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PROGRAM INFORMATION DOCUMENT (PID) APPRAISAL STAGE Report No.: AB3407 Indonesia Infrastructure Development Policy Loan

Project Name
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Region Sector Project ID Borrower(s) Implementing Agency

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Date PID Prepared Date of Appraisal Authorization Date of Board Approval

East Asia Water Supply (30%), Power (30%), Roads and Highways (25%), General Transportation (10%), Telecommunications (5%) P107163 The Republic of Indonesia Ministry of Finance Mr. Rio Silaban Jl. Lapangan Banteng Timur no 2-4 Jakarta 10710 Indonesia Ph: 62-21-(384-1067)/ Fax: 62-21-(380-8395) October 24, 2007 October 12, 2007 December 04, 2007

1. Country and Sector Background Prior to the 1997 financial crisis, infrastructure investment of 5-6 % of GDP contributed substantially to Indonesias good progress on growth and poverty reduction. The first priority of successive governments since the crisis has been to restore macro-economic stability, reducing inflation, stabilizing the Rupiah, and reducing public debt as a share of GDP. The World Bank has recognized these substantial macro-economic achievements in a program of four annual policy loans, commencing in 2004 (DPL 1, DPL 2, DPL 3, and DPL 4). While the priority lay with restoring macro-economic stability, infrastructure investment suffered, falling to a low of less than 2 percent of GDP in 2000, and reaching less than 3 percent of GDP in 2004. In 2004, the World Bank published a major study of Indonesias infrastructure crisis, urging that infrastructure investment be increased by 2% of GDP, and providing recommendations for a host of sectoral reforms to remove policy blockages to investment. The Yudhoyono Government, elected in September 2004, recognized the importance of these recommendations, and set infrastructure as a major priority. An Infrastructure Summit was held in January 2005, offering 91 public-private partnership (PPP) transactions to the private sector. The reaction to these offerings was disappointing; many existing policy blockages remained to the preparation of bankable projects, and in practice many projects were not well prepared. The Government has recognized these weaknesses, and has taken strong steps to address them. During the course of 2005, new regulations were put in place requiring competitive bidding of PPPs and appropriate risk management of guarantees for PPPs. New institutions were developed to support project preparation. During 2006 the Government

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prepared a wide-ranging Infrastructure Policy Package aiming to encourage competition, to eliminate discriminatory practices that obstruct the private sectors participation in infrastructure provision, and to redefine the governments role, including separating policy-making, regulatory and operational responsibilities. A second Infrastructure Summit was held in December 2006, where ten PPP transactions were identified to be the particular focus of efforts to improve the quality of project preparation. In 2007, the PPP initiatives to boost infrastructure investment were complemented with major increases in budgeted public spending, made possible by the Governments improved fiscal situation. Indonesias improved fiscal position has permitted increases in public investment in infrastructure. Total national public expenditure (all levels of government) was Rp. 536 trillion (about US$ 60 billion) in 2005. The Government is reviewing its overall PSO strategy in Electricity, it has a draft WSS strategy which includes development of fiscal incentives for subnational governments to improve PDAM financial performance, addressing PDAM debt arrears, and opening up PDAM access to new borrowing, and it has doubled its roads investment budget for 2008 from about US$1.1 billion equivalent in 2007 to about US$ 1.9 billion equivalent planned for 2008. The government has created a Risk Management Unit to ensure that appropriate forms and levels of government support are given to individual public private partnerships, and to ensure that the overall level of contingent support is consistent with sound fiscal management. It is working towards the creation of a guarantee fund for private infrastructure projects and developing a pipeline of PPPs. Regarding land, environment and governance, a National Land Agency Implementation Guideline (3/2007) has been introduced covering land acquisition. Initiatives to improve environmental management are going forward, both through the environmental impact assessment process and through decentralized governments. At the forefront of public procurement reform is the imminent creation/ establishment of a fully independent Goods/Services Procurement Policy Development Institution

2. Operation Objectives The reform agenda will be supported through a programmatic budget support instrument. This would be implemented through a series of three tranches of financial support under the proposed Infrastructure Development Policy Loan. Prior actions for the loan include: (i) increasing the central government budget allocation for infrastructure by 30% 2007-2008 (ii) publication of the PLN PSO compensation payment by region and customer category; (iii) ending government support for infrastructure projects that are Perpres 67 non-compliant and lack a project specific Perpres allowing for non-compliance; (iv) allocating Rp 3 trillion in the 2008 budget for the Indonesia Infrastructure Fund, the Guarantee Fund and land acquisition (v) issuing a decree to establish an inter-ministerial Land Working Group; and (vi) use of semi-e-procurement system for all national roads projects in Java and Sumatra above Rp. 10 billion 3. Rationale for Bank Involvement

Now that substantial macroeconomic progress has been achieved, inadequate infrastructure has emerged as one of the main factors that could prevent Indonesia from reaching its full growth potential. The Government is committed to addressing an infrastructure agenda that is complex, technically detailed, and challenging. A separate IDPL series provides the flexibility to adjust the timing of operations to actual progress in relatively risky infrastructure reform. Establishment of a new IDPL series also responds to strong country demand. The Government as a whole recognizes the importance of Bank support in advancing key reforms within the bureaucracy, as well as the intellectual leadership and assistance the Bank can provide on the details of particular reforms. The launching of a new infrastructure series provides a strong signal of Bank support for the infrastructure policy loans of the ADB and JBIC. The policy loans provide a platform for all three development partners to work together in support of the Governments infrastructure program. 4. Financing The Borrower is the Republic of Indonesia and this operation is a single-tranche IBRD loan of US$ 200 million that would be made available upon loan effectiveness, as all policy actions supported by the loan/credit would have been completed prior to Board presentation. For the IBRD loan, the Government has confirmed that Indonesia would borrow this amount as a Fixed Spread Loan (FSL) in US$ currency with annuity repayment schedule linked to commitments. 5. Institutional and Implementation Arrangements The Ministry of Finance will be in charge of implementation. Bank staff will focus on the impact outcomes of the program and the adjustments that need to be made to the operation as it evolves, to take into account the latest country developments, stakeholder support, and feasible options for realizing the intended development goals.

6. Benefits and Risks The IDPL is expected to support a considerable increase in the extent and quality of infrastructure provision in Indonesia, on the basis of a 25 percent increase in spending on national infrastructure and a 20 percent increase in subnational infrastructure capital expenditure 2006 2010 as well as sectoral reform that will encourage private investment and improved efficiency of both public and private financing. This will support (inter alia) the extension and improved condition of the national road network, an expansion in access to electricity and piped water, improved environmental monitoring and a decline in the open-dump disposal of solid waste and expanded and fair compensation for land acquisition. There remain strong political pressures to circumvent competitive bidding pressures, to bring projects to market before they are adequately prepared, or to support the bankability of PPP

projects with inappropriate government guarantees. At the same time, the present Government appears strongly committed to the reform program. In addition, the launch of the IDPL series is itself aimed at mitigating commitment risks since future loans will be delayed if the reform agenda stalls (Moderate Risk). The Governments infrastructure reform program is undoubtedly complex and it is clear that the relatively slow pace of progress so far is due at least in part to capacity constraints. The Government is well aware of these issues and the Governments request for Bank support through the IDPL series is aimed in part at enlisting Banks assistance in this regard (High Risk). Indonesia is struggling with issues of corruption, and corruption could certainly have an impact on the success of the IDPL series. The Bank is pursuing multiple anti-corruption initiatives in Indonesia, including in respect of infrastructure. There are anti-corruption initiatives in multiple Bank infrastructure projects, and the procurement reforms set out in the IDPL are part of the anti-corruption effort (High Risk). Macroeconomic performance is subject to multiple risks, of varying likelihood and gravity. The potential risks to macro-economic stability which are most likely to be realized are shocks over which the Government has little or no control (natural disasters, the world economy). The mitigation strategy is to improve the Governments overall fiscal and monetary management, to improve the economys resilience. Moderate risk) 6. Poverty and Social Impacts and Environment Aspects International experience indicates strong linkages between infrastructure service provision and poverty reduction. Several IDPL reforms are focused on directly increasing household access to services, including rural electrification and access to piped water. Access to such services is currently highly regressive. Network expansion is likely to reduce this regressivity. Policies addressing sub-national governments incentives to invest in infrastructure may, in time, improve the provision of rural roads. Rural roads typically have significant effects on the reduction of poverty. Upward electricity tariff revisions would adversely affect those who already have connections, but would help to expand the rate of connection, particularly in the eastern provinces where poverty rates tend to be higher. Notwithstanding the many social benefits of improved infrastructure, there may be some social costs associated with expanded infrastructure investment. In particular, land acquisition associated with road construction may have adverse social consequences. The IDPL reforms which envisage improved compensation standards may help to mitigate the adverse social consequences. Many of the reforms supported by the IDPL will help improve environmental outcomes in priority areas, such as sanitation and energy efficiency. Investments in water supply, quality and access have the potential to improve sanitation and environmental health outcomes for affected populations. The operation has been designed to help mitigate or strengthen the Governments capacity to address potential negative environmental impacts. The implementation of the IDPL will be accompanied by the provision of technical assistance to help the Ministry of Public Works improve its environmental performance. The first step will involve the conduct of an

assessment of the capacity and needs of the Ministry to carry out environmental assessments of infrastructure projects. The proposed work will build on the existing work done on AMDAL at national and local level and will be led jointly by the Ministry of Environment and the World Bank. It is expected that this assessment will inform a complementary capacity building effort to ensure that projects comply with the existing environmental legislation (and that which is in the process of being updated) at planning, construction and implementation stages. 7. Contact point Hongjoo J. Hahm Lead Infrastructure Specialist World Bank Indonesia Jakarta Stock Exchange Building, Tower 2, 12th & 13th Floor Telephone: +(62-21) 5299-3000 Fax: +(62-21) 5299-3111 hhahm@worldbank.org

8. For more information contact:

The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-5454 Fax: (202) 522-1500 Web: http://www.worldbank.org/infoshop)
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