VZCZCXRO1077
RR RUEHCHI RUEHDT RUEHHM
DE RUEHJA #3559/01 3550943
ZNR UUUUU ZZH
R 210943Z DEC 06
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 2556
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUEHKO/AMEMBASSY TOKYO 0168
RUEHBJ/AMEMBASSY BEIJING 3770
RUEHBY/AMEMBASSY CANBERRA 0254
RUEHUL/AMEMBASSY SEOUL 3832

UNCLAS SECTION 01 OF 04 JAKARTA 013559 
 
SIPDIS 
 
SIPDIS 
SENSITIVE 
 
DEPT FOR EAP/MTS AND EB/IFD/OIA 
TREASURY FOR OASIA 
USDOC FOR 4430/ BERLINGUETTE AND JBENDER 
DEPT PASS TO USTR DKATZ AND WEISEL 
 
E.O. 12598: N/A 
TAGS: ECON EINV EFIN ELAB PGOV ID
SUBJECT: INDONESIA TAKES STOCK OF ECONOMIC REFORMS 
 
¶1. (SBU) Summary. Coordinating Minister for Economics Boediono told 
a gathering of Embassy and private sector representatives on January 
18 that he expects Parliament to pass new investment and tax laws 
"in the early months of 2007."  Minister of Trade Mari Pangestu went 
further in her description of Parliament's deliberations of the 
draft investment law, stating that discussions are in the "final 
phase" and likely to be completed the week of December 18.  A 
Parliamentary plenary session would then pass the law shortly after 
January 8.  Pangestu was uncharacteristically silent on whether the 
draft law would eliminate Indonesia's investment approval system, a 
previous Government of Indonesia (GOI) priority.  Minister of 
Finance Sri Mulyani Indrawati described an ambitious reform program 
at the Ministry of Finance (MOF) in the areas of treasury 
management, debt management, tax, and customs, but conceded she was 
disappointed by Parliament's failure to pass the draft tax laws in a 
speedy fashion.  Investment Coordinating Board (BKPM) Chairman 
Mohammed Lutfi noted that the GOI is in the process of revising and 
making more generous Indonesia's investment incentive regulations 
and is using the Batam Special Economic Zone's (SEZ) streamlined 
investment procedures as a pilot for other SEZs across Indonesia. 
Boediono made very cautious comments about the possibility of 
reforming Indonesia's overly rigid severance pay and contract work 
systems, noting that the GOI is "not close" to consensus.  The 
Director of the University of Indonesia's Institute for Economic and 
Social Research (LPEM), Dr. Chatib Basri, presented the results of a 
survey showing little progress on the investment climate between the 
end of 2005 and mid-2006, a conclusion that surprised few of the 
business leaders in attendance.  End Summary. 
 
¶2. (U) A team of ministers led by Coordinating Minister Boediono and 
Bank Indonesia (BI) Governor Burhanuddin Abdullah reviewed progress 
on the GOI's economic reform agenda, as well as plans for 2007, for 
a group of 150 Embassy and private sector participants on December 
¶18.  The GOI scheduled the meeting in response to a request from the 
co-chairs of the Consultative Group on Indonesia's (CGI) Investment 
Climate Working Group (the U.S., Japan, European Union, and World 
Bank).  However, the GOI decided to hold the meeting outside the CGI 
framework, and in addition to approximately 20 CGI member countries 
or organizations, also invited representatives from a number of 
domestic and international business groups and the Chinese, Indian, 
Qatar, Saudi Arabian, Kuwaiti and ASEAN country Embassies. 
 
Positive Macroeconomic Outlook and MOF Reforms 
--------------------------------------------- - 
 
¶3. (U) Boediono, Minister of Finance Sri Mulyani Indrawati, and BI 
Governor Abdullah provided uniformly upbeat assessments of 
Indonesia's macroeconomic situation, noting that GDP growth is 
rising, public debt and inflation are falling, the Rp/USD exchange 
rate and overall balance of payments situation are steady, and 
banking system indicators are improving.  However, Boediono noted 
that Indonesia still needs a "growth push" to create more jobs. The 
non-oil sector is growing well at approximately a 6.5% rate, he 
said, but the oil and gas sector suffers from "specific problems," 
and is stagnant.  The GOI "needs to do something" about this 
situation, he said.  Boediono also stated that the GOI is working to 
stabilize rice prices and will "do whatever it takes" to normalize 
the situation.  Burhanuddin repeated recent BI statements cautioning 
that the potential exists for increased inflationary pressures in 
2007, requiring prudent monetary policy. 
 
¶4.  (SBU) Mulyani provided some details on the ambitious internal 
reform program underway at the MOF.  As part of the GOI's fiscal 
consolidation efforts, which have seen budget deficits drop from 
2.4% of GDP in 2001 to approximately 1% in 2006 and 2007, Mulyani 
said the MOF is pursuing "fundamental reforms" in its treasury 
operations.  President Yudhoyono created a new Director General for 
State Treasury position in November as part of an overall 
restructuring at the MOF.  The MOF is working to manage its cash and 
risk better, and adopt a multi-year budget framework, a Treasury 
Single Account system, and accrual basis accounting.  The MOF is 
also taking a "disciplined approach" toward contingent liabilities 
from state-owned enterprise capital injections, infrastructure 
risk-sharing, Rp 11 trillion ($1.2 billion) in unpaid value added 
tax refunds from 1999-2001, and local government borrowing.  On the 
latter, the Mulyani said the MOF will control both the total level 
of local government borrowing as well as the procedures local 
governments must follow to issue bonds, including obtaining approval 
by the Minister of Finance. 
 
 
JAKARTA 00013559  002 OF 004 
 
 
¶5. (SBU) Internal reforms in the Directorates General for Taxation 
(DGT) and Customs and Excise (DGCE) are also moving forward, Mulyani 
said.  The MOF has finalized a draft Presidential Decree "radically 
changing" the structure at DGT from one based on type to tax to one 
based on functional directors.  In response to continuing complaints 
about the behavior of tax officials, the MOF is also trying to 
improve governance by modernizing the structure of tax offices, 
implementing an enhanced code of conduct, and raising discipline and 
enforcement.  Current regulations on civil service conduct are weak, 
Mulyani said, and the MOF is working closely with the Corruption 
Eradication Commission (KPK) in cases of suspected misconduct in the 
DGT.  If there are indications that DGT officials have committed 
acts "close to criminal activity," the KPK will launch an 
investigation.  Mulyani added that she has asked DGT to review the 
functioning of existing Large Taxpayer Offices (LTOs).  Although 
revenue from these offices has increased on average by 40% a year, 
7-10% of complaints from firms covered by LTOs are still related to 
governance.  "This is unacceptable," Mulyani said, and the GOI needs 
to reduce complaints so it can expand the LTO system further. 
 
¶6. (SBU) In an effort to improve the functioning of Indonesia's 
customs clearance system, Mulyani said the MOF is establishing pilot 
"Major Customs Offices" in Batam and Tanjung Priok port in Jakarta, 
which together process 60-70% of Indonesia's exports and imports. 
These offices are similar in concept to the LTOs--they will have 
more modern organizational structures, and officials stationed at 
them will receive significantly higher salaries but be subject to 
much stronger discipline. 
 
Draft Tax Laws:  "We're Ready to Discuss Anytime" 
--------------------------------------------- ---- 
 
¶7. (SBU) Mulyani noted that although it was unfortunate that 
Parliament had not yet passed revised taxation procedures, value 
added tax, and income tax laws, the MOF is ready to discuss the 
draft laws "anytime, even during the holiday recess."  Mulyani 
appealed to Golkar Parliamentarian and Chairman of the Indonesian 
Chamber of Commerce and Industry (KADIN) Mohammed Hidayat, who was 
in attendance, for help in "increasing motivation among Parliament" 
to pass the law.  Boediono said that he hoped Parliament can pass 
the three tax bills "in the early months of 2007" so that parts of 
the laws could be partially implemented in 2007. 
 
Parliament Close to Passing Investment Law 
------------------------------------------ 
 
¶8. (SBU) Minister of Trade Mari Pangestu expressed optimism that 
Parliament would pass the draft investment law soon after it 
returned from recess on January 8.  She reported that consultations 
between GOI and Parliament on the draft law were nearly complete and 
that she expected to appear once more before Parliament's Commission 
VI before Parliament votes on the draft law in a plenary session. 
Pangestu asserted that the GOI had already made considerable 
progress in drafting the law's accompanying regulations, including 
the creation of a clear and concise negative list, and that they 
would be issued in conjunction with the enactment of the law. 
(Comment: An international consultant working closely with the 
Ministry of Trade (MOT) on the negative list had a different view, 
and told us that the process has a long way to go.  With no 
existing, comprehensive list of investment restrictions, the MOT has 
received as much as a hundred pages of detail on existing investment 
restrictions from a number of ministries.  The MOT will compile the 
various lists into one comprehensive document, and then present the 
cabinet with options for paring down the list of restrictions. This 
process could take several months.  End Comment.) 
 
Investment Incentives/Investment Approval System? 
--------------------------------------------- ---- 
 
¶9. (U) Investment Coordinating Board (BKPM) Chairman Mohammed Lutfi 
reported that the GOI is in the process of revising Government 
Regulation 148/2000 which establishes a set of standard incentives 
for qualifying investments.  Specifically, the draft regulation 
allows qualifying investors to deduct up to 30 percent of their 
realized investment from gross taxable income (five percent of the 
realized investment per annum for the first six years of the 
project); carry forward losses for up to 10 years; and utilize an 
expedited depreciation schedule. According to an Indonesian language 
MOF presentation, the draft regulation would also reduce from 15 to 
10 percent the income tax rate on dividends paid outside Indonesia. 
 
JAKARTA 00013559  003 OF 004 
 
 
Pangestu explained that the incentives will be available to new 
investors in selected "pioneer sectors" and regions. 
 
¶10. (SBU) In contrast to previous CGI investment climate meetings, 
Pangestu made no mention of efforts to transform Indonesia's 
investment approval system into a streamlined registration regime, 
an earlier GOI reform goal. Lutfi, however, claimed that the GOI has 
made considerable progress in reducing the time needed to obtain 
approvals for starting a business on Batam Island through a 
newly-established "Integrated Investment Services Center" (IISC). 
The IISC is a one-stop-shop that houses all GOI agencies responsible 
for issuing business approvals in Batam, including the BKPM, the 
MOF, the Ministry of Transmigration and Manpower, the Ministry of 
Law and Human Rights, the Batam regional government, and the Batam 
Authority.  According to Lutfi, BKPM approvals processed through the 
Batam IISC now take just one to two days on average.  Lutfi also 
claimed that the Batam IISC now processes approvals for a dozen 
required permits and licenses in a cumulative 59 days, less than the 
97 days in other areas as cited in a 2006 IFC survey. 
 
¶11. (SBU) Pangestu added that her Ministry continued to reform its 
business regulation and licensing systems and had implemented 
significant reforms in December 2005 and March 2006.  She cautioned, 
though, that meeting the GOI's target of reducing the number of days 
it takes to start a business from 150 to 30 days would take time. 
(Comment: The consultant cited in para eight also told us that when 
a GOI team had examined the MOT's streamlining of procedures to 
obtain the Trade Business License (SIUP), a document required of 
almost all businesses in Indonesia, they had found that the new 
"streamlined" procedures took significantly longer than the old 
ones.  End Comment.) 
 
Batam Special Economic Zone 
--------------------------- 
 
¶12. (SBU) Lutfi blamed an IMF-imposed removal of Batam's free trade 
zone (FTZ) status in 2001 for Batam's recent decline.  At its height 
in 2001, the Batam FTZ accounted for 14 percent of Indonesia's 
non-oil and gas domestic exports and created over 200,000 new jobs. 
The export figure had fallen to eight percent by 2005, and Lutfi 
said the GOI's goal is to lure $1 billion in new investment in 
2007-2010 and create 100,000 new jobs.  To reinvigorate the area, 
Lutfi said the GOI planned to clarify its status, laws and 
regulations; remove import duties except for consumable goods; 
create model customs and tax offices; ease labor restrictions; and 
reduce to 33 days the time it takes to start a business.  Pangestu 
added that the GOI had already established a pilot ASEAN Single 
Window in Batam -- a one stop service for processing import and 
export documents -- and that the DGCE would establish the next 
Single Window would in Jakarta's Tanjung Priok port, Indonesia's 
busiest.  (Comment:  We are not sure of the relationship between the 
ASEAN Single Window initiative and the Major Customs Offices 
described by Mulyani.  End Comment.) 
 
¶13. (U) Pangestu said that the GOI hopes to use Batam as a model for 
creating similar special economic zones or "areas of excellence" in 
strategic locations across Indonesia.  She noted that it is easier 
to remove "supply-side constraints" in such small geographical areas 
than throughout the entire country.  Like Batam, each zone would 
have a single authority that would employ best practices in 
providing services to investors, such as licensing and permitting, 
dispute resolution, and import and export procedures.  Pangestu said 
the GOI is still considering where to locate the zones, but is 
basing its assessment on supporting infrastructure and industries, 
and access to inputs of production, such as raw materials and 
skilled labor. 
 
Labor Reform Continues to Flounder 
---------------------------------- 
 
¶14. (SBU) Boediono admitted there has been little progress on labor 
issues following the July release of a GOI-commissioned study on 
draft labor legislation by six local universities.  Proposed 
revisions to Indonesia's labor law, especially those related to 
levels of severance pay and outsourcing, spurred mass labor 
demonstrations in April and May 2006.  The study recommended against 
the GOI's proposed revisions to the Labor law and suggested 
adjustments to existing regulations as a better approach to 
alleviating investor concerns.  Boediono suggested that all parties 
need to come together to discuss these sensitive issues.  He quickly 
 
JAKARTA 00013559  004 OF 004 
 
 
added, though, that the GOI is "not close" to reaching consensus on 
the issue, and that progress on labor issues would have to wait for 
the right moment politically.  (Comment: A senior official at the 
Coordinating Ministry expressed frustration that although the GOI 
received the University study in July, it has made no effort to 
publicize the study's recommendations, a clear sign of GOI 
reluctance to take up labor reforms.  End Comment.) 
 
Movement on Infrastructure Priorities 
------------------------------------- 
 
¶15. (SBU) Boediono reiterated the importance of infrastructure 
investment to the GOI. Although overall investment remains low, 
spending on infrastructure is rising.  Boediono was optimistic on 
the passage of transportation, postal, electricity, and energy 
reform laws reducing or eliminating SOE monopolies in these sectors 
and opening them up to private investment. Boediono assured 
investors, "the laws are in a high level committee of the DPR" and 
expected to pass in the early part of 2007. He also reiterated the 
GOI's commitment to bringing a list of 10 GOI model projects to 
completion next year, an important step for investor confidence. 
However, he acknowledged that almost two months after the November 
1-3 Infrastructure Forum, none of the model projects are ready for 
tendering.  Mulyani also reiterated her intent to scrutinize 
government support for "non-compliant and high profile" projects 
handled outside of the formal public private partnership system 
established by Presidential Decree 67/2005.  Although not compliant 
with Decree 67/2005, Mulyani noted that these projects are not 
necessarily bad, and need to be reconciled with the Decree 67 
framework.  She urged participants not to view GOI support for these 
projects as a deviation from "good or best practices."   (Comment: 
Mulyani was likely referring to the $650 million Jakarta Monorail 
project, which the GOI has reportedly awarded a modest ridership 
guarantee capped at $25 million annually.  However, newspaper 
reports indicate that investors in the project continue to seek 
access to more GOI funds. End Comment.) 
 
Survey Shows Stagnant Investment Climate 
---------------------------------------- 
 
¶16. (SBU) The University of Indonesia's LPEM presented the 
conclusions of the third and last round of its World Bank-funded 
Investment Climate Monitoring survey.  LPEM conducted the survey 
from June through August of this year, and their results show a 
marked decrease in business confidence in the investment climate 
from the previous survey taken at the end of 2005.  The biggest 
constraints to business remain macroeconomic stability, policy 
uncertainty, and corruption.  However, the survey showed a 
significant increase in the number of manufacturers concerned with 
electricity supply and transportation infrastructure, due to 
frequent brownouts and transportation delays. 
 
¶17. (U) According to the survey, labor indicators (labor 
regulations, labor skills/education) also continue to worsen with 
severance pay and lay-off procedures seen as the biggest obstacles. 
Respondents also noted that Indonesia's labor laws reduce the 
competitiveness of manufacturing firms and that both the number and 
cost of labor disputes are rising.  The survey noted that the 
majority of labor problems affect large, export-oriented 
manufacturing firms in sectors where Indonesia has the potential to 
be regionally competitive. The survey also noted some areas of 
improvement in the customs and trade regulations at both the local 
and central government level. Firms reported decreased times and 
informal payments for customs clearance. 
 
HEFFERN