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UNCLAS SECTION 01 OF 05 JAKARTA 011767 
 
SIPDIS 
 
SIPDIS 
SENSITIVE 
 
DEPT FOR EAP/MTS AND EB/IFD/OMA 
TREASURY FOR IA-SETH SEARLS 
COMMERCE FOR 4430/GOLIKE 
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO FOR FINEMAN 
DEPARTMENT PASS EXIM BANK 
 
E.O. 12598: N/A 
TAGS: EFIN EINV ECON PGOV KCOR ID
SUBJECT: INDONESIA'S ECONOMY - RIGHT DIRECTION, WRONG SPEED 
- VISIT OF TREASURY OFFICIALS BAUKOL AND SEARLS 
 
Ref: A) Jakarta 5704 (Labor); B) Jakarta 10539 (Newmont); 
 
C) Jakarta 11110 (Mudflow); D) Jakarta 9864 (Biofuels); 
E) Jakarta 9336 (Infrastructure); F) Jakarta 1833 (Banking 
Sector) 
 
¶1. Summary.  Private sector and Government of Indonesia 
(GOI) interlocutors expressed optimism about the financial 
sector's growth and progress, but concern about the real 
sector, during the September 13-15 visit of Department of 
Treasury officials Andrew Baukol and Seth Searls.  Most 
agreed Indonesia's economy needs more growth and investment 
and that GOI spending is slow in part due to inefficient 
local spending and fears by project managers that they may 
face corruption charges.  The investment climate remains 
very challenging for western firms, so Indonesia will 
probably be a market mainly for Asian investors for a long 
time.  In this environment, capital markets, rather than 
long-term investment, are receiving the bulk of overseas 
investor interest.  Infrastructure development is still 
lagging, but the Asian Development Bank (ADB) is helping the 
GOI develop a few credible infrastructure projects for 
tender in time for a November 1-3 infrastructure conference 
in Jakarta.  The rest of the banking sector is growing and 
relatively healthy.  A new GOI regulation on the 
restructuring of non-performing loans (NPLs) may help Bank 
Mandiri and BNI, the two largest state-owned banks, clean up 
their balance books.  Bank Indonesia (BI) Senior Deputy 
Governor Miranda Goeltum said she worries that recent strong 
capital market inflows are a sign that expectations are a 
bit too high, but others in the private sector view this 
dynamism as a positive sign.  End Summary. 
 
Macroeconomy - Good but Could Be Better 
--------------------------------------- 
 
¶2. (SBU) During three days of meetings with GOI officials 
and private sector contacts September 13-15, visiting 
Department of Treasury officials Andrew Baukol and Seth 
Searls heard that Indonesia's macro-economy is stable but 
needs stronger growth.  A prominent expat consultant noted 
that his most recent presentation on Indonesia's economy and 
investment climate is called, "Right Direction, Wrong 
Speed."  Investment bankers we spoke with agreed that 
Indonesia has a good economic team and reasonable growth, 
but needs more and that longer-term foreign direct 
investment (FDI) is not coming in fast enough.  A ratings 
agency representative sounded a similar theme, telling us 
that he would like to see Indonesia have more exports, 
investment and a more stable currency.  Senior Bank 
Indonesia (BI) Deputy Governor Miranda Goeltum also agreed 
with this conclusion, stating that Indonesia has made great 
progress compared with the past, but that it is still 
lagging behind in the region.  One positive aspect is that 
inflationary pressures have been more subdued than in 
previous episodes when the GOI raised administered prices. 
Consumers reacted calmly, and the October 2005 fuel price 
hikes did not cause excessive increases in the prices of 
other staples or lead to the stockpiling of goods.  Thus BI 
was abe to bring inflation expectations down in six monts. 
Goeltum said she expects inflation will fall t 6.5% on a 
year-on-year basis by the end of the ear. 
 
Anti-Corruption Efforts Slow GOI Spending 
----------------------------------------- 
 
¶3. (BU) Several contacts told us that GOI spending is low 
because project leaders responsible for impleenting 
projects at the sub-national level are afaid to do their 
jobs for fear of corruption accuations.  One Indonesian 
 
economist and advisor tothe GOI told us that many project 
managers have esigned, and those remaining are not spending 
themoney.  One private sector contact suggested that he 
incentives need to be changed, perhaps by offring a 
transparent bonus" for good project implemntation.  Other 
observers note that provincial gvernments simply lack a 
clear mandate as well as apacity to budget and monitor 
spending.  Severaldonors, including USAID and the World 
 
JAKARTA 00011767  002 OF 005 
 
 
Bank, are helping Indonesia with local government capacity 
building. 
 
Investment Climate - FDI Needed 
------------------------------- 
 
¶4. (SBU) One prominent expat consultant noted that Indonesia 
still has a "socialist ethos" which is suspicious of foreign 
direct investment (FDI).  In a climate which requires 
significant incentives to compete regionally, this system 
remains an impediment to Indonesia's competitiveness. The 
international business chambers and the Indonesian Chamber 
of Commerce and Industry (KADIN) are quite frustrated that 
President Susilo Bambang Yudhoyono (SBY) has not been able 
to deliver on promises to improve the investment climate. 
The consultant noted that given all the investment climate 
challenges here, Indonesia will probably remain a 
destination for mainly Asian investors for a long time. 
Inflexible labor regulations are stifling investment, and 
planned GOI changes to the labor law have been held up for 
some time.  Our consultant contact opined that, "If labor 
reform doesn't happen soon, it won't happen."  The window is 
closing for progress since the elections in 2009 will play 
an increasingly complicating role.  The investment law has 
been in Parliament since late March and may pass by early 
¶2007. 
 
¶5. (SBU) BI officials told us another constraint on 
investment is poor infrastructure: companies do not have any 
certainty that what they need to be successful will be 
available or reliable, including roads, water, electricity, 
human capital, and property rights.  Dr. M. Chatib Basri, 
Director of the Institute of Economic and Social Research 
concurred, noting that while many analysts have focused on 
inflexible hiring and firing practices, logistics represent 
14% of production costs while labor is only 7%.  Factors 
that raise costs include inefficient roads, "irregular" 
trucking and customs fees, and congested ports.  On the 
positive side, tax reforms are beginning to produce results. 
In special tax offices set up for medium-sized companies, 
VAT collection is up 80% as a result of new information 
technology systems.  Customs reform, however, remains 
sluggish. 
 
¶6. (SBU) Several international business contacts noted the 
dramatic contrast between the Environment Ministry's harsh 
handling of the international mining company Newmont in the 
Buyat Base case and the lenient treatment afforded the 
Indonesian firm Lapindo in the Sidoarjo mudflow disaster. 
The Environment Ministry initially condemned the company, 
but backed off a few days later, a fact likely due to 
Lapindo's connection with Coordinating Minister for Peoples' 
Welfare Aburizal Bakrie.  The Environment Minister has even 
made public comments downplaying the environmental and 
health effects of the mud and its noxious, sulfurous gases, 
and no one involved has yet been charged with any crime. 
One expat consultant remarked, "I'm surprised the 
international media has not publicized this story.  It's a 
huge environmental disaster." 
 
Infrastructure - Credible Projects by November? 
--------------------------------------------- -- 
 
¶7. (SBU) Several contacts noted Indonesia has had difficulty 
in reviving its real sector.  BI officials told us that many 
of the large Indonesian companies that could be players in 
infrastructure development have a corrupt history and are 
therefore unappealing to potential foreign partners.  In 
order to move forward, Indonesia needs to establish a good 
model for public-private partnerships.  ADB officials, who 
have been advising the GOI on infrastructure issues, said 
the ADB and GOI are selecting a short list of 6-8 projects, 
and hoped to have 2-3 ready for a credible tender by the 
November 1-3 Infrastructure Conference November 1-3 (Ref E). 
Another ADB official said that, "If Indonesia can showcase 
even one, non-corrupt, bankable, credibly implemented 
infrastructure tender and project, it will make a huge 
 
JAKARTA 00011767  003 OF 005 
 
 
positive impact."  ADB officials also said that the debate 
about corruption in Jakarta's monorail project is "exactly 
what is supposed to happen.  Expectations are higher for 
greater transparency now." 
 
Biofuels - Right Goals, Wrong Concept? 
-------------------------------------- 
 
¶8. (SBU) Dr. M. Chatib Basri, Director of the Institute of 
Economic and Social Research and informal economic advisor 
to SBY, gave us some insight into the thinking behind SBY's 
biofuel initiative (reftel D).  Basri said that the 
President specifically had Roosevelt's "New Deal" in mind 
and asked Basri to find him a good book about it.  The 
President has been growing impatient with the lack of 
progress on reducing unemployment.  He has in mind three 
initiatives to generate new jobs, especially to achieve 
results before the 2009 election. 
 
- a "cash for work" program for the unemployed; 
- better facilitation of overseas worker remittances; 
- a biofuel initiative to generate 3.5 million jobs. 
 
¶9. (SBU) However, Basri said he was concerned about 
underlying economics of SBY's biofuel initiative since Crude 
Palm Oil (CPO) production requires a huge amount of land and 
too much lead time to get results quickly.  Land issues in 
Indonesia are always very difficult because a patchwork of 
different property rights and land use practices, laws and 
regulations prevail in different areas.  The plantation 
sector is "hot" right now, Basri noted, and prices of some 
good land have already inflated to US $6,000 per hectare. 
Political parties are already interfering.  An international 
investment bank also noted that CPO, the primary ingredient 
in the biodiesel, costs Rp 3,500 (US $0.40) per kilogram to 
purchase and Rp 1,500 (US $0.17) to process into biofuel. 
By comparison, subsidized diesel fuel sells for Rp 
4,300/liter (US$ 0.45). 
 
¶10. (SBU) Basri added that with state-owned energy company 
Pertamina serving as the sole buyer, it is not clear how the 
program can be profitable.  As a job creation program, the 
biofuel initiative will probably not be either effective or 
sustainable.  Basri said he is recommending that a cash-for- 
work program would bring better results.  He suggests that a 
rural infrastructure development program - already part of 
the GOI's priorities - would achieve both goals of creating 
jobs and improving rural economies. 
 
Policy Packages - Getting Results? 
---------------------------------- 
 
¶11. (SBU) We asked our contacts what they thought about the 
new financial sector reform package.  An international 
economist noted that part of the reason for these packages 
is to impose a "new form of coordination" on the ministries. 
Coordinating Minister Boediono, for example, has 16 line 
ministries under him from Finance to Fisheries headed by 
Ministers from several different political parties.  The 
packages, with responsible ministries and deadlines clearly 
stated, create some measure of discipline.  Currently, it is 
difficult to get ministries to do what they are not already 
planning to do themselves, the economist commented. 
 
¶12. (SBU) The new package also addresses the non-bank 
financial sector. Some of Indonesia's small domestic 
insurers are in poor financial condition and the insurance 
sector has not been closely regulated in the past.  However, 
on August 31, the Financial Institution and Capital Markets 
Supervisory Board (BAPEPAM-LK) BAPEPAM-LK issued a decree on 
insolvent insurance companies.  The decree outlines the 
government's strategy for managing insolvent insurance and 
reinsurance companies.  Our Coordinating Ministry contact 
said the Directorate of Insurance under MOF is already 
looking at the books of many small insurance companies. 
They will not become efficient on their own, our contact 
noted, "we must force them to grow up."  Insolvent companies 
 
JAKARTA 00011767  004 OF 005 
 
 
will have to restructure or close. 
 
Banking Sector - Healthy Except 
Those Big State-Owned Banks 
------------------------------- 
 
¶13. (SBU) Private bankers told us that last year's fuel 
price hikes and subsequent inflation are still hurting the 
buying power of consumers.  Consumers were hit three times, 
one banker noted, with fuel prices going up, prices for 
staples rising in response, and interest rates increasing as 
well for consumer loans.  Car and motorcycle sales are 
beginning to creep up again, he noted, but mortgages remain 
soft.  The overall non-performing loan ratio is about 8% but 
without state-owned banks Mandiri and BNI it would only be 
4.8% (Ref F).  A private commercial banker told us that it 
is relatively easy for private banks to restructure bad 
loans, but state-owned banks have strict rules and limited 
options.  Under current regulations, state-owned banks must 
obtain approval from the Minister of Finance before taking a 
haircut on loans up to US $1 million.  For loans up to US 
$10 million, banks must get the approval of both the 
Minister of Finance and the President, and for loans above 
this amount Parliament must approve as well.  By relaxing 
these rules a new Presidential Instruction under the 
financial sector package should help the state-owned banks 
clean up their books. 
 
¶14. (SBU) Private commercial bankers at large domestic banks 
told us that their business is expanding.  Representatives 
from two large private banks, Bank Central Asia (BCA) and 
Bank Danamon, said they continue to expand their business 
and the number of branches.  BCA has 773 branches: it added 
29 new ones in 2005 and will add another 27 by the end of 
¶2006.  Bank Danamon said that a recent banking services 
demographics study showed that the 60,000 wealthiest 
households in Indonesia keep most of their assets overseas. 
Most banks focus on the next wealthiest sector of the market 
consisting of about 6 million households: they try to sell 
them car loans, credit cards, mortgages, etc. and this 
segment has become very competitive.  However, the largest 
(by population) sector of the market consists of 50 million 
households largely categorized as "self-employed mass 
market."  Bank BRI, a state-owned bank and one of the 
largest micro-lenders in the world, services about 30% of 
this market.  Danamon has also been setting up small 
marketplace branches to offer four simple loan products and 
four simple savings products to this sector and has been 
very successful.  It opened its first small "marketplace" 
branch in July 2004 and now has over 800. 
 
¶15. (U) BI officials told us that its new credit bureau is 
working fairly well.  Due to a lack of unique identifier 
however, three parameters were required to search a 
borrower: name, address and date of birth.  BI has been 
discussing a unique taxpayer identification number with the 
GOI. 
 
Capital Markets Growing 
----------------------- 
 
¶16. (SBU) Capital markets are receiving the bulk of overseas 
investor interest in Indonesia.  The Ministry of Finance 
noted that foreign ownership of rupiah-denominated bonds has 
more than doubled from 6% of total in September 2005 to 14% 
in August 2006.  The main owners of domestic bonds, however, 
remain domestic banks at 55%.  Indonesia is still designing 
a primary dealers market for GOI bonds.  It is not yet clear 
if or when the GOI would offer Treasury bills with shorter 
maturities since "these could present another challenge for 
debt management," MOF officials told us. 
 
¶17. (SBU) The Jakarta Stock Exchange (JSX) has also received 
a great deal of investment from overseas and domestic 
buyers.  However, the JSX is still relatively thin, with 
only 336 listed companies valued at about US $88 billion. 
As a result, large portfolio flows from overseas can create 
 
JAKARTA 00011767  005 OF 005 
 
 
big swings.  The Jakarta Composite Index (JCI) has risen 
from 750 in mid-2004 (before President SBY was elected) to 
over 1,400 in August 2006.  Senior BI Deputy Governor 
Miranda Goeltum said she worries that these historic highs 
could mean a bubble.  "The markets may be expecting more 
than we can fulfill," she noted.  So much foreign exchange 
is coming into the capital markets that BI has to sterilize 
some of the inflows to smooth out the appreciation of the 
currency.  "If the rupiah gets too strong, exporters can't 
compete," she said.  Others in the private sector were 
encouraged by the dynamism in the capital markets, "We will 
have a very interesting couple of years ahead of us in 
Indonesia," one analyst told us. 
 
HEFFERN