15. The Government mandated the use of electronic public procurement system (e-procurement) for all public procurement of goods and services, which increased the total value of public procurement of goods and services through e-procurement from Rp. 2.8 trillion ($212 million) in 2013 to Rp. 580.9 trillion ($4.4 billion) in 2015.

16. The National Public Procurement Agency (LKPP) and the

Jakarta local government introduced the electronic platform for transparent competitive bidding for procurement of local goods and services.

The Government continues to improve the governance of public procurement and expedite public procurement process at national and subnational levels. These measures will include:

15. National Public Procurement Agency (LKPP) will enhance e-procurement system to enable

reverse auction of goods.

16. The National Public Procurement Agency (LKPP) will assist the Jakarta local government to pilot the usage of (i) the electronic platform for competitive bidding of procurement of local goods and services; and (ii) local electronic catalogue.

80% of total government procurement of goods is procured through e-procurement system.

75,000 of items are listed in the government’s e-catalogue system.

3.2. Improved capacity of public procurement delivery ADB TA, Stepping Up Investment for

The government, through the National Public Procurement Agency (LKPP), started to measure public procurement performance to enhance the capacity of public procurement entity and ensure timely delivery of national priority infrastructure projects. Accomplishments included:

17. LKPP improved capacity of public procurement units in line

The government will accelerate public procurement delivery and implement measures to build capacity of public procurement officers at national and local levels. This measure will include:

17. LKPP will continue to improve public procurement performance by (i) conducting procurement

40% of line

Appendix 4 23






(2019 – 2023) Growth Acceleration Program (SIGAP) (TA-8661)

ministries by introducing (i) tools to assess and benchmark procurement performance and (ii) e-learning platforms for training public procurement officers on public procurement regulations.

18. LKPP opened up foreign firms’ direct participation in competitive bidding for large public infrastructure projects by introducing International Competitive Bidding documents for procurement of goods and services.

benchmarking in at least 5 central government agencies and 5 local government agencies and (ii) strengthening e-learning modules to include procurement of goods and services in large infrastructure projects.

18. The Government will strengthen legal

framework on public procurement to incorporate procurement audit.

ministries annual work plan include procurement planning.

BKPM = Badan Koordinasi Penanaman Modal (National Investment Coordinating Board), CMEA = Coordinating Minister of Economic Affairs, ICB = International Competitive Bidding, ICT = Information, Communication, and Technology, KPPIP = Komite Percepatan Penyediaan Infrastruktur Prioritas (Committee for Acceleration of Priority Infrastructure Delivery), LKPP = Lembaga Kebijakan Pengadaaan Barang dan Jasa untuk Pemerintah (National Public Procurement Agency), MOF = Ministry of Finance, PPP = Public Private Partnerships, PT SMI = Perusahaan Terbatas Sarana Multi Infrastruktur (Sarana Multi Infrastruktur Incorporated), RIA = Regulatory Impact Assessment, Sukuk = Shariaf compliance bond, VGF = Viability Gap Funding. Source: Asian Development Bank