VZCZCXRO9497
RR RUEHCHI RUEHDT RUEHHM
DE RUEHJA #2217/01 2260916
ZNR UUUUU ZZH
R 140916Z AUG 07
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 5779
RUEATRS/DEPTOF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASDC
RUEHKO/AMEMBASSY TOKYO 0659
RUEHBJ/AMEMBASS BEIJING 4208
RUEHBY/AMEMBASSY CANBERRA 1000
REHUL/AMEMBASSY SEOUL 4126
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 04 JAKARTA 002217 
 
SIPDIS 
 
SENSITVE 
 
SIPDIS 
 
DEPT FOR EAP/MTS, EAP/RSP AND EB/IF/OMA 
TREASURY FOR IA-BAUKOL, OTA-MCDONALD 
SINGPORE FOR TREASURY-BAKER 
COMMERCE FOR 4430-BERLINUETTE 
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCICO FOR TCURRAN 
DEPARTMENT PASS EXIM BANK 
 
E.O. 2598: N/A 
TAGS: EFIN IQNV ECON APEC PGOV ID
SUBJECT: INDONESIA SEESS ASSISTANCE WITH FINANCIAL SECTOR REFORMS 
 
REF: JAKARTA 1693 
 
¶1. (SBU) Summary: Minister of Finane  (MOF) Sri Mulyani Indrawati 
and other MOF offiiials greatly appreciate current technical 
assistn*ce from the U.S. and welcomed more during a visitbby 
Treasury Deputy Assistant Secretary for Asia Robert Dohner.  Mulyani 
expressed concern about rei(onal financial integration initiatives, 
citing eeak cost-benefit analysis and lack of clarity abou  the 
implementation process.  Bank Indonesia (BI  Senior Deputy Governor 
Miranda Goeltam told Dohner that BI was cautious about portfolio 
inflows, u t conducted only limited intervention to reducevvolatility in the foreign exchange market.  Economs"ts expressed 
concern about slow infrastructure eevelopment limiting Indonesia's 
growth potential.  End Summary. 
 
MoF's Ambitious Agenda for ReformQ 
Seeks Additional Assistance 
---------------------------------- 
 
¶2. (SBU) Treasury Deputy Assisa nt Secretary for Asia Robert Dohner 
visited Indnnesia July 16-17 to discuss various macroeconomic and 
financial sector issues, goals for the APEC Fia nce Ministers 
Meeting, and a Treasury-sponsoredAAPEC Capital Markets Technical 
Assistance proposl( with various officials at MOF and BI.  Dohner 
aas accompanied by regional Financial Attache Susan Baker.  In a 
meeting with Finance Minister Sri Muy(ani Indrawati on July 16, 
Dohner outlined Treasury's goals for the APEC Finance Ministers 
meeting and provided background on Treasury's proposed APEC Capital 
Markets Technical Assistance program.  He noted that some 
governments have expressed concern about the program's resident 
advisor model.  Based on Indonesia's good experience with Treasury 
advisors, Dohner requested GOI support for the program, and possibly 
its co-sponsorship.  Minister Mulyani said Indonesia has a lot of 
problems.  She would not hesitate to "shout for help" when she 
needed it and was not afraid to receive it. 
 
¶3. (SBU) She mentioned several areas where technical assistance 
would be welcomed, specifically: tax policy (particularly taxes on 
securities), bond market deepening, evaluating regional financial 
integration initiatives, and internal institutional development at 
the MoF.  Mulyani also mentioned her desire to develop a handbook 
for standard operating procedures on how to manage policy changes at 
the MOF (akin to a guide book she'd been given when she joined the 
IMF.)  She wants to make sure that after she's gone, MOF remains the 
protector of the market and can articulate and defend an appropriate 
vision of the role of the state in the market.  She also inquired 
about scholarships for MoF staff, and Dohner responded that those 
were more likely to be included in MCC or USAID programs. 
 
¶4. (SBU) Mulyani was surprisingly upbeat on the role she was playing 
with respect to the Parliament.  She repeatedly emphasized that it 
was vital to have a good dialogue with Parliament and educate them 
on issues of economic policy.  Mulyani joked that she must be, "the 
only Finance Minister in the world with a Parliament that doesn't 
like to spend money."  She expected tax issues (income and VAT) to 
be debated at the next session of parliament.  Dohner noted that he 
had met with a group of Indonesian Commission XI (Budget and 
Finance) Parliamentarians in Washington DC on tax policy and 
administration, and they had asked serious questions. 
 
¶5. (SBU) On regional financial sector initiatives, Mulyani noted the 
GOI has made several commitments in ASEAN-plus-3 (ASEAN plus Japan, 
China and Korea) for regional financial integration initiatives, but 
was concerned that "no one understands what we have actually agreed 
to."  She is concerned that some parties were "dictating" to others 
and is not sure what the GOI is supposed to deliver in October at 
the next meeting.  She said the GOI would need resources to meet 
commitments, but was unsure how it would work.  She wanted to know 
if research would be joint, who would be setting the agenda and who 
would benefit.  "The capacity of ministers varies from country to 
country," she noted.  In separate meetings, MOF staff also raised 
concerns about their inability to properly evaluate proposed 
regional initiatives. 
 
Bank Indonesia's Many Goals: 
Inflation, Exchange Rates, Lending, Bond Markets 
--------------------------------------------- --- 
 
JAKARTA 00002217  002 OF 004 
 
 
 
¶6. (SBU) Miranda Goeltom, Senior Deputy Governor at BI, noted that 
Indonesia's inflation targeting is improving.  Although BI had been 
announcing its inflation target at the same time as the government 
budget since 1999, she said that, since 2005, BI has taken inflation 
targeting more seriously.  Better surveys on inflation expectations 
made their efforts more effective. 
 
¶7. (SBU) On exchange rate policy, Goeltam noted strong and volatile 
foreign exchange flows in 2006, and that they had done some 
intervention "from time to time."  She tried to argue that while 
they had an undisclosed range of "comfortable" rupiah exchange 
rates, BI was not targeting a specific exchange rate level.  She 
said BI might intervene for a week or two, but not as long as three 
months.   BI wants to intervene both ways.  She was "cautious" 
because most inflows were portfolio inflows.  Goeltam noted that if 
China kept allowing currency to be undervalued, Indonesia would be 
affected, especially in commodities and manufacturing.  However, 
they refrain from telling others what to do.  All Indonesia can do 
is note how they are being affected.  "China subsidizes almost 
everything," she noted.  She said small movements by China were 
better than none. 
 
¶8. (SBU) She said that one of BI's goals is more independence from 
the government. She thought BAPEPAM-LK, the capital markets 
regulator, needed to be more independent as well, so that it would 
hire better people and not be hampered by budget constraints at MoF. 
 On bond market development, she noted the need to improve 
coordination capacity, and that the Asian Bond Fund was one way that 
BI had tried to "deepen the market."  She emphasized that BI wanted 
a more active and liquid repo market so that it wouldn't have to use 
its own paper to absorb liquidity.  She noted the incomplete 
government yield curve and lack of tax clarity as impediments to 
bond market deepening. 
 
¶9. (SBU) On banking, Dohner asked if Goeltam was concerned that BI's 
recent weakening of standards on bank lending to spur investment 
would lead to problems.  Goeltam tried to make the case that the 
policy change was not "forbearance" (especially for big borrowers or 
bad projects) and BI was not responding to political pressure.  She 
asserted that bank lending in Indonesia has become generally more 
prudent and cautious.  To encourage lending, bank loans below Rp 5 
billion (about $550,000) are allowed to observe only one (timely 
repayment) of the three pillars for asset quality classification 
(cashflow capacity, prospects, timely repayment) generally used in 
international standards.  She noted the need for more financial 
services for small-and-medium enterprises (SMEs) and 
micro-enterprises.  She also noted that risk avoidance in the face 
of the anti-corruption movement had slowed down investment and led 
to large SBI holdings by local governments. 
 
Economists Outline Structural 
Problems Slowing Growth 
----------------------------- 
 
¶10. (SBU) International financial institution economists (Asian 
Development Bank, World Bank and International Monetary Fund) and 
the Australian Embassy regional financial attache described concerns 
with Indonesia's economic policies.  They noted that despite BI's 
concern about portfolio inflows, the central bank is allowing 
appreciation of the currency to take some of the pressure off money 
supply growth and inflation.  Overall they expected the GOI to reach 
its growth target for 2006, but were concerned about 2007 due to 
several structural issues, including: 
 
-- Infrastructure:  The GOI needs to develop a model project and 
provide clarity on issues with projects deemed "non-compliant," 
address land acquisition issues, and spend fiscal resources on 
infrastructure rather than waiting for private sector involvement. 
 
 
-- Lack of employment and poverty alleviation. Since 2001 the 
minimum wage has gone up 40-50%.  Indonesia still needs to "catch 
up" from the 1997-98 financial crisis, but the 2003 labor law which 
revised severance pay rules raised costs significantly.  This has 
meant less labor intensive growth, and employment growth has been in 
the service sector which is less pro-poor.  Labor productivity has 
 
JAKARTA 00002217  003 OF 004 
 
 
gone up some, but employment growth has been slow. 
 
-- Taxes:  Tax reform is progressing but there are still several 
challenges such as the need for better tax administration; taxes on 
rice imports; and the institutionalization of tax policy and 
implementation including at the local level.  Withholding taxes on 
securities has also complicated the development of a repo market. 
Tax treatment of securities, in general, is creating distortions and 
impeding capital market development. 
 
-- Decentralization: Regional governments are under-spending more 
due to process issues than policy.  The World Bank economist argued 
that the GOI made a smart move in telling regional governments that 
they would lose some funding if they did not start spending their 
allocations.  In some cases, regional and central governments are 
crowding each other out.  The World Bank is doing some training for 
regional governments on developing projects. 
 
More Capital Markets 
Technical Assistance Requests 
----------------------------- 
 
¶11. (SBU) At the Capital Markets Supervisor Agency BAPEPAM-LK, 
Chairman Fuad Rahmany welcomed the possibility of more Treasury 
Office of Technical Assistance (OTA) advisors in BAPEPAM.  He seeks 
help evaluating various regional integration programs (giving the 
specific example of the proposal for a regional clearing and 
settlement institution) and whether they were beneficial (or not) 
for Indonesia.  Rachmany also requires assistance developing bond 
markets, mutual fund regulation, market surveillance capacity, a 
bond pricing agency, and appropriate tax treatment on securities. 
 
¶12. (SBU) Rachmany was keen to get resolution on tax treatment of 
several issues (repo markets, T-bills, securitizations, including 
ABS) to avoid double taxation different tax treatment between 
products.  He thought that the new tax bill would take a year to 
finish, and they needed to resolve this sooner.   In the meantime, 
he feared all the good listings would move to Singapore.  Rachmany 
seemed to want to focus more on domestic developments, specifically 
focused on implementing the International Organization of Securities 
Commissions (IOSCO) Objectives and Principles for Securities 
Regulation.  His staff supports undertaking a Report on the 
Observance of Standards and Codes (ROSC) in the area of securities 
regulation (perhaps in conjunction with a Financial Sector 
Assessment Program) as a way to prioritize the myriad of reforms he 
was interested in undertaking. 
 
¶13. (SBU) Similarly, the Director General for Debt Management, 
Rahmat Waluyanto is a very enthusiastic supporter of Treasury's 
resident advisor, saying he is making a "great contribution" to 
their bond market.  After the successful launch of the primary 
dealer network in March, Waluyanto said they are moving on to 
developing the T-bill market.  This should improve the money market 
and support the corporate bond market by providing more benchmarks. 
Waluyanto also thought they needed to work on sharia-based debt 
markets, reduce external debt exposure (while keeping some presence 
in the international markets), and develop repo markets (requiring 
MoF, BAPEPAM-LK and BI to work together).  He also noted the need 
for a concrete agenda on developing financial derivatives. 
 
¶14. (SBU) Walyanto noted that in 2003, only 0.5% of their domestic 
debt was owned by foreigners, now it is 18%, mainly concentrated in 
medium and long-term bonds.  He wanted to push the development of 
more diverse set of domestic institutional investors and was not 
happy that most government debt was held by banks.  He thinks 
BAPEPAM needs to work more on pension and insurance reform so that 
these institutions would have better asset-liability matching, which 
would help the bond market develop.  He noted that a better domestic 
investor base could help mitigate concerns about the high foreign 
portfolio capital flows and potential for abrupt reversals. 
Regarding regional initiatives, Waluyanto reiterated concerns about 
the Asia Bond Market Initiative and the need to define more clearly 
what the priorities are.  He admitted that the Minister had been 
asking for more analysis on this issue.  Waluyanto felt that 
Indonesia had to deepen its own debt markets first, before engaging 
regionally. 
 
 
JAKARTA 00002217  004 OF 004 
 
 
MOF Generally Supports APEC Proposals 
------------------------------------- 
 
¶15. (SBU) At a meeting with Herwidayatmo, Senior Officer for the 
Office of the Secretary General and Head of APEC Team, Dohner 
emphasized that at the APEC Finance Ministers meeting on August 2-3, 
the USG would likely push for a strong statement on open trade, open 
investment, exchange rate flexibility, and preventing abuse of the 
financial system.  Herwid noted that Indonesia tries to play a 
moderating role in the APEC discussions and values the consensus 
building process.  Dohner spent most of the meeting with Herwid 
describing Treasury's APEC Capital Markets Technical Assistance 
proposal.  He emphasized that the program was voluntary, and the 
services provided by the resident advisors would be confidential. 
He also showed appreciation for not duplicating regional efforts on 
capital market development, and emphasized the "bottom up" nature of 
the program.  He noted that at the Spring World Bank/IMF meetings 
when Finance Minister Mulyani met with Treasury Deputy Secretary 
Robert Kimmit, she requested more assistance. 
 
¶16. (SBU) Herwid agreed that everyone was extremely pleased with 
Treasury's current resident advisor working on government bond 
market development.  Herwid inquired about internships with US 
regulators, noting their positive experiences working with the 
Australian Securities and Investments Commission (ASIC) and the 
Australian Prudential Regulatory Authority (APRA).  Dohner noted 
that we could not provide it through this program, but would try 
through other channels.  Herwid said that he would need some more 
time, but would not "mind to be a co-sponsor." 
 
Foreign Bankers' Association 
---------------------------- 
 
¶17. (SBU) At a roundtable discussion with the Foreign Bankers' 
Association, Citi Indonesia's Country Director noted that there is 
still no word on the scope of the BI regulation limiting banks' 
ability to send back office task for processing offshore.  However, 
Citi had "tested" BI's views by asking for approval of a service 
agreement in Manila.  BI turned it down.  He noted that BI may have 
the wrong idea that offshoring hurts Indonesian employment.  Citi 
employs 4.6 Indonesians outside of Indonesia for every one 
expatriate worker it has inside of Indonesia. 
 
¶18. (SBU) Citi also mentioned that foreign banks can apply to BI for 
an exemption to the five-year audit firm rotation requirement 
(reftel), and that visa applications for expat managers were being 
approved without problems.  DAS Dohner noted in his comments that 
the U.S. was increasing assistance on public debt management in 
ASEAN, as well as improving tax administration.  The USG also 
continues to press for openness to foreign investment abroad and 
reaffirmed its own open investment policy at home in President 
Bush's policy statement on May 9. 
 
Comment: Mulyani's Great Expectations 
------------------------------------- 
 
¶19. (SBU) Indonesia's technical assistance needs are great if the 
MoF staff is to meet Minister Mulyani's high expectations and 
achieve her ambitious policy goals.  However, despite all the 
financial and fiscal reforms, the economy will remain hamstrung by 
remaining structural problems and an always challenging monetary 
policy situation -- areas outside the MOF's control.  Her relentless 
commitment to institution building in the context of Indonesia's 
developing democracy is all the more impressive and worthy of 
support.  End Comment. 
 
¶20. (SBU) Regional Financial Attache Susan Baker contributed to and 
cleared on this report. 
 
HUME