Progress Report on the State-Owned Enterprise Governance ......that almost all of the 125 SOEs under MSOE’s jurisdiction submitted audited annual financial reports to the General

Progress Report on the State-Owned Enterprise Governance and Privatization Program (Loan 1866-INO) in Indonesia September 2005

Asian Development Bank

CURRENCY EQUIVALENTS

(as of 5 September 2005)

Currency Unit – rupiah (Rp) Rp1.00 = $0.00010

$1.00 = Rp10,275

ABBREVIATIONS

ADB – Asian Development Bank FY – fiscal year IBRA – Indonesian Bank Restructuring Agency JSX – Jakarta Stock Exchange MSOE – Ministry of State-Owned Enterprises OECD – Organization for Economic Cooperation and Development PPP – public private partnership PSO – public service obligation SCI – Statement of Corporate Intent SOE – state-owned enterprise SOEGPP – State-Owned Enterprise Governance and Privatization Program TA – technical assistance

NOTES

(i) The fiscal year (FY) of the Government ends on 31 December. (ii) In this report, “$” refers to US dollars.

This report has been prepared by Ramesh Subramaniam, Principal Economist, Indonesia Resident Mission and Asa Malmstrom Rognes, Senior Financial Economist, Southeast Asia Department.

I. INTRODUCTION 1. With the overall objective of improving resource allocation in the public sector and promoting private sector participation in economic activities that have traditionally been controlled by the state, the Asian Development Bank (ADB) approved the State-Owned Enterprise Governance and Privatization Program for $400 million on 4 December 2001.1 ADB also approved two technical assistance (TA) grants, the first for the privatization and restructuring of state-owned enterprises (SOEs)2 and the second for the commercialization of public service obligations (PSO)3, to help the Ministry for State-Owned Enterprises (MSOE) implement the Program). 2. The aim of the Program is to reform the SOE sector through a range of targeted measures in five areas, namely: (i) subjecting SOEs to sound corporate governance practices, (ii) improving resource allocation by separating SOEs’ commercial activities from their public service obligations (PSOs), (iii) restructuring and privatizing SOEs to enhance their profitability and revenue flows to the Government, (iv) establishing fair and transparent labor practices, and (v) strengthening and effectively enforcing procurement guidelines for SOEs. 3. The Program comprises policy actions in these five areas supported by the $400 million loan to be disbursed in three tranches. The first tranche of the Program, had 19 conditions that were completed prior to the release of $150 million in December 2001, upon loan effectiveness. The second tranche ($150 million), originally scheduled for disbursement in July 2003, has 7 tranche release conditions and 23 monitorable actions. The third tranche ($100 million), originally scheduled to be disbursed in July 2004, has 7 tranche release conditions and 15 monitorable actions. 4. The Government has substantively complied with all the second and third tranche release conditions and all monitorable actions. Appendix 1 presents the status of compliance with the tranche release conditions, and Appendix 2 outlines progress under the monitorable actions. The development objectives of the Program have been met. Supported by Program measures to improve both corporate governance and operational efficiency, the overall profitability of the SOE sector increased during 2000–2003. 5. The SOE reforms under the Program involve the transfer of ownership and management to the private sector. The Government adopted a strategic approach in implementing the Program. First, it identified over 30 enterprises for restructuring and privatization initiatives. Second, it prioritized the divestment of State shares in high-value enterprises to mobilize revenues that financed part of the fiscal costs associated with the economic restructuring in the post-crisis period. This in turn facilitated fiscal consolidation and contributed to macroeconomic stability. Third, it leveraged the restructuring of state-owned banks and successfully divested shares in several large and medium sized banks under the Program. 6. The SOEs remain significant in the Indonesian economy, with 158 SOEs and 17 enterprises with minority state shareholdings together contribute about 40% to the gross 1 ADB. 2001. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the

Republic of Indonesia for the State-Owned Enterprise Governance and Privatization Program. Manila. 2 ADB. 2001. Technical Assistance to the Republic of Indonesia for the Privatization and Restructuring of State-

Owned Enterprises. Manila. TA 3714-INO, for $2.6 million, approved on 5 September 2001. 3 ADB. 2001. Technical Assistance to the Republic of Indonesia for the Commercialization of Public Service

Obligations. Manila. TA 3728-INO, for $1 million, approved on 25 September 2001.

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domestic product (GDP). While part of the contribution comes through the rise in business activity over the last few years in key segments of the economy with SOE concentration, it also captures the impact of the reclassification of the national energy company, PT Pertamina, and the national basic food products distributor Bulog as SOEs. PT Pertamina alone generates 4 times the revenue of the State electric utility company (PT PLN), and 7.5 times that of the telecommunications enterprise PT Telkom. Further, the transfer of ownership to the private sector in 13 large SOEs through the capital markets means the SOEs now represent a sizeable portion – estimated at 35% of the value of all listed securities - of the capital markets. It is noteworthy that the Indonesian equity market capitalization has grown from less than $30 billion in late 1990s to about $72.3 billion at end-2004. SOEs are likely to play a greater role in years to come as they launch major infrastructure development initiatives. The Government’s Medium-term Development Plan projects infrastructure requirements to exceed $72 billion over the next 5 years.

II. IMPLEMENTATION PROGRESS UNDER THE PROGRAM A. Progress Under the Second and Third Tranches4

1. Subjecting SOEs to Sound Corporate Governance Practices 7. The Program stipulated 3 core conditions under the second and third tranches to strengthen corporate governance in SOEs. In compliance with the Program, MSOE has (i) issued appointment agreements for all newly appointed directors and commissioners5; (ii) prepared statements of corporate intent (SCIs) for 36 SOEs against the target of 35 for the second tranche, and adopted SCIs for 50 SOEs against the target of 50 SOEs; and (iii) ensured that almost all of the 125 SOEs under MSOE’s jurisdiction submitted audited annual financial reports to the General Meeting of Shareholders for 2001-2003 in accordance with Indonesian company law, against the Program requirement that at least 80% of the SOEs comply. 8. The Program also included 11 monitorable actions under the second tranche and 9 under the third tranche, all of which have been complied with in a satisfactory manner. MSOE has introduced certain sound corporate governance norms through a range of measures outlined in Appendix 2, with particular focus on improving transparency in SOEs not listed on a stock exchange. It has also ensured that listed SOEs comply substantially with the listing rules of the Jakarta Stock Exchange (JSX). 9. There have been substantial improvements in the overarching corporate governance regime under which SOEs operate. A TA6 evaluated the Indonesian corporate governance framework against international best practice for State Owned Enterprises as developed by the Organization for Economic Co-operation and Development (OECD), and concluded the governance framework has many positive features.7

5 Since each second tranche condition has a follow-up third tranche condition, the discussion of

progress under the two tranches is presented in a seamless manner. Appendix 1 and 2 present complete details of compliance with trance release conditions for the second and third tranches.

5 Or individual SOE Ministerial decrees. 6 ADB. 2003. Technical Assistance to the Republic of Indonesia on State-owned Enterprise Restructuring. Manila.

TA 4280-INO, for $600,000, approved on 18 December 2003. 7 The OECD Steering Group on Corporate Governance in June 2002 decided to mandate the Working Group on

Privatisation and Corporate Governance of State-Owned Assets to develop a set of non-binding principles and best

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10. The SOE Law and associated regulations set out requirements for SOEs in relation to (i) rules regarding conflicts of interest on the part of directors, commissioners, and certain other SOE officers; (ii) mandatory internal supervisory units and regulations on audit committees; (iii) compulsory audits of the financial statements of SOEs; (iv) adherence to the principles of good corporate governance issued by MSOE; and (v) special circumstances, such as the privatization and restructuring of SOEs. 11. In addition the August 2002 Ministerial Decree on Corporate Governance, adopted as part of the Program, emphasizes:

(i) transparency—openness in decision making processes and in disclosing material and relevant information about enterprises,

(ii) independence—ensuring that enterprises are managed professionally without influence being exerted by any party contrary to applicable laws and regulations and good corporate principles,

(iii) accountability—clarity in the functions, and responsibilities of corporate organs so that enterprise management is carried out effectively,

(iv) responsibility—management compliance with applicable laws and regulations and adherence to good corporate principles, and

(v) fairness—equity in upholding the rights of shareholders under agreements and applicable laws and regulations.

12. Within the SOEs the key outcomes have been (i) the introduction of improved corporate governance practices in nonlisted SOEs, including qualitative changes in the composition of boards of commissioners and directors; (ii) the appointment of an appropriate number of independent commissioners in proportion to the number of shares held by noncontrolling shareholders in listed SOEs; (iii) introduction of a performance incentive system for SOE managers; (iv) the establishment of audit committees in listed SOEs; (v) the establishment of audit committees, comprising one commissioner and two outside experts, in 26 SOEs8; (vi) the appointment of a corporate secretary in each listed SOE and in those that were to be listed within the following 12 month period; and (vii) the submission of audited annual reports by nonlisted SOEs. Implementation of these measures was facilitated by the ADB TA approved prior to the Program.9 13. Improvements in the corporate governance of SOEs are reflected partly in their improved financial performance. (Table 1 in Appendix 3). SOE profits grew by almost 2.5 times over 2000-2003 to Rp.18 trillion ($2.0 billion). Receipts in the form of dividends and corporate income taxes to the Government as a shareholder also grew by more than 140%, to over $2.6 billion in 2003. It is noteworthy that dividends alone have averaged Rp.10.8 trillion ($1.1 billion) on average per year over the last 4 years. The financial turnaround is significant as several SOEs had reported losses during 1997-2000 because of mismanagement and the impact of the Asian financial crisis 14. The SOE balance sheet strengthened during 2000-03 (Table 2 in Appendix 3). Total assets grew by 32%, largely because of higher retained earnings and partly due to revaluations, and current assets grew at a faster rate than current liabilities. This trend is partly reflected by

practices on corporate governance of state-owned assets. TA 4280 analyzed the Indonesian SOE framework against this best practice.

8 Listed and unlisted SOEs 9 TA 3484-INO: Technical Assistance to the Republic of Indonesia for Corporate Governance Reform. Manila for

$300,000, approved on 28 August 2000.

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the increase in total equity in the SOE sector, which increased by 140% to Rp 277 trillion ($30.5 billion) in the selected SOEs. 15. Qualitative improvements are also evident, through analytical work undertaken by an ADB TA which shows that corporate governance practices in publicly listed SOEs are aligning with international practices in privately held companies. A survey measuring the progress of corporate governance in SOEs was conducted in 200210, to assess the corporate governance environment in 9 large SOEs (8 publicly listed plus one to be listed). The results showed that the publicly listed SOEs had engaged in better corporate governance practices than 14 private sectors publicly listed companies. 16. Extending and deepening of corporate governance reforms in the large and diverse SOE sector will be critical to have more sustained impact on overall economic growth, both through immediate contributions and improved privatization prospects. In the years 2002, 2003 and 2004 there has been a substantive shift of resources from the public to the private sector. This has occurred through: (i) sale of SOE shares through the capital markets, which has created large minority shareholders positions in several SOEs; and (ii) increasing use of public private sector partnerships (PPP). Both these developments create new corporate governance issues, for instance relating to the treatment of minority shareholders in publicly listed SOEs, while the PPP process does not yet have the same governance oversight in place that exists for privatization transactions. Another issue is the MSOE’s capacity to monitor and implement reform is increasingly being stretched as the size of the SOE portfolio increases. These issues are subject to continued policy dialogue between the Government and ADB.

2. Separating SOEs’ Commercial Activities from Their PSOs 17. Traditionally, the Government often used SOEs to provide public goods and services to the population. Frequent political interference in the pricing of such services and inadequate accountability in SOEs resulted in inefficient delivery of goods and services, characterized by profitable business units within the SOEs cross-subsidizing the PSO delivery. Furthermore, the Government did not usually provide any compensation or made only inadequate subsidy payments to meet the SOEs costs of delivery. Given the adverse impact of such practices on the commercial viability of several SOEs, the Program supported reform of PSOs in selected enterprises. 18. This component comprised 3 monitorable actions for the second tranche and 2 for the third tranche, all of which have been fully complied with. With support from an ADB TA (footnote 3), MSOE has (i) identified PSOs in 15 SOEs, and (ii) quantified PSO costs and their environmental impacts. MSOE received substantial cooperation from the SOEs involved in the exercise, which are now requesting for commercialization or other alternative treatment of the PSOs. The treatment of PSOs will become increasingly important, as they may complicate the design and delivery of the massive infrastructure investments in Indonesia over the next 5-10 years.

10 The SOEs include PT Aneka Tambang, PT Timah, PT Indofarma, PT Bank Negara Indonesia, PT Indosat, PT

Telkom, PT Kimia Farma, PT Bank Mandiri, and PT Tambang Batubara Bukit Asam. The Government has divested varying proportions of its shares in eight of these SOEs and divestment is under way in PT Bank Negara Indonesia

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3. Corporate Restructuring and Privatization of SOEs 19. This component is one of the key pillars of the Program, as it aims to restructure and privatize SOEs. In this area, the Program included 3 tranche release conditions under the second and third tranches, 3 monitorable actions under the second tranche, and one monitorable action under the third tranche. Progress under the Program is discussed in the sub-sections below. 20. The MSOE strengthened the legal and regulatory framework for corporate restructuring and privatization reform through the June 2003 SOE Law and through Presidential and Ministerial decrees outlining privatization procedures including employee buy-out, strategic sale, free share transfers, initial public offering, joint venture, leasing of operating assets, granting of concessions, and cash auctions.

a. Financial Assessment, Restructuring and Liquidation

21. In the preparatory stages of the Program, MSOE assessed the financial and operational viability of 60 SOEs with ADB TA support.11 Subsequently, as a first step (in compliance with a monitorable action) towards implementation, MSOE developed policies and procedures for privatization and issued a Ministerial Decree to provide guidance on approaches and modalities of privatization, including employee buy-out, strategic sale, free share transfers, initial public offering, joint venture, leasing of operating assets, granting of concessions, and cash auctions. 22. Under a second and third tranche release condition, at least 30 SOEs were to undertake comprehensive financial audits covering remuneration and all expenses of the members of the board of commissioners and directors, and submit the audited accounts. This requirement was surpassed as 111 SOEs submitted their audited financial reports for the 2001 audit cycle, 99 SOEs submitted their reports for the FY2002 audit cycle and 100 SOEs did so for the FY2003 audit cycle.12 23. Corporate restructuring, as defined under the Program, involved operational and financial restructuring. The scope of operational restructuring covered changes to one or more of: management information systems, production and logistics planning, distribution network, marketing strategy, workforce strength and composition, and organizational structure. Financial restructuring involved one or a combination of: sale of subsidiaries and/or surplus assets, equity injection from third parties, mergers and acquisition, debt restructuring and liquidation. 24. Based on the preparatory actions and the operational and financial assessment of 60 SOEs, MSOE identified 12 SOEs for liquidation, and prepared and initiated a time-bound liquidation plan for 11 of them in compliance with a monitorable action for the second tranche (see C.3. in Appendix 2). Out of these, 4 SOEs have been fully liquidated, the liquidation of another SOE is at an advanced stage, and closure of 5 SOEs is being finalized. A merger partner has been identified for the last remaining SOE under this category. 25. In order to enhance the performance and viability of SOEs, MSOE prepared and adopted corporate restructuring plans for 45 SOEs (36 cases with ADB support - footnote 2), in 11 ADB. 1998. Technical Assistance to the Republic of Indonesia for the Corporate Governance and Enterprise

Restructuring. Manila. TA 3149-INO, for $2.47 million, approved on 29 December 1998. 12 Under current requirements, SOEs must submit their audited statements to both MSOE and the Ministry of Industry

and Trade. The number of SOEs complying with this condition varies from one FY to the next. Only those SOEs that complied fully with this requirement are included here.

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line with Program monitorable actions. The restructuring program focused on a number of key industry segments in Indonesia, including: (i) fertilizer – 7 SOEs; (ii) plantation – 14 SOEs; (iii) construction – 2 SOEs; (iv) financial institutions – 1 SOE; (v) airlines – 2 SOEs; (vi) electricity – 1 SOE; (vii) fisheries – 5 SOEs; (viii) trading – 3 SOEs, (ix) trading – 3 SOE, and (x) forestry - 6 SOEs. 26. Based on a review of the Annual Reports13 and discussions with the MSOE and SOE officials it is clear that a large number of SOEs have been restructured in addition to the restructuring which has taken place with ADB support. PPPs are increasingly being used as a way for the private sector to participate in SOE restructuring efforts. Table 1 shows that several PPPs have already been established in the large SOEs14. In addition to the list of PPPs shown in Table 1, there are 15 plantation SOEs which have established in excess of 50 PPPs since 2002. This follows on analytical and advisory support on restructuring of plantations provided under ADB TA.

Table 1: Public Private Sector Partnerships by Type

Type of PPP Leasing PPA/

No. Company JV BOT Rent GPA Total

1 PT Perusahaan Listrik

Negara (electricity) 4 9 13

2 PT Telkom

(Telecommunications) 3 5 8 3 PT PUSRI (fertilizer) 12 12

4 PT Perushaan Gas

Negara (gas) 4 2 6 5 PT PELNI (shipping) 3 3

6 PT KERETA API

(railways) 7 7

7 PT PELINDO III

(seaports) 1 1

8 PT PELINDO I

(seaports) 2 2 Total 24 12 5 11 52

Source: Ministry of State Owned Enterprises b. Privatization of SOEs

27. The Government has adopted privatization as a key strategy to enhance economic efficiency, promote growth, and generate revenues for debt repayments and bank recapitalization. During the course of the Program, there has been recognition on the part of the Government that its multiple roles as owner, regulator, supervisor and manager of SOEs have led to serious conflicts of interest, besides constraining potential growth. The Program has been a catalyst in leveraging the Government’s commitment towards achieving reforms in a

13 Review of the Annual Reports conducted by TA 4280. 14 This list does not include all PPPs. It excludes consideration of PT Pertamina, which is known to have PPP

arrangements.

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systematic manner. In preparing for the divestment of state shares in SOEs, the Government had sequentially taken a number of strategic steps during 2002-2004 with ADB support:

(i) Assessment of operational and financial viability of 60 SOEs – which facilitated finalization and implementation of liquidation plans for 12 SOEs, and adoption of corporate restructuring plans in 36 SOEs;

(ii) Strengthening the legal and regulatory framework for privatization, first through Presidential and Ministerial decrees outlining privatization procedures; enactment of the Law on State Finances in March 2003 (Law 17/2003) to regulate revenue generation modalities for the state budget, including SOE privatization; enactment of Law on SOEs in June 2003 (Law 19/2003) to guide SOE management, conduct and privatization;

(iii) Formulation of privatization options for 42 of the SOEs covered in the assessment above; and prioritization of 28 SOEs for privatization, and submission of a program to Parliament for its consideration in early 2003; and

(iv) Sequencing the privatization of larger and strategic SOEs aimed at:

(a) restructuring and privatizing commercial banks in order to recover the liquidity support given to such institutions during the Asian financial crisis;

(b) meeting budgetary needs during 2002-04 to sustain macroeconomic stability.

28. With regard to the actual divestment of state shares, the Program required MSOE to achieve satisfactory progress in privatizing at least 7 SOEs for the second tranche release and at least 8 SOEs for the third tranche release).15 In satisfactory compliance with these conditions, MSOE has obtained Parliamentary approvals and completed all Government-level actions in connection with privatizing at least 15 SOEs. Table 2 presents the details on the privatization transactions.

Table 2: Compliance with Privatization Conditions, 2002–2005

No.

SOE and Sector Government Shareholding (%) Board

Appointments Before Program As of Aug 2005

I. Divestment of Shares in Fulfillment of Second Tranche Release Condition 1 PT Indosat

(telecommunications) 66.0 15.0

2 PT Bank Central Asia 100.0 5.0 3 PT Bank Danamon 100.0 0.0 4 PT Bank Internasional

Indonesia 100.0 5.5

5 PT Bank Niaga 100.0 0.0

Majority by private investor

6 PT Angkasa Pura Ia (airport) 100.0 49.0 7 PT Angkasa Pura IIa (airport) 100.0 49.0 II. Divestment of Shares in Fulfillment of Third Tranche Release Condition 1 PT Bank Lippo 100.0 1.2 2 PT Bank Permata 97.0 26.2

Majority by private investor

15 For purposes of the Program, satisfactory progress with respect to the privatization of SOEs was defined as

(i) transfer of more than 50% of the voting shares of an SOE to private investors, (ii) transfer of 50% or less of the voting shares of an SOE combined with the transfer of a majority of the seats on the boards of commissioners and directors of an SOE to private investors, and (iii) formulation of an action plan to effect a transfer as described in either scenario (i) or (ii) that could not be implemented because of adverse economic or other circumstances.

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No. SOE and Sector Government Shareholding (%)

Board Appointments

Before Program As of Aug 2005 3 PT Batubara Bukit Asam

(mining) 100.0 65.8

4 PT Pembangunan Perumahan (housing construction)

100.0 51.0

5 PT Adhi Karya (construction) 100.0 51.0 6 PT Hotel Indonesia 100.0 30-year lease 7 PT Hotel Wisata 100.0 30-year lease 8 PT Merpati Nusantara

Airlinesb 100.0 49.0 To be determined

Source: MSOE

a The privatization options for the two Angkasa Pura companies had been developed to the transaction stage in 2002 and involved the transfer of 49% of share ownership and the majority of board positions to the private sector, when the terrorist attacks in Bali adversely affected investor interest, which has yet to revive because of uncertainty in relation to tourism forecasts. Current share ownership refers to intended ownership.

b On 27 September 2004, Parliament approved a restructuring program for PT Merpati consisting of debt restructuring, a strategic sale of majority state ownership to foreign or local investors. Current share ownership refers to intended ownership.

29. The Government has taken a strategic approach and focused on privatizing large institutions of systemic importance, to ensure adequate support to the state budget. This approach has been facilitated by: (i) significant investor interest in financial institutions and other large SOEs, whose viability or value has not been affected by security concerns stemming from events over 2002-04; and (ii) continuing momentum for banking sector restructuring and reforms. The sale of shares in Bank Mandiri, Bank Rakyat Indonesia, PT Persuhaan Gas Negara, PT Indosat, PT Telcom and PT Indocement fall into this category. Furthermore, its approach has also been to privatize state assets with the objective of improving economic efficiency, while mobilizing the required resources to support the budget. The privatization initiatives in the banking sector have increased competition and improved the quality of financial services. Table 3 presents the outcomes through the sale of the large and strategically important SOEs, since the crisis.

Table 3: Major Privatization Initiatives, 1999 - August 2005 (Measured by Proceeds to the Budget)

No. SOE % Sold Method Revenue (Trillion of

Rp) 1 PT Indosat 51 SS 4.3 2 PT. Perusahaan Gas

Negara 39 IPO 1.2

3 PT. Indocement TP Tbk. 16.67 SS 1.2 4 PT. Bank Mandiri Tbk. 30 IPO & P 5.4 5 PT. Bank Rakyat

Indonesia 45 IPO &

ESOP 2.5

6 Bank Central Asia 95.0 SS 6.6 7 Bank Danamon 100.0 SS 5.2 8 Bank Internasional

Indonesia 94.5 SS 3.4

9 Bank Niaga 100.0 SS & P 2.9

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10 Bank Lippo 60.8 SS 1.4 11 Bank Permata 71.0 SS 2.9

Total Privatization Proceeds in 2002-2004

37.0 ($3.6 billion)

Source: Ministry of State-Owned Enterprises Note: SS – Strategic Sale; IPO – Initial Public Offering; P – Placement in the capital market;

ESOP-Employee Stock-Option Placement. In addition to the above, Government raised Rp 120 billion ($13.2 million) from the sale of PT Pembangunan Perumahan, PT Bukitbara Asam and PT Adhi Karya.

c. Sale of Government’s Minority Shareholdings 30. In addition to the divestment of majority positions, the Program required MSOE to achieve satisfactory progress in selling all state shares in at least 12 minority companies. As part of the preparatory work for the Program, the Government had formulated divestment plans in 20 enterprises in which it had minority ownership. Based on this assessment, the 2004 privatization program presented to Parliament had 12 minority enterprises, including 5 enterprises for release of the second tranche and 7 enterprises for release of the third tranche. 31. Given the Government’s strategic focus on the larger SOEs and the budgetary needs, the low value transactions related to the divestment of minority shareholdings and the smaller enterprises have not progressed as quickly as the high value larger SOE transactions. Labor sensitivities in some of the enterprises and the uncertainty surrounding elections and Government transition over 2003-05 have complicated the privatization process in these cases. As a result, the Government has taken a number of significant steps to move forward to fully comply with Program condition. This process has resulted in:

(i) Divestment of all its remaining holdings in PT Wisma Nusantara (42.0%) in December 2002 and in PT Indocement (16.9%) in October 2003;

(ii) Inclusion of 12 enterprises with minority state ownership in the current privatization program, to seek Parliament’s approval;

(iii) Completion of all valuations and assessments to facilitate immediate sale upon approval;

(iv) Approval by the President of Indonesia of Government Regulation No. 33/2005 (PP 33/2005) on Procedures for Privatization of SOEs to confer authority to divest state shareholdings on the Government once Parliament approves such divestments as part of the annual budget deliberations; and

(v) Finalization of plans to sell Government’s remaining minority positions in various banks and other enterprises in which the Government had earlier planned to retain some ownership.

32. Among these measures, item (iv) relating to the adoption of the Government Regulation by the President marks a significant milestone, as until recently, Parliament and Government have been in a deadlock over procedures for privatization of SOEs. In particular, the two key relevant laws in this area, namely the Law on State Finances and the Law on SOEs, both enacted in 2003 within a span of 4 months, appear to be inconsistent with regard to the relative approval authorities of the Government and Parliament. In view of this discrepancy, the Government – based on consultations with relevant Commissions of Parliament – has now adopted this Regulation, which reinforces that the Government’s Privatization Plan and the annual value of privatization proceeds in the Budget will be in principle approved by the Parliament but once these approvals are obtained, the Government is vested with adequate authority to decide on the mode as well as timing of the privatization transactions.

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33. The Government has requested ADB that the signing of the Regulation by the President of Indonesia on 7 September 2005 be taken as a key step in this process, as it allows the Government to proceed with divestment of shares in the minority enterprises once the privatization program and 2006 Budget are approved by Parliament.

4. Establishing Fair and Transparent Procedures for Managing Labor Redundancy

34. This component of the Program included 5 monitorable actions, 3 under the second tranche and 2 under the third tranche, all of which have been fully complied with. With assistance from ADB TA (footnote 2), MSOE formulated a labor rationalization policy covering (i) severance payments and gratuity based on length of service; (ii) early retirement; (iii) assistance with re-employment, training or retraining of employees and financing of entrepreneurial initiatives; and (iv) employee rights in assessing claims against pension funds. A monitoring mechanism was also developed to oversee the SOEs in implementing the policy and provide input for improving it.

5. Strengthening and Effectively Enforcing Guidelines for Procurement in SOEs

35. Under this component, one tranche release condition under the second and third tranches focused on the submission of independent procurement audits by at least 40 SOEs. In line with this condition, 20 SOEs have submitted independent procurement audits for FY2001 and an additional 20 SOEs have submitted procurement audit reports covering FY2002. 36. In line with the 3 monitorable actions under the Program, MSOE has also assessed the procurement audit findings. Audit companies audited the 40 SOEs against then current procurement regulations as outlined in Presidential Decree 18/2000, which were applicable to SOEs as well as to all public sector projects (and are consistent with ADB’s Procurement Guidelines). 37. The independent audits did not disclose corruption, but did disclose inefficient practices which can provide fertile ground for corrupt activity and the waste of resources. The audits also scrutinized standard operating procedures for procurement by individual SOEs, and found deviations from global best practices. MSOE has appointed a committee for improving the standard operating procedures on procurement and is in the process of appointing consultants to assist in the process. The Government has further advanced in this area with new procurement procedures (Decree No. 80/2003 dated 3 November 2003) which revoked Decree No. 18/2000. MSOE is also working within a broader government initiative to draft guidelines on electronic procurement, with the idea of promoting future procurement over the Internet to promote transparency, including updating information on the tendering process.

III. SUMMARY

38. The basic premise of the Program is that SOE reforms that involve the transfer of ownership and management and confine the Government’s role to policymaking and regulation will release scarce resources for poverty reduction and social programs. In this regard, the Program has, in a satisfactory manner:

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(i) achieved the establishment of sound policy, legal, regulatory, and operational frameworks for improving corporate governance in the SOE sector;

(ii) improved awareness of international norms and practices in corporate and financial governance;

(iii) improved the financial performance of the SOE sector significantly during 2001–2003 partly by means of the good governance measures introduced under the Program;

(iv) promoted transparency and disclosure by stipulating the regular submission of financial, operational, and procurement audits that include financial outcomes, board compensation, and compliance with legislation (labor, environmental, and procurement);

(v) initiated a fairly robust program for restructuring SOEs that could serve as a model for the Government to adopt as it moves forward in relation to SOE management and reforms, for instance, the Program has supported the liquidation of 8 nonperforming SOEs and the restructuring of 36 others;

(vi) catalyzed the gradual divestment of state control in 15 large SOEs, including several systemically important financial institutions, and initiating the privatization of another 13 SOEs as part of the Government’s privatization program, thereby contributing significantly toward meeting budgetary needs, which has been a crucial factor in Indonesia’s macroeconomic recovery; and

(vii) addressed efficiency issues in the SOE sector by facilitating the divestment of shares held by the Government in sectors where the state has no sound rationale justifying its involvement, for example, construction.

39. In summary, Government has fully complied with 6 of the 7 tranche release conditions. While the Government has partially complied with the condition relating to the divestment of minority shareholdings, it has made substantial progress and clarified all regulatory issues for moving towards full compliance. Satisfactory progress has been achieved with respect to all the monitorable actions in a timely manner. 40. The Program has had clear and significant development impact resulting in enhanced corporate governance and a focused and strategic approach to privatization. There is demonstrable evidence for greater awareness of corporate governance norms in SOEs during the course of implementation of the Program. The Program has also been successful in leveraging privatization of several large SOEs. As reported in Table 3 above, divestment of the Government’s shareholdings in SOEs in the real sector has contributed Rp 6.7 trillion ($652 million) to the budget, while the sale of Government ownership in the banking sector has contributed Rp 30.3 trillion ($2.9 billion) under the Program period. 41. With the initial phase of divestment of state shares in larger and more strategic SOEs completed, the Government plans to focus on improving efficiency in its management of SOEs and to continue to transfer assets to the private sector. In particular, the Government intends to move forward with privatizing its shareholdings in a number of SOEs in sectors such as infrastructure, natural resources, and plantations. The Government is likely to focus on initiatives to improve macroeconomic growth performance by addressing key issues relating to competitiveness and employment promotion. The Program has helped formulate a comprehensive reform agenda that is expected to provide a good foundation for further reforms in the SOE sector.

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IV. PRESIDENT’S RECOMMENDATION 42. In view of the satisfactory progress made in the implementation of the State-Owned Enterprise Governance and Privatization program and substantial fulfillment of all the policy conditions for release of the second and third tranches, the President recommends that the Board approve the release of $250 million, compromising $150 million under the second tranche and $100 million under the third tranche, of the program loan.

Appendix 1 13

LOAN 1866-INO: STATE-OWNED ENTERPRISE GOVERNANCE AND PRIVATIZATION PROGRAM COMPLIANCE WITH TRANCHE RELEASE CONDITIONS UNDER SECOND AND THIRD TRANCHES

Core Tranche Release Conditions Under Second and Third Tranches Compliance with Second Tranche Release Conditions Compliance with Third Tranche Release Conditions 1. Subjecting SOEs to sound Corporate Governance Principles A.2.(i) Negotiate and sign appointment

agreements for all newly appointed directors and commissioners (both tranches).

Complied with. SOE commissioners and directors have been appointed in line with MSOE guidelines that have been in effect since 2001.

Complied with. MSOE issued a ministerial decree (59/2004) in June 2004 stipulating a revised template for appointment agreements outlining complete terms and conditions pertaining to all newly appointed directors. This decree provides an updated implementation framework for the 2003 SOE Law and the August 2002 Ministerial Decree on Corporate Governance. MSOE is updating the previous guidelines on appointments of new commissioners.

A.2.(ii) Prepare SCIs for 35 SOEs (second tranche).1

(iii) Prepare SCIs for 50 SOEs (third Third tranched

Complied with. A total of 36 SCIs covering the period 2003–2005 were completed. These were reviewed and endorsed by MSOE and published on its web site.2

Complied with. MSOE has identified 76 SOEs and issued instructions to them to complete SCIs for 2004–2006. Of these, 50 SOEs have completed their draft SCIs, with 49 of them having obtained the approval of all their shareholders at annual general meetings and the endorsement of the MSOE shareholder nominees.3 Advanced progress is under way for the remaining one SCI (of PT Danareksa).

A.4.(iii) At least 80% of SOEs under MSOE jurisdiction to file annual reports with MSOE and the company registrar at the Ministry of Industry and Trade that comply fully with legal requirements (for both tranches).

Complied with. All 125 SOEs under MSOE jurisdiction had filed their 2001 annual reports with MSOE by 31 August 2002, fully complying with the legal requirements for such annual reports. For 2002 financial statements, MSOE had received all 125 annual reports by December 2003. Lodging of these reports had been delayed because of a dispute about the right to audit between MSOE as the shareholder and the State Audit Agency, which resulted in

Complied with. MSOE has reported almost 100% compliance with regard SOEs’ submission of their audited financial statements to annual general meetings, subsequent endorsement of the statements by the annual general meetings, and the lodging of the reports with MSOE. A uniform electronic reporting format has been developed with technical assistance support5 that will be suitable for submission to the Ministry of Industry and

1 In selecting the SOEs, preference was given to those that are not to be privatized during the Program. 2 www.bumn-ri.com. The 36 SOEs include PT Pelni, PT PN-II, PT PP, PT Jasa Marga, PT Sarinah, PT Pusri, PT Bio Farma, PT Petrokimia Gresik, PT Garam, PT

Angkutan Sungai, PT Garuda Indonesia, PT RNI, PT Dok Perkapalan KB, PT IPTN, Perum RRI, PT Pos Indonesia, PT Asuransi Jiwasraya, PT Taspen, PT Inhutani I, PT Bank Ekspor, Perum Pegadaian, PT Perusahaan Gas Negara, PT Asuransi Jasa Rahardja, PT Jakarta Lloyd, PT Sucofindo, Perum DAMRI, Bhanda Ghara Reksa, PT Balai Pustaka, PT TWC Borobudur, PT Shang Hyang Seri, Kawasan Berikat Nuantara, PT Tirtaraya Mina, PT Dahana, PT PP Berdikari, Perum Percetakan Uang RI, and PT Wijaya Karya.

3 The 50 SCIs include: Posindo, Inhutani I, Damri, Pusri, Pelni, TWC Borobudur, Asuransi Ekspor Indon, Biro Kasifikasi Indon, Perumnas, PNM, Hutama Karya, Danareksa, Wastika Karya, Nindya Karya, Jamsostek, Asuransi Kesehatan, Surveyor Indonesia, Taspen, Industri Sandang Nusantara, Kereta Api Indonesia, Pelindo IV, Merpati, Hotel Indonesia, Dok Perkapalan Sur, PDIP Batam, Bali Turism, Kima, Rukindo, Kawasan Industri Medan, INTI, PLN, Pindad, PTPN IV, PTPN V, PTPN VI, PTPN VII, PTPN VIII, PTPN X, PTPN XII, PTPN XIII, Perhutani, Percetakan Negara, PAL Indonesia, Krakatau Steel, Industri Soda, RRI, Jasa Marga, ASDP, Pusri, and TVRI.

14 Appendix 1

Core Tranche Release Conditions Under Second and Third Tranches Compliance with Second Tranche Release Conditions Compliance with Third Tranche Release Conditions

a delay of annual shareholders meetings. About 50% of these reports have been registered at the Ministry of Industry and Trade. 4

Trade.

3. Corporate Restructuring and Privatization of SOEs C.5. Conduct a complete independent (nonfinancial and Development Supervisory Board), 3-year financial audit that includes remuneration and all expenses (direct as well as fringe benefits) of the members of tboards of directors and commissioners of 30 SOEs (both tranches).

Complied with. This requirement has been exceeded, in that a total of 111 SOEs had lodged audit reports from independent private sector auditors with MSOE by the end August 2002, including the remuneration and expenses of members of boards of directors and commissioners.

Complied with. More than 100 SOEs submitted their audit reports from independent auditors for fiscal years 2002 and 2003, including the remuneration and expense information relating to directors and commissioners. Support was provided under ongoing technical assistance6 to improve disclosure and reporting requirements, with a particular focus on disclosing remuneration and expense details by category of expenses and by individual directors and/or commissioners.

C.7. MSOE to achieve satisfactory progress in privatizing at least seven SOEs (second tranche) and at least eight SOEs (third tranche)

Complied with. The Government has fully complied with the second tranche release condition through various actions in the following 7 SOEs:

(i) Divesting majority state ownership (85%) in PT Indosat;

(ii) Divesting majority ownership in 4 commercial banks - Bank Central Asia; Bank Danamon; Bank Internasional Indonesia; and Bank Niaga;

(iii) Completion of all transaction steps with regard to the privatization of PT Angkasa Pura I and PT Angkasa Pura II, the SOEs managing the international airports in Bali and Jakarta, following Parliamentary approval in 2002.

With support from the Program, the Government expedited privatization activity. During 2003–2004, it proposed to Parliament the divestment of shares in 23 SOEs. Strategically, the Government’s focus has been on

Complied with. The Government has fully complied with the third tranche release condition through various actions in the following 8 SOEs:

(i) Divesting 49% of state shares in PT Pembangunan Perumahan, with the Government currently owning 51%, but ceding majority of board positions to the private investors.

(ii) Divesting 49% of state shares in PT Adhi Karya, with the Government owning 51%, but listing the company on the Jakarta Stock Exchange and ceding majority of board positions to the private investors.

(iii) Divesting 35% of state shares in PT Batubara Bukit Asam with the Government owning 65%, but listing the company on the Jakarta Stock Exchange and ceding majority of board positions to the private investors.7

(iv) Ceding state management and operational control over the major assets of PT Hotel Indonesia

4 SOEs are required to send an electronic copy of the annual report to the Company Registrar in the Ministry of Industry and Trade. A review shows that this

procedural requirement has not been fully complied with. However, a fundamental issue here is that the Ministry of Industry and Trade’s database is in disarray. The database problems worsened dramatically in 2002, when all the staff responsible for the database were transferred to the newly empowered regional governments, but the responsibility for database maintenance remained with the central Government. This shortage of manpower and technology persists and has resulted in the database essentially become unreliable. MSOE is currently reviewing the policy of dual submission.

5 ADB. 2001. Technical Assistance to the Republic of Indonesia for the Privatization and Restructuring of State-Owned Enterprises. Manila. TA 3714-INO, for $2.6 million, approved on 5 September 2001.

6 TA 3714-INO. 7 However, the Government owns a golden share in some enterprises, which gives it control on key operational decisions, regardless of the size of its ownership.

Appendix 1 15

Core Tranche Release Conditions Under Second and Third Tranches Compliance with Second Tranche Release Conditions Compliance with Third Tranche Release Conditions

divesting state shares in the largest enterprises and financial institutions. It has adopted a combination of privatization methods, including strategic sales, divestment or new issuance through the stock market, and employee and management buyouts. As a result of these actions, the Government has ceded all its ownership in 11 SOEs during the program period, including: (a) the divestment of minority positions (C8); (b) sale of 39–49% of shares in 3 other SOEs; (c) divestment of majority ownership in 5 commercial banks; and (d) divestment of 40–49% of shares in 2 of the largest state-owned commercial banks.

through a 30-year, long-term lease. (v) Ceding state management and operational control

over the major assets of PT Hotel Wisata through a 30-year, long-term lease.

(vi) Divesting almost 99% in Bank Lippo through strategic sale.

(vii) Divesting almost 74% of the Government’s shareholding in Bank Permata; a consortium consisting of Standard Chartered Bank and PT Astra International has acquired the bank.

(viii) Finalizing the restructuring of PT Merpati Nusantara Airlines and obtaining Parliament’s approval to privatize up to 51% of the company.

The Government also divested its shareholdings in a few strategic SOEs, including:

(i) divestment of 39% of state shares in PT PGN, with the Government owning 61%, with Parliamentary approval to sell 7.5% more in 2005;

(ii) divestment of 30% of state shares in Bank Mandiri, the largest state-owned financial institution, with the Government currently owning 70%; and

(iii) divestment of 40.5% of state shares in Bank Rakyat Indonesia, the largest microfinance institution and the third largest commercial bank, with the Government owning 59.5%.

In addition to the successful divestments and/or transfer of management control in 18 SOEs, the Government’s privatization program targets another 10 SOEs–9 nonfinancial SOEs and 1 financial institution—and it has presented plans for their full or majority divestment to Parliament. These include

(i) PT Bank Negara Indonesia (30% of 99%), (ii) PT Indah Karya (all 100%), (iii) PT Indra Karya (all 100%), (iv) PT Virama Karya (all 100%), (v) PT Bina Karya (all 100%), (vi) PT Yodya Karya (all 100%), (vii) PT Cambrics Primissima (all 52.8%), (viii) PT Perkebunan Nusantara III (30% of

100%), (ix) PT Timah (14% of 65%), and (x) PT Aneka Tambang (14% of 65%).

16 Appendix 1

Core Tranche Release Conditions Under Second and Third Tranches Compliance with Second Tranche Release Conditions Compliance with Third Tranche Release Conditions C.8. For minority shareholdings, MSOE to achieve satisfactory progress in completely selling shares in at least five companies (second tranche) and in at least seven companies (third tranche).

Partially complied with. Through the Program, the Government has divested all its shareholdings in PT Wisma Nusantara (42.0%), and PT Indocement (16.7%). In addition, the Government’s privatization program includes divestment of minority shareholdings in 12 enterprises. The Government has finalized a Regulation to be signed by President, which confers the authority to sell on the Government once such divestments are included as part of the budget and upon approval by Parliament.

Partially complied with. The President of Indonesia approved the Government Regulation (PP 33/2005, 7 September 2005) which provides for clarity on the privatization procedures and confers divestment authority on the national Government once Parliament approves their sale as part of the annual budget deliberations. In 2004, the Government has divested its remaining 10.5% shareholding in Bank Danamon and 16.3% in Bank Niaga. The Government intends to divest its remaining minority shareholdings in 6 banks (Bank Central Asia – 5%; Bank Internasional Indonesia – 5.5%; Bank Lippo – 1.2%; Bank Permata – 26.2%; BTPN – 28.4%; and May Bank – 6.1%).

5. Strengthening and Effectively Enforcing Guidelines for Procurement in SOEs E.2.(ii) MSOE will initiate random, independent (nonfinancial and Development Supervisory Board) audits of procurement for 40 SOEs (20 SOEs each under the second and third tranches), present audit reports to the Steering Committee and the Asian Development Bank, publish summary findings, and identify measures to recover losses and prosecute culprits.

Complied with. Procurement audits for 2001 were undertaken and reports were submitted by October 2002 for 20 SOEs.8

Complied with. Procurement audits for 2002 were undertaken and reports submitted by December 2003 for 20 SOEs.9

8 PT PN IV, PN PN IX, PT Kertas Leces, PT Pertaini, PT Garuda Indonesia, PT Perikanan Samodra Besar, PT Sarinah, PT Kawasan Berikat Nusanta, PT

Pelindo III, PT Kimia Farma, PT Asuransi Ekspor Indonesia, PT Jasa Rahardja, PT Sucofindo, PT Wijaya Karya, Perum Sarana Pengembang Usaha, PT Industri Sandang Nusantara, PT Gas Negara, PT Tambang Batubara Bukit Asam, PT Semen Baturaja, and PT Pindad.

9 Asuransi Jasa Indo, Asuransi Kesehatan, Danareksa, Wasita Karya, Brantas Abipraya, Pelni, Angkasa Pura I, Angkasa Pura II, Pos Indonesia, BTDC, Perebunan Nusantara V, Perebunan Nusantara VI, Pupuk Sriwijaya, Perum Peruri, PNRI, PAL Indonesia, Krakatau Steel, Batan Teknologi, Perjan TVRI, and Semen Kupang.

Appendix 2 17

LOAN 1866-INO: STATE-OWNED ENTERPRISE GOVERNANCE AND PRIVATIZATION PROGRAM COMPLIANCE WITH MONITORABLE ACTIONS UNDER THE SECOND AND THIRD TRANCHES

Monitorable Actions Compliance with Monitorable Actions

Under the Second Tranche Compliance with Monitorable Actions

Under the Third Tranche 1. Subjecting SOEs to sound Corporate Governance Principles A.2. MSOE to implement corporate governance policy for SOEs not listed on a stock exchange through the following measures:

(i) Review and comment on the composition of boards of commissioners and directors, including numbers of people on the boards, their skills mix, and their qualifications (second and third tranches); and the role, obligations, and composition of boards to verify whether the board of commissioners has guided and monitored the implementation by the board of directors of an SOE’s long-term plan, annual business plan, and budget.

Complied with. The June 2003 SOE Law and the MSOE Decree on Corporate Governance of August 2002, based on the Best Practice Code formulated by the Indonesian National Committee on Corporate Governance, provide a substantive set of rules and regulations on corporate governance in SOEs. Based on these guidelines, an assessment of corporate governance practices, including a review of boards of commissioners and directors, was undertaken for 28 SOEs.1

Complied with. An assessment of corporate governance practices was undertaken in nine SOEs.2

(ii) implement a performance incentive system for remunerating managers to reward them for improvements in defined performance indicators by means of a ministerial decree (second tranche).

Complied with. The minister for SOEs issued a guideline for a performance incentive system to be applied by individual SOEs. TA 3714-INO3 provided recommendations based on an assessment of performance incentive systems in a group of 30 SOEs that are being reviewed by MSOE.

Not applicable.

(iii) Submit a performance review report on the implementation of corporate

Not applicable. Being complied with. The performance review reports were supported under TA3714-INO (footnote 3). Based

1 PT Garuda, PT Jasa Marga, PT PN IV, PT Telkom, PT Pelindo II, PT Indofarma, PT Kimia Farma, PT Aneka Tambang, PT Timah, PT Indo Farma, PT BNI, PT

Semen Gresik, PT Indosat, PT Telkom, PT Kimia Farma, PT Danareksa, PT Tima, PT PLN, PT BNI, PT PN VIII, PT Telkom, PT Adhi Karya, PT Asuransi Ekspor Indonesia, PT Surveyor Indonesia, PT Krakatau Steel, PT Pelindo II, PT Hotel Indonesia Natour, and PT Kereta Api Indonesia.

2 PT Aneka Tambang, PT Timah, PT Indofarma, PT Bank Negara Indonesia, PT Indosat, PT Telkom, PT Kimia Farma, PT Bank Mandiri, and PT Tambang Batubara Bukit Asam.

3 ADB. 2001. Technical Assistance to the Republic of Indonesia for the Privatization and Restructuring of State-Owned Enterprises. Manila. TA 3714-INO, for $2.6 million, approved on 5 September 2001.

18 Appendix 2



Under the Third Tranche governance policy covering SOEs with at least 1 year of experience (third tranche).

on the format developed, actual performance review reports were completed for 35 SOEs under TA4280-INO.4

A.3. MSOE to ensure that listed SOEs substantially comply with the listing rules of the Jakarta Stock Exchange, in particular, with the following provisions on corporate governance.

(i) Appointment of independent commissioners in proportion to the number of shares held by non-controlling shareholders.

Complied with. By July 2002, all listed SOEs had appointed additional independent commissioners in sufficient numbers to comply with the requirements.5

Complied with. The appointment practices have been adopted for newly listed company, PT Adhi Karya.

(ii) Establishment of an audit committee consisting of at least three members, one of whom is an independent commissioner and the others of whom are independent professionals in accounting and/or finance recruited from outside the company.

Complied with. Assessments done in the following listed SOEs indicate that the audit committee requirement has been met: PT BNI, PT Kimia Farma, PT Indofarma, PT Aneka Tambang, PT Timah, PT Batubara Bukit Asam, PT Perusahaan Gas Negara, PT Telkom, and PT Semen Gresik.

Complied with. In addition to those listed under the second tranche, the new SOEs that went for listing or whose shares were divested have also complied with this requirement, namely, PT Bank Mandiri, PT BRI, and PT Adhi Karya.

(iii) Appointment of a corporate secretary. The position must be held by a member of the board of directors or a corporate officer specifically appointed to this function.

Complied with. List of SOEs is the same as in A.3(ii).

Complied with. List of SOEs is the same as in A.3(ii).

A.4. Improve transparency of SOEs not listed on a stock exchange.

(i) Create a new corporate secretary position for all SOEs to be listed in the next 12 months. The secretary is to be appointedwithin 4 months of the expected listing date of the SOE and is to be responsible for corporate communications with shareholders, the company registrar,

Complied with. As of 2002, PT Bank Mandiri and PT BRI were the only state-owned institutions to undertake initial public offerings during the next 12 months and had appointed corporate secretaries.

Complied with. Subsequently, this requirement was met by the other SOE preparing for listing in 2003, namely, PT Adhi Karya.

4 ADB 2003. Technical Assistance to the Republic of Indonesia for State-owned Enterprise Restructuring. Manila. TA4280-INO, for $600,000, approved in

December 2003. 5 The SOEs and number of additional independent commissioners appointed were as follows: PT Telkom (two), PT Indosat (one), PT Semen Gresik (3), PT

Tambang Timah (two), PT Aneka Tambang (two), PT Indofarma (two), and PT Kimia Farma (one).

Appendix 2 19



Under the Third Tranche and the stock exchange.

(ii) MSOE to require that all SOEs prepare an annual report,6 including statement on compliance with environmental legislation (where appropriate) and audited financial statements in line with existing regulations applying to (a) all limited liability companies,7 (b) companies whose line of business involves public fund raising or which have assets of at least Rp50 billion or have issued an acknowledgement of indebtedness,8 and (c) publicly listed companies.9

Complied with. The state minister for SOEs issued a letter in March 2002 outlining the reporting requirements. Compliance was verified in annual reports and audit reports were submitted to MSOE for fiscal year 2001.

Substantially complied with. Compliance with the requirements during fiscal year 2002 was verified in 2003. Subsequent to the minister’s letter of March 2002, the requirements on compliance with environmental legislation were incorporated in the Law on SOEs, enacted by Parliament in June 2003.

(iii) MSOE to publish SCIs and annual reports, including audited financial statements, of SOEs with majority Government ownership on a specially designed web site. The system will also be used for SOEs to submit data and reports to MSOE.

Complied with. A total of 36 SCIs has been published on www.bumn-ri.com. The web site has links to the web sites of all SOEs. Financial statements are also on the web site.

Complied with. MSOE periodically updates the information submitted to the Government by the SOEs.

(iv) Establish audit committees in 30 SOEs (to include one commissioner and two outside experts) that will report directly to the board of commissioners to evaluate the audit results of the company, review the company’s compliance with statutory requirements and the adequacy of audit procedures, and make recommendations about internal control systems and their

Complied with. Complied with. During 2002–2004, a total of 30 SOEs established audit committees, of which 13 were listed on the Jakarta Stock Exchange.

6 he annual report, including the audited financial statements, must be in accordance with the Company Law and with Generally Accepted Accounting Principles

as approved by the Indonesian Institute of Accountants. 7 Consistent with Company Law, articles 56, 57, 58, and 86. 8 Consistent with Government Regulation No. 24/1998 of 14 February 1998 on corporate annual financial Information. 9 In line with the Decision Letter of chair of BAPEPAM No. KEP-80/PM/1996, dated 17 January 1996, on the obligation to submit periodic financial statements.

20 Appendix 2



Under the Third Tranche implementation.

A.5. Capacity building for effective implementation of corporate governance mechanisms by attending corporate governance workshops covering all items in A.1. organized with the support of ADB, the World Bank, or others, to be attended by at least (i) all MSOE deputy ministers, directors,

and deputy directors and other relevant staff, and

(ii) commissioners and directors of all SOEs to be subjected to the new corporate governance system under the second and third tranches.

Complied with. Under TA 3714-INO (footnote 3) a total of 34 workshops, seminars, and conferences were held, with contributions from 178 speakers. The events were attended by 368 staff members of MSOE, including senior staff; 1,327 SOE employees; and 494 others.

Not applicable.

2. Separating SOEs Commercial Activities from their PSOs B.1. MSOE, with the support of TA for the commercialization of PSOs, will (i) identify PSOs in 15 selected SOEs, (ii) quantify PSO costs and their environmental impact, and (iii) develop rules and regulations for

tendering such services (allowing bidding by private companies) with the objective of minimizing subsidies.

Complied with. Significant advisory support was provided under TA 3728-INO: Commercialization of Public Service Obligations,10 as follows:

(i) Over 15 SOEs were initially selected and an assessment of their PSOs was undertaken – however, following the transfer of various special purposes agencies (for example, schools and hospitals) from MSOE’s purview, the number of SOEs with direct and significant PSOs got reduced to 14.

(ii) The survey undertaken helped quantify PSO costs, which were further elaborated in the accounting report, and assess the environmental impact stemming from the PSOs.

(iii) MSOE developed draft appropriate rules and regulations, although the actual compliance has differed from company to company.

Not applicable.

10 ADB. 2001. Technical Assistance to the Republic of Indonesia for the Commercialization of Public Service Obligations. Manila. TA 3728-INO, for $1 million,

approved on 25 September 2001.

Appendix 2 21



Under the Third Tranche B.2. MSOE to work closely with the relevant line ministries to (i) introduce the rules and regulations for

tendering PSOs by private companies with the objective of minimizing subsidies; and

Not applicable Complied with. The June 2003 SOE Law recognizes the existence of PSOs and the need for their approval by the technical ministries. In addition, the draft rules (referred to in B.1) requiring open tendering have been adopted by MSOE, which is at present disseminating the rules with relevant technical ministries.

(ii) line ministries to contract out the provision of selected public services to the most competitive bidder, which may or may not be the SOE that had previously been providing the services.

Not applicable. Complied with. A framework for contracting out services on a sustainable basis has yet to emerge. However, the state budget currently provides for PSOs only in two SOEs, namely, PT Kereta Api (railways) and PT Pelni (shipping), because the former is the only provider of railway services by legislation, while the latter has come to enjoy a monopolistic position because of the exit of several private shipping operators. These two SOEs have engaged in services contract with the technical ministries.

3. Corporate Restructuring and Privatization of SOEs C.2. Develop policies and procedures and issue a ministerial decree for the following privatization processes: employee buyouts, strategic sales, free share transfers, initial public offerings, joint ventures, leasing of operating assets, granting of concessions, share arrangements, and cash auctions. This will include procedures for selecting auditors, investment bankers, and other technical advisers.

Complied with. Presidential Decree No. 122 of 2001 (30/11/01) reinstated and defined the authority of MSOE. As agreed with ADB, the new decree states that SOEs will retain the proceeds from issuing new shares. MSOE Decision Letter of Minister No. 35/M.BUMN/2001 of 28 December 2001 regulates policies and procedures for privatization processes fully in line with recommendations developed under TA 3149-INO,11 including all modalities defined in the condition.

Not applicable.

C.3. MSOE to provide a time-bound plan

and initiate liquidation of eight SOEs.

Complied with. Following the identification of 12 nonviable SOEs as part of the first tranche, MSOE has adopted a time-bound plan with support from TA 3714-INO (note c) on the liquidation of 11 SOEs, namely, PT Cipta Niaga, PT Barata Indonesia, PT B Pakarya Industri S, PT Dok & Perk. Kadja, PT Industri Kapai, PT Industri Soda, PT Kerta Niaga, PT Lokanata, PT Perhotelan, PT

Not applicable.

11 ADB. 1998. Technical Assistance to the Republic of Indonesia for the Corporate Governance and Enterprise Restructuring. Manila. TA 3149-INO, for $2.47

million, approved on 29 December 1998.

22 Appendix 2



Under the Third Tranche Pradnya Paramita, PT Sarana Karya. Of these, PT B Pakarya Industri S and PT Kerta Niaga were liquidated by July 2002 and PT Lokanata and PT Perhotelan Indonesia by December 2002. The liquidation of PT Sarana Karya is under way. MSOE has initiated the liquidation process for the all the other SOEs included in the list, with the exception of PT Pradnya Paramita which is likely to merge with PT Balai Pustaka, another profitable SOE.

C.4. MSOE to implement corporate restructuring plans for 10 SOEs (second tranche) and 15 SOEs (third tranche),12 with appropriate consideration for all relevant legislation and policies stipulated under the Program.

Complied with. The following 26 SOEs have, with assistance from TA 3714 (note c), presented restructuring plans to their annual general shareholder meetings, which have accepted the plans and initiated the restructuring:

(i) fertilizer industry (7 SOEs): Pupuk Sriwijaya, Pupuk Kalimantan Timur, Pupuk Kujand, Pupuk Iskander Muda, Petrokimia Gresik, Rekayasa Industri, and Mega Eltra;

(ii) plantation industry (14 SOEs): PT PN I through PT PN XIV;

(iii) construction Industry (2 SOEs): PT Hutama Karya and PT Jasa Marga (financial restructuring);

(iv) financial Institutions (1 SOE): PT Danareksa (financial restructuring);

(v) airlines (1 SOE): PT Garuda (debt restructuring plan); and

(vi) electricity ndustry (1 SOE): PT PLN (20 independent power purchase agreements).

Complied with. In addition to the 26 SOEs for which restructuring plans were formulated and initiated, 10 other SOEs have subsequently formulated such proposals, including (i) 6 SOEs in fisheries, which were in the process of merging as of September 2004; (ii) 3 SOEs in the trading sector that will be merging; and (iii) PT Merpati Airlines, whose management has submitted a debt restructuring plan and sought Government approval to privatize the company in order to seek fresh cash injections from a strategic investor.

4. Establishing Fair and Transparent Procedures for Managing Labor Redundancy D.1. MSOE to approve the consultative working group’s recommendations on labor policy.

Complied with. MSOE has endorsed the recommendations of the working group.

Not applicable.

D.2. MSOE will implement a labor rationalization program in accordance with the policy as follows:

(i) SOEs will lodge their labor

Complied with. MSOE sent letter to all SOEs informing them about the Program. Several SOEs have submitted plans for labor restructuring to MSOE and the Ministry of Manpower. However, the Ministry of Finance is reviewing

Complied with. A number of SOEs referred to in C.4 have submitted restructuring plans.

12 Corporate restructuring includes financial and/or operational restructuring. Financial restructuring could take one or more of the following forms: (i) selling

subsidiaries and/or surplus assets, (ii) injecting equity from third parties, (iii) undertaking mergers or acquisitions, (iv) restructuring debt, and (v) liquidation. Operational restructuring could involve changes to one or more of the following: (I) management information systems, (ii) production and logistics planning, (iii) distribution networks, (iv) marketing strategy, (v) workforce number and composition, and (vi) organizational structure.

Appendix 2 23

Monitorale Actions Compliance with Monitorable Actions


Under the Third Tranche restructuring plans, if any, including cost implications with MSOE and the Ministry of Manpower to provide endorsement of the restructuring options;

(ii) the Ministry of Manpower to record financial assistance being provided by the Government to SOEs unable to meet the costs of redundancies.

its policy of providing financial support to SOEs to manage labor rationalization.

5. Strengthening and Effectively Enforcing Guidelines for Procurement in SOEs E.3. Based on the results of random procurement audits (see E.2 under core conditions), MSOE will

(i) develop guidelines for procurement by SOEs, including requirements for compliance with environmental legislation in technical specifications of tender documents, differentiated by industry groups if necessary;

(ii) introduce these new guidelines for necessary action.

Complied with. Consultants under TA 3714-INO have assessed the 20 procurement audit reports commissioned by MSOE in August 2002 and received in October 2002. According to these 20 reports, the current procurement regulations as outlined in Presidential Decree 18/2000, which are applicable to SOEs as well as to all public sector projects (and are consistent with ADB’s Procurement Guidelines), are fully sufficient for procurement by SOEs. Therefore there is no need for formulating and monitoring new guidelines. However, the audit reports also assessed the standard operating procedures for procurement in these SOEs, and made recommendations for improvement. MSOE is prioritizing the recommendations for implementation.

Complied with. Using the more than 40 procurement audits, MSOE is drafting guidelines on electronic procurement, with the idea of handling all future procurement over the Internet to promote transparency, including updating information on the tendering process.

Source: Ministry of State Owned Enterprise

Appendix 3 24

Financial Performance of State Owned Enterprises in Indonesia, 2000-03

Table A3.1: Profits and Losses, 111 SOEs, 2000–2003

Rp million

(Parentheses refer to negative values) Change 2000–2003

Profits and Losses 2000 2001 2002 2003 Rp million Percent Revenues 130,454,454 157,954,686 180,248,385 195,050,395 64,595,941 50 Gross Profits 37,638,500 45,184,186 53,821,664 67,217,014 29,578,514 79 Overhead 26,363,081 30,254,800 47,068,055 52,782,538 26,419,457 100 Other (non-operating

income/expenses) 999,818 (10,192,771) (14,855,156) (13,637,491) (14,637,309) (1,464) Earnings before interest and taxes 10,275,601 25,122,157 21,608,765 28,071,967 17,796,366 173 Interest Expense 22,061,648 11,015,898 9,645,612 11,301,748 (10,759,900) 49 Profits Before Taxes (11,786,047) 14,106,259 11,963,153 16,770,219 28,556,266 242 Taxes 3,642,463 3,562,605 6,237,946 8,137,686 4,495,223 123 Extraordinary Items (38,452) (240,761) (2,767,948) (1,481,986) (1,443,534) (3,754) Net Profits (15,390,058) 10,784,415 8,493,155 10,114,520 25,504,578 166 Dividends 3,040,666 4,450,840 5,724,577 6,802,753 3,762,087 124 Adjustments 3,991,597 3,013,891 3,228,134 (242,365,577) (246,357,174) (6,172) Adjusted Retained

Earnings (22,422,321) 3,319,684 -459,556 245,677,344 268,099,665 1,196 SOE = state-owned enterprise. Note: The table includes 111 SOEs for which data were available on a reliable and consistent basis for 2000–2003. Source: Ministry of State Owned Enterprises

Table A3.2: Balance Sheets, 111 SOEs, 2000–2003 Rp Million (Parantheses refer to negative values) Change 2000-2003 Balance Sheet Items 2000 2001 2002 2003 Rp Million Percent Current Assets 238,149,675 301,040,351 301,214,435 335,643,102 97,493,427 41 Noncurrent

Assets 434,194,564 421,478,371 556,013,577 543,710,614 109,516,050 25

Total Assets 672,344,239 722,518,722 857,228,012 879,353,716 207,009,477 31 Current Liabilities 411,700,625 479,464,655 471,405,013 491,200,869 79,500,244 19 Noncurrent

Liabilities 162,481,523 144,331,692 145,736,585 137,001,304 (25,480,219) (16) Total Liabilities 574,182,148 623,796,347 617,141,598 628,202,173 54,020,025 9 Equity 98,162,097 98,722,375 240,086,412 251,151,543 152,989,446 156 Liabilities and

Equity 672,344,245 722,518,722 857,228,010 879,353,716 207,009,471 31 Note: The table includes 111 SOEs for which data were available on a reliable and consistent basis for 2000–2003. Source: Ministry of State Owned Enterprises

Documents

Progress Report on the State-Owned Enterprise Governance ......that almost all of the 125 SOEs under MSOE’s jurisdiction submitted audited annual financial reports to the General