Indonesia WT/TPR/S/51
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I. ECONOMIC ENVIRONMENT
(1) INTRODUCTION
1. The sharp downturn in 1997/98 interrupted a quarter of a century of continuous growth in
Indonesia's GDP, at annual rates of 6-7%.  Duri ng this period, the population benefited, albeit
unequally, from an increase in living standards and the improvement of social conditions (literacy
rates, health and food situation, etc.).  Indonesia undertook a successful, though incomplete,transformation of its economy from one based on natural resources to one relying increasingly on
manufactured products and services.  The transforma tion was fostered by the liberalization of trade
and investment, which have long been the main factors contributing to Indonesia's economic
development.
2. Despite this liberalization, together with prudent macroeconomic policies, Indonesia has
probably been the ASEAN country most seriously affected by the Asian crisis.  While relatively
sound macroeconomic fundamentals had initially protected Indonesia during the Thai currency
turmoil, which erupted in mid-1997, market sentiment sharply deteriorated in the following months
over concerns about the fragility of the financial system and the overall country risk.  The subsequent
collapse of the rupiah, whose value fell from 2,400 to 13-14,000 per U.S. dollar in less than a year,severely damaged an already unsound banking sector and caused a deterioration in the financial
position of private corporations, whose debt was largely denominated in foreign currency.  This
situation contributed to the transmission of the financial crisis to the real economy, and to the
subsequent sharp deterioration in the main macroeconomic indicators (GDP, inflation, public
finances).  In 1998, a projected decline of GDP of over 10% will constitute Indonesia's deepest
recession since 1963.
3. In the face of economic urgency, the Government committed itself to bold economic and
trade reforms.  While reiterating its commitment to  prudent macroeconomic policies, it focused on the
restructuring of the banking sector and steps to address long-standing structural impediments to
growth, many of which had been identified by previous Trade Policy Reviews.
1  In recent months, the
Government has begun to remove many of the distorting trade barriers that survived the decade-long
liberalization process (Chapter III), and which have, over time, generated growing (input) costs for the
economy as a whole.  Current reforms are therefore intended to promote more rational use of
Indonesia's resources, particularly its immense natural resources, and to strengthen its industrial and
export base, which would eventually reduce its vulnerability to future downturns.  To support such
reforms, Indonesia is receiving extensive technical and financial assistance from bilateral, regional
and multilateral sources.
4. While trade and structural reforms may benefit the economy over the medium term, the
enormous depreciation of the rupiah puts considerable pressure on the conduct of economic policy in
the short term.  By increasing the prices of imported food, in a period of drought, the depreciation of
the currency has generated increased needs for subsidies, particularly for food, the cost of which is
borne by the State budget.  As imported inflation spreads through the economy, Bank Indonesia facesthe dilemma of, on the one hand, tightening its monetary policy to contain domestic price increases,
                                                     
1The 1994 Review noted that the Indonesian economy was dogged by high and uneven levels of
assistance across sectors, preventing market mechanisms from efficiently allocating resources (p.90).  It
analysed the numerous barriers to trade, including import tariffs, licensing, export taxes, local-content
requirements, and restrictions on domestic trade and distribution (pp.49-89).  It also pointed out the existence ofa wide and costly network of public enterprises ( pp.84-86) and the uncertainties created by the absence of
competition rules (p.82), the lack of enforcement of rule s and regulations, together with the weaknesses and lack
of transparency of government procurement procedures (p.64), etc.WT/TPR/S/51 Trade Policy Review
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and on the other hand, injecting enough liquidity to prevent the collapse of Indonesia's ailing banking
system.  While, at the current exchange rate, Indonesian products enjoy a tremendous increase in
competitiveness, exports have not yet fully responded owing to difficulties encountered in importing
necessary inputs and obtaining trade finance.
Table I.1
Basic economic and social indicators, 1993-97
(Per cent, US$ and Rupiah billion)
1993 1994 1995 1996 1997
Population (million) 189.1 192.2 195.3 198.3 201.4
Urban Population (%) 33.5 .. 35.8 36.0 36.4
Employment (%) 41.9 42.7 41.0 43.2 43.2
Birth rate (per thousand) .. 24.1 23.6 23.3 ..
Life expectancy at birth (male/female) .. 61.6/64.9 61.5/65.3 63.0/66.0 ..
Inflationa10.2 9.7 9.0 6.6 11.6
GDP  at market prices (Rupiah billion)
- Current prices 329,777 377,354 452,381 532,631 624,337
- Constant 1993 prices 329,777 353,974 383,768 414,419 433,685
GDP  at market prices (US$ billion)
- Current prices 158.0 174.6 201.2 227.4 214.6
- Constant 1993 prices 158.0 169.6 183.9 198.6 207.8
GDP  per  capita  (US$)
- Current prices 835.6 908.6 1,030.1 1,146.7 1,065.5
- Constant 1993 prices 835.6 882.4 941.5 1,001.3 1,031.7
Share in GDP  (%)
Agriculture 17.9 17.4 17.2 16.5 16.1
Mining and quarrying 9.6 8.3 8.4 8.6 9.5
Manufacturing 22.3 23.9 24.2 25.2 25.6
Utilities 1.0 1.0 1.2 1.2 1.2
Construction 6.8 7.4 7.6 7.9 7.5
Trade, hotels, and restaurants 16.8 16.6 16.8 16.7 16.7
Transport and communications 7.0 7.1 6.8 6.6 6.8
Banks and finance 4.2 4.5 4.7 4.3 4.1
Dwellings and real estate 2.9 3.0 2.6 2.5 2.4
Other services 11.4 10.7 10.5 10.2 10.1
Share in employment
Agriculture .. .. 44.0 44.0 41.2
Mining and quarrying .. .. 0.8 0.9 1.0
Manufacturing .. .. 12.6 12.6 12.9
Other .. .. 42.6 42.5 44.9
.. Not available.
a As measured by the CPI (end-period).Note: Fiscal years (i.e, 1993 corresponds to fiscal year 1993-94).  The Indonesian fiscal year commences 1 April.
Source: World Bank;  Bank Indonesia Financial Statistics, Vol. XXXI No. 6, June 1998; ESCAP, Statistical indicators for Asia and  the
Pacific, June 1998;  IFS, July 1998.
5. The resumption of economic growth is therefore tightly linked to the return to a more realistic
exchange rate, which in turn depends on the stabilization of the economy and the restoration ofIndonesia WT/TPR/S/51
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investor confidence.  Both are linked to the fulf ilment of several conditions, including the resolution
of the external debt problem, the restructuring of the banking sector, and the implementation of
broader microeconomic reforms, in cooperation with international economic institutions.  At the same
time, Indonesia's autonomous economic and trade reforms need to be complemented by support from
the international community.  While Indonesia's main trading partners already provide substantial
financial and technical assistance, they also need to maintain a stable and predictable trading regime,by resisting protectionist pressures.  The success of Indonesia's liberalization process, and its rapid
economic recovery depend crucially on the pick-up of exports, which itself relies on the openness of
major external markets and stable trading conditions.
6. A summary of the basic features of the Indonesian economy is contained in Table I.1 and
recent economic performance indicators are presented in Table I.2.
Table I.2
Economic performance, 1993-97(Per cent change)
1993 1994 1995 1996 1997
Income and absorption
GDP 6.5 7.5 8.2 8.0 4.6
Oil/gas GDP -0.3 2.6 0.0 1.4 -1.4
Non-oil/gas GDP 7.5 7.9 8.8 8.4 5.0
By expenditure
- Consumption 4.9 4.4 14.0 8.0 6.7
- Private 5.8 4.7 15.9 8.6 7.5
Fixed capital investment 5.7 13.8 14.0 14.5 4.1
Domestic demand 6.9 8.8 10.1 8.7 ..
Exports of goods + non-factor services 6.6 9.1 8.6 7.7 6.3
Imports of goods + non-factor services 4.4 14.5 27.1 6.9 6.6
Competitiveness indicators
GDP deflator (period average) .. 7.8 9.9 8.6 12.0
Consumer price index (period average) 10.2 9.7 9.0 6.6 11.6
Real effective exchange rate (1990=100) 101.9 94.7 100.8 108.4 ..
Monetary survey (end period)
Private sector credit 20.5 21.6 23.0 42.1
Narrow money 12.0 23.9 18.5 18.4 19.6
Broad money 22.0 20.1 27.6 29.6 23.2
Interest rate
3-month deposit rate (% per annum) 10.8 9.9 13.9 15.0 20.7
Fiscal balance  (% of GDP)
Domestic government revenue 17.0 17.6 16.2 16.0 17.3
Government expenditure 13.8 15.0 14.2 14.0 13.5
Fiscal balance (excluding foreign aid) -3.2 -2.6 -2.0 -2.0 -3.8
.. Not available.
Note: Fiscal years (i.e. 1993 corresponds to the fiscal year 1993/1994).  The Indonesian fiscal year commences 1 April.
Source: IMF and World Bank.WT/TPR/S/51 Trade Policy Review
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(2) RECENT ECONOMIC DEVELOPMENTS
(i) Recent growth and employment trends
7. The Indonesian economy experienced a deep cycl ical swing in the period under review, from
high growth to its deepest recession in recent history.  In a first stage, from 1994 to 1996, real GDP
growth exceeded its average of the last fifteen years (6.9%), and possibly its long-term potential.  It
reached 7.5% in 1994, 8.2% in 1995 and 8% in 1996.  Economic activity peaked in the second half of1996 with an annualized rate of GDP growth of 10%.  However, since then growth has declined.  By
the time the currency crisis broke in the second half of 1997, the growth rate of GDP had already
fallen by half from peak levels.  The financial cris is transformed a soft landing into a deep recession.
Economic activity shrunk in the first half of 1998, with a decline in GDP of about 12% at an
annualized rate.  For 1998 as a whole, GDP is projected to decline by 10 to 15% (section (4) below).
8. The manufacturing sector was the main engine of growth in the earlier part of the review
period (1994 to 1996), with an average growth rate of 12% per year, slightly above the average of the
previous decade (10%).  This period was also characterized by the rapid growth of the services sector,
which now accounts for 40% of total output (Table I.1).  Since mid-1997, however, production has
been on the decline in all sectors (agriculture, manufacturing and services), unfavourable climaticconditions (the El Niño drought) being an aggravating factor in agriculture.
9. Economic activity in the earlier part of the review period was driven by high levels of
investment, of both domestic and foreign origin, and, to a lesser extent, exports (Table I.2).  However,
the period was also marked by a rapid rise in private consumption, a relatively new factor in
Indonesia's development process, which was linked to the rapid increase in living standards and
private borrowing.  Since the second half of 1997, however, domestic demand has been deeply
affected by a drop in investment, the collapse of the banking and corporate sectors, and a fall inpersonal incomes.
10. Until 1997, changes in the structure of employment continued to reflect the modernization of
the country:  the share of agriculture fell from 44% of total employment in 1995 to 41% in 1997,
manufacturing remained stable (about 13% of the total) and the share of services increased from 43 to
45%.  Employment recorded rapid increases in the years of high growth (about 4.5% per year between
1995 and 1997), but worsened in 1998, as a result of the economic collapse.  The rate of
unemployment, which stood around 5% at the peak of the economic cycle in 1996, is forecast by the
Federation of Indonesian Workers to reach over 14% at the end of 1998.  In less than a year
(mid-1997 to mid-1998), an estimated 8 million workers had lost their jobs.  As Indonesia needs a
minimum rate of  growth of about 6% to absorb the estimated 2.5 million new entrants to theworkforce each year, bleak prospects for GDP growth raise fears about further deterioration of the
labour market.
(ii) Macroeconomic policies
11. Prudent fiscal and monetary policies have been a major factor in Indonesia's long economic
expansion.  Indonesia entered the currency turmoil with relatively sound macroeconomicfundamentals:  a balanced budget, an inflation rate  below 10%, and an increasing but sustainable
current account deficit (about 3.5% of GDP in 1996).  However, the collapse of the rupiah has caused
a deterioration in macroeconomic performance, by driving the cost of imports to prohibitive levels,
pushing up domestic inflation, and creating a general situation of insolvency that impairs the
financing of production and trade.Indonesia WT/TPR/S/51
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(a) Public finances
12. For over two decades, Indonesia has conducted a sound budgetary policy, requiring that
domestic tax revenues plus foreign aid match expenditure (both recurrent and development)
(Table I.3).  In the years of high growth, abundant domestic tax revenues limited the need for foreign
aid to about 2% of GDP.  As a consequence of the collapse of economic activity and its social
consequences, with, on the revenue side, a slowdow n in the growth of tax receipts, and on the
spending side, an increase in subsidies on essential commodities and services (food, energy,
medicines), the budget excluding foreign aid slipped to a deficit of 3.7% of GDP.2  A deficit of 8.5%
of GDP is projected in 1998/99.3  It will be financed from foreign sources.  Accordingly, in July 1998,
donor countries and multilateral financial organizations, in the Consultative Group for Indonesia
(CGI), pledged a record amount  of aid of US$7.9 billion.
Table I.3
Summary of government finances(Billions of Rupiah)
1994/95 1995/96 1996/97 1997/98
Revenue 76,256 82,023 95,840 132,001
Domestic revenue 66,418 73,014 84,792 108,184
  Oil/gas 13,537 16,055 19,872 35,357
  Non-oil/gas 52,881 56,959 64,920 72,827
Foreign aid 9,838 9,009 11,048 23,817
Expenditure 74,761 79,216 95,022 131,544
  Recurrent 44,069 50,435 61,568 84,606
  of which:
    Personnel costs 12,595 13,001 18,021 19,175
    Debt service 18,402 22,109 23,432 29,697
  Development expenditure
    of which:30,692 28,781 33,454 46,938
    Transport and communication
    Regional development 7,353 7,212 8,489 10,025
    Education and culture .. .. .. ..
    Mining and energy .. .. .. ..
Balance 1,495 2,807 818 457
.. Not available.
Source: World Bank;  Bank Indonesia, Indonesian Financial Statistics , Vol. XXXI No. 6, June 1998.
13. The Government committed itself to fiscal m easures in order to limit slippages in the
short-term and maintain the budget in a long-term perspective.  The main policy measures aimed at
the restoration of sound public finances are contained in the January 1998 package outlined in the
                                                     
2As indicated in Indonesia's fourth Letter of Intent, "the overall budgetary cost of social safety net
programme is now estimated at about 7.5% of GDP.  Food, fuel, electricity, medicine and other subsidies areestimated, with present prices, to amount to about 6% of GDP in 1998/99".
3The 8.5% deficit is based on several economic assumptions, such as a rate of inflation of 80-100%, a
contraction of GDP by 10-15%, and a rupiah at 10,000 per U.S. dollar.WT/TPR/S/51 Trade Policy Review
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second Letter of Intent (Annex1, paragraphs 8 to 22).  Further guidelines regarding the formulation of
the 1998/99 budget are contained in the fourth Letter of Intent of June 1998.4
14. In the second Letter of Intent, the Government had focused on the revenue raising measures,
notably an increase in excise taxes, the removal of the numerous VAT and other tax exemptions, the
increase in the number of goods subject to the luxury tax, and a re-evaluation of the tax base on land
and building property.  In addition, further efforts are envisaged to improve tax collection andadministration.  On the spending side, the Government cancelled several large infrastructure projects
5,
removed specific privileges to government-sponsored projects such as the IPTN aircraft and the
"national car", and indicating its intent to gradua lly phase out certain subsidies, depending on the
economic recovery and social acceptability.6  It is also committed to the introduction of greater
transparency in budgetary accounts, including the integration of all off-budget accounts into thebudget.
15. Nevertheless, in order to mitigate the harsh impact of the crisis on the poor, the Government
reinforced the social safety net and increased fo od subsidies, particularly those for rice.  Rice is
provided to low income families at about half of  the prevailing market price, the difference being
borne by the state budget.  The total cost of the social safety net is expected to exceed 6% of GDP infiscal year 1998/99 and is largely responsible for the increase in the budget deficit.
(b) Monetary and exchange rate policies
16. Indonesia's stated objective is to maintain a monetary policy aimed at ensuring the stability of
the internal and external values of the rupiah.  Before the currency crisis, monetary authorities
succeeded in keeping domestic inflation below 10%, despite booming domestic demand.  In 1995 and
1996, domestic credit and the minimum industrial wage grew by over 20%.  Monetary policy was
tightened on several occasions during this period, notably through increases in reserve requirementson commercial banks (February 1995 and April 1997).  Direct or indirect control on the prices of
essential goods and services, such as basic agricultural commodities, energy and public transport
prices, also contributed to holding back inflation, though at the cost of creating economic distortions.
17. Externally, Indonesia operated a crawling-peg strategy for the rupiah, allowing for annual
depreciations of 3-5% annually vis-à-vis the U.S. dollar (Chart I.1).  Over the last decade, this strategyguaranteed the relative stability of the currency, while at the same time maintaining export
competitiveness.  However, in a fully convertible financial environment, the peg became increasingly
difficult to maintain, and on several occasions Indonesia's monetary authorities widened the
intervention bands to gain flexibility (in December 1995, from plus or minus 1% to 1.5%;  in June
1996, to 2.5%;  and finally in September 1996, to 4%, when downward pressures first affected therupiah).
                                                     
4Since requesting the assistance of international financial institutions, Indonesia has signed four Letters
of Intent with the IMF (November 1997, January 1998, April 1998 and June 1998).  While each Letter of Intentcomplemented the programme set out in the initial one, the second Letter of Intent was, in many respects themost comprehensive.  This applies to budgetary policy as  well as to other areas (notably structural measures).
5In its fourth Letter of Intent (paragraph 7), the Government stated that, in close cooperation with the
Asian Development Bank and the World Bank, it had cut or delayed projects amounting to about 2.5% of GDP.
6In its fourth Letter of Intent (paragraph 7), the Government further indicates that further increases in
the administrative prices of staple foods and fuels would exacerbate the impact of the crisis on the poor, and willhave to be delayed until the economy has begun to improve.  It remains our objective however to phase outsubsidies as output and household incomes recover, and a system for adjusting administered prices on a regularbasis will be developed by the en d of the fiscal year (1998/99).Indonesia WT/TPR/S/51
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18. In the early weeks of the regional currency crisis, from July to mid-August 1997, Indonesia
seemed to be relatively less affected than most of its neighbours.  Recent surveys outlined that market
sentiment over Indonesia, still favourably influenced by past growth and macroeconomic
performance, remained relatively positive until August 1997, as confirmed by the stability of stock
and bond prices as well as the absence of any rise in interest rates' risk premia.7  However, the value
of the Indonesian currency became increasingly difficult to defend after the floating of the Thai bahtand the Philippines peso, and in the light of the general withdrawal of international investors from
Asia.  In July 1997, the Government widened again the intervention band, from 8% to 12%.  A month
later, Bank Indonesia abolished the intervention band and let the rupiah float, in order to limit
profitable speculative opportunities ("one way bets") and preserve its foreign exchange reserves.
8
This decision was strengthened by the tightening of domestic monetary conditions.9  D e s p i t e  B a n k
Indonesia's determination, and the subsequent intervention of international financial institutions, the
rupiah underwent a series of increasingly sharp drops  in the autumn and winter of 1997.  It fell from
around 3,000 dollar in mid-August 1997 to 17,000 at its lowest in January 1998, before stabilizing in
the early spring in the 8-13,000 range.  Social unrest in May 1998 led to renewed pressure on the
rupiah, which fell to 15,000 per dollar in June.  Following the second review of the IMF Stand-byarrangement and the strong financial support provided by the CGI, the rupiah gradually recovered
throughout the summer, to stabilize around 11,000 per dollar.
19. Overall, since the start of the crisis, the rupiah has lost more than 80% of its value against the
U.S. currency (Chart I.1).  The Indonesian Govern ment and international financial institutions have
based their economic forecasts on the assumption that the rupiah will stabilize at about 10,000 to the
dollar at the end of 1998.
20. The causes of the collapse of the rupiah are multiple and well analysed in recent IMF and
World Bank documents.
10  External factors, such as the massive flight of international investors from
the region and the contagion effects of the Thai, Philippines and Korean crises, added to internal
causes, such as growing uncertainty about the eco nomic and political situation in Indonesia, thus
creating a heavy loss of confidence in the country's immediate economic prospects.  Contrary to other
countries, macroeconomic imbalances have not been a major source of market concern in the case ofIndonesia.  Instead, a late change in perception ab out the soundness of the banking system led to a
radical reassessment of the country's risk, and, as economic activity deteriorated, a reassessment also
of political and social risks.
21. With an import to GDP ratio of 30%, the la rge depreciation of the rupiah has had strong
spill-over effects on domestic prices.  In July 1998, year-on-year inflation was running at a rate of70%, compared with 15% six months earlier. The Government has projected an increase in domestic
prices of about 80% for the 1998 calendar year.
                                                     
7World Bank (1998a), p.1.3.  In its report, the World Bank provides evidence that "the major credit
rating agencies did not signal increased risk until the crisis in Indonesia was well underway".
8The decision by Bank Indonesia followed several days of uncertainty and heavy selling of rupiah in
foreign exchange markets.  On 13 August, the Bank was reported to have sold about US$500 million in the spot
market and increased SBI interest rates (i.e. the rate on Bank Indonesia's certificates of deposits) to support thecurrency.
9Overnight rates for certificates of deposits were raised to over 80%.
10See in particular Annex 1.1, paragraphs 3 to 5 of this report, and World Bank (1998a).WT/TPR/S/51 Trade Policy Review
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100120140
1994 1995 1996 1997Exports Imports
-20 -15 -10 -5 051015
1994 1995 1996 1997
012345
Jan
1994Jan
1995Jan
1996Jan
1997Jan
1998
 IMF, International Financial Statistics, various issues; Bank Indonesia, Indonesia Financial Statistics, Jan. 
1996, Dec. 97 and June 1998.Chart I.1
Main indicators of macroeconomic performance 1994-97
Balance of paymentsExport and import indices
1994=100
US$ billion
Exchange rate
US$ per 10,000 rupiahMerchandise trade balance Balance on services Current account
Source :Indonesia WT/TPR/S/51
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(c) Balance-of-payments, competitiveness and external debt
22. Reflecting cyclical trends, Indonesia's current account deteriorated during years of rapid
growth (a deficit of 2% of GDP in 1994, and 3.5% in 1995 and 1996).  However, it has improved
since 1997 (Table I.4 and Chart I.1), and a surplus of about 2% of GDP is projected for 1998.  The
deficits in 1995 and 1996 resulted both from a strong increase of merchandise imports (+32% in twoyears), reflecting strong GDP and investment growth, and from slower export growth.  The
slow-down of exports stemmed from falling external demand, especially from Japan (Indonesia's main
market) and a real effective appreciation of the rupiah (about 11% between 1995 and mid-1997).
Since the emergence of a current account surplus has b een due more to the fall of imports than to a
recovery of exports (section (3)(i)).  Despite the enormous depreciation of the rupiah, export growth isbeing held back by an unfavourable international environment (the crisis in Asia), the lack of trade
finance, and the disruption of production owing to increased difficulty in obtaining imports of
essential inputs (because of their sharply higher prices and/or means to finance their purchase).
23. In the period 1994 to mid-1997, current account deficits were readily financed by large capital
inflows, which contributed to increased foreign exchange reserves.  While net foreign directinvestment and long-term foreign aid remained the main source of such inflows (each totalling about
US$6 billion per year), private-sector finance such as portfolio investment, private bank lending and
short-term capital also emerged as a major source of external financing.  In the absence of sufficient
domestic savings, the availability of abundant foreign capital undoubtedly benefited the Indonesian
economy by contributing to the financing of its large investment needs.  However, it also left the
country vulnerable to rapid change in market sentiment.  The 1997 balance of payments shows a
reversal of capital flows compensated by a reduction of foreign exchange reserves and an increase inofficial foreign assistance.
24. In the period under review (1994 to mid-1998), total external debt increased rapidly, from
US$100 to 140 billion (about two thirds of GDP).  This rise was the outcome of massive borrowing in
foreign currency (essentially in U.S. dollars) by the private sector, which took advantage of the
difference between interest rates on dollar loans and higher rates on the rupiah.  Since most externalprivate debt is denominated in U.S. dollar, its value increased proportionally to the depreciation of the
rupiah.  By contrast, public debt recorded only moderate increases, as a result of a more diversified
currency structure (a large share of this debt be ing denominated in Yen and European currencies) and
close monitoring and control by the Government.
11  Between 1994 and mid-1998, the share of private
sector debt in total external debt is estimated to have increased from one third to half.
25. Unlike public debt, the large majority (about two thirds) of private debt is short-term.  It
accounts for about 80% of the estimated US$32 billion of amortization payments due in 1998.  As a
result, most of the 230 largest banks and non-bank private institutions face debt-servicing problems.
After six months of negotiations, the Steering Committee, comprising representatives of international
creditor banks and Indonesian borrowers, reached a framework agreement in June 1998, whichprovides for the restructuring of corporate debts, a scheme for the repayment of interbank debts and
                                                     
11Each year, Indonesia attracts large but relatively stable amounts (ranging from US$5-7 billion) of
official financing, generally under concessional terms, from multilateral and bilateral donors under the auspices
of the CGI.  In order to keep the other sources of public borrowing under control, the Government put in place
in the early 1990s the Commercial Offshore Loan Team, a body responsible for monitoring foreign commercialborrowing by state-owned enterprises and banks and setting annual limits on overall loans.  By contrast, in theabsence of exchange controls, private sector borrowing  was not subject to tight control or monitoring in
Indonesia.WT/TPR/S/51 Trade Policy Review
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an arrangement to maintain trade finance facilities.12  At the same time, the Government of Indonesia
has engaged in discussions with official creditors, within the framework of the Paris Club, on terms
and conditions for rescheduling sovereign debt principal repayments.
Table I.4
Balance-of-payments, 1993-97
(US$ million, unless otherwise  specified)
1993 1994 1995 1996 1997
A - Overall balance 727 616 2,651 3,898 -15,987
B - Current account balance -2,940 -3,488 -6,987 -8,069 -2,103
       - Merchandise trade balance 7,377 8,039 6,252 6,219 12,964
    - Exports (f.o.b.) 36,504 42,161 47,754 52,038 56,316
      - Non-oil/gas 27,170 31,716 37,138 39,267 45,970
      - Oil/gas 9,334 10,445 10,616 12,771 10,346
       - Imports (f.o.b.) 29,127 34,122 41,502 45,819 43,352
            - Non-oil/gas 25,311 30,476 37,597 41,126 39,180
            - Oil/gas 3,816 3,646 3,905 4,693 4,172
       - Services - net balance -10,317 -11,527 -13,239 -14,288 -15,067
      - Non-oil/gas -7,333 -8,515 -10,001 -10,747 -10,404
      - Oil/gas -2,984 -3,012 -3,238 -3,541 -4,663
C – Capital account balance 5,711 4,750 11,463 12,668 -4,845
       - Official capital 1,063 105 -209 -820 4,102
           - Inflow 6,195 5,651 5,730 5,298 8,220
           - Debt repayments -5132 -5,546 -5,939 -6,118 -4,118
       - Private capital 4,648 4,645 11,672 13,488 -8,947
            - Direct investment 1,971 2,566 5,357 6,546 1,833
            - Others 2,677 2,079 6,315 6,942 -10780
D – Errors and omissions -2,044 -646 -1,825 -701 -3,073
Memorandum items:
  Gross official reserves 12,708 13,324 15,975 19,873 12,599
   - (in month of non-oil/gas imports f.o.b.)  5.2 4.7 4.6 5.2 3.5
Export price index (1993=100) 100 100 113 129 152
Import price index (1989=100) 100 102 109 115 123
Terms of trade (per cent change) -2.7 -1.9 6.0 7.9 9.6
Current account balance/GDP (per cent) -1.9 -2.0 -3.5 -3.5 -1.0
Note: Fiscal years (i.e. 1993 corresponds to fiscal year 1993/1994).  The Indonesian fiscal year commences 1 April.
Source: World Bank; Bank Indonesia, Indonesian Financial Statistics , Vol XXXI No. 6, June 1998.
(iii) Structural and trade reforms
26. Trade, investment and economic growth are closely intertwined.  This was recognized in the
1994 Review, which stated that "increased efforts to remove impediments to international trade andinvestment are expected to contribute to Indonesia's prosperity.  Liberalization of investment rules
needs to be complemented by trade reforms to ensure that private investment is attracted into efficient
                                                     
12World Bank (1998a), p.2.3.Indonesia WT/TPR/S/51
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industries that can survive without Government assistance."13  Confirming this evaluation, the
Government of Indonesia recognized four years later, in its second Letter of Intent (paragraph 2), that
"a number of underlying weaknesses have made the country vulnerable to external shocks.  Structural
rigidities arising from regulations in domestic trade and import monopolies have impeded economic
efficiency and competitiveness".
27. In recognition of the structural dimension of the current economic crisis, the Government, in
cooperation with international financial institutions, designed in the automn and winter of 1997 an
ambitious programme of reforms.  This programme is aimed at "bringing the economy back to a path
of rapid growth, by transforming the high cost economy into one which would be more open,
competitive and efficient.  To achieve this transformation, the strategy called for foreign trade and
investment to be further liberalized, domestic activities to be further deregulated, and the privatizationprogramme accelerated.  At the same time, it envisaged that measures would continue to be taken to
alleviate poverty" (paragraph 31 of the second Letter of Intent).
28. Individual trade and trade-related measures, including investment measures and other
structural policies are described and discussed in the rest of this report (Chapters III and IV).
Indonesia's second Letter of Intent, which embodies most of the structural measures to which the
Government is committed in response to the present crisis, is contained in Annex I.1.
(3) TRADE AND INVESTMENT PERFORMANCE
(i) Trade patterns
29. During the past two decades, expanding trade has been the key to Indonesia's economic
growth and the main source of industrial diversif ication.  While relying initially on exports of raw
materials, particularly oil, Indonesia increased the local content and capital intensity of its exports.
The share of oil exports was reduced to one fifth of total exports, and manufactured exports rose totwo thirds.
30. While the value of Indonesia's merchandise trade continued to grow at a sustained pace until
1995 (+19% in that year), it slowed down sharply in 1996 (+8%), and fell further in 1997 (+3%), with
the outbreak of the regional crisis.  Merchandise exports grew at a rate of 14% in 1995, 10% in 1996
and 7% in 1997.  Import growth, which stood at 27% in 1995, fell to 6% in 1996.  In 1997, as a resultof the devaluation of the rupiah and the weakening of the domestic economy, total imports shrank by
3%.  Reflecting the rapid decline in the growth  of imports compared to exports, Indonesia's
merchandise trade surplus increased from US$4.8 billion in 1995 to US$11.5 billion in 1997.  Data on
Indonesia's trade are provided in Tables AI.1 to AI.4.
31. The slowdown of exports in 1996 is generally attributed to a combination of factors, including
the real appreciation of the rupiah, slower demand from Japan as well as structural elements, such as
fiercer competition from other low-wage countries  (e.g., Viet Nam and China), and the negative
effects of Indonesia's trade policy as regards some commodities-based products (Chapters III and IV).
The latter factor partly explains the stagnation of exports of wood and wood products, one of
Indonesia's main exports, since 1995.  In 1997, the further deceleration of exports was largelyexplained by the worsening of the international environment, particularly in Asia (since about half of
Indonesia's exports are shipped to Asia).  While currency depreciation should in principle have
                                                     
13GATT (1994), Trade Policy Review, Indonesia, Geneva, pxxii.  The Secretariat Report adds that "the
continuation and broadening of reforms aimed at creating a less regulated economy should benefit bothIndonesia's trading partners and - primarily through more competitive markets and improved resource allocationinto more efficient uses - for the domestic economy".WT/TPR/S/51 Trade Policy Review
Page 12
resulted in a pick-up in exports in the course of 1998, this did not materialize in the first half of the
year, due to unavailability of trade finance, the absence of containers linked to the sharp fall in
imports, and the high prices of imported inputs at the current exchange rate.  Preliminary data for the
first quarter of 1998 indicate that the value of Indonesia's exports have fallen by 4% (year-on-year).
32. Until 1996, the dynamism of the Indonesian economy, including high levels of investment
and rising living standards, stimulated imports of capital goods, raw materials, and certain durablegoods.  In the second half of 1996 and the first half of 1997, import growth moderated in reaction to
the slowdown of investment.  Following the curren cy crisis, imports collapsed under the combined
effects of the recession, the large devaluation of the rupiah, and finance problems.  Current estimates
for the first quarter of 1998 show a decline of the value of imports of 30% (year-on-year).
(a) Trade by products33. Manufactured products accounted for 42% of total exports, and three-quarters of non-oil
exports in 1997 (Chart I.2 and Table AI.1)  The share of oil exports has continued to decline since the
previous Review.  Indonesia's traditional non-oil e xports, such as textiles and garments, wood and
plywood and footwear, experienced only limited growth in the review period.  As a result, the share of
textiles and clothing exports in total exports fell, from 14.5% in 1994 to 9.8% in 1997.  The fastestgrowing exports have been electronics (consumer electronics, electrical appliances, semiconductors
and other electronic equipment) and chemicals, reflecting Indonesia's successes in attracting foreign
investors in high technology products and its liberal trade policy in these sectors.  Since the currency
crisis, export-oriented industries using a high pro portion of imported inputs (including textiles and
clothing, machinery and electronics) have been severely affected by the devaluation of the Indonesian
currency and hence the sharp rise in import prices.
34. Imports are essentially composed of manufactured products (three quarters of the total), half
of which are intermediate industrial goods such as iron and steel and chemical products, and the other
half being capital goods (machinery).  The first two years of the review period saw a rapid increase in
the import of capital goods (machinery and equipment) and raw material, which enter as inputs in
foreign investors' and domestic exporters' production.
(b) Trade by country35. The geographical structure of Indonesia's trade has not undergone major changes since the
1994 Review.  A large share of Indonesia's trade is conducted with Asia, which accounts for two
thirds of total exports and half of total imports (Chart I.3 and Tables AI.3 and I.4).  While Japan
remains Indonesia's largest individual trading partner, its share has been declining gradually.  The
shift is explained by Japan's slower GDP grow th (and hence slower imports from Indonesia), and
stiffer competition from European and South-East Asian partners on the Indonesian market.  During
the review period, the European Union has consolidated its second position in Indonesia's trade, with
15% of exports and 20% of imports in 1997.  The United States is Indonesia's third largest trading
partner with 13% of exports and imports.
(c) Trade in services36. Indonesia runs a large deficit in services, at about US$10 billion per year, throughout the
period under review.  While a large part of this deficit is explained by interest payments on large
combined public and private debt as well as investment income payments, all non-factor services
except tourism are also in deficit (transport, construction, financial and business services).  By
contrast, Indonesia's tourism industry generated a balance-of-payments surplus of about US$4 billion
in 1996 and US$5.7 billion in 1997.Indonesia WT/TPR/S/51
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Chart I.2
Merchandise trade by sector, 1994 and 1997
1994 1997
(a)    Ex ports
Total:   US$39 ,907.1million Total:   US$53,219.6million
(b)    Im ports
Total:   US$31,980.6million Total:   US$41,678.9million
Source :  UNSD, Comtrade database (SITC Rev.1).Per cent
Other semi-
manufactures
12.9Machinery and 
transport equipment
  8.7Textiles  4.2Clothing  5.6Other consumer 
goods
7.4Other
17.1Food
11.4
Agricultural raw 
materials
4.6
Fuels
24.6
Chemicals
3.6Other semi-
manufactures
16.6Machinery and 
transport equipment
7.6Textiles 6.3Clothing  8.2Other consumer 
goods
10.6Other
4.1Food
12.8
Agricultural raw 
materials
4.9
Fuels
26.4
Chemicals
2.5
Non-electrical 
machinery  20.3Office machines & 
telecommunications 
equipment  3.9Other electrical 
machines  5.7Automotive 
products
 8.5Iron and 
steel
5.3Other
20.0Food
7.8Agricultural raw 
materials
5.6
Fuels
7.5
Chemicals
15.4
Non-electrical 
machinery
21.0Office machines & 
telecommunications 
equipment  5.6Other electrical 
machines  5.7Automotive 
products 6.7
Iron 
and 
steel
5.5Other
18.0Food
8.8
Agricultural 
raw materials
4.7
Fuels
9.5
Chemicals
14.5WT/TPR/S/51 Trade Policy Review
Page 14
Chart I.3
Direction of merchandise trade, 1994 and 1997
1994 1997
(a)    Ex ports
Total:   US$39 ,907.1million Total:   US$53,219.6million
(b)    Im ports
Total:   US$31,980.6million Total:   US$41,678.9million
Source :  UNSD, Comtrade database (SITC Rev.1).Per cent
Korea, Rep. Of
6.5China  3.3Chinese Taipei
4.1Hong Kong  3.3Other Asia
9.0Other
6.8United States
14.6
European 
Union (15)
14.9
Japan
27.4Singapore
10.1Korea, Rep. Of
6.5China  4.2Chinese Taipei
3.4Hong Kong  3.3Other Asia
12.3Other
8.2
European 
Union (15)
15.2
Japan
23.5Singapore
10.0
Singapore
5.9Korea, Rep. o f 
6.8Chinese Taipei
4.5Other Asia
 13.8Australia
4.8Other
8.1United States
11.2
European 
Union (15)
20.7
Japan
24.2 Singapore
8.2Korea, Rep. o f 
5.6Chinese Taipei
3.8Other Asia
15.0Australia
5.8Other
8.7United States
13.1
European 
Union
(15)
20.0
Japan
19.8United States
13.4Indonesia WT/TPR/S/51
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(ii) Investment trends
37. The period under review was marked by an exceptional increase in inward foreign direct
investment (FDI), as measured by investment approvals (Table I.5).14  Between 1994 and 1997,
Indonesia approved a total of US $131 billion of FDI, equivalent to twice the amount of total
approvals of the previous 25 years.  FDI approval s during the review period accounted for about a
third of total investment approved in the country.  FDI has therefore been pivotal in the development
of manufacturing, the expansion of non-oil exports and the emergence of an indigenous
entrepreneurial class (through association in join t ventures).  The FDI drive followed crucial
deregulatory measures adopted in 1994 and 1995 (Chapter II(4)).  While in the previous review period
(1990 to 1993) the total amount of FDI approvals was stable at around US$9 billion annually, the
1994-97 average was US$32 billion.  Estimates for 1997 seem to indicate that, despite the current
economic crisis, FDI approvals have not, so far, suffered a major decline.
38. Cumulative statistics since the enactment of th e 1967 FDI law indicate that the bulk of FDI
originates from Asia, which accounts for more than half of total FDI approvals.  Japan is the largest
single investor in Indonesia, with about 20% of approved investment, Hong Kong is the third (11%)and Singapore the fifth (7%).  Recent years have seen the emergence of Chinese Taipei and the
Republic of Korea as major Asian investors.  The European Union accounts for more than a quarter of
total FDI approvals, the bulk of which originat es in the United Kingdom, the Netherlands and
Germany.  The main sectors receiving FDI are chemicals, paper, iron and steel, metals and metal
products, real estate, banking, tourism, and, since its liberalization in 1994, telecommunications
services.  Indonesia has also attracted large amounts of FDI in the oil and gas sector, under
production-sharing arrangements, and in mining, under contract-of-work arrangements.
(4) OUTLOOK
39. A larger-than-expected decline of output in the first half of 1998 (about 12%) resulted in
downward revisions of official forecasts (from th e Government of Indonesia, the IMF and the World
Bank) for 1998.  Consensus forecasts now predict a fall of GDP exceeding 10% in 1998 (between
10% and 15% if expressed in the 1998/99 fiscal year, according to the World Bank).  The collapse ofproduction is linked to that of domestic demand (investment, consumption), which itself is affected by
the financial crisis (such as the general situati on of insolvency), the fall in incomes, and the
deterioration of confidence.  Exports, the only element that could support activity in current
circumstances, are actually being held back by depressed international demand, particularly from
Japan and Asian countries, the lack of trade finance and containers, and the paralysis of productiongenerated in export-oriented industries by the lack of imported inputs.  Imports are expected to fall by
10-15% in 1998.  Fuelled by the devaluation, inflation is expected to range between 80% and 100%
(as against 11% in 1997).
40. In such an unstable situation, any forecasts over 12 months should be viewed with great
caution.  There is a multiplicity and great complexity of factors at work, including the influence ofregional developments, socio-political factors, developments in foreign exchange markets and trends
in world commodity prices.  While it is hard to predict when exactly the Indonesian economy will
bottom out and recover, the most optimistic scenarios envisage a stabilization of the economy in 1999
(the World Bank sees GDP growth of between –2% and +2% in fiscal year 1999/2000 and a modest
recovery in the following years).WT/TPR/S/51 Trade Policy Review
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Table I.5
Approved foreign investment by sector, 1990-97
(US$ million)
Sector 1990 1991 1992 1993 1994 1995 1996 1997
Agriculture 117 14 66 138 690 1,153 1,306 437
Forestry 20 1 138 22 0 0 136 0
Fishery 20 11 28 0 40 231 80 27
Mining & quarrying 116 0 2,312 0 0 0 1,697 2
Manufacturing 5,822 3,970 5,669 3,423 18,739 30,441 19,884 24,857
Food 99 382 213 141 1,235 1,332 691 573
Textiles & leather 1,094 532 591 419 396 471 515 373
Wood & wood products 218 62 34 50 68 263 101 70
Paper & paper  products 730 822 686 202 5,120 2,540 2,907 5,353
Chemicals & rubber 1,991 923 2,342 1,171 7,743 19,368 7,362 12,339
Non-metallic minerals 125 133 841 98 632 289 793 1,457
Basic metals 825 197 47 186 2,082 292 651 357
Metal products 460 856 863 1,114 1,423 2,258 2,939 2,332
Others 281 62 52 42 40 3,628 3,925 2,004
Construction 77 26 41 97 77 206 297 307
Trade & hotels 874 4,019 919 1,088 430 1,029 1,762 472
Wholesale trade 0 0 0 693 87 31 45 9
Hotels 874 4,019 919 394 344 999 1,717 463
Transport & communications 803 167 14 85 145 5,539 695 5,900
Real estate & business services 902 570 1,136 3,292 3,604 1,314 4,076 1,831
Total 8,750 8,778 10,323 8,144 23,724 39,915 29,931 33,833
Source: Investment Coordinating Board.
                                                                                                                                                                    
14Since reliable annual figures on realized foreign direct investment in Indonesia are not available,
statistics presented in this chapter are for FDI approvals.  On average, however, realization rates of approvedinvestment vary between 40% and 60%.Indonesia WT/TPR/S/51
Page 17
Annex I.1
Indonesia - Memorandum on Economic and Financial Policies (Second Letter of Intent,
January 1998)
I. BACKGROUND
1. For the past several decades, prudent macroeconomic policies and continuing structural
reforms have kept Indonesia on a path of rapid economic development.  Since the 1970s, economic
growth has averaged 7% per annum, raising GDP  per capita toward the level of middle income
countries, while dramatically lowering the incidence of poverty.  The economic structure has become
diversified, as dependency on the oil sector has declined and an export-oriented manufacturing basehas emerged, led by a dynamic private sector and fuelled by high domestic savings and large inflows
of foreign direct investment.  Meanwhile, macroeconomic balance has been maintained:  the budget
has been balanced;  inflation has been contained at relatively low levels;  current account deficits have
been kept moderate;  and international reserves have remained at comfortable levels.
2. Despite this strong macroeconomic performance, a number of underlying weaknesses have
made the country vulnerable to adverse external shocks.  Structural rigidities arising from regulations
in domestic trade and import monopolies have impeded economic efficiency and competitiveness.  At
the same time, the relative stability of the rupiah during most of the 1990s, together with high rates of
return on domestic investment, both encouraged and facilitated high levels of overseas borrowing, a
significant portion of which has been private short-term debt that has been unhedged.  Byend-December 1997, Indonesia's external debt sto od at $140 billion (about two thirds of GDP), of
which $20 billion was short term, while its debt service has remained close to one third of exports of
goods and services.  Also, the rapid expansion of the financial system since the late 1980s has left a
number of banks with significant amounts of non-performing loans, straining their liquidity and, in a
number of cases, undermining their financial viability.
3. In the wake of the recent currency turmoil in the region, the exchange rate has depreciated to
alarming levels.  From mid-July last year to early January this year, the cumulative depreciation of therupiah reached 70%, with over half of this decline occurring since the end of November, while the fall
in the Jakarta stock-exchange index reached 50%, both the largest declines in the region.  The
enormous depreciation of the rupiah did not seem to stem from macroeconomic imbalances, which
remained quite modest.  Instead, the large depreciation reflected a severe loss of confidence in the
currency, the financial sector, and the overall economy.
4. The plummeting of the rupiah has led to very la rge increases in the rupiah debt service costs
of banks and corporations that had borrowed - largely without hedging - from abroad.  Moreover,
since the currency depreciation has engendered a substantial rise in domestic interest rates, the burden
of paying for, and collecting, domestic currency loans has also increased, further straining the position
of corporations and financial institutions, particularly those that were already weak.  A major concernfor the government is that the process has become self-reinforcing:  growing strains on firms have
amplified investor uncertainty and encouraged capital flight, thereby intensifying pressures on the
exchange rate and domestic interest rates.
5. From the outset of the currency crisis, the government has taken strong corrective action.  To
discourage speculative attacks, the exchange rate band was widened in July and, in August, in the faceof continued pressure on the currency, the rupiah was allowed to float.  This policy was backed by a
significant tightening of liquidity conditions and an announcement that the budget surplus would be
preserved by postponing major infrastructure projects, cutting low priority development programmes,
and extending the coverage of the luxury sales tax.  At the same time, import tariffs on over 150 itemsWT/TPR/S/51 Trade Policy Review
Page 18
(mainly raw materials and other intermediate goods) were reduced effective mid-September, while the
49% limit on foreign holdings of listed shares was abolished.  Further trade liberalization measures,
including removing monopoly restrictions on agricultural imports were announced in November last
year.  These actions, however, were not sufficient to restore confidence in the rupiah and the
economy.
II. THE POLICY FRAMEWORK
6. In November, in the context of an IMF-supported programme, the government put in place a
comprehensive policy package to restore confidence and arrest the decline of the rupiah.  Fiscal policy
was formulated to preserve a budget surplus of about 1% of GDP while monetary policy aimed at
containing inflation and supporting the exchange rate.  These policies were to provide the supportive
macroeconomic framework for the continuing efforts to restructure the financial sector and acceleratestructural reforms.
7. However, following a short-lived strengthening, the rupiah plummeted owing to a
combination of contagion from currency turmoil in the region, political developments, and other
uncertainties.  It is now clear that the original  macroeconomic targets cannot be realized.  Under
current volatile conditions, it is difficult to set precise macroeconomic targets.  Nevertheless, theprogramme is designed to avoid a decline in output, while limiting inflation to about 20%, which,
although high by Indonesian standards, is unavoidable given the substantial depreciation of the rupiah.
At the same time, the external current account bala nce is expected to move from a deficit in 1997/98
to a surplus in 1998/99.
A. Macroeconomic Policies
Fiscal Policy
8. The government is fully committed to maintainin g a sound fiscal policy.  However, with the
sharp depreciation of the rupiah and the deterioration in the economy, it is no longer feasible to aim at
a surplus of 1% of GDP in 1998/99.  The budget has therefore been framed to strike an appropriate
balance between preventing undue deterioration of the fiscal position and avoiding an excessive fiscal
contraction.  Accordingly, the government is determined to follow its long-standing policy of a
balanced budget (in the Indonesian presentation), which avoids any recourse to domestic financing.The corresponding deficit in the IMF presentation is about 1% of GDP.  To realize this objective, the
government has strengthened the budget introduced on 6 January by adopting new measures.
9. To reduce economic distortions, and strengthen the fiscal position, the government intends to
adjust administered prices with the aim of gradually eliminating subsidies on fuel and electricity.  As
the price increases necessary to eliminate these subs idies are very large owing to the depreciation, it is
not feasible to bring domestic prices to the level of  international prices abruptly.  The government will
therefore aim to eliminate these subsidies gradually over the course of the programme, starting with
the sizable initial adjustment on 1 April, 1998, in fuel and electricity prices, except for prices of
kerosene and diesel fuel, where increases will be kept to a minimum so as to protect the poor.
10. On the revenue side, the government has already announced increases in excises on alcohol
and tobacco, which will effectively raise revenue from these items by 80% and 10%, respectively.
These excises will be increased further on 1 July, 1998, to reflect exchange rate and price
developments.  In addition, effective 1 April 1998, the government will remove all VAT exemptions
(apart from those on capital goods or those explicitly mandated by law);  these include, inter alia ,
electricity for private companies, taxis, soybean food for cattle, sugar, personal goods, medical
equipment, and other machinery and capital equipment.  All VAT exemption arrangements will beIndonesia WT/TPR/S/51
Page 19
reviewed regularly.  With regard to other taxes, a 5% local sales tax will be introduced on
1 April 1998 and the number of goods subject to the luxury sales tax will be increased.  The
government will also shortly increase the prop ortion of the market value of land and buildings
assessable for tax to 40% for plantations and forestry property.
11. In order to improve tax administration and the structure of the tax system, the government has
introduced a single taxpayer registration number which will come into effect on 1 April 1998.  Furtherplanned improvements, in line with recommendations of the Fiscal Affairs Department of the IMF, to
increase non-oil tax revenue, include:  (i) raising the annual audit coverage;  (ii) developing improved
VAT audit programmes to target large potential taxpayers;  and (iii) increasing the recovery of tax
arrears.  To accelerate progress in this area, the government intends to request further technical
assistance from the Fund.
12. To ensure the quality and durability of the fiscal reform, the government will move to a
comprehensive and transparent system to report on the public sector financial position, particularly
including quasi-fiscal operations.  Accordingly, th e government has decided to accelerate provisions
under the Non-tax Revenue Law of May 1997, which re quire all off-budget funds to be incorporated
in the budget within five years.  The accounts of the two large off-budget accounts, the InvestmentFund and the Reforestation Fund, will be incorporated in the central government budget at the
beginning of the 1998/99 fiscal year.  In the specific case of the Reforestation Fund, the government
will ensure that the funds are used exclusively for their intended purpose of financing reforestation
programmes, which include those outside the concessional forest areas, development of industrial
forestry areas, reforestation of unproductive land, and other reforestation programmes.
13. In recognition of the serious financial crisis facing Indonesia, the government has cancelled
12 major infrastructure projects that had been reinstated earlier, including the Tanjung Jati-C powerplant.  The government has also decided to disc ontinue immediately any special tax, customs, or
credit privileges granted to the National Car.  In any event, the government will implement ahead of
schedule the ruling of the WTO dispute panel.  Moreover, consistent with Indonesia's commitment to
the WTO, the local content programme for motor vehicles, which gives preferential tariff rates to
vehicle manufacturers using a high percentage of local parts, will be phased out by 2000.  It has alsodecided to discontinue immediately any budgetary and extra-budgetary support and credit privileges
granted to IPTN projects.
Monetary and Exchange Rate Policy
14. Since the crisis began, Bank Indonesia's monetary strategy has been to support the rupiah
exchange rate, and limit any increase in inflation, by maintaining a firm monetary stance.  Theexecution of this policy, however, has been hampered by problems in the banking system.  Following
the closure of 16 insolvent banks in November last year, customers concerned about the safety of
private banks have been shifting sizeable amounts of deposits to state and foreign banks, while some
have been withdrawing funds from the banking system entirely.
15. These movements in deposits have greatly complicated the task of monetary policy, because
they have led to a bifurcation of the banking system.  By mid-November, a large number of banks
were facing growing liquidity shortages, and were unable to obtain sufficient funds in the interbank
market to cover this gap, even after paying interest rates ranging up to 75%.  At the same time,
another smaller group of banks were becoming increasingly liquid, and were trading among
themselves at a relatively low JIBOR (Jakarta Interbank Offer Rate) of about 15%.  As this
segmentation continued to increase, while the stress on the banking system intensified, Bank
Indonesia was compelled to act.  It provided banks in distress with liquidity support, whileWT/TPR/S/51 Trade Policy Review
Page 20
withdrawing funds from banks with excess liquidity , thereby raising JIBOR to over 30% in early
December, where it has since remained.
16. Nevertheless, despite this increase in interest rate s - to levels higher than in any other country
in the region - the problems of the rupiah have only intensified.  From early December to early
January, the exchange rate lost a further 53% of its external value, falling from around Rp 3,700 per
U.S. dollar to around Rp 8,000 per U.S. dollar.  Part  of the reason was that the rupiah was affected by
the financial turmoil in other neighbouring countr ies.  Another factor was that markets became
increasingly concerned about the deterioration in Indonesia's economic situation, which has weakened
the financial health of the banking system and the corporate sector.  Most of all, however, markets
were concerned that the programme originally designed in November was no longer sufficient to
overcome the country's economic predicament.
17. With the overall policy package that has recently been adopted, and set out in this
Memorandum, the government is now convinced that confidence in the economic direction of the
country will be speedily restored.  As this occurs, the exchange rate of the rupiah will finally stabilize.
However, during the transitional period, in which confidence is taking hold, lingering concerns about
exchange rate depreciation are likely to keep market interest rates at high levels.  Bank Indonesiarecognizes that, in these circumstances, it will need to keep its own interest rates high, as well.
Accordingly, Bank Indonesia is raising interest rates on SBI (central bank) certificates across the
entire spectrum of maturities, from overnight to one year, thereby bringing them in line with
conditions prevailing in the money market - and sending a clear message to financial markets that it
will maintain a firm monetary stance for as long as proves necessary.  At the same time, Bank
Indonesia is also providing full autonomy to state banks to adjust rates on credit and deposit liabilities,
so that their rates could also reflect developments in money and credit markets.
18. This tight monetary stance will inevitably mean that, at least for the time being, the amount of
credit available for lending to the corporate sector will remain constrained and the cost of credit will
remain very high.  Such a situation will place a particular burden on smaller enterprises, which rely on
bank credit for their sole source of financing.  To alleviate this burden, the government has introduced
a temporary programme under which credit will be provided to small-scale enterprises through thestate banks at subsidized interest rates.  The cost of the subsidy will be borne not by the state banks,
but rather by the central government budget.  A facility will also be established to extend credit to
exporters at commercial terms.  Eventually, though, these arrangements should prove redundant, since
once confidence is fully restored and the exchange rate stability is regained, then funds should flow
back into the banking system and the overall policy stance can be relaxed gradually, therebyproviding greater room for banks to expand credit and lower their interest rates - for all firms.
19. Bank Indonesia's financial programme has been formulated in the context of extremely
uncertain financial conditions, including with regard to the demand for monetary aggregates.  Over
the course of 1997, the growth of broader monetary aggregates slowed considerable, with M2 growth
falling from year-on-year rates of 25.5% in June to 23% by November.  At the same time, the moneymultiplier has fallen sharply, partly because ther e has been a marked increase in the demand for
currency, as concerns grew over the scale of banking sector difficulties, but also because financial
intermediation has declined, as banks become more reluctant to lend.  Consequently, even though
base money growth exceeded the programme objective, broad money was well within the December
target.
20. Bank Indonesia has established, in consultation with the Fund, a financial programme for
1998, to ensure that monetary policy continues to operate within a well-defined framework, with aclear inflation objective.  This programme aims to  contain inflation to less than 20%, implying thatIndonesia WT/TPR/S/51
Page 21
policy will ensure that there is only a limited pass through of the very substantial depreciation onto the
prices of imports, and only a muted impact of the drought on food prices.  To achieve this ambitious
objective, Bank Indonesia plans to limit the growth of broad money to 16% in 1998.  As in 1997,
broad money growth targets will be attained by controlling base money, rather than by relying on
direct quantitative lending targets.
21. This monetary strategy will be complemented by judicious foreign exchange intervention to
stabilize and support the exchange rate.  The scale of this intervention will be determined in close
consultation with IMF staff, and will also be subject to Bank Indonesia maintaining net international
reserves above the monthly and quarterly floors specified in the programme.  As in our previous
Memorandum on Economic and Financial Policies, any sterilization of exchange market intervention
will be strictly limited so as to ensure that monetary conditions become firmer as the scale ofintervention increases.
22. Bank Indonesia will immediately be given autonomy in formulating and implementing
monetary policy.  To ensure that the central bank remains accountable, the inflation objective will
continue to be decided by the government as a whole, but the policies for achieving this objective,
such as changes in official interest rates, will  be determined solely by the central bank.  To
institutionalize the autonomy of the central bank, a draft law will be submitted to Parliament by the
end of 1998, which will also include changes in the composition and the mandate of the Monetary
Board.
B. Financial Sector Restructuring
Bank restructuring programme
23. The government has already taken decisive action to implement a comprehensive programme
of bank restructuring aimed at restoring the soundness of the banking system.  On 1 November 1997,16 insolvent banks were closed.  The bank closures made it clear to the market that the owners would
lose their stake in banks that become unviable.  A number of other banks, including regional
development banks, have been placed under intensive supervision by the central bank.  Rehabilitation
plans for some of these banks have been approved by the central bank and are being implemented,
while others are still under preparation.
24. However, the continued depreciation of the rupi ah, the slowdown in growth, and high interest
rates since then have led to a marked deterioration of the financial condition of the remaining banks.
This deterioration has been exacerbated by deposit runs and capital flight, forcing many banks to
increasingly resort to central bank liquidity support.  The large depreciation of the rupiah in recent
weeks has raised the concerns that these problems will only intensify.
25. In these circumstances, the government believes that re-establishing confidence in the ability
of the banking system to meet its commitments and play its intermediation role is of paramount
importance.  Therefore, Bank Indonesia is working closely with the AsDB, IMF, and World Bank
staff to establish and expeditiously implement uniform, transparent and equitable rules for resolving
liquidity and solvency problems, of private banks.  These measures will be announced shortly.  Thecentral bank will provide liquidity support to banks subject to increasing conditions, while ensuring
that liquidity support extended to banks will be consistent with the programme's monetary growth
objectives.
26. With technical assistance from the World Bank, the government has also taken steps to
resolve the problems of the state banks and ensure their safety and soundness.  The aim of this
programme is to improve their efficiency and subseque ntly privatize them.  Toward this objective, theWT/TPR/S/51 Trade Policy Review
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government announced in December 1997 that BTN will become a subsidiary of BNI and that four
state banks, Bapindo, Bank Bumi Daya, BDN and Bank Exim, will be merged.  The government will
ensure that the merger process will be used to downsize the operations of the merging banks, sell
redundant facilities and bank branches, reduce excessive manpower, economize on automated
systems, maximize benefits from complementary strengths, and prepare the institutions for
privatization.  The state banks will not be recapitalized except in conjunction with privatization.  Thegovernment will ensure that, until privatization, the state banks perform according to criteria detailed
in performance contracts prepared by the Ministry of Finance (Directorate General for State
Enterprises) with assistance from the World Bank, by end March 1998.  These contracts will spell out
the objectives of the management of each institution and form the basis for assessing performance.
27. In support of the ultimate goal of full privatization of all state banks, the government will
introduce legislation by end-June 1998 to amend the Banking Law in order to remove the limit on
private ownership.  The new bank formed from the merger of the four state banks will be staffed by
new managing directors.  This new management will be in place by end-February 1998 and will
formulate and implement a plan for interim opera tions of the four merging banks including a
timetable for the final merger.  Foreign strategic partners will be sought for the merged bank to assistin attracting other private sector participation and for eventual privatization.  The timetable for
privatization for all the state banks will be determ ined in consultation with the IMF and the World
Bank.
28. As preparation for the mergers and acquisition process, as well as for privatization, all state
banks (including those that will not be merged) will conduct portfolio, systems, and financial reviews
to internationally acceptable standards using teams fr om internationally recognized audit firms.  These
reviews will be initiated by end-February 1998 and completed by end-June 1998.  Subsequent reviewswill be conducted annually.  The portfolio, systems, and financial reviews will serve to appraise the
value of the assets and establish a basis for segregation of good and bad assets, according to uniform
criteria and procedures.  In addition, a financial plan for funding of bad debts of the state banks will
be prepared with the assistance of the World Bank by end-July 1998.  A new asset resolution entity
will be established by end-March 1998, and made fully operational by end-July 1998.  This entity willreceive the bad debts of state banks and will concentrate solely on debt recovery within a defined
scheduled.
Strengthening the legal and supervisory framework for banking
29. The government is firmly committed to improv ing the supervision of the banking system.
Enforcement of prudential regulation has been strengthened through establishment of a graduatedsystem of penalties for noncompliance, culminating in the withdrawal of banking licence.  Capital
adequacy rules are being enforced within the contex t of the bank restructuring strategy, and in the
case of the non-foreign-exchange banks, minimum capital requirements will be increased gradually to
put them on with the foreign exchange banks.  New loans classification and provisioning guidelines
have been prepared and loan loss provisions will be made fully tax-deductible by end-March 1998.The reporting and monitoring procedures for foreign exchange exposure of banks have been upgraded
and the limits strictly enforced.  The central bank's capacity for risk-based supervision will be further
strengthened with technical assistance from the IMF and the World Bank.  Beginning in March 1998,
internationally recognized specialists are to provide active support in on and off-site supervision.
Moreover, to eliminate the conflict of interest in herent in central bank ownership of banks, Bank
Indonesia has established a programme for divestiture of its interests in private banks, and has already
made substantial progress towards this goal.Indonesia WT/TPR/S/51
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30. To further strengthen the policy and institutional infrastructure for banking, the government
has taken steps to:
(a) revise the legal framework for banking operations, after a thorough review of central bank
and banking laws as well as the company law and liquidation regulations, which will be completed by
end-September 1998.  Areas of focus will include bankruptcy, banking disclosure, taking and
realizing collateral, and regulations on financial instruments.  Action plans to improve the legalframework will be prepared by the end of 1998 with the help of the IMF and the World Bank;
(b) improve transparency and disclosure in banking.  To this end, the government will
immediately require all banks to publish audited financial statements annually.  Bank Indonesia will
also review the adequacy of data provided in bank s' condensed biannual balance sheets with a view to
improving the dissemination of information on the financial condition of individual banks.  Thegovernment will also require banks to regularly publish more comprehensive data on their operations,
after a transition period that is expected to be less than two years.  Banks wishing to publish such data
prior to the end of the transition period would be free to do so;
(c) level the playing field for foreign investors in banking.  As part of its WTO negotiations for
liberalizing trade in financial services, the government has decided to lift restrictions on branching of
foreign banks by February 1998;  in addition,  it will submit to the Parliament a draft law to eliminate
restrictions on foreign investment in listed banks by June 1998;
(d) eliminate all restrictions on bank lending, other than those required for prudential reasons, or
those to support cooperatives and small-scale enterprises (the KUK scheme).
C. Structural Reforms
31. In November, the government set out an ambitious strategy of structural reform, aimed at
bringing the economy back to a path of rapid gr owth, by transforming the "high-cost economy" into
one which would be more open, competitive, and efficient.  To achieve this transformation, the
strategy called for foreign trade and investment to  be further liberalized, domestic activities to be
further deregulated, and the privatization programme accelerated.  At the same time, it envisaged that
measures would continue to be taken to alleviate poverty.
32. The government has already made considerable progress toward the strategy's objectives.  In
November, a major step was taken toward opening up the economy and increasing competition, when
BULOG's import monopoly over wheat and wheat flour , soybeans, and garlic were eliminated.  To
ensure that final consumers obtained maximum benefits from this reform, importers were allowed to
market all of these products domestically, except wheat (until recently;  see paragraph 44 below).
Similarly, to ease the adjustment costs for farmers, tariffs were simultaneously introduced on all of
these products, but these rates were limited to 20% or less, and will be reduced to 5% by 2003.
33. In addition, two other important structural measures have also been taken under the
programme.  First, in November, the administrati ve retail price for cement was eliminated, thereby
improving the degree of competition in this industry, and immediately reducing prices for
construction firms and consumers.  Second, the medium-term tariff reduction programme was
extended to cover two key additional sectors, chem icals and metal products.  Tariffs on most chemical
products have already been reduced by 5 percentage points, effective 1 January 1998, while those on
steel/metals will be lowered beginning 1 January 1999.  In line with the overall programme, further
reductions in these tariffs are scheduled for subsequent years, so that by 2003, the maximum tariff onthese products will be brought down to the medium-term target of 10%.WT/TPR/S/51 Trade Policy Review
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34. Despite this steady progress, the economic crisis has deepened during December and early
January, making it clear that bolder, and faster, reform will be necessary to overcome the economy's
problems.  Accordingly, the government has decided to reinforce its structural reform programme, by
accelerating some of the measures that were earlier planned, and by supplementing them with
additional actions.
Foreign Trade and Investment
35. Over the past two months, it has become evident that the drought afflicting the country is the
most severe in half a century, and requires emergency measures.  Accordingly, to ensure that adequate
food supplies will be available to the population at reasonable prices, the government has decided to
go beyond the original programme strategy, and include agricultural goods in the general programme
of tariff reduction (leaving motor vehicles as the only exception).  As an immediate measure, tariffson all food items have been cut to a maximum of 5%, while local content regulations on dairy
products have been abolished, both effective 1 February 1998.  At the same time, tariff rates on non-
food agricultural products will be reduced by 5 percentage points, and will gradually be reduced to a
maximum of 10% by 2003.
36. At the same time, as another major step in assuring a level playing field, on 1 February 1998,
all import restrictions on all new and used ships were also abolished.  All other remaining quantitative
import restrictions, other than those which may be justified for health, safety, environment and
security reasons, and other non-tariff barriers that protect domestic production, will be completely
phased out by the end of the programme period.
37. The government also intends to phase out punitive export taxes, since these can no longer be
justified, given the country's now pressing need  to augment its inflows of foreign exchange.
Accordingly, on 1 February 1998, export taxes on a wide range of products - including leather, cork,ores and waste aluminum products - will be abolished.  For other products, however, export taxes
cannot simply be eliminated, since they serve as an important means of discouraging
over-exploitation of Indonesia's natural environment.  In such cases, therefore, exports taxes will be
replaced by resource rent taxes, which would protect the environment, while eliminating the bias
against production for export, rather than for domestic use.  As a first step, in March 1998, exporttaxes on logs, sawn timber, rattan, and minerals will be reduced to a maximum of 10% ad valorem ,
and appropriate resource rent taxes imposed.  At the same time, similar steps will be taken for all of
the remaining items currently subject to an export tax:  the levies on exporting will be abolished and
replaced by resource rent taxes, where appropriate.
38. The government will also eliminate all other types of export restrictions, such as quotas, by
the end of three years.  The only exceptions will be for those restrictions imposed for health and
security reasons, as well as time-bound, temporary, measures introduced in the event of occasional
domestic shortages - such as the recently imposed export ban on palm oil.  This ban will need to be
retained through the first quarter of 1998, to ensure adequate domestic supplies of palm oil and
restrain price rises.  After March, however, it will not be renewed, nor will the previous system ofexport quotas and punitive taxes be reintroduced.  Instead, palm oil will be subject to export taxes at
rates not exceeding 20%.
39. Another pressing need in the current circumstances is to encourage foreign investment.
Accordingly, the government has decided that in June 1998 it will issue a revised and shortened
negative list of activities closed to foreign investors.  As part of this process, the government has
removed restrictions on foreign investment in palm oil plantations on 1 February 1998, while those on
wholesale and retail trade will be lifted by March 1998.Indonesia WT/TPR/S/51
Page 25
Deregulation and Privatization
40. The second major thrust of the structural reform strategy will be to deregulate and privatize
the economy in order to promote domestic competiti on and expand the scope of the private sector.  As
a first, bold step, all of the existing formal and in formal restrictive marketing arrangements - including
those for cement, paper, and plywood - will be dissolved, as of 1 February 1998.  Henceforth, no firm
will be forced to sell its product through a joint marketing organization, nor be required to pay fees orcommissions to it.  Neither will any organization be allowed to assign exclusive marketing areas, or to
dictate production volumes or market shares to individual enterprises.  In the case of cement, internal
and external trade restrictions have also been eliminated, so that traders are now free to purchase and
distribute all brands of cement in all provinces and export without acquiring permits other than a
general exporter's licence.
41. Similarly, trade in agricultural products is also being deregulated.  Effective 1 February 1998,
traders will have the freedom to buy, sell, and transfer all commodities across district and provincial
boundaries, including cloves, cashew nuts, oranges, and vanilla.  In particular, traders will be able to
buy and sell cloves at unrestricted prices to all agents, effective immediately, and the Clove Marketing
Board will be eliminated by June 1998.  The system of quotas limiting the sale of livestock will beabolished by September 1998.  Furthermore, pr ovincial governments will be prohibited from
restricting interprovincial or intraprovincial trade, effective 1 February 1998.
42. To support export expansion government is now enforcing the prohibition of retribusi  (local
taxes) at all levels on export goods.  To strengthen competition and market integration, government
will develop and implement a one-year programme for abolishing taxes on interprovincial and
inter-district trade.  Any loss of local government revenue will be addressed through a combination of
local fuel taxes and transfers from the central government.
43. BULOG's monopoly will be limited to rice.  Earlier, the government had planned that,
following the November 1997 liberalization of wheat imports, domestic millers should distribute their
flour through BULOG for a 3-5 year transition perio d.  Now, however, we have decided to eliminate
this requirement, while flour millers will be permitted to sell or distribute flour to any agent, both
effective 1 February 1998.  Also effective the same date, all traders will be allowed to import sugarand market it domestically, while farmers will be released from the formal and informal requirements
for the forced planting of sugar cane.  This major measure will have a number of important economic
benefits.  It will rationalize sugar production, enabling old and inefficient government mills to be
closed.  It would increase rice output, as farmer s switched from growing cane on irrigated land to
producing higher value-added paddy.  And it would increase the efficiency and competitiveness ofsugar-using industries, such as food processing.
44. In parallel with these efforts to increase private sector productivity, the government is
undertaking a public sector expenditure and investment review in order to promote a more efficient
use of government resources.  This review, which is being carried out in collaboration with the World
Bank, will be completed by June 1998 and will result in a comprehensive programme to improvefiscal efficiency, and restructure state-owned enterprises and strategic industries.
45. This review will also be the basis for an accelerated programme of privatization.  Already,
oversight of public enterprises was moved to the Ministry of Finance from line ministries and a
Privatization Board has been established.  A clear framework will be established for the management
and privatization (either through share flotation or negotiated enterprise sales) of government assets
by April 1998, including:  (i) criteria for determining whether enterprises should be closed,WT/TPR/S/51 Trade Policy Review
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restructured or fully privatized;  and (ii) a transparent sales process that maximizes the return to
government and treats all bidders equally.
46. Within this framework, the government aims to accelerate privatization and to take decisive
action to restructure or close poorly performing enterprises.  Twelve enterprises will be prepared for
listing during the first year of the programme.  In all of these cases, the government intends to go
beyond the recent pattern of seeking minority shareholders in public enterprises, by sellingcontrolling, or even complete, stakes to the private sector.  In addition, further tranches of
government-controlled shares in public enterprises which are already listed will be offered for sale, so
that these enterprises, too, can be fully privatized.
47. As for those enterprises remaining within the public portfolio, clear profit and performance
targets will be established, which will be made public and reported upon annually.  Non-viableenterprises will be audited by end-1998 and non-viable enterprises closed.  Progress in this area will
be assessed at the time of the second review.
Social Safety Net
48. Indonesia has made significant progress in alleviating poverty over the past 30 years.  Yet,
large numbers of poor still remain, and it is imperative that the adjustment programme does not resultin a worsening of their economic and social conditions.  To some extent, the depreciation should
benefit the rural poor by raising output prices in the export-oriented agricultural sector.  Nonetheless,
the poor are likely to suffer extensively from the economic crisis, particularly as it has been
compounded by an unusually severe drought.  In these circumstance, special government initiatives
will be necessary.  In particular, the government plans to introduce community-based work
programmes to sustain the purchasing power of the poor in both rural and urban areas.
49. In addition, efforts to target assistance to the poor will be intensified, including by expanding
the programme for the least developed villages, initiated in 1994, which has proved to be cost
effective in creating rural infrastructure and expanding employment opportunities for the poor.
Moreover, poverty eradication and more equal income distribution are to be major themes of the next
five-year development plan, which begins in 1999.  In particular, budgetary allocations for social
spending will be increased, so as to ensure that all Indonesians receive at least nine years of educationand better basic medical services.
Environment
50. To strengthen overall environmental sustainability, the government will draft and establish
implementation rules for the new environmental law by March 1998.  In addition, government will
review and raise stumpage fees, auction concessions, lengthen the concession period, and allowtransferability by June 1998, and will implement performance bonds and reduce land conversion
targets to environmentally sustainable levels by the end of 1998.  To improve air quality, the
government is accelerating its programme for conversion to cleaner fuels, including unleaded
gasoline, to meet the President's 1999 deadline.