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PROGRAM INFORMATION DOCUMENT (PID)

APPRAISAL STAGE

Report No.: AB3407

Project Name Indonesia Infrastructure Development Policy Loan

Region East Asia

Sector Water Supply (30%), Power (30%), Roads and Highways (25%),General Transportation (10%), Telecommunications (5%)

Project ID P107163

Borrower(s) The Republic of Indonesia

Implementing Agency Ministry of Finance

Mr. Rio SilabanJl. Lapangan Banteng Timur no 2-4

Jakarta 10710 Indonesia

Ph: 62-21-(384-1067)/ Fax: 62-21-(380-8395)Date PID Prepared October 24, 2007

Date of Appraisal

Authorization

October 12, 2007

Date of Board Approval 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 Bankhas 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 infrastructurecrisis, 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 theserecommendations, 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 placerequiring 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, toeliminate discriminatory practices that obstruct the private sectors participation in infrastructureprovision, and to redefine the governments role, including separating policy-making, regulatoryand 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 investmentwere complemented with major increases in budgeted public spending, made possible by theGovernments improved fiscal situation.

Indonesias improved fiscal position has permitted increases in public investment ininfrastructure. 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 inElectricity, it has a draft WSS strategy which includes development of fiscal incentives for sub-national 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 budgetfor 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 levelsof government support are given to individual public private partnerships, and to ensure that theoverall level of contingent support is consistent with sound fiscal management. It is workingtowards the creation of a guarantee fund for private infrastructure projects and developing apipeline of PPPs.

Regarding land, environment and governance, a National Land Agency ImplementationGuideline (3/2007) has been introduced covering land acquisition. Initiatives to improveenvironmental management are going forward, both through the environmental impactassessment process and through decentralized governments. At the forefront of publicprocurement reform is the imminent creation/ establishment of a fully independentGoods/Services Procurement Policy Development Institution

2. Operation Objectives

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

3. Rationale for Bank Involvement

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Now that substantial macroeconomic progress has been achieved, inadequate infrastructure hasemerged 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 thedetails of particular reforms.

The launching of a new infrastructure series provides a strong signal of Bank support for theinfrastructure 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 infrastructureprogram.

4. Financing

The Borrower is the Republic of Indonesia and this operation is a single-tranche IBRD loan ofUS$ 200 million that would be made available upon loan effectiveness, as all policy actionssupported by the loan/credit would have been completed prior to Board presentation. For theIBRD loan, the Government has confirmed that Indonesia would borrow this amount as a FixedSpread 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 itevolves, to take into account the latest country developments, stakeholder support, and feasibleoptions for realizing the intended development goals.

6. Benefits and Risks

The IDPL is expected to support a considerable increase in the extent and quality ofinfrastructure provision in Indonesia, on the basis of a 25 percent increase in spending onnational infrastructure and a 20 percent increase in subnational infrastructure capital expenditure

2006 2010 as well as sectoral reform that will encourage private investment and improvedefficiency of both public and private financing. This will support (inter alia) the extension andimproved condition of the national road network, an expansion in access to electricity and pipedwater, improved environmental monitoring and a decline in the open-dump disposal of solidwaste and expanded and fair compensation for land acquisition.

There remain strong political pressures to circumvent competitive bidding pressures, to bringprojects to market before they are adequately prepared, or to support the bankability of PPP

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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 isitself 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 therelatively 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. Thepotential 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

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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 atnational 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 IndonesiaJakarta Stock Exchange Building, Tower 2, 12th & 13th Floor

Telephone: +(62-21) 5299-3000

Fax: +(62-21) 5299-3111hhahm@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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