i FOR OFFICIAL USE ONLY Report No: PD000168 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROGRAM DOCUMENT FOR A PROPOSED LOAN IN THE AMOUNT OF EUR1,386,600,000 (EQUIVALENT TO US$1.5 BILLION) OF WHICH US$200 MILLION FROM THE GLOBAL SOLUTIONS ACCELERATOR PLATFORM (GSAP) UNDER THE IBRD FRAMEWORK FOR FINANCIAL INCENTIVES (FFI) FOR THE Indonesia Productive and Sustainable Investment Development Policy Loan May 7, 2025 Finance, Competitiveness and Innovation East Asia And Pacific This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) GOVERNMENT FISCAL YEAR January 1 – December 31 CURRENCY EQUIVALENTS (Exchange Rate Effective as of March 31, 2025) Currency Unit US$1.00 = IDR16,566 US$1.00 = EUR0.9243 ABBREVIATIONS AND ACRONYMS ADB Asian Development Bank LCR Local Content Requirement AFD French Development Agency LDP Letter of Development Policy AMDAL Analisis Mengenai Dampak Lingkungan LKPP National Public Procurement Agency AM Accountability Mechanism LVC Land Value Capture Mitigation, Adaptation and New Technologies Applied ASA Analytic and Advisory Services MANAGE General Equilibrium Model ASEAN Association of South-East Asian Nations Mbps Megabits per second BI Bank Indonesia MCDA Ministry of Communication and Digital Affairs BPK Badan Pemeriksa Keuangan M&E Monitoring and evaluation Finance and Development Supervisory BPKP MEMR Ministry of Energy and Mineral Resources Agency B- Business Ready MFD Maximizing Finance for Development READY CAD Current Account Deficit MHz Megahertz CET1 Core Equity Tier 1 MOE Ministry of Environment CMEA Coordinating Ministry for Economic Affairs MOF Ministry of Finance CPF Country Partnership Framework MOI Ministry of Industry CTAS Core Tax Administration System MSME Micro, Small & Medium Enterprises DPL Development Policy Lending MTEF Medium-Term Expenditure Framework EAP East Asia & Pacific NDC Nationally Determined Contributions European Bank for Reconstruction and EBRD NGO Non-Governmental Organization Development EnMS Environmental Management Systems NPL Non-performing Loans EIP Eco-industrial park OSS Online Single Submission EWS Early Warning Systems PA Paris Agreement FED Federal Reserve PA Prior Action FDI Foreign Direct Investment PCE Private Capital Enabling FSAP Financial Sector Assessment Program PEFA Public Expenditure and Financial Accountability The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) FSOL Financial Sector Omnibus Law PER Public Expenditure Review FX Foreign Exchange Perpres Presidential regulation GDP Gross Domestic Product PFB Disaster Pooling Fund GHG Greenhouse Gas POD Program Development Objective GHz Gigahertz RE Renewable energy GNP Gross National Product RI Result Indicator GoI Government of Indonesia RPJMN National Medium-Term Development Plan GRS Grievance Redress Service SCD Systematic Country Diagnostic International Bank for Reconstruction and IBRD SDR Special Drawing Rights Development IDA International Development Association SLA Service Level Agreement IDR Indonesian Rupiah SPP Sustainable Public Procurement IFC International Finance Corporation TA Technical Assistance Investment Facilitation for Trade IFDA UNCAC United Nations Convention Against Corruption Agreement Environmental Management Efforts and Environmental IMF International Monetary Fund UKL-UPL Monitoring International Organization of Securities IOSCO VAT Value Added Tax Commissions Indonesia Productive and Sustainable IPSI WB World Bank Investment Project ISR Implementation Status & Results WBG World Bank Group JGR Joint Growth Report Regional Vice President: Manuela V. Ferro Regional Practice Director: Lalita M. Moorty Division Director: Carolyn Turk Practice Manager: Ilias Skamnelos, Lars Christian Moller Task Team Leader(s): Wael Mansour, Alexandre Hugo Laure, Ou Nie The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) REPUBLIC OF INDONESIA Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) TABLE OF CONTENTS SUMMARY OF PROPOSED FINANCING AND PROGRAM ...................................................................... i I. COUNTRY CONTEXT AND OPERATION SUMMARY......................................................................... 1 II. MACROECONOMIC POLICY FRAMEWORK .................................................................................... 2 A. Recent Economic Developments .....................................................................................................3 B. Macroeconomic Outlook and Debt Sustainability ...........................................................................4 C. IMF Relations ...................................................................................................................................9 III. PROPOSED OPERATION ............................................................................................................... 9 A. Link to Government Program, CPF, other WBG operations, and Corporate Priorities ...................9 B. Prior Actions, Triggers, Expected Results and Analytical Underpinnings ......................................11 C. Consultations and Collaboration with Development Partners ......................................................19 IV. OTHER DESIGN AND APPRAISAL ISSUES .................................................................................... 19 A. Poverty and Social Impacts ............................................................................................................19 B. Environmental, Forests, and other Natural Resources Aspects ....................................................20 C. PFM, Disbursement, and Auditing aspects ....................................................................................21 D. Monitoring, Evaluation, and Accountability ..................................................................................23 V. SUMMARY OF RISKS AND MITIGATION ...................................................................................... 23 ANNEX 1. Policy and Result Framework .......................................................................................... 25 ANNEX 2. Paris Alignment Assessment ............................................................................................ 27 ANNEX 3. Operation Specific Annex ................................................................................................ 32 ANNEX 4. Required Accompanying Documentation ......................................................................... 36 The Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) was prepared by a World Bank Group team led by Wael Mansour, Ou Nie, and Alexandre Hugo Laure and comprising Aly Salman Alibhai, I Gede Putra Arsana, Dara Lengkong, Neni Lestari, Cynthia Clarita Kusharto, Aufa Doarst, Agnesia Adhissa Hasmand, Fajar Pane, Gabriela Inge Maria Susilo, Marleyne Danuwidjojo, Evilia Nusi, Suwit Kongkiatkamon, Novira Kusdarti, Indira Hapsari, Ratih Dwi Rahmadanti, Dwi Endah Abriningrum, Csilla Lakatos, Lamiaa Bennis, Griya Rufianne, Claudia Ines Vasquez Suarez, Vincent Palmade, Nah Yoon Shin, David James Kaczan, Mohammad Emil Widaya Pradana, Shu Yu, Novira Asra, Budi Permana, Jessica Ludwig, Jing Zhao, Ragchaasuren Galindev and William Seitz. The team gratefully acknowledges the excellent collaboration of the Government of Indonesia, the comments of peer reviewers Martin Melecky (Lead Economist, EFCF2), Smita Kuriakose (Lead Economist, EAEF2), and Alexis Sienaert (Lead Economist, EAWM2), and the comments from George Euan Marshall (Country Manager, IFC). The team benefitted from guidance from Carolyn Turk (Division Director, EACIF), Lalita Moorty (Regional Practice Director, EEADR), Ilias Skamnelos (Practice Manager, EEAF2), Lars Moller (Practice Manager, EEAM2), Bolormaa Amgaabazar (Operations Manager, EACIF), and Habib Rab (Lead Economist and Prosperity Program Leader, EACIF). The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) @#&OPS~Doctype~OPS^dynamics@paddpfbasicinformation#doctemplate SUMMARY OF PROPOSED FINANCING AND PROGRAM BASIC INFORMATION Operation ID Programmatic P508323 No Proposed Development Objective(s) To mobilize finance and enable markets for productive, sustainable and resilient investment. @#&OPS~Doctype~OPS^dynamics@padborrower#doctemplate Organizations Borrower: Republic of Indonesia Contact Title Telephone No. Email Dian Lestari Director Loans and Grants 0062213449230 dian.lestari74@kemenkeu.go.id Implementing Agency: Coordinating Ministry of Economic Affairs Contact Title Telephone No. Email Edi Prio Pambudi Deputy for Economic 0062213521835 edi.pambudi@ekon.go.id Cooperation and Investment Coordination @#&OPS~Doctype~OPS^dynamics@padfinancingsummary#doctemplate PROJECT FINANCING DATA (US$, Millions) Maximizing Finance for Development Is this an MFD-Enabling Project (MFD-EP)? Yes Is this project Private Capital Enabling (PCE)? Yes SUMMARY Total Financing 1,500.00 i The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) DETAILS World Bank Group Financing International Bank for Reconstruction and Development (IBRD) 1,500.00 @#&OPS~Doctype~OPS^dynamics@padclimatechange#doctemplate PRACTICE AREA(S) Practice Area (Lead) Contributing Practice Areas Macroeconomics, Trade and Investment; Urban, Finance, Competitiveness and Innovation Resilience and Land; Digital Development CLIMATE Climate Change and Disaster Screening Yes, it has been screened and the results are discussed in the Operation Document @#&OPS~Doctype~OPS^dynamics@padoverallrisk#doctemplate OVERALL RISK RATING Overall Risk ⚫ Moderate @#&OPS~Doctype~OPS^dynamics@paddpfannexpolicyandresult#doctemplate RESULTS Baseline Closing Period Mobilize Finance for Investment 1: Credit to MSMEs as a share of total credit from peer-to-peer lenders (Percentage) Jun/2024 Dec/2026 32 55 ➢of which to female borrowers (Percentage) Dec/2026 50 2: Credit to MSMEs as a share of total credit (Percentage) Sep/2024 Dec/2026 20.50 25 3: The number of listed security futures on the stock exchange (IDX) (Number) May/2024 Nov/2026 11 16 4: Systemic commercial banks adopting climate risk management policies (Percentage) ii The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) Jun/2024 Dec/2026 0 100 5: Percent of funds used (or disbursed) from the calendar year 2024 proceeds of the disaster pooling fund to finance active risk transfer solutions (Percentage) Jun/2024 Dec/2026 0 5 Enabling Markets for Investment 6: Reduction of the cost of the renewable energy procurement in the power sector (Percentage) Jun/2024 Dec/2026 0 15 7(a): Proportion of industrial estates adopting Environmental Management Systems in line with international standards (Percentage) Jun/2024 Dec/2026 25 45 7(b): Proportion of industrial estates with early warning systems (ESW) for natural disasters and climate shocks (Percentage) Jun/2024 Dec/2026 20 40 8: Private capital identified through the LVC mechanism (Amount(USD)) Jun/2024 Dec/2026 0 250 million iii The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) IBRD PROGRAM DOCUMENT FOR A PROPOSED LOAN TO (REPUBLIC OF INDONESIA) I. COUNTRY CONTEXT AND OPERATION SUMMARY 1. Indonesia has a strong record of economic growth. The economy grew at an average of 5.5 percent per year between 2000 and 2023. Indonesia achieved Upper Middle-Income country status in 2023, with extreme poverty significantly reduced from 19 to 1.5 percent between 2002-24. High investment levels (averaging over 30 percent of GDP since 2009, bolstered by commodity windfalls) helped address basic infrastructure gaps and physically connect domestic markets. Indonesia aims to become a high-income economy by 2045, leveraging its demographic dividend and committing to its national targets on green transition. The government has established a strong record of macroeconomic management, building adequate buffers to respond effectively to external shocks. Progress on structural reforms has resulted in a reduction in overall unemployment to 4.9 percent in 2024 and an increase in the labor force participation rate to 70.6 percent, including for women at 56 percent. However, the real sector still faces regulatory barriers that impede productive and sustainable investment, while a shallow financial sector dominated by banks has limited financial intermediation. 2. Unlocking the private sector's dynamism is essential to achieve high-income status by 2045. The “Golden Indonesia 2045” vision targets an accelerated annual economic growth rate of six to eight percent to escape the middle- income “trap.” Achieving and sustaining such growth rates requires reversing the declining trends in productivity growth (which fell from 2.3 to 1.2 percent from 2011 to 2024) and improving returns on investment. Reducing obstacles to private sector development is essential for enhancing productivity, accelerating economic growth, and creating high-quality jobs (as the private sector accounts for over 90 percent of all jobs). Regulatory compliance costs remain significant, with time spent complying with government regulations being a major constraint to productivity in 2023 (“Unleashing Indonesia’s Business Potential,” World Bank 2024). A more dynamic private sector can capitalize on investment opportunities that align economic development with sustainability goals. Additionally, with 58 percent of Indonesia’s GDP concentrated in Java, regional inequalities are exacerbated. Industrial zoning policies could promote balanced regional growth, sustainability, and industrial decarbonization. 3. Indonesia must also continue developing its financial system to escape the middle-income trap. The experience of high-income countries shows the growth benefits of expanding the financial sector's reach, depth, and efficiency. In Indonesia, the financial system is relatively small and dominated by banks, which account for 78 percent of total financial system assets. Total financial sector assets represent 70.6 percent of GDP compared to 258.2 in Thailand, 117.4 in the Philippines, 196.3 in Malaysia, and 136.18 in Viet Nam. Credit to the private sector was 31.4 percent of GDP in 2023, one of the lowest among peer East Asia and Pacific (EAP) countries that average 124 percent of GDP. Furthermore, the domestic bank deposits to GDP ratio, at about 39 percent, falls short of the regional median of 75 percent and the income- group median of 56 percent. Finally, with micro, small, and medium enterprises (MSMEs) accounting for 99 percent of all firms and contributing 61 percent of the nation’s GDP, the current MSME loan ratio at 20.6 percent of all bank lending is low. The 2023 Indonesia Enterprise Survey reveals that access to finance is considered the biggest obstacle for businesses by 29 percent of the surveyed firms, particularly small and medium firms (32 and 23 percent, respectively). The 2024 Financial Sector Assessment Program (FSAP) highlights the importance of complementing prudential policy with broadening and deepening financial markets and services by increasing the ease of intermediation and competition forces. This includes easing credit infrastructure constraints, leveraging digital financial services, expanding capital markets and long-term finance, and refining the role of the state. New fintech participants and stronger capital markets can provide competition to the dominant banking sector and help mobilize savings, allocate resources efficiently, and provide a wider range of financial services to support economic activity. 4. Indonesia faces significant challenges in transitioning to a low-carbon and resilient economy, but has taken important steps toward achieving its climate targets. Global warming impacts, such as floods and extreme weather, Page 1 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) threaten urban centers like Jakarta. Meanwhile, as the 5th largest carbon emitter, the country faces a steep energy transition dominated by coal and land use. Recently, Indonesia raised its Nationally Determined Contributions (NDC) targets to reduce carbon emissions by 31.9 percent in 2030, and by 43.2 percent conditional on foreign financing. It also introduced a net-zero target for 2060. Mobilizing private finance will be crucial as public resources could only supply a small fraction of the investment needed for the climate transition. As the largest source of private finance and a critical intermediary, Indonesia’s bank-dominated financial system has a crucial role in providing climate finance. However, the adoption of sustainable finance practices is still nascent – notably around the management of climate-related financial risks and opportunities. To support the low-carbon transition, the financial system must effectively channel savings to climate-related goals. At the same time, despite some recent progress, the private sector continues to face significant challenges. Investment climate reforms and enhanced investment facilitation are essential to enabling greater private sector participation in both mitigation and adaptation.1 5. The Productive and Sustainable Investment Development Policy Loan (IPSI DPL) supports key reforms to develop the financial sector and enable markets for productive, sustainable, and resilient investment. The proposed DPL of US$1.5 billion to the Republic of Indonesia is a stand-alone IBRD loan that supports the reform efforts of the Government of Indonesia (GOI). The operation is structured around two pillars. The first pillar aims to enhance the supply of finance through policy actions that expand the volume and lower the cost of financing. The second pillar aims to increase the supply of investment projects by expanding investment opportunities and lowering investment costs. Multiple reforms under both pillars support sustainability efforts and improve resilience to climate change. 6. The operation is aligned with the development priorities of the GOI, anchored by the World Bank’s core diagnostics, and designed to maintain the reform momentum supported by past DPLs. The reforms proposed under this operation are aligned with Indonesia’s 2045 vision and the upcoming five-year development plan. They are anchored around the World Bank’s Country Climate and Development Report (CCDR, 2023), the Growth and Jobs Report (GJR, 2025), and the joint WB-IMF FSAP (2024). The DPL is also aligned with the goals of the Paris Alignment and contributes to Climate Co-Benefits. It is gender-tagged and supports Maximizing Finance for Development (MFD) and Private Capital Enabling (PCE). The DPL also supports reforms that create jobs, most notably in the formal sector and with potentially higher earnings. The choice of a standalone operation reflects the need to account for the transition to a new administration that assumed office in October 2024 and is formulating a new reform agenda. The administration has initiated a ministerial reorganization to strengthen the delivery of its new policy priorities, which is expected to be finalized by March 2025. The DPL supports reforms that operationalize many legislations enacted over the past three years and address short-term priorities set by the new administration. Notably, this operation continues the World Bank’s support of Indonesia's economic policy reforms through successive DPLs. This includes the 2019-2023 financial sector reform DPL series, which culminated in the key legislative reform of the Financial Sector Omnibus Law (FSOL) in 2023, and the 2021 investment and trade DPL that opened more sectors to private investment and boosted competitiveness and business environment. II. MACROECONOMIC POLICY FRAMEWORK 7. The macroeconomic policy framework is adequate for this operation. Prudent macro policies have supported resilient economic growth of 5 percent within a stable macroeconomic environment. Post-pandemic fiscal consolidation has brought the deficit back within the 3 percent of GDP legal limit, gradually reducing public debt from a peak of 41 percent of GDP in 2021 to 39 percent of GDP in 2024. The new administration is implementing social programs while maintaining sustainability, partly through a major re-allocation of public spending. Monetary policy objectives include price and exchange rate stability. Although inflation has eased, Bank Indonesia is likely to adjust its policy rate in step with a slower-than-expected pivot by the US Federal Reserve, to preserve a rate spread that helps manage external financing 1 Indonesia Country Climate and Development Report (CCDR), 2023, World Bank Group. Page 2 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) and currency pressures. Indonesia’s sound macro policy mix has sustained policy space and contributed to a decline in government financing costs and external perceptions of risk. Inflation is projected within BI’s target range. Liquidity buffers in the banking sector are adequate, and foreign currency reserves cover 6.6 months of imports. Public debt remains sustainable, even under multiple adverse shock scenarios. A. Recent Economic Developments 8. Indonesia has sustained robust growth in 2024, while inflation softened because of stabilizing food prices. The economy has maintained 5.0 percent growth in 2024, buoyed by strong domestic demand and a recovering service sector. Rising private and public consumption boosted growth, offsetting the weaker contribution from net exports due to falling commodity prices. Inflation accelerated in early 2024 due to El Niño’s impact on the previous year’s harvest. This prompted the authorities to address supply-chain constraints and introduce food, cash, and fertilizer assistance programs. Coupled with a rebound in agriculture production, inflation has moderated. However, these interventions came at a fiscal cost. On average, yearly inflation went down to 2.3 percent in 2024 from 3.7 percent in 2023. 9. Following sustained fiscal consolidation after the pandemic, fiscal policy was moderately expansionary in 2024. The fiscal deficit widened to 2.3 percent of GDP in 2024 from 1.6 percent in 2023. Public expenditure rose by 0.2 percentage points (ppts) of GDP compared to the previous year. Several policy decisions contributed to this increase. First, civil servant wages were increased by 8 percent in January 2024, whilst election-related spending also grew. Second, spending accelerated for the construction of the new capital city, whilst spending on the completion of transport-related projects also increased. Third, spending increased on social assistance programs, namely rice and fertilizer aid, to tackle the food shock. On the other hand, declining commodity prices caused overall revenues to fall by 0.8 ppts of GDP. 10. Public debt remains stable with low rollover and exchange rate risks. Public debt increased from 39.0 percent of GDP in 2023 to 39.3 percent in 2024, driven by a widening fiscal deficit. Most debt is held in local currency (72 percent) and in medium- to long-term instruments, reducing both rollover and exchange rate risks. However, debt repayment peaks coupled with higher interest rates have led to rising debt service from 5.1 percent of GDP in 2023 to 6.3 percent in 2024. 11. The GOI only partially implemented the planned increase in the Value Added Tax (VAT) rate in 2025. On December 31st 2024, the GOI announced a last-minute revision to a planned VAT rate hike (from 11 to 12 percent), which was mandated by the 2021 Tax Harmonization Law. According to the revision, only luxury goods have been subjected to the full 12 percent VAT rate. However, the coverage of luxury goods is very narrow. Forgone revenues from this policy revision are estimated at around 0.3 percent of GDP. Prior to the policy change, the GOI had unveiled a support package (0.2 percent of GDP) to cushion the impact of the planned VAT rate increase. The package comprised social assistance transfers alongside tax incentives for households, MSMEs, and employers. Despite the revision of the VAT hike, the GOI will still distribute this package. 12. In January 2025, the government initiated major shifts in the 2025 Budget, reflecting its new priorities. This includes the Nutritious Meals Program, a program to build 3 million new houses per year, and the establishment of a new Sovereign Wealth Fund for priority investments (Danantara). Budget adjustments have included: (i) a 22 percent budget cut across all ministries (equivalent to 1.1 percent of GDP); and (ii) a 6 percent cut to subnational transfers (0.2 percent of GDP). The Ministries of public work, defense, health, and transport are among the most affected. The budget reallocation process has been disruptive whilst the impact on service delivery is yet unclear. The Presidential Instruction preserves the government’s commitment to the fiscal rules and does not imply substantial changes to total public spending, the fiscal deficit, or public debt. These changes are fully reflected in the macro framework (Table 2). Page 3 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) 13. Despite a widening current account deficit (CAD), sound monetary policy has helped contain rising external vulnerabilities amid renewed pressures from portfolio outflows. The CAD widened to 0.6 percent of GDP in 2024 due to a shrinking goods trade surplus and increased services imports. Foreign Direct Investments rose (up 0.6 percent yoy) and a BI policy rate hike in April 2024, as well as the introduction of BI’s high-yielding securities, helped reverse portfolio outflows. In 2025, a turnaround in global market conditions renewed net portfolio outflows from Indonesia. Outflows reached $1.33 billion (0.1 percent GDP) year-to-date (YTD), mostly exiting from the equity market. These outflows were also influenced by the domestic uncertainty linked to recent changes to fiscal policy. Combined, this resulted in a Rupiah depreciation of 2.0 percent against the USD YTD. Nevertheless, new government borrowing from bilateral and multilateral sources has partially offset pressures on foreign exchange (FX) reserves, which are sufficient to cover 6.4 months of imports and external debt repayment. To further bolster FX reserves, the authorities mandated that, starting March 2025, 100 percent of natural resource export proceeds must remain onshore for at least a year.2 Low inflation prompted BI to cut its policy rate twice by a combined 50 bps in September 2024 and January 2025 to boost private credit. However, it has decided in March to halt further decreases in support of boosting portfolio flows. 14. The banking sector remains resilient to shocks, with adequate capital and liquidity buffers and healthy profits. Banks account for 78 percent of total financial system assets. The top 10 banks hold 66 percent of total bank assets, with four state-owned commercially run banks accounting for 43 percent of the banking sector.3 The capital adequacy ratio stood at 27 percent, more than double the regulatory minimum of 10.5 percent. Furthermore, the liquidity coverage ratio and the net stable funding ratio, designed to gauge bank liquidity conditions in times of stress, stood at 223 percent and 130 percent, respectively, as of September. Both are above the 100 percent regulatory minimum. The system-wide non- performing loan (NPL) ratio stayed low at 2.2 percent in November. The level of provisioning was at 192 percent of NPL, providing ample loss-absorption capacity. Results of recent bank solvency stress tests suggest that the overall banking sector is resilient to multiple shocks. Meanwhile, rising levels of credit to the private sector, up 10.4 percent in 2024, coupled with reasonable margins, has boosted banking sector profitability. As a result, return-on-assets and return-on- equity surpassed pre-pandemic levels (at 2.7 and 14.7 percent respectively). Two commercial state-owned banks are included in Danantara, giving rise to potential interconnectedness and governance risks, although such risks are mitigated by partial state ownership and solid balance sheets. B. Macroeconomic Outlook and Debt Sustainability 15. Domestic demand is expected to sustain economic resilience over the medium term. Growth is forecast at 4.8 percent annually, on average, over 2025-27 (Table 1). There are concerns over Indonesia’s shrinking middle class and purchasing power due to a lack of good jobs; though private consumption overall is projected to grow and be supported by low and stable inflation, rising wages, and government social assistance programs. Investment is expected to pick up as the government begins to roll out its housing program and Danantara, the newly established sovereign wealth fund, begins new projects. There are also several energy and infrastructure projects that have already been initiated and will see an acceleration in implementation over the medium term. These should partially offset the drag on growth from net exports as expected shifts in global trade could impact investment and growth. Meanwhile, commodity-based manufacturing, agribusiness, the construction sector, and services are expected to drive the supply-side. This reflects government sectoral priorities over the medium term. Inflation, after easing in 2024, is projected to pick up in the medium term to 2.6 percent but will remain anchored within BI’s target range (2.5±1 percent). 2 This regulation replaces a previous rule mandating that 30 percent of export proceeds remain onshore for at least three months. 3 State-owned commercial banks are subject to the same regulation and supervision as conventional ones. They are incorporated as publicly listed companies with partial government ownership. They have strong financial positions with high return on equity, high capital ratios, and low NPLs. Page 4 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) Table 1. Selected Economic and Financial Indicators Actual Projections 2021 2022 2023 2024 2025 2026 2027 National Accounts Annual percentage change, unless otherwise indicated GDP at constant prices (%) 3.7 5.3 5.0 5.0 4.7 4.8 5.0 Private consumption 2.0 5.0 4.9 5.1 4.9 4.9 4.9 Government consumption 4.3 -4.4 3.0 6.6 -2.1 0.3 0.9 Investment 3.8 3.9 3.8 4.6 6.1 6.2 6.3 Exports 18.0 16.2 1.3 6.5 4.8 5.1 5.5 Imports 24.9 15.0 -1.6 7.9 4.5 5.0 5.1 Sectoral contribution to growth (percentage points) Agriculture 0.2 0.3 0.2 0.1 0.4 0.3 0.3 Industry 1.3 1.6 1.9 2.0 1.5 1.5 1.5 Services 1.6 2.9 2.7 2.8 2.6 2.7 3.0 Inflation Annual percentage change, unless otherwise indicated Consumer prices (average) 1.6 4.1 3.7 2.3 2.3 2.6 2.6 External sector Percent of GDP, unless otherwise indicated Exports, fob 20.8 23.9 21.2 21.7 22.6 22.5 22.6 Imports, fob 18.3 20.7 19.2 19.9 21.5 21.4 21.3 Current account balance 0.3 1.0 -0.1 -0.6 -1.3 -1.6 -1.7 Foreign Direct Investment 1.5 1.4 1.1 1.0 1.2 1.3 1.5 Gross reserves (months of next 8.0 6.0 6.7 6.6 6.1 6.0 6.0 year’s imports) Public debt 40.7 39.5 39.0 39.2 40.1 40.8 41.4 External debt 16.9 14.8 14.6 14.5 15.0 15.2 15.3 Debt service 5.3 4.6 5.1 6.2 5.9 5.9 6.1 Fiscal Accounts Total revenue and grants 11.8 13.5 13.3 12.8 11.9 12.3 12.4 Total expenditure 16.4 15.8 14.9 15.1 14.5 15.0 15.1 Overall fiscal balance -4.6 -2.4 -1.6 -2.3 -2.7 -2.7 -2.7 Memorandum items GDP per capita (% growth) 2.6 4.3 3.9 3.9 3.6 3.8 4.0 Nominal GDP (trillion IDR) 16,977 19,588 20,892 22,139 23,112 24,376 25,693 Source: Ministry of Finance, Bank Indonesia, World Bank staff projections 16. Fiscal policy will be impacted by the GOI’s new priority programs but is expected to remain prudent and within fiscal rules. In 2025, the GOI will reduce operational spending of line ministries and agencies and increase spending on priority programs4, leaving total spending at the same level. Central government investment is projected to decline in 2025 as large infrastructure projects will be financed and executed through the Danantara. Over the medium term, central government capital spending will return to the relatively low pre-pandemic level by 2027 5 . Spending on basic 4 These include the flagship school meal program, housing support, and other type of social assistance spending especially in the areas of food and agriculture, education and health. 5 Danantara has a special statue by law, it has autonomy and is not considered part of the central government. Page 5 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) infrastructure, including maintenance, will be important to support growth alongside flagship projects. Total spending is projected to gradually increase as priority programs are rolled out and will reach 15.1 percent of GDP by 2027 (Table 2). Public spending composition is expected to change, though, from capital spending and subnational transfers/programs to a stronger focus on social assistance. Public financial management as well as operational constraints could decelerate the disbursement of some of the more complex programs envisaged. Table 2. Key Fiscal Indicators (percent of GDP) Actual Projections 2021 2022 2023 2024 2025 2026 2027 Total revenue and grants 11.8 13.5 13.3 12.8 11.9 12.3 12.4 Revenue 11.8 13.4 13.2 12.7 11.9 12.3 12.4 Tax revenues 9.1 10.4 10.3 10.1 9.9 10.3 10.5 Income tax 4.2 5.2 5.2 5.0 4.8 5.2 5.4 Value-added tax 3.3 3.5 3.7 3.7 3.7 3.7 3.7 International Trade Tax 0.4 0.5 0.3 0.3 0.4 0.4 0.4 Excise duties 1.2 1.2 1.1 1.0 1.0 1.0 1.0 Other domestic taxes 0.1 0.0 0.0 0.0 0.0 0.0 0.1 Non tax revenues 2.7 3.0 2.9 2.6 1.9 2.0 1.9 Grants 0.0 0.0 0.1 0.1 0.0 0.0 0.0 Total expenditures 16.4 15.8 14.9 15.1 14.5 15.0 15.1 Current expenditures 15.0 14.6 13.5 13.6 13.7 13.9 14.0 Wages and salaries 2.3 2.1 2.0 2.1 2.1 2.1 2.1 Goods and services 3.1 2.2 2.1 2.0 2.3 2.3 2.3 Interest payment 2.0 2.0 2.1 2.2 2.3 2.3 2.4 Subsidies 1.4 1.3 1.3 1.4 1.3 1.3 1.2 Social assistance 1.0 0.8 0.7 0.7 0.7 0.7 0.7 Other expenditures 0.5 2.1 1.1 1.1 1.2 1.2 1.2 Transfer to Local Government 4.6 4.2 4.2 4.1 3.8 4.0 4.1 Capital Expenditure 1.4 1.2 1.5 1.5 0.8 1.1 1.1 Overall fiscal balance -4.6 -2.4 -1.6 -2.3 -2.7 -2.7 -2.7 Primary balance -2.5 -0.4 0.5 -0.1 -0.4 -0.4 -0.3 Financing 5.1 3.0 1.7 2.5 2.7 2.7 2.7 Domestic (Net) 5.2 2.9 1.3 2.1 1.9 1.8 1.8 External (Net) -0.1 0.1 0.4 0.4 0.8 0.9 0.9 Source: Ministry of Finance, World Bank staff projections. 17. Meanwhile, improved tax enforcement, particularly with the introduction of the new Core Tax Administration System (CTAS) in 2025, is expected to increase revenues slightly. 6 This will also be accompanied by a rebound in income tax as domestic demand remains robust. However, non-tax revenues will see a large drop caused by softening commodity windfalls and by a cut in SOEs dividend payments which will now accrue directly to the Danantara. As a result, the fiscal deficit is projected to average 2.7 percent of GDP over 2025-27, below the 3 percent of GDP fiscal rule. Meanwhile, gross fiscal financing needs will rise, averaging 4.8 percent of GDP over 2025-27. Expanding financing needs coupled with 6 CTAS integrates all business processes of tax administration from taxpayer registration, reporting of tax returns, payments and audits. Page 6 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) elevated borrowing costs are forecast to raise interest payments to around 2.4 percent of GDP, or 19 percent of total revenues (Table 3). Table 3. Public Debt Stock and Debt Service Debt stock (end of period) Debt service 2024 2025 2026 2027 2025 2026 2027 in billion Percent Percent in billion US$ Percent of GDP US$ of Total of GDP Public debt stock 545.7 100.0 39.2 81.3 85.8 94.5 5.9 5.9 6.1 Domestic Debt 343.2 62.9 24.7 59.3 65.9 72.2 4.3 4.5 4.7 Bonds 341.3 62.5 24.5 59.0 65.7 72.0 4.3 4.5 4.7 Loan 1.9 0.4 0.1 0.3 0.3 0.2 0.0 0.0 0.0 External Debt 202.5 37.1 14.5 22.0 19.8 22.3 1.6 1.4 1.4 Bonds 123.6 22.6 8.9 13.4 12.2 13.8 1.0 0.8 0.9 Loan 78.9 14.5 5.7 8.6 7.6 8.5 0.6 0.5 0.6 Source: Ministry of Finance, Bank Indonesia, World Bank staff projections. 18. Central government debt is projected to remain sustainable, stabilizing at around 41 percent of GDP in the medium term, which is below the legal ceiling of 60 percent of GDP (Figure 1). Debt sustainability shock scenarios indicate that a 30 percent currency depreciation shock in 2025 could raise debt to 46.9 percent of GDP, while a shock reducing GDP growth by 2 ppt would push debt to 42.5 percent in 2027. An increase in expenditure of up to 1 percent of GDP in response to a natural disaster could raise debt to 42.7 percent in 2027. A combined scenario of all the above shocks raises debt to GDP to 50.2 percent in 2027. The interest-to-revenue ratio is projected to rise from 17.1 percent to a maximum of 23 percent over 2024-27. This is higher than the pre-pandemic average of 13 percent. A shock of 1 percentage point in the interest rate in 2025 raises debt by 0.3 percentage points in 2027 compared to the baseline. With most budget financing sourced domestically; external debt share is expected to decline (Figure 2) Figure 1. Central government debt under different Figure 2. Public and Private Debt sourced from shock scenarios. external markets. (percent of GDP) (percent of GDP) Government 40 Central bank & private 35 30 25 20 15 10 5 0 2023 2018 2019 2020 2021 2022 2024 2025 2026 2027 Source: Ministry of Finance, Bank Indonesia, World Bank staff projections. Note: DSA last updated in March 2024. Page 7 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) 19. External financing needs will increase due to a widening CAD and rising public debt amortization. Robust domestic demand will boost imports, while moderating terms of trade, expected shifts in global trade and China’s slowdown will hamper export growth, leading the CAD to gradually reach 1.7 percent of GDP by 2027. Larger CAD coupled with rising public debt amortization will expand external financing needs (Table 4) but will stay below pre-pandemic levels. FDI inflows are forecast to rise gradually and reach 1.5 percent of GDP by 2027 and will remain the largest source of external financing. These inflows are expected to come to industrial downstreaming, services sectors, and potentially renewable energy following a lowering of local content requirements in the sector. Portfolio flows will remain volatile given rising global uncertainty but might slightly improve as global monetary conditions ease over the medium term. Table 4. External Financing Needs and Sources (billion US$) Actual Projections Avg 2020 2021 2022 2023 2024 2025 2026 2027 2017-19 Current account deficit 25.7 4.4 -3.5 -13.2 2.0 8.9 18.5 23.1 26.6 Scheduled government debt 9.0 9.4 8.7 8.2 8.2 11.5 13.3 11.7 12.3 amortization Private sector debt 25.0 23.4 24.8 25.5 21.6 22.2 23.5 24.8 26.2 redemption Total financing needs 59.7 37.2 30.0 20.5 31.8 42.6 55.4 59.6 65.1 Total financing sources 59.7 37.2 30.0 20.5 31.9 42.6 55.4 59.6 65.1 FDI inflows (net) 17.2 14.1 17.3 18.1 14.4 14.5 16.6 19.0 23.7 Portfolio inflows (net) excl 10.5 -3.8 -4.1 -17.3 -12.0 -4.8 -5.0 -4.6 -5.0 govt Other investment (net)(a) excl 21.9 11.8 16.0 8.0 11.4 7.8 7.5 8.3 8.0 govt Government borrowing 15.4 20.6 16.2 15.6 16.6 26.1 26.6 26.8 27.7 (gross) Securities 10.3 10.9 12.2 8.4 5.9 15.5 15.8 15.5 16.4 Loans 5.1 9.7 4.0 7.3 10.7 10.6 10.8 11.3 11.3 Other items (net)(b) 0.2 -2.9 -1.8 0.1 7.8 2.6 11.9 13.7 15.2 Use of reserves(c) -5.5 -2.6 -13.5 -4.0 -6.3 -3.6 -2.3 -3.6 -4.6 Source: Ministry of Finance, Bank Indonesia, World Bank staff projections. Note: (a) Including other equity, trade credits, loans, etc., but excludes government and private borrowing and currency swaps. (b) Comprising capital account, derivatives, and errors and omissions components; for historical data also includes discrepancy between balance of payments and fiscal data on government borrowing. (c) Use of reserves: ‘–’denotes an increase; ‘+’ denotes a decrease. 20. The financial sector is generally resilient to multiple shocks, although pockets of vulnerabilities remain in certain parts of the system. A thorough bank solvency and bank liquidity stress tests were conducted on a sample of 105 commercial banks as part of the joint IMF-WB FSAP 2024. Results of bank solvency stress tests show that the sector is resilient against multiple macroeconomic shocks. Under a baseline scenario, systemwide Core Equity Tier 1 (CET1) ratios remain above 22 percent over a 5-years horizon. Under an adverse stagflation scenario, the systemwide CET1 ratio declines by about 5 ppts, with capital losses mostly driven by credit risk, followed by market and interest rate risks. The liquidity stress tests suggest that all banks have enough liquidity to cover severe outflows, although bank-specific risks include higher reliance on wholesale and uninsured funding, FX liquidity shortfalls, and concentration risks. The recent introduction of climate risk management policies by OJK will also help the banking sector manage climate financial risks. Page 8 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) 21. The outlook remains vulnerable to downside risks. Whilst the government has set out clear priorities, this involves major institutional changes (e.g., government reorganization, large budget adjustments, establishment of Danantara and transfer of SOE ownership to the new SWF), which are disruptive and create uncertainty. This may slow down the implementation of investment plans and government programs. Though government borrowing costs have come down, spreads on local borrowing remain high, as do interest payments to revenues. A big boost in investment without an acceleration in structural reforms, like the ones supported by this DPO, could lead to declining returns to investment, a deterioration in the quality of jobs, and a slowdown in growth. Geopolitical shocks, including the expected shifts in global trade, could worsen terms of trade, spur inflation, and squeeze fiscal space. Global uncertainty and a reversal of planned global monetary easing could also impact portfolio flows, put pressure on the Rupiah, and raise the costs of borrowing for both public and private sectors. On the upside, stronger growth in major trading partners or higher commodity prices could boost exports, expand fiscal space, and enhance growth. C. IMF Relations 22. Indonesia does not have an ongoing program with the IMF. The IMF Executive Board concluded the last Article IV consultation with Indonesia on July 22, 2024. A Fund assessment letter has been provided for this operation. The World Bank and the IMF collaborate in the areas of fiscal and monetary policies, financial sector, trade, industrial policy, labor markets, and poverty analysis. Technical teams meet regularly to exchange analyses and coordinate policy messages. A joint Financial Sector Assessment Program (FSAP) assessment was recently conducted and published in August 2024. III. PROPOSED OPERATION A. Link to Government Program, CPF, other WBG operations, and Corporate Priorities 23. Indonesia is pursuing an ambitious economic reform program with the aim of becoming a high-income economy by 2045 while meeting its national targets for green transition. The “Golden Indonesia 2045” vision and its related National Medium-Term Development Plan (RPJMN) 2025-2029 seek an accelerated annual economic growth rate of six to eight percent to escape the middle-income trap. The country has also set enhanced climate goals in its NDC, targeting a 31.9 percent GHG emission reduction by 2030 from the business-as-usual scenario, or 43.2 percent with foreign assistance. Furthermore, key legislative reforms were initiated, such as the Jobs Creation Omnibus Law (JCOL) in 2020 and the FSOL in 2023, addressing areas of investment liberalization, business environment, and financial sector deepening. These reforms are critical for boosting productivity, raising investment levels, and enhancing growth potential. 24. The government is also considering a set of structural reforms to accelerate the implementation of its national reform program. Specifically, the government is considering business enabling reforms, including regulatory simplification, automated approvals, and adherence to the principle of single reference. The government is also considering trade reform options, including expedited anti-dumping and safeguards measures, simplification of import licensing and trade, and several other measures. Additionally, reforms will enhance investment in mobile broadband internet and the digital economy (such as allocating spectrum for mobile broadband services with established coverage obligations for licensees) to support digital transformation and associated economic opportunities. 25. The GOI is also committed to undertaking ambitious reforms of the business licensing regime. The reforms will reduce uncertainty for businesses and lower the direct and indirect costs of doing business, including both informal and formal licensing costs. The planned reforms include strengthening the Online Submission Portal (OSS) for all licensing requirements and submissions. The government will introduce Service Level Agreements (SLAs)7 in the licensing process, setting a time-bound limit for approving licenses, conditional on the firm submitting complete documentation. Applications exceeding the SLA time limit will be automatically approved, allowing firms to proceed without delays. The 7 SLAs are formal commitments/agreements between the government and a firm on a time-bound limit for approving a license. Page 9 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) "Automatic Approval" mechanism ensures government accountability for timely service in obtaining a license. Additionally, some unnecessary requirements for operational and commercial licenses will be removed. These reforms will reduce the time and costs of starting a business in Indonesia. This will be done by reforming existing regulations, including the Government Regulation No.5/2021 on business licensing. 26. This operation aligns with the World Bank Group FY21-25 Country Partnership Framework (CPF) for Indonesia and several corporate priorities. The CPF is structured around four engagement areas: (i) enhancing economic competitiveness and resilience, (ii) improving the supply of and access to sustainable infrastructure services, (iii) nurturing human capital, and (iv) strengthening the management of natural assets, natural resource-based livelihoods, and disaster resilience. This operation directly supports the first CPF engagement area by supporting reforms that deepen the financial sector, improve the investment climate, and address market failures in productive sectors. Additionally, reforms directed towards the green transition contribute to the engagement area focused on natural assets and disaster resilience. The operation substantially contributes to climate Co-Benefits through Policy Actions (PAs) #4, #5, #6, and #7, is gender-tagged through PA #1, and supports MFD reforms through PA #3, #6, #7, and #8 and PCE reforms through PAs #1 and #2. 27. This operation is aligned with the goals of the Paris Climate Agreement. First, the PDO and reform program is consistent with the implementation of the Indonesia NDC. Second, regarding the alignment of the prior actions with mitigation goals, none of the PAs is likely to result in a significant increase in GHG emissions or reduction of carbon sinks. In particular, PA#4 contributes to a better assessment of climate risks, and PA#6 and PA#7 promote investment in green and sustainable projects and may contribute to decarbonization consistent with the country’s mitigation goals. Other PAs have a negligible impact on decarbonization as they do no harm to the country’s transition towards low-carbon emission pathways. Third, regarding alignment with adaptation and resilience goals, none of the PAs is likely to be significantly impacted by climate physical risk, so the program is also considered aligned for adaptation and resilience. Hence, the DPF program is considered Paris Aligned overall. 28. This operation supports MFD-enabling reforms and PCE reforms. PA#1 and PA#2 promote private finance for MSMEs by enabling more lending from fintech/P2P lenders and by addressing credit information asymmetries, a key binding constraint for MSME finance. Increased lending is expected to deliver US$5 billion in PCE, tracked by Result Indicators (RIs) #1 and #2. PA#3 will help develop the derivatives market, with positive implications for risk hedging instruments and hence a deeper capital market that could provide reliable funding for economic development. PA#6 lowers trade barriers for renewable energy investments and will thus increase private finance, including from abroad, for the energy transition. PA#7 encouraged increased investment in sustainable practices. PA#8 enables private financing for infrastructure in collaboration with local governments through land value capture. 29. This operation builds on lessons-learned and core diagnostics. The World Bank has supported Indonesia's economic policy reforms through successive DPLs in recent years, focusing on financial sector depth and investment competitiveness.8 Two lessons learned are integrated into this operation: (i) having extensive analytical work completed prior to the DPL is critical for building consensus among technocrats and policymakers on specific reforms, and (ii) the presence of a strong government counterpart to serve as coordinator is an important success factor in an operation involving multiple institutions. The IPSI DPL is firmly anchored by Indonesia’s latest CCDR and GJR, which emphasize the role of structural reforms to accelerate economic growth, including through policies to open and enable markets, accelerate investments, and expose the domestic economy to greater competition. It is also anchored by the recommendations from the 2024 joint WB-IMF FSAP, which underscores the need to enhance the financial system’s breadth and depth while maintaining stability to break out of the middle-income trap. The DPL also complements other operations and technical assistance (TA) programs in the suggested reform areas including the Indonesia Disaster Risk 8 Notably, the 2019-2023 financial sector reform DPL series culminated in the FSOL legislation in 2023, and the 2021 investment and trade DPL improved the investment climate, opening more sectors to private investment and boosting competitiveness. Page 10 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) Finance and Insurance project (P173249), the recently closed Indonesia Infrastructure Finance Facility project (P092218), and the recently launched investment climate TA (i.e., Business Ready (B-READY) initiative at national and subnational levels; and the Investment Facilitation for Development Agreement (IFDA) gaps analysis. The DPL is overseen by the MOF, coordinating reforms across implementing agencies. 30. The operation is allocated $200 million from the Global Solutions Accelerator Platform (GSAP) under the IBRD Framework for Financial Incentives (FFI) for producing significant cross-border externalities related to climate change mitigation. PA#6 contributes indirectly to GHG reduction by accelerating the transition to clean energy. Reducing the local content requirements in the power sector is expected to reduce the weighted average price of solar photovoltaic independent power projects over a three-year period, resulting in a 15 percent reduction in the cost of renewable energy procurement. This is expected to incentivize investments in solar power generation projects, helping to accelerate the transition to clean energy. Meanwhile, PA#7 introduces new rules that help reduce industrial wastewater and pollution impacts on Indonesia’s marine and coastal ecosystems, including coral reefs and mangroves. The prior action aims to address these issues by requiring that new industrial estates avoid ecologically sensitive or disaster-prone coastal areas (which may include mangroves and other high-biodiversity terrestrial sites), and that developers install essential infrastructure such as centralized wastewater treatment and drainage systems to reduce water pollution and runoff. B. Prior Actions, Triggers, Expected Results and Analytical Underpinnings 31. The reform program supported by this operation aims to mobilize finance and enable markets for productive and sustainable investment. The first pillar aims to enhance the supply of finance through policy actions that expand the volume and lower the cost of financing. The second pillar aims to increase the supply of investment projects by expanding investment opportunities and lowering investment costs. Multiple reforms under both pillars support sustainability efforts, improve resilience to climate change, and create more and better jobs.9 It is estimated that the two main jobs- related Prior Actions (i.e., PA #1, #2), if implemented, will create about 0.7 million more and better jobs by 2026. Pillar A: Mobilizing Finance for Investments 32. The first pillar of this operation aims to mobilize finance for productive and sustainable investments. The 2024 joint WB-IMF FSAP highlights the importance of broadening and deepening financial markets and services. Following the Asian financial crisis, the financial system prioritized stability. It is dominated by banks (78 percent of total financial system assets), performing limited financial intermediation (total assets to GDP at 70.6 percent, credit to GDP at 31.4 percent, and domestic bank deposits to GDP at about 39 percent). There appears to be limited incentive to target riskier segments, with the dominant banking sector having a combination of high capital and liquidity positions, as well as high profitability, and decent credit and deposit growth. To broaden and deepen the financial sector, the authorities will need to focus on easing intermediation and releasing forces of competition: leveraging digital financial services (PA#1), removing credit infrastructure constraints (PA#2), and expanding capital markets (PA#3). Notably, new fintech participants and stronger capital markets can provide competition to the dominant banking sector and help mobilize savings, allocate resources efficiently, and provide a wider range of financial services to support economic activity. At the same time, the financial 9 In this section, the results indicators for each prior action and their underlying mechanisms were incorporated into the World Bank MANAGE CGE model for Indonesia to estimate the potential impact on the quantity and quality of jobs. The concept of More and Better Jobs used here consists of the percent change in total earnings attributed to the PAs based on the RIs times pre-reform employment. More and Better Jobs reflects both increases in employment and increases in earnings, expressing the latter as increases in pre-reform employment equivalents. As measured, a 10 percent increase in earnings with no change in employment would be equivalent to a 10 percent increase in employment with no increase in earnings Page 11 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) sector will need to adjust to significant exposure to climate and natural disaster risks (PA#4) and play a critical role in markets for disaster resilience (PA#5). Prior Action # 1. To increase MSME finance through digital financial services, OJK has increased the maximum loan ceiling by peer-to-peer lenders through OJK Regulation No. 40/2024. 33. Rationale: As of end 2023, MSMEs account for 99 percent of all firms in Indonesia, but lending to MSMEs accounts for just 20.5 percent of all bank lending. Access to finance is considered the biggest obstacle to business by 29 percent of Indonesian firms, with the highest constraints reported by small and medium firms (32 and 23 percent, respectively).10 Peer-to-peer (P2P) lending is an innovative fintech activity that connects borrowers directly with lenders through online platforms that bypass traditional financial institutions like banks. P2P lenders use data-driven credit scoring and risk-based pricing models to assess borrowers, easing information constraints and lowering transaction costs compared to traditional banks that look for fixed-asset collateral. P2P lenders in Indonesia reached 119 million borrower accounts in 2024, exhibiting significantly higher outreach to MSMEs than banks, and reaching large proportions of female borrowers. This is because they draw on innovative credit scoring methods and alternative forms of collateral rather than relying on large, fixed assets that women and small firms are less likely to own. Additionally, the fully digital product offerings of P2P lenders address the mobility constraints that women often face. As a result, as of November 2024, women comprised 52 percent of P2P borrowers in contrast to less than 20 percent of commercial bank borrowers. However, P2P lenders face a loan ceiling limiting their ability to fully compete and reach their potential in the MSME market, which faces a financing gap of IDR 1,290 trillion. Outstanding risks associated with P2P lending may include cybersecurity and data privacy, portfolio quality, unethical business practices, and flawed governance and risk management. Therefore, the Financial Services Authority (OJK) has issued a series of regulations for lenders to address these risks to protect consumers, including capital and provisioning requirements, disclosure mandates, and transparent reporting on portfolio quality.11 NPLs in the P2P sector are below 3 percent and exposures of individual investors are limited.12 34. Reform: To expand access to credit for MSMEs, OJK has issued Regulation No. 40/2024 to raise the maximum loan ceiling by licensed P2P lenders to MSMEs from IDR 2 billion to IDR 5 billion (US$ 130,000 to US$ 330,000). This enables licensed P2P lenders to expand MSME lending and increases competition in the MSME market segment currently underserved by the dominant banking sector. The same regulation also provides for more stringent requirements on corporate governance, consumer protection, and information security for P2P lenders. 35. Expected results: The increased maximum loan ceiling for fintech loans by P2P lenders is expected to increase the percentage of credit to MSMEs as a share of total credit from P2P lenders from 32.5 percent in 2024 to 55 percent in December 2026, with outreach to women remaining above 50 percent. Achieving the Results Indicators (RIs) for PA#1 and PA#2 is estimated to increase the credit to the private sector by about 4 percentage points of GDP, create about a quarter million new P2P loans in 2025 and 2026, increase the efficiency of fund allocation and hence GDP by 0.3 percent above 10 Data from 2023 Indonesia Enterprise Survey. Gender-specific barriers further limit access to finance. The share of micro and small entrepreneurs who rely on savings to start or run their business is greater among women than men – 64 vs 55 percent, respectively. 11 International good practices call for a balanced approach between safeguarding against financial stability risks and allowing for innovation, due to the nature of the platforms’ operations. 12 The exposures of individual investors are also limited: according to available data, 90 percent of funding in the sector comes from institutional investors rather than individuals. Individual investors are subject to investment limitations based on their incomes. Page 12 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) the baseline, and create 0.7 million more and better jobs by 2026.13 Furthermore, this reform will increase women’s access to capital (also a World Bank Corporate Scorecard Indicator).14 Prior Action #2. To increase MSME finance through better credit information, OJK has enabled innovative credit scoring services through OJK Regulation No. 29/2024. 36. Rationale: Credit information plays a crucial role in helping lenders make informed decisions about extending credit to borrowers, including households and MSMEs. Lenders use credit information to evaluate a borrower's creditworthiness and predict how likely a borrower is to repay a loan. Traditionally, credit registries and bureaus have fulfilled this role by collecting and reporting credit information from financial institutions, such as the borrowers’ payment history. Recent innovations have leveraged alternative data by turning to non-traditional information sources such as mobile, utility, and e-commerce payments. The credit reporting system in Indonesia includes a credit registry run by the OJK (for supervisory purposes), three credit bureaus (with access to the credit registry’s data), and five temporary licensed innovative credit service (ICS) providers. The 2024 IMF-WB FSAP indicates that due to data gaps and inconsistencies, the credit information and services currently made available by the credit bureaus are considered less than optimal. Enabling ICS services is an integral part of overall credit reporting system reform, which OJK is actively pursuing through the development of a national strategy and roadmap. Prior to the regulation's issuance, the ICS providers, who use alternative data, operated in a ‘regulatory sandbox’, i.e., a controlled environment created by OJK to test innovative services under relaxed regulatory requirements. This has allowed OJK to facilitate innovation while addressing concerns about data privacy, fairness, potential discrimination, etc. 37. Reform: To expand access to credit for MSMEs, the OJK has issued Regulation No.29/2024 to provide a legal basis for regulating and supervising ICS activities. This regulation defines ICS providers and permitted business activities and stipulates licensing, consumer protection, governance, and risk management requirements, among other compliance aspects. It also contains requirements and guidance on the source and use of data and quantitative models in generating credit scores. Under this regulation, prospective ICS providers can apply for licenses directly instead of going through regulatory sandbox process. This regulatory framework is also expected to balance OJK's support for market development and the need for proper supervision. 38. Expected results: The enabling of innovative scoring services, and hence the overall credit information ecosystem, is expected to contribute to the increase in the percentage of credit to MSMEs as a share of total credit from 20.5 percent in September 2024 to 25 percent in December 2026. Prior Action #3. To increase liquidity in local capital markets, (a) the Government has transferred the regulatory and supervisory authority over security based financial derivatives to OJK through Government Regulation No. 49/2024, and (b) OJK has operationalized the transferred authority by exercising its power to regulate and supervise securities-based financial derivatives through OJK Regulation No. 1/2025. 39. Rationale: The Indonesian capital markets do not provide adequate and competitive alternative funding sources beyond the dominant banking sector. Equity market capitalization was at 48.5 percent of GDP in December 2022 13 A recent survey from Indonesia suggested that the household income (of an MSME owner) is estimated to increase by 14.7 percent as the outcome of gaining access to a new business loan, implying that PA #1 and 2 can increase overall labor productivity by about 0.02-0.07 percentage points per year. According to the CGE estimates, by 2026, one in seven of the more and better jobs will be new jobs, suggesting that the “jobs” benefits will mainly come from productivity gains (or labor income) gains. 14 To be calculated as the total number of loans above the previous ceiling (IDR 2 billion) made to female borrowers between effectiveness and December 2026. Page 13 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) compared to a regional median of 79.2 percent; private debt securities outstanding are about 2.3 percent of GDP against a regional median of 55.2 percent; and the government securities market stands at 27.1 percent of GDP while the regional median is 40.1 percent. Derivatives play a crucial role in capital markets by allowing investors to manage risks by hedging against potential losses, facilitate price discovery, and gain access to otherwise inaccessible markets. By doing so, they help in improving market efficiency and liquidity. However, Indonesia's derivatives market is underdeveloped, including limited trading of interest rate and forex derivatives, due in part to regulatory limitations. The number of listed security futures traded on the Indonesia Stock Exchange stood at just 11 in 2024. Importantly, derivatives markets are critical to maintaining financial stability, especially in times of high market stress. Therefore, international good practices call for their regulation and supervision under financial authorities. Accordingly, the FSOL of 2023 required the shift of the regulatory and supervisory authority of financial derivatives from the Ministry of Trade to OJK, aiming to strengthen the regulatory framework and integrate it within OJK’s financial sector oversight. 40. Reform: The MOF has issued the Government Regulation #49 Year 2024 to implement the FSOL required transfer of financial derivatives regulations to OJK. Following the transfer of authority, OJK has issued Regulation No. 1/2025 on financial derivatives that focus on i) ensuring a stable and manageable transition, ii) strengthening the supervisory and regulatory framework, and iii) promoting long-term market development and investor protection. This regulation defines derivatives, outlines approval procedures for derivatives product development, stipulates licensing procedures for traders, brokers, investment advisors, and operators of market infrastructure involved in derivatives market activities, and also covers disclosure, consumer protection, and other compliance aspects. The OJK regulation constitutes evidence of the transfer of authority and the establishment of a proper regulatory framework on derivatives, with the expectation that future regulations will complement and continue to address any existing gaps. 41. Expected Results: The regulation on financial derivatives is expected to enable OJK to establish a clearer and stronger framework for derivative market regulation and supervision, pursuant to the International Organization of Securities Commissions (IOSCO) Objectives and Principles of Securities Regulation. This will further promote capital market development by helping to increase investor confidence, enhance market stability, and reduce systemic risk. Market development is measured by the number of listed security futures on the Indonesia Stock Exchange (IDX), which is expected to increase to 16 in December 2026 compared to the June 2025 baseline of 11. Prior Action #4. To strengthen the management of climate-related financial risks in the banking sector, OJK has established a comprehensive framework for climate risk analysis and risk management policies through CRMS Guidelines. 42. Rationale: Indonesia’s financial sector is highly exposed to climate-related risks, and financial institutions remain at an early stage in assessing such risks. The 2024 IMF-WB FSAP indicates that climate-related physical risk shocks could lead to direct damage to physical capital and negatively affect productivity, thus affecting the profitability and capital of banks. Furthermore, there are transition risks from moving to a carbon-neutral economy, and banks have considerable exposure to transition vulnerable sectors, with higher default risks under an ambitious carbon tax scenario. Yet, the integration of climate-related financial risk into governance, risk management, and reporting practices is at an early stage for most banks. OJK has issued a binding regulation (No. 17/2023) requiring banks to implement good practices in assessing and managing climate-related risks. However, given the highly technical and cutting-edge nature of this topic, this regulation has not been operationalized. The lack of proper methodological guidance and capacity-building for financial institutions have prevented them from effectively assessing and managing climate-related financial risks. 43. Reform: The OJK has issued comprehensive guidelines for the banking sector through a Climate Risk Management and Scenario Analysis (CRMS). The OJK guidelines include detailed guidance on risk management policies and Page 14 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) methodological guidance on climate risk analysis.15 The guidelines complement and operationalize the earlier binding regulation to enable banks to assess, manage, and disclose the resilience of their business model to climate risks, in line with international good practices advocated by international standard setters. Notably, guidelines in the financial sector are de facto compliance requirements for financial institutions and, although not legally enforceable, shortcomings can lead to higher supervisory intensity and risk ratings from regulators, providing strong incentives to comply. 44. Expected results: The CRMS Guidelines are expected to lead to all systemic banks adopting climate risk management policies by December 2026 (from zero in 2024). Prior Action #5. To strengthen the Government’s financial resilience to disasters, MOF has established a dedicated mechanism for the collection, investment and disbursement of resources under the Disaster Pooling Fund through [MOF regulation #28]. 45. Rationale: Indonesia has faced numerous climate-related natural disasters, health crises, and other adverse 16 shocks. Despite the high risk posed by such disasters, the institutional structure of disaster risk financing has been fragmented, and funds are often insufficient, and response delayed. Ex-ante financial planning to ensure liquidity after a disaster can alleviate the financial impact on the government’s budget and ensure timely financial response, avoiding significant socio-economic impacts and costs associated with delays in response. In 2018, Indonesia launched the National Disaster Risk Finance and Insurance Strategy. Soon after, the country began implementing two key priorities i) budget protection by establishing a disaster pooling fund (PFB) through Perpres 29/2021 and ii) protection of assets by insuring government buildings, education and healthcare facilities. The PFB is a financial mechanism that collects dedicated funding for disaster preparedness, response, and recovery efforts. Funds for the PFB are collected through regular allocations in the state budget, sub-national government budgets, and other funding sources such as grants. The PFB funds are pooled in an independent account and can be invested through various instruments, including deposits and investments in government securities, mutual funds, corporate bonds, and stocks. Furthermore, the PFB funds can be used under the country’s overall ex-ante disaster risk finance approach for pre-disaster activities and new financial risk transfer solutions, such as public asset insurance. 46. Reform: The MOF regulation stipulates the overarching framework for the collection, investment, and channeling of the PFB resources. The PFB will be a dedicated mechanism to: (i) ensure effective access to sufficient resources for disaster response; and (ii) streamline execution of spending, building transparency. Through financing risk transfer solutions, such as domestic and international insurance for public assets, the PFB is also expected to help promote the development of domestic insurance markets. The regulation also outlines and brings transparency on how funds for pre- disaster expenditures can be channeled to different government agencies. 47. Expected Results: The readily available PFB resources will enable the Government of Indonesia (GoI) to strengthen its financial resilience to disasters by enabling the use or disbursement of 20 percent of funds by the PFB to finance active risk transfer solutions. 15 This consists of: i) CRMS General Guidebook, ii) CRMS Technical Guidebook, iii) Carbon Emissions Calculation Methodology, iv) Supporting Data on Indonesia’s Potential Physical Risks, v) Supporting Data on Indonesia’s Macroeconomic Projections, and vi) Working Papers for Reporting Climate Risk Impacts and Carbon Emissions from Banks to OJK. 16 Between 1990-2021, Indonesia experienced more than 300 natural disasters ‒including 200 flooding events affecting more than 11 million people. The frequency of disasters is increasing and climate-related ones account for approximately 70 percent of the total. Page 15 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) Pillar B: Enabling Markets for Investments 48. The second pillar of this operation aims to enable markets for productive and sustainable investments. Since 2015, Indonesia has implemented significant economic reforms, such as investment liberalization, to enhance the business environment. Nevertheless, the private sector continues to face substantial challenges. The World Bank’s “Unleashing Indonesia’s Business Potential” report (June 2024) shows that regulatory compliance costs remain significant constraints on productivity in addition to access to finance. Time spent complying with government regulations was one of three major constraints to productivity in 202317. At the same time, a dynamic private sector can capitalize on new investment opportunities that achieve economic growth aligned with Indonesia’s sustainability goals. To enable markets for productive and sustainable investments, the authorities will need to focus on removing business obstacles and providing investment opportunities by focusing on several key areas: reforming local content requirements to reduce the cost of procuring renewable energy (PA#6), aligning industrial estates policies with international environmental sustainability and climate standards (PA#7), and implementing a land value capture mechanism to attract private capital and fund infrastructure development (PA#8). These measures will stimulate climate mitigation, promote sustainable industrial practices, and accelerate infrastructure development, ultimately contributing to economic growth. Prior Action #6. To reduce generation cost and increase investment for renewable energy, the Borrower has eased its local content requirements in the power sector for renewable energy projects, as evidenced by MOI Regulations No. 33/2024, 34/2024 and MEMR Regulation No. 11/2024, and MEMR Decree No. 191./EK.01.MEM.E.2024. 49. Rationale: Indonesia has set an ambitious target to increase the share of renewable energy (RE) generation in the power sector to 44 percent by 2030, a significant increase from 13.3 percent in 2023. However, long-standing barriers hinder the large-scale adoption of RE. Stringent local content requirements (LCRs, i.e., the requirement to use local goods, services, or labor) have significantly increased the costs of RE projects and slowed their deployment.18 Even where local manufacturers were able to meet LCRs, costs were much higher relative to imported RE components.19 Limited domestic supply20 and the use of lower-quality technology have further increased costs and hindered RE adoption in the power sector. Reforming LCRs would lead to lower procurement costs, making low-carbon technologies more competitive vis-a- vis higher carbon alternativities, thereby contributing to reduce greenhouse gas emissions. 50. Reform: The MOI and MEMR have reformed local content regulations and significantly lowered the LCR thresholds across all renewable energy infrastructure projects, e.g., geothermal, hydroelectric, solar, wind, biomass, biogas, waste- to-energy, etc. For instance, the LCR for solar power plants was reduced from 43 to 20 percent, while for hydropower plants, it decreased from an average of 55 to 34 percent.21 LCRs were also shifted from the previously applied component level to the project level, further reducing their restrictiveness. The reforms transferred responsibility for LCRs for electricity infrastructure from the Ministry of Industry to the Ministry of Energy and Mineral Resources, streamlining their governance. 17 According to the World Bank Enterprise Surveys, last conducted in 2023 and before that in 2015. 18 In 2023, Indonesia’s state-owned electricity company (PLN) stated that nine renewable energy projects (valued at US$3.2 billion) were facing financing challenges due to the stringent LCR. International evidence suggests that stringent LCRs could have imposed an additional capital cost of 12-24 percent per GW of installed solar PV (Indonesia Renewable Energy Society 2021). 19 Solar PV modules manufactured in Indonesia cost almost 40 percent more than the imported equivalents. 20 27 out of 33 main components from Solar PV modules, wind turbines, geothermal systems, and batteries are not available domestically and would need to be imported (Opportunities and Challenges to Promote Development of a Domestic Supply Chain to Support the Growth of Renewables in Indonesia, World Bank 2019). 21 These reforms were supported by World Bank analytical work and recommendations advocating for the relaxation of LCR including in the 2024 report Trading Towards Sustainability: The Role of Trade Policies In Indonesia’s Green Transformation . Page 16 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) 51. Expected Results: The reform of the LCRs in the power sector is expected to reduce the cost of the renewable energy procurement by fifteen percent. The LCR reform in the renewable energy sector is expected to have the most significant impact in the solar power generation projects. The result indicator is the weighted average price of solar photovoltaic independent power projects over a three-year period. Prior Action #7. To align industrial development with sustainability goals, the Borrower has established a regulatory framework promoting the adoption of environmentally sustainable practices in Industrial Estates through Government Regulation No. 20/2024. 52. Rationale: By Law No.3 of 2014 on Industrial Affairs article 63, all manufacturing firms in Indonesia must be in Industrial Estates (IEs), that is, in areas permitted to conduct industrial activities. Subsequently, Government Regulation No. 142 of 2015 on the establishment, development, and management of IEs has led to the establishment of many private sector-led estates.2223 In 2017, approximately 36 percent of manufacturing firms in Indonesia were located within these industrial estates, contributing to 62 percent of the total manufacturing output and accounting for 49 percent of employment in the manufacturing sector. Nevertheless, this regulation lacked clear guidelines, indicators, and targets for improving environmental sustainability, resulting in industrial practices that often harmed the environment and became vulnerable to the impacts of climate change. The 2015 regulatory framework also created entry barriers hindering industrial growth. These challenges necessitated a comprehensive reform to align industrial estates policies with Indonesia's goals for environmental sustainability, increased climate resilience, and improved regulatory clarity. Such reforms will help attract investment in sustainable industrial practices, leading to the growth of environmentally conscious industries by, among others, providing a clearer framework to managers of industrial estates. 53. Reform: The Government has issued Regulation No. 20 of 2024 on industrial estates, bringing major reforms to the sector. It is consistent with the Indonesia Country Climate and Development Report (CCDR)24 recommendation E.21 “Industrial Estates offer opportunities for improved efficiencies and resilience.” For instance, a World Bank survey of 108 IEs shows that wastewater recycling remains limited (less than 8 percent) although 47 percent of IEs have wastewater treatment systems in place and have the potential to increase cost savings from collective wastewater reuse. Key changes from the reform include the establishment of environmentally friendly industrial estates as part of the government’s Smart Eco-Industrial Park (EIP) Initiative, with defined criteria to ensure that activities are sustainable and minimize environmental impact through the adoption of green certifications and infrastructure systems in line with international good practices on EIPs. It will enable markets for sustainable and resilient investment by mandating the managers of IEs to expand their role from land management to adopting greener management practices, considering renewable energy solutions, fostering circularity and waste management, and establishing disaster prevention and climate mitigation mechanisms. It is expected to have positive global externalities by helping reduce wastewater and solid waste pollution discharged into rivers and seas. It also expands support for IEs managers and industrial businesses, 25 encouraging 22 Of these industrial estates, 77 percent are privately owned, 6 percent are joint ventures, and 17 percent are State Owned Enterprises 23 While the presence of industrial estate usually associated with fiscal incentives, there is no such link in Indonesia. Based on “Tax Expenditure Review, 2023” from the Fiscal Policy Office of the Ministry of Finance , there is no evidence that any fiscal incentives were provided to IEs in Indonesia between 2019-23, and none were projected for the years 2024-26. 24 https://openknowledge.worldbank.org/bitstreams/97ed886f-3a18-4301-ba8d-998bc23d8041/download 25 Part of the investments in green technologies/ practices can be deducted from corporate tax and there are reduced (or waived) import duties for green equipment. Furthermore, tenants will benefit from accelerated licensing in eco-industrial parks. Fiscal and non-fiscal incentives, including duty-free or reduced import tariffs, are common in international zone regulations. According to the Page 17 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) investment in green and climate-resilient industrial estates. An updated permitting process to improve regulatory clarity and compliance with spatial and environmental planning will become mandatory. The reform will foster greater alignment with international standards, encouraging managers of industrial estates to improve their green management practices, offer renewable energy and circularity services to their tenants, and best prepare and protect them against natural disasters and climate shocks. 54. Expected Results: The regulation aims to minimize industrial activities' environmental footprint and enhance the compliance of industrial estates with environmental and climate adaptation standards. It creates a decarbonization framework for industrial clusters and creates a market for private IEs managers to build on agglomeration and economies of scale to accelerate decarbonization efforts and resilience measures in the manufacturing sector. The proportion of IEs implementing Environmental Management Systems (EnMS) according to international standards (e.g., ISO140001) will increase from 25 to 45 percent. Additionally, the number of IEs equipped with early warning systems for natural disasters and climate shocks will increase from 20 to 40 percent. Prior Action #8. To increase infrastructure financing, the Borrower has introduced a Land Value Capture mechanism to recover and reinvest land value increases from public infrastructure investments, supporting private sector participation through Presidential Regulation No. 79/2024. 55. Rationale: Indonesia faces critical challenges in infrastructure development. The reliance on state and subnational public funding for infrastructure projects has increased but remains insufficient to meet the growing demands of urbanization and the development of strategic economic corridors and zones. Funding mechanisms for infrastructure have traditionally relied on financing from state-owned enterprises or direct contributions from national or subnational governments, often becoming an important burden on budgets. Indonesia has not utilized innovative financing mechanisms for infrastructure development, such as land value capture (LVC) for area-driven development. In general, cities in Indonesia have not yet utilized innovative financing methods like Land Value Capture (LVC), except for Jakarta, the capital city of the country. LVC is a strategy that allows the government to recover and reinvest the increased land value resulting from public investments and/or policy actions. LVC enables the government to enhance the value of an area through initial public investments (or also could be initiated by private investment, subject to the area’s characteristics) and capture some of the increased value using various instruments to generate revenue for the city or attract private sector financing. For example, when a new road or transit system is built, positive externalities are expected in the surrounding areas, leading to reevaluation and, in most cases, an increase in land prices due to improved access and the area’s strategic potential. The increased value could be captured through tax,26 fees, or invitation to the private sector to invest. This recovered value can then be used to repay initial investments or reinvested into further infrastructure projects. By demonstrating a clear return on investment and sharing the risks, LVC can make infrastructure projects more attractive to private investors. It shows that there is a tangible benefit and profit to be made, which can boost investor confidence and participation. This approach can reduce the financial burden on the government, facilitate integrated Global Special Economic Zone Database, 80 percent of countries with zone regimes offer such incentives. Asset-based incentives, such as tax reductions or exemptions on capital expenditures or accelerated depreciation, are less common than corporate income tax reductions but are increasingly adopted in zone regulations. Non-fiscal incentives may include measures like international eco- industrial park certification (currently being developed by the World Bank and IFC) or preferential visa policies for foreign employees working in eco-industrial parks. 26 The tax-based schemes typically include recurring property taxes, land value increment taxes, transfer taxes, and stamp duties. The fee-based schemes include betterment levies, development impact fees, and developer exactions. Development-based schemes include the sale of development rights, land pooling, and land readjustment. Page 18 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) infrastructure development, and promote economic growth in targeted areas. Relying on LVC financing will also help ensure infrastructure investments are private sector-led (demand) driven. 56. Reform: The Presidential Regulation of Infrastructure Financing through Land Value Capture (Perpres No 79/2024) introduces a national framework for the LVC mechanism, a legal basis for capturing and reinvesting the increased land value, leveraging public investments within an Economic Corridor/Zone. It outlines the process for selecting, preparing, implementing, and monitoring LVC projects, with the CMEA as the lead policy institution. The regulation defines the roles and responsibilities of subnational governments in implementing LVC mechanisms. The revenue generated from LVC will be used to repay initial investments, fund further infrastructure projects or to capitalize the high-impact investments through private sector participation. The regulation also provides guidelines for managing assets created through LVC. 57. Expected Results: The implementation of Perpres 79/2024 is expected to enable private capital participation in infrastructure projects. In the first two years, it is estimated that US$ 250 million of financing will be identified through LVC investments, as assessed by the completed site-level models. C. Consultations and Collaboration with Development Partners 58. The authorities consulted with industry stakeholders to inform policy actions. The consultation process involved broad participation using the exhaustive country system. This system includes external stakeholders as well as inter- ministerial and inter-agency consultations where legal drafts are shared and discussed. This is also complemented by an official harmonization process organized by the Ministry of Law to ensure legal consistency and feedback from all relevant ministries and agencies. For financial sector reforms (PA#1-2), regulations were shared for feedback before finalization as part of the Financial Sector Omnibus Law implementation process. For capital markets and institutional investor reforms, the OJK mandated a 30-day public comment period on draft regulations, often preceded by focus group discussions (PA#3). The MOF also held ad hoc consultations on disaster risk finance reforms (PA#5). 59. The World Bank also consulted with the private sector and development partners through its technical assistance programs and analytical underpinnings. The World Bank has leveraged its existing technical assistance programs (TAs) as well as its analytic and advisory work (ASAs) to engage and consult regularly with government officials, private sector representatives, civil society, and development partners on the reforms proposed in this operation. This includes TAs and ASAs in the areas of financial sector reform, business environment, trade, and energy among others. Discussions have also included the IMF and other development partners, including the Asian Development Bank (ADB), the Australia Department of Foreign Affairs and Trade, and the French Development Agency (AFD). All consultations indicated strong support for various reform objectives. IV. OTHER DESIGN AND APPRAISAL ISSUES A. Poverty and Social Impacts 60. The proposed operation is expected to reduce poverty and improve the welfare of the poor by expanding access to credit and financial services and encouraging business formalization and growth. The operation will also have a positive distributional impact through efficient subnational public infrastructure financing. A detailed poverty and social impact analysis is available in Annex 3A. In summary: • PA #1 reduces poverty by enhancing financial inclusion, expanding Sharia-compliant financing, and improving competition in credit markets for MSMEs. Simplified licensing and higher lending caps for fintech companies are expected to boost competition and provide more accessible and affordable credit for MSMEs. This addresses the Page 19 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) major constraint of limited access to finance for MSMEs. Evidence shows that access to finance significantly boosts income growth and labor demand among MSMEs in Indonesia. • PA #2 improves financial inclusion and economic growth by enhancing credit scoring. This allows financial institutions to extend credit to a wider range of borrowers, including those in Indonesia's informal sector who may lack credit history or financial documentation. The action is anticipated to reduce poverty by enabling more informal MSMEs to qualify for loans, increasing business investment and profitability, reducing interest rates through improved risk assessment, and expanding the market of eligible borrowers, thereby promoting competition and labor demand. • PA #8 focuses on financing public infrastructure by capturing increased land values from government development. This method minimizes economic inefficiencies and includes protections for vulnerable populations. LVC will tax higher-income groups with valuable land, enhancing tax progressivity and discouraging land speculation. 61. After accounting for mitigation measures, this operation is not expected to generate significant negative poverty or distributional impacts. PAs #3, 4, 5, 6, and 7 are all expected to have neutral short-term poverty and distributional impacts. However, there are modest risks of negative impacts in some actions that are effectively addressed through policy-based mitigation. Expanding P2P lending (PA#2) poses risks due to the potential emergence of undercapitalized lenders and borrower over-indebtedness. These are mitigated by regulations requiring an OJK license for all P2P lenders, ensuring oversight of financial stability and management practices (refer to details in section III.B). Additionally, the regulation mandates transparent reporting of terms, conditions, risks, and potential liabilities to borrowers for informed decision-making. Finally, LVC mechanisms (PA#8) may have inadvertent negative effects on low- income landowners in high-demand areas. The regulation governing this PA includes safeguards to mitigate this risk, including protections against unaffordable tax increases for low-income residents, while providing guidelines for incentives and compensation to mitigate financial burdens on lower-income residents. A portion of LVC revenue is allocated to affordable housing and public services, enhancing the reform's inclusiveness. B. Environmental, Forests, and other Natural Resources Aspects 62. The operation is expected to have potentially positive impacts on the environment and climate. Potential negative impacts on forests and ecosystems are identified, but these are expected to be managed by Indonesia’s risk - management system. Out of the eight PAs, two have potential for negative effects (PA#6, P#8), three have potential for positive effects (PA#4, PA#6, P#7), and four will likely have no significant environmental effects (PA#1, PA#2, PA#3, and PA#5). Some actions have the potential for both negative and positive impacts. The country risk management system is expected to mitigate potential negative environmental impacts. 63. Three prior actions will likely have significant positive effects on the environment. Reform to facilitate greater transparency regarding climate risks in investments (PA#4) is expected to have positive effects. The Climate Risk Management and Scenario Analysis guidelines will support the provision of more systematic and reliable information to investors regarding GHG emissions, helping to facilitate green investment strategies. The guidelines are expected to encourage banks to adopt climate risk management practices, which could encourage capital provision towards those sectors of the economy that are at reduced risk from climate impacts and low-carbon policies. Reform to lower the procurement costs and regulatory burden for renewable energy projects (PA #6) is also expected to be positive. Greater investment in renewables can reduce the use of fossil fuels in energy generation, with positive effects on GHG emission reductions and local air quality. Reform to industrial estates (PA#7) is also expected to have a positive impact by introducing defined criteria for sustainable activities, reducing import duties for green equipment, and mandating compliance with spatial and environmental planning. While the reform aims to promote regional development (which could increase industrial development and pollution impacts), industrial estate siting is expected to occur within existing Page 20 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) brownfield sites. Businesses within these zones are expected to receive incentives for less polluting and less-resource intensive production, providing environmental benefits relative to status quo development. 64. Reforms that contribute to improved investment climate and competitiveness have some potential for negative environmental impacts. There have been improvements in government capacity due to complementary reforms (described below). Reforms for a land value capture tax mechanism (PA#8) could also potentially have negative impacts if infrastructure development accelerates significantly. This is considered unlikely, and development is expected in existing urban areas rather than in sensitive forests or ecosystems. Large-scale renewable energy development (PA#6) could also have the potential for negative impacts, including from the construction of hydroelectric dams and geothermal facilities, which are often placed within sensitive forest and mountainous areas. Indonesia’s environmental licensing system (including AMDAL for high-risk projects) provides a regulatory framework to mitigate environmental damage from renewable energy projects. 65. Risks are expected to be managed by the GOI’s environmental risk-management system. The Job Creation Law and Government Regulation No. 22/2021 on Environmental Protection and Management introduced changes that help to safeguard against the remaining risks described above. These changes included: (1) partially recentralized AMDAL review to improve technical quality, with greater input from technical ministries and independent experts, and formation of environmental feasibility test teams (Tim Uji Kelayakan Lingkungan Hidup) to standardize application evaluation; (2) stronger requirements for Environmental Monitoring Plans (RKL-RPL); and (3) more stringent environmental protection requirements (e.g., for pollution emissions). These changes, set out by Government Regulation No. 22 of 2021, are expected to mitigate against negative impacts of potential renewables development in sensitive areas (PA#6), and potential impacts of brownfield industrial development (PA#7). The reforms also introduced a risk-based screening process (under MOEF Regulation No. 4 of 2021). The World Bank undertook an assessment of the AMDAL system and its capacity needs as part of a TA to the former MOEF in 2022-23. 66. The operation does not foresee direct and significant impacts on the environment, forests, or natural resources from other reform measures supported by this DPL. Reforms that support the deepening of the financial sector (PA#1, PA#2, and PA#3) are expected to increase MSME activity and increase liquidity in local capital markets without favoring environmentally harmful sectors (i.e., are neutral in environmental impact). The reform to operationalize the disaster risk pooling fund (PA#5) is also expected to be neutral. C. PFM, Disbursement, and Auditing aspects 67. PFM is characterized by prudent fiscal management, controlled budget execution, and a well-defined treasury management system. The use of technology and integrated systems has enhanced financial reporting and oversight. The latest Public Expenditure and Financial Accountability (PEFA) report (2017)27 indicates that 17 of 31 indicators scored either “A” or “B”. According to the report28, Government Regulation No. 17/2017 aims to align the national development plan and budget process. Pillars that did well included transparency of public finances, policy based fiscal strategy, and budgeting, while those that required improvement included budget reliability, audit, and external scrutiny. Public investment management 29 indicators also required significant improvement. The 2020 Public Expenditure Review on Spending for Better Results highlighted the need to improve performance-based budgeting and fiscal transfer to incentivize the performance of sub-national governments. To strengthen performance-based budgeting, government 27 World Bank, 2018, Public Expenditure and Financial Accountability (PEFA) Assessment Report (2017). 28 PI-16.3 Alignment of Strategic Plans and medium-term Budgets 29 IMF’s Public Investment Management Assessment (2019) corroborated the PEFA assessment findings. Coordination of public investment institutions, project oversight and ex-post evaluation, needed improvement. Page 21 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) regulation No. 6/2023 was issued, followed by implementation guidelines issued by MoF (PMK No. 62/2023). The national government budget is made available to the public on the MoF website. Other reforms to address these issues are included under the country’s PFM roadmap for 2020-2024, supported by the PFM MDTF. The supreme audit institution in Indonesia, Badan Pemeriksa Keuangan (BPK), conducts financial audits on the central government’s financial statements (LKPP) in a timely manner and the audit reports for the last five years30, including for 2023, have had an unqualified (clean) opinion. The audit report is publicly available on the MoF and BPK websites. 68. GoI continued its efforts to reform the country’s public procurement system. Presidential Regulation (Perpres) No.16/2018, as amended by Perpres No.12/2021, introduced key provisions to: (i) improve procurement planning quality; (ii) promote transparent, open, and competitive procurement; (iii) enhance institutional and human resource capacity; (iv) develop procurement e-marketplace; (v) use ITC technology and electronic transaction; (vi) increase opportunities for Micro and SMEs; (vii) support research and creative industries; and (viii) implement sustainable procurement. Furthermore, all ministries, institutions, and local governments are now required to use the e-procurement system to ensure a more transparent and efficient public procurement process. However, the performance measurement of the procurement system remains limited to a few indicators. It requires a more developed mechanism for monitoring and evaluating the success of the country’s public procurement system reform initiative. 69. A comprehensive assessment of the Indonesian public procurement system using the Methodology for Assessing Procurement Systems (MAPS) was completed in 2022. The assessment was led by the National Public Procurement Agency (LKPP) with support from the World Bank in collaboration with the ADB and the Islamic Development Bank (IsDB). A detailed MAPS key recommendation is provided in Annex 5. LKPP has started implementing MAPS recommendations, such as: i) issuing a guideline for sustainable procurement, including a list of green products; ii) collaborating with a local telecom company to develop a new integrated platform that centralized the database and e- procurement application to improve data accuracy, system availability, and information security; iii) developing a performance monitoring mechanism with KPIs to measure the public procurement system's overall performance. 70. Indonesia Central Bank, Bank Indonesia (BI) is mandated to manage foreign reserves for monetary operations and international obligations. The Central Bank Law and Forex System Law have been duly implemented, with the most recent update in 202331 aiming to establish a modern and internationally standardized forex market. IMF’s 2024 Article IV report indicated that Indonesia’s financial system is considered broadly resilient and well-capitalized, with robust capital liquidity buffers. IMF recommends further enhancement of financial sector supervision, regulatory frameworks, and crisis management mechanisms to address potential vulnerabilities and improve overall resilience. Nevertheless, a number of DPL operations were disbursed successfully in 2019-2023. The program’s dedicated foreign currency account is held at BI. There is a monthly bank reconciliation between the treasury and spending units. BPK has expressed a clean opinion of BI's financial statements for the last five years32, including for 2023. Based on an assessment of the PFM Systems and Forex control environment, the fiduciary risk is moderate. Given the fiduciary risk level, no DPL audit will be required. 71. The loan disbursement will follow standard World Bank procedures for DPLs. The Borrower is the Republic of Indonesia (GOI), and this operation is a single-tranche IBRD loan of US$ 1.5 billion equivalents. Consistent with previous DPLs, the loan will be disbursed into a foreign currency account of the Borrower at BI, and the equivalent Rupiah amount will be immediately transferred to the Borrower's General Operational Treasury account. The Borrower, within 30 days, will provide to the World Bank a written confirmation that this transfer has been completed and provide any other pertinent information, including the exchange rate used for the conversion from US dollars to Rupiah, that the World Bank may request. Disbursement of the loan will not be linked to any specific purchases, and no procurement requirements 30 LKPP obtained unqualified opinion since 2016. 31 Bank Indonesia (Indonesia Central Bank) Regulation no 6 on Moneys Market and Foreign Exchange Market. 32 BI received unqualified opinion in the last 21 years. Page 22 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) must be satisfied, except that the Borrower is required to comply with the standard negative list of excluded items that may not be financed with World Bank loan proceeds as defined in the General Conditions for IBRD Financing (Development Policy Financing (2023)). Should this be the case, the Bank will seek a refund from the Government of Indonesia, which will subsequently be canceled from the loan. D. Monitoring, Evaluation, and Accountability 72. The Borrower will monitor and evaluate progress on the results indicators. The Ministry of Finance will designate an executive agency from within its departments for this standalone DPL operation, while CMEA, OJK, the Ministry of Energy, and the Ministry of Investment will serve as implementing agencies. The executive agency will be responsible for overseeing the implementation of various prior actions and will work with implementing agencies to collect data, documentation, and other information in relation to progress on results indicators. The MOF is well-coordinated and, with extensive experience in implementing Development Policy Operations (DPOs) with the World Bank, it is increasingly well- prepared to obtain and share data to monitor implementation against the agreed results indicators. In particular, the gender-related result indicator on the share of P2P lending to women entrepreneurs will be tracked by OJK, with technical support from the World Bank. 73. The World Bank will closely follow this progress through supervision activities. An implementation status & results (ISR) report for operation will be conducted six months after the Board approval of the loan. The ISR would specifically monitor the progress made on the results indicators. 74. Grievance Redress. Communities and individuals who believe that they are adversely affected by specific country policies supported as Prior Actions or tranche release conditions under a World Bank Development Policy Financing may submit complaints to the responsible country authorities, appropriate local/national grievance mechanisms, or the World Bank’s Grievance Redress Service (GRS). The GRS ensures that complaints received are promptly reviewed in order to address pertinent concerns. Project affected communities and individuals may submit their complaint to the World Bank’s independent Accountability Mechanism (AM). The AM houses the Inspection Panel, which determines whether harm occurred, or could occur, as a result of World Bank non-compliance with its policies and procedures, and the Dispute Resolution Service, which provides communities and borrowers with the opportunity to address complaints through dispute resolution. Complaints may be submitted at any time after concerns have been brought directly to the World Bank’s attention, and Bank Management has been given an opportunity to respond. For information on how to submit complaints to the World Bank’s corporate Grievance Redress Service (GRS), please visit http://www.worldbank.org/GRS. For information on how to submit complaints to the Bank’s Accountability Mechanism, please visit https://accountability.worldbank.org. V. SUMMARY OF RISKS AND MITIGATION 75. The overall risk rating of this operation is moderate. The attainment of project development objectives could primarily be impacted by political and governance, institutional capacity, stakeholders, and macroeconomic risks. The reforms supported intend to create markets and spur productive investments, which would require political backing to change existing market practices and hurdles to business environment. It will also require capacity at the ministries and agencies level not only to ensure execution of the various regulations, but also a capacity for monitoring and evaluation, and for ensuring a continuous dialogue with private sector representatives and other stakeholders. Such feedback loop is indeed important to ensure that corrections can be made to solve implementation problems. Furthermore, it will require maintaining macroeconomic stability, which is an anchor to reduce the country’s risk premium and encourages private investors to commit to longer-term investments. Expanding financing needs could also entail risks of crowding out private sector credit and private investors especially as the new sovereign wealth fund start operations in the domestic market. Page 23 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) 76. Mitigation measures are well in place to manage those risks. The strong ownership of the proposed reforms, their linkages with the reform momentum in the past three years, the multiple technical assistance projects, and the government recent reorganization all mitigate a large part of these risks and ensure they remain moderate. Moreover, the supported reforms do not depend on specific budget programs and are geared to facilitate private investments with higher returns. Hence, they are not expected to be impacted by the recent budget adjustments. Meanwhile, the reforms supporting financial sector deepening expand domestic markets and private sector lending and hence minimize crowding out risks. Furthermore, GOI growth strategy is targeting an increased role for private investment, both domestic and foreign, and has outlined in the RPJMN commitments to explore modalities of cooperation with private sector especially as it implements projects under the newly created Danantara. The macroeconomic policy framework remains strong, and Indonesia has strong buffers (i.e., low public and private debt, declining external debt, high levels of forex reserves, well capitalized banking sector) to manage economic shocks. In this context, as the government implements its new programs, it will be important to sustain a transparent and credible macro policy framework whilst also accelerating structural reforms, such as the ones supported by this DPO, to accelerate productivity growth and creation of good jobs. Table 4: Summary Risk Rating33 @#&OPS~Doctype~OPS^dynamics@padrisk#doctemplate Risk Categories Rating 1. Political and Governance ⚫ Moderate 2. Macroeconomic ⚫ Moderate 3. Sector Strategies and Policies ⚫ Moderate 4. Technical Design of Project or Program ⚫ Moderate 5. Institutional Capacity for Implementation and Sustainability ⚫ Moderate 6. Fiduciary ⚫ Moderate 7. Environment and Social ⚫ Low 8. Stakeholders ⚫ Moderate 9. Other ⚫ Overall ⚫ Moderate 33 There are allegations of forced labor in the production of solar panels and components. This DPL focuses on policies and institutional reforms in Indonesia. DPL proceeds are not earmarked to any specific purpose, including the manufacture or procurement of solar panels or components. Page 24 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan(P508323) ANNEX 1. Policy and Result Framework Prior actions Results Prior Actions Indicator Name Baseline Target (June 2024) (December 2026) Pillar A. Mobilizing finance for productive and sustainable investments. Prior Action # 1. To increase MSME finance through digital financial services, OJK has Results Indicator #1. Credit to MSMEs 32 55 increased the maximum loan ceiling by peer-to-peer lenders through OJK Regulation No. as a share of total credit from peer-to- 40/2024. peer lenders (Percentage) N/A 50 - Of which to female borrowers Prior Action #2. To increase MSME finance through better credit information, OJK has Results Indicator #2: Credit to MSMEs 20.5 25 enabled innovative credit scoring services through OJK Regulation No. 29/2024. as a share of total credit (Percentage) Prior Action #3. To increase liquidity in local capital markets, (a) the Government has Results Indicator #3: The number of 11 16 transferred the regulatory and supervisory authority over security based financial listed security futures on the stock derivatives to OJK through Government Regulation No. 49/2024, and (b) OJK has exchange (IDX) (Number) operationalized the transferred authority by exercising its power to regulate and supervise securities-based financial derivatives through OJK Regulation No. 1/2025. Prior Action #4. To strengthen the management of climate-related financial risks in the Results Indicator #4: Systemic 0 100 banking sector, OJK has established a comprehensive framework for climate risk analysis commercial banks adopting climate risk and risk management policies through CRMS Guidelines. management policies (Percentage) Prior Action #5. To strengthen the Government’s financial resilience to disasters, MOF Results Indicator #5: Percent of funds 0 5 has established a dedicated mechanism for the collection, investment and disbursement used (or disbursed) from the calendar of resources under the Disaster Pooling Fund through [MOF regulation #28]. year 2024 of the disaster pooling fund to finance active risk transfer solutions (Percentage) Pillar B. Enabling markets for productive and sustainable investments. Prior Action #6. To reduce generation cost and increase investment for renewable Results Indicator #6: Reduction of the 0 15 energy, the Borrower has eased its local content requirements in the power sector for cost of the renewable energy Page 25 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan(P508323) Prior actions Results renewable energy projects, as evidenced by MOI Regulations No. 33/2024, 34/2024 and procurement in the power sector MEMR Regulation No. 11/2024, and MEMR Decree No. 191./EK.01.MEM.E.2024. (Percentage) Prior Action #7. To align industrial development with sustainability goals, the Borrower Results Indicators #7(a) and #7(b): has established a regulatory framework promoting the adoption of environmentally sustainable practices in Industrial Estates through Government Regulation No. 20/2024. #7(a): Proportion of industrial estates 25 45 adopting Environmental Management Systems (EnMS) in line with international standards (Percentage) #7(b): Proportion of industrial estates 20 40 with early warning systems (ESW) for natural disasters and climate shocks (Percentage) Prior Action #8. To increase infrastructure financing, the Borrower has introduced a Results Indicator #8: Land Value Capture mechanism to recover and reinvest land value increases from public infrastructure investments, supporting private sector participation through Presidential Private capital identified through the 0 250 Regulation No. 79/2024. LVC mechanism (Amount in million USD) Page 26 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) ANNEX 2. Paris Alignment Assessment Program Development Objective(s): mobilize finance and enable markets for productive, sustainable and resilient investment. Step 1: Considering our climate analysis (e.g., Yes. Part of the reform program contribute directly to the Indonesia NDC (2022) Country Climate and Development Reports or and Long-Term Strategy for Low Carbon and Climate Resilience 2050, through CCDRs), is the operation consistent with the enabling the financial system to channel savings to climate-related goals, and country's climate commitments, including for promoting investment climate reforms needed to engage private sector instance, the NDC, NAP, LTS, and other relevant participation in mitigation and adaptation. The reform program builds on the strategies? Indonesia CCDR, which emphasizes the importance of enabling economic policies and institutions for achieving Indonesia’s national climate aspirations. Mitigation goals: assessing and reducing risks Pillar A. Mobilizing Finance for Investments Prior Action 1. To increase MSME finance through digital financial services, OJK has increased the maximum loan ceiling by peer-to- peer lenders through OJK Regulation No. 40/2024. Prior Action 2. To increase MSME finance through better credit information, OJK has enabled innovative credit scoring services through OJK Regulation No. 29/2024. Prior Action 3. To increase liquidity in local capital markets, (a) the Government has transferred the regulatory and supervisory authority over security based financial derivatives to OJK through Government Regulation No. 49/2024, and (b) OJK has operationalized the transferred authority by exercising its power to regulate and supervise securities-based financial derivatives through OJK Regulation No. 1/2025. Step M2.1: Is the prior action likely to cause a Answer: No. significant increase in GHG emissions? Explanation: PA1 supports expanded fintech lending and PA2 enhances the credit information ecosystem. PA 3 seeks to deepen the capital market through developing derivatives. It is not expected that these reforms lead to a significant increase in GHG emissions. Step M2.2: Is the prior action likely to introduce Answer: N/A or reinforce significant and persistent barriers to transition to the country’s low-GHG emissions development pathways? Step M3: Is the risk of the prior action Answer: N/A introducing or reinforcing significant and persistent barriers being reduced to low after mitigation measures have been implemented? Conclusion for PA1, PA2 and PA3: ALIGNED with the mitigation goals of the Paris Agreement. Prior Action 4. To strengthen the management of climate-related financial risks in the banking sector, OJK has established a comprehensive framework for climate risk analysis and risk management policies through CRMS Guidelines. Prior Action 5. To strengthen the Government’s financial resilience to disasters, MOF has established a dedicated mechanism f or the collection, investment and disbursement of resources under the Disaster Pooling Fund through [MOF regulation #28]. Step M2.1: Is the prior action likely to cause a Answer: No. significant increase in GHG emissions? Explanation: PA4 includes assessment and management of climate transition risks. If banks take this risk into consideration, this may lead to the banking sector reducing financing for emissions intensive sectors and hence decrease GHG emissions over time. PA5 will increase disaster resilience, and it is not expected to lead to a significant increase in GHG emissions. Step M2.2: Is the prior action likely to introduce or Answer: N/A reinforce significant and persistent barriers to Page 27 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) transition to the country’s low-GHG emissions development pathways? Step M3: Is the risk of the prior action introducing Answer: N/A or reinforcing significant and persistent barriers being reduced to low after mitigation measures have been implemented? Conclusion for PA 4 and PA5: ALIGNED with the mitigation goals of the Paris Agreement. Pillar B. Pillar B: Enabling Markets for Investments Prior Action 6. To reduce generation cost and increase investment for renewable energy, the Borrower has eased its local content requirements in the power sector for renewable energy projects, as evidenced by MOI Regulations No. 33/2024, 34/2024 and MEMR Regulation No. 11/2024, and MEMR Decree No. 191./EK.01.MEM.E.2024. Prior Action 7. To align industrial development with sustainability goals, the Borrower has established a regulatory framework promoting the adoption of environmentally sustainable practices in Industrial Estates through Government Regulation No. 20/2024. Step M2.1: Is the prior action likely to cause a Answer: No. significant increase in GHG emissions? Explanation: These two prior actions will lead to a significant increase in green and sustainable investment in the country which would support the climate transition and directly contribute to a decrease in GHG emissions. Step M2.2: Is the prior action likely to introduce or Answer: N/A reinforce significant and persistent barriers to transition to the country’s low-GHG emissions development pathways? Step M3: Is the risk of the prior action introducing Answer: N/A or reinforcing significant and persistent barriers being reduced to low after mitigation measures have been implemented? Conclusion for PA6 and PA7: ALIGNED with the mitigation goals of the Paris Agreement. Prior Action 8. To increase infrastructure financing, the Borrower has introduced a Land Value Capture mechanism to recover and reinvest land value increases from public infrastructure investments, supporting private sector participation through Presidential Regulation No. 79/2024. Step M2.1: Is the prior action likely to cause a Answer: Yes. significant increase in GHG emissions? Explanation: This reform could lead to more private infrastructure investment and hence a possible increase in GHG emissions originating from the construction activities. Step M2.2: Is the prior action likely to introduce or Answer: No. reinforce significant and persistent barriers to Explanation: The prior action enables the entry of additional private capital in transition to the country’s low-GHG emissions the infrastructure development investments without creating barriers to development pathways? Indonesia’s low GHG emissions pathways. Most of the emission reduction target in Indonesia’s enhanced NDC (Nationally Determined Contribution) would be met through actions in the FOLU (Forest and Other Land Use) and energy sector, including transportation. Indonesia has also set FOLU Net Sink 2030, aimed to be achieved through reducing emissions from deforestation. Meanwhile the Land Value Capture (LVC) mechanism that leverages the increased value of land resulting from public investments and policy decisions in the Economic Corridors/ Zones can positively contribute to low GHG emissions in several intertwined ways. First, LVC promotes higher-density, mixed-use development in urban areas, hence reducing the risk for deforestation and conversion of productive land in FOLU sector. Second, related to the energy sector, by promoting compact development, LVC reduces the risk for urban expansion Page 28 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) and sprawl, shortens travel distances and creates conditions for low-carbon transport modes. LVC thus has a low risk of locking in carbon intensive patterns. In addition, LVC can attract private capital to fund sustainable infrastructure projects, resulting in the revenue that can be used to invest in green spaces, green buildings and other adaptive infrastructure that mitigate the impact of climate change while lowering the overall GHG emissions. Step M3: Is the risk of the prior action introducing Answer: N/A or reinforcing significant and persistent barriers being reduced to low after mitigation measures have been implemented? Conclusion for PA8: ALIGNED with the mitigation goals of the Paris Agreement. Mitigation goals: PAs 1-7 are not likely to cause a significant increase in GHG emissions. While PA8 could spur greater investment in infrastructure and cause an increase in GHG emissions, it is not likely to introduce or reinforce significant and persistent barriers to transition to Indonesia’s low-GHG emissions development pathways. Adaptation and resilience goals: assessing and managing the risks Pillar A. Mobilizing Finance for Investments Prior Action 1. To increase MSME finance through digital financial services, OJK has increased the maximum loan ceiling by peer-to- peer lenders through OJK Regulation No. 40/2024. Prior Action 2. To increase MSME finance through better credit information, OJK has enabled innovative credit scoring services through OJK Regulation No. 29/2024. Prior Action 3. To increase liquidity in local capital markets, (a) the Government has transferred the regulatory and supervisory authority over security based financial derivatives to OJK through Government Regulation No. 49/2024, and (b) OJK has operationalized the transferred authority by exercising its power to regulate and supervise securities-based financial derivatives through OJK Regulation No. 1/2025. Step A2: Are risks from climate hazards likely to Answer: No. have an adverse effect on the prior action’s Explanation: Climate hazards do not pose any threat to the reforms supported contribution to the Development Objective(s)? under PAs 1-3 promoting SME access to finance and the deepening of capital markets. Step A3: Does the design of the prior action Answer: N/A reduce the risk from climate hazards to an acceptable level, considering climate adaptation good practices applicable to the country context? Conclusion for PA1, PA2 and PA3: ALIGNED with the adaptation goals of the Paris Agreement. Prior Action 4. To strengthen the management of climate-related financial risks in the banking sector, OJK has established a comprehensive framework for climate risk analysis and risk management policies through CRMS Guidelines. Prior Action 5. To strengthen the Government’s financial resilience to disasters, MOF has established a dedicated mechanism f or the collection, investment and disbursement of resources under the Disaster Pooling Fund through [MOF regulation #28]. Step A2: Are risks from climate hazards likely to Answer: No. have an adverse effect on the prior action’s contribution to the Development Objective(s)? Explanation: PA4 and PA5 contribute to climate adaptation by promoting resilience against climate-related hazards. PA4 promotes better understanding of climate-related financial risks for financial institutions and PA5 improves disaster risk finance mechanisms post natural disasters, including those related to climate change. Thus, risks from climate hazards are not expected to hurt the PA’s contribution to the PDO. Page 29 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) Step A3: Does the design of the prior action Answer: N/A reduce the risk from climate hazards to an acceptable level, considering climate adaptation good practices applicable to the country context? Conclusion for PA4 and PA5: ALIGNED with the adaptation goals of the Paris Agreement. Pillar B. Enabling Markets for Investments Prior Action 6. To reduce generation cost and increase investment for renewable energy, the Borrower has eased its local content requirements in the power sector for renewable energy projects, as evidenced by MOI Regulations No. 33/2024, 34/2024 and MEMR Regulation No. 11/2024, and MEMR Decree No. 191./EK.01.MEM.E.2024. Step A2: Are risks from climate hazards likely to Answer: No. have an adverse effect on the prior action’s Explanation: PA6 promotes necessary market enabling conditions for contribution to the Development Objective(s)? investments, by improving the business environment and lowering trade barriers respectively. Risks from climate hazards are not likely to hurt this PA’s contribution to the PDO. Step A3: Does the design of the prior action Answer: N/A reduce the risk from climate hazards to an acceptable level, considering climate adaptation good practices applicable to the country context? Conclusion for PA6: ALIGNED with the adaptation goals of the Paris Agreement. Prior Action 7. To align industrial development with sustainability goals, the Borrower has established a regulatory framework promoting the adoption of environmentally sustainable practices in Industrial Estates through Government Regulation No. 20/2024. Prior Action 8. To increase infrastructure financing, the Borrower has introduced a Land Value Capture mechanism to recover and reinvest land value increases from public infrastructure investments, supporting private sector participation through Presidential Regulation No. 79/2024. Step A2: Are risks from climate hazards likely to Answer: No. have an adverse effect on the prior action’s Explanation: PA7’s contribution through the PDO is through greening eco- contribution to the Development Objective(s)? industrial estates and improving the local government’s ability for mobilizing private finance through land value capture, so climate hazards are not likely to hurt the prior action’s contribution to the PDO through exposure of specific infrastructure to such hazards. For PA7, the underlying principle is to strengthen industrial estates and development with regard to environmental climate and social standards. On climate adaptation, there are provisions for adoption of early warning systems and insuring zones against natural disasters. The reform will increase compliance towards those standards including ISO certifications. For PA8, the objective of Presidential Regulation (Perpres) No. 79/2024 is to implement the Land Value Capture mechanism in the Economic Corridor/ Zone, improving private sector participation in infrastructure development that drives economic growth while promoting sustainable development. Although the Perpres on LVC operates does not specifically emphasize/encourage climate subprojects, climate-related risks associated with its implementation are anticipated and mitigated during the development planning and project stages, in accordance with existing regulatory frameworks related to climate change adaptation and mitigation. These frameworks reinforce sustainability and resilience in infrastructure and spatial policies, including Law No. 32/2009 on Environmental Protection and Management (as Page 30 The World Bank Indonesia Productive and Sustainable Investment Development Policy Loan (P508323) amended by Law No. 11/2020 and Law No. 6/2023)34, Minister of Environment and Forestry Regulation No. 12/2024 on the Implementation of the Nationally Determined Contribution (NDC) for Climate Change Action, Minister of Public Works and Housing Regulation No. 9/2021 on Guidelines of Sustainable Construction Implementation (establishes technical standards for sustainable infrastructure construction that include climate change mitigation), Government Regulation 22/2021 and Ministry of Environment and Forestry Regulation on Environmental Impact Assessment, and Ministry of Finance’s Environmental, Social, and Governance (ESG) Framework and Manual on Government Support for Infrastructure Financing (2022). Step A3: Does the design of the prior action Answer: N/A reduce the risk from climate hazards to an acceptable level, considering climate adaptation good practices applicable to the country context? Conclusion for PA7 and PA8: ALIGNED with the adaptation goals of the Paris Agreement. Adaptation and resilience goals: Risks from climate hazards are not likely to hurt the contributions of PAs 1-8 to the Development Objectives. OVERALL CONCLUSION OF PARIS ALIGNMENT ASSESSMENT: The PDO and reform program is consistent with the implementation of the Indonesia NDCs and National Climate Change Action Plan. All the Prior Actions are Paris-Aligned as per the assessment. Hence, the Indonesia Productive and Sustainable Investment DPL is deemed Paris-Aligned. 34 The Government of Indonesia (GOI) and local governments must prepare an Environmental Protection and Management Plan (Rencana Perlindungan dan Pengelolaan Lingkungan , RPPLH) as the basis for long-term and medium-term development plans (RPJPN & RPJMN at the national level; RPJPD & RPJMD at the regional level). RPPLH explicitly incorporates climate adaptation and mitigation as key components of Indonesia’s development planning. GOI and local governments are mandated to implement Strategic Environmental Assessment (Kajian Lingkungan Hidup Strategis, KLHS) in the preparation and evaluation of spatial planning (RTRW) and development plans (RPJPN & RPJMN for national, RPJPD & RPJMD for regional). KLHS must include assessments of climate vulnerability and adaptation capacity. Page 31 ANNEX 3. Operation Specific Annex A. Poverty and Social Impact Assessment 1. The operation is expected to reduce poverty and improve the welfare of the poor by expanding access to credit and banking services and encouraging business formalization and growth. Actions supported by this DPL are also expected to generate positive distributional impact through efficient and progressive public infrastructure financing mechanisms. The remaining actions are expected to have broadly neutral short-term poverty and distributional impacts. No prior actions are expected to increase poverty or generate notable negative distributional impacts (Table A3.1). Table A3.1: Summary of Poverty and Social Impact by Prior Action Significant poverty, social or distributional Prior Actions effects positive or negative Operation Pillar 1: deepening the financial sector Prior action #1: Expanding SME access to finance through Digital Positive Financial Services Prior action #2: Enhancing the credit information ecosystem. Positive Prior action #3: Developing Capital Markets Neutral Prior action #4: Assessing and Managing Climate Financial Risks Neutral Prior action #5: Establishing Disaster Risk Finance Mechanisms Neutral Operation Pillar 2: enabling markets Prior action #6: Accelerating Renewable Energy Investment Neutral Prior action #7: Greening Industrial Estates Neutral Prior action #8: Land Value Capture Positive 2. Prior action 1: PA1 is expected to reduce poverty through the beneficial growth effects from increasing financial inclusion, expanding Sharia-compliant financing, and improved competition in credit markets for MSMEs. Simplified licensing and increased lending caps for fintech companies are expected to increase competition in the sector. MSMEs will benefit from more readily available credit on more affordable terms, as well as potentially reduced transaction costs from digital platforms. Growth effects and increased labor demand are expected to benefit the entire income distribution with potentially larger proportional benefits for middle to upper income households due to the greater propensity to borrow for business purposes among higher income households. According to the Listening to Indonesia survey in 2024, about 15 percent of households in the poorest quintile borrowed for a business activity, compared to 28 percent of the highest- income quintile. 3. Increasing the lending ceiling for fintech and P2P platforms is expected to boost support to a broader range of MSMEs. Evidence from studies on MSMEs in Indonesia suggest access to finance is a common binding constraint. At 31.3 percent of GDP in 2023, domestic credit provision by banks trails the average of 109 percent of GDP among upper-middle income in the EAP region, and among formal firms surveyed in the 2023 World Bank Enterprise Survey, limited access to financing was the most cited bottleneck to growth. When available, borrowing enables businesses to invest in productive activities, smooth income, and manage shocks. Among Indonesian MSMEs, loan servicing costs accounted for about 9 percent of revenue in 2023 (figure A3.1) but according to data collected in the Listening to Indonesia survey in 2024, the household income of MSME owner-operators typically rose by 16.7 percent after obtaining a new business loan, while total hours worked increased by about 1.7 percent. This suggests recent loans to Indonesian MSME stimulated income growth largely through increased firm productivity. Figure A3.1: MSME cost structure as a share of revenue (left), Bank credit as a share of GPD per capita in EAP (right) Share of MSME Revenue Indonesia bank credit as a share of GDP vs. EAP Profit, 24% Hired wages and Utiliti Loan sevices, es, repayment 5% 3% and banking, Raw inputs, 60% 9% Other, 2% 4. Expanding the peer-to-peer lending sector generates some risks of undercapitalized lenders, and the potential for over-indebtedness among borrowers. However, the regulation supported by this operation mitigates these risks by requiring an OJK license for all P2P lenders to operate, providing an oversight mechanism for financial stability and management practices. To encourage informed decision-making, the regulation also requires transparent reporting of terms and conditions, including the risks and potential liabilities to borrowers. 5. Prior action 2: A large literature finds that improved credit scoring facilitates financial inclusion, improves lending efficiency, and contributes to broader economic growth. Better credit scoring allows financial institutions to extend credit to a wider range of borrowers by reducing information asymmetries, particularly benefiting those previously excluded due to a lack of credit history or financial documentation. In Indonesia these benefits are expected to be especially impactful due to the large informal sector, accounting for at least 80 percent of the labor force and 93 percent of MSMEs. In a 2023 survey of MSMEs conducted by the World Bank, only 11.5 percent of owner-operators believed they had the documentation required to formally register their business, indicating substantial unmet need for innovative approaches for assessing creditworthiness. 6. The PA is expected to have indirect poverty reduction impacts through three channels. First, improved credit scoring will enable less formal MSMEs to qualify for loans they otherwise would not receive. Microfinance institutions and fintech lenders leveraging improved credit scoring tools would increase business investment, profitability, and income smoothing among MSMEs, in turn raising labor demand and promoting resilience. Second, by more accurately assessing risk, improved credit scoring is expected to reduce the need for lenders to charge elevated interest rates to compensate for uncertainty. This effect is likely to lead to more cost-effective borrowing and increased profitability for MSMEs. Finally, expanding the market of eligible borrowers is expected to generate widely dispersed benefits through increased competition in credit markets, which may further reduce interest rates and spur higher profitability and labor demand. 7. Prior actions 3, 4, 5, 6 and 7: These PAs are expected to have neutral immediate distributional or poverty impacts. 8. Prior action 8: The prior action is expected to increase the efficient financing of public infrastructure using a distributionally progressive mechanism. While LVC may pose modest risk of increasing poverty in specific circumstances, Indonesia’s Presidential Regulation No. 79/2024 includes a range of safeguards for vulnerable populations, mitigating these concerns. Compared to other approaches, land value capture (LVC) is an efficient and progressive mechanism to mobilize financing for infrastructural development, especially in underserved urban areas. LVC is a more efficient tax than the most common alternatives—taxes on labor, consumption, or capital—because the latter create deadweight loss while LVC does not. Particularly in the form of a land value tax (LVT), LVC avoids deadweight loss because the supply of land is fixed and perfectly inelastic, such that taxes on land value have no effect on the quantity of land available. Because there is no risk that the supply of land will fall in response, LVC avoids creating economic inefficiencies and distortions. Furthermore, because the relevant increase in land value results from government-sponsored infrastructure development rather than investments by landowners, LVC is also better targeted, obtaining revenue from what would otherwise be windfall gains to landowners. Finally, LVC discourages speculation and land hoarding, incentivizing landowners to develop vacant or underutilized properties to generate income, encouraging efficient land use and positively affecting employment growth. 9. LVC in Indonesia is expected to have strongly progressive distributional effects as land values are highly concentrated among higher-income groups. Housing, a close proxy for land value, demonstrates stark disparities in consumption: the top welfare decile consumes more than 11 times the value of housing per person as the poorest decile, and this gap widens to more than 12 times in urban areas where infrastructure development is concentrated. LVC mechanisms will thus predominantly tax relatively high-income Indonesians and those who benefit the most from public investments, thereby improving the progressivity of tax incidence compared to alternative financing approaches. 10. While LVC mechanisms are generally progressive, some groups such as low-income homeowners in areas with rising demand may experience unintended regressive effects. However, the regulation incorporates several safeguards to protect low-income and vulnerable populations. It prioritizes investment in underdeveloped and underserved areas, including informal settlements and regions lacking basic infrastructure. It mandates public consultations with affected communities to ensure transparency and prevent displacement. Protections against unaffordable tax increases are also stipulated in the regulation, requiring revenue strategies to consider an individual’s ability to pay. Additionally, incentives and compensation mechanisms are available to mitigate financial burdens on lower-income residents. A portion of LVC revenue is earmarked for affordable housing, public services, and critical infrastructure, further increasing the inclusiveness of the reform measure. Figure A3.3: Annual housing consumption in 2023 in millions of IDR 35 Rural Total Urban 30 25 20 15 10 5 0 Poorest 2 3 4 5 6 7 8 9 Richest Source: SUSENAS 2023, World Bank staff calculation. B. Indonesia MAPS Key Recommendations The MAPS has identified priority areas for improvement, which will help GoI to prioritize reforms initiatives: 1. Coverage of the legal and regulatory framework: Undertake critical review of procurement using Swakelola and SOEs procurement: Undertake a study/analysis to assess the use and impact of Swakelola and, in particular whether, how and to what extent Swakelola has an adverse impact on value outcomes in procurement. Consider also the classification of each of the types of Swakelola. Consider conducting a study of SOE procurement, to assess both the impact and operation of the separate procurement regime for procurement by SOEs of public funds and the impact including on competition, integrity and VfM outcomes of business cooperation among SOEs, their subsidiaries and affiliated companies. 2. E-procurement system, financial procedures and the procurement cycle: Ensure that the SPSE and other LKPP systems supporting e-procurement remain up-to-date with current trends and security requirements. A technology refresh through a digital transformation initiative would allow LKPP to enhance the e-GP service offering, security of the system environment and leverage additional value from the data. Expand reporting and information management systems to take full advantage of the information collected through systems to offer notification services to vendors and advanced monitoring and planning tools for procuring entities and LKPP using Open Contracting Data concepts and additional classifications applied to procurement transactions. Consider ensuring an efficient level of interoperability between the SPSE and SPAN (PFM system) so that the GOI could have a full end-to-end procurement and contract information. 3. Strengthening the performance monitoring and measurement mechanisms: Enhanced data analytics dashboard for real-time monitoring and measurement of public procurement performance using pertinent KPIs, including for improving competition, value-for-money, and contract management. 4. Sustainable public procurement: prepare strategy, action plan and practical guidelines including use of Life-Cycle Costing principles in the entire procurement process. Consider undertaking an in-depth assessment to inform the strategic planning process leading to the preparation and adoption of a comprehensive SPP policy/strategy in support of national policy objectives supported by an implementation plan and to support increased participation of women in public procurement. Consider promoting the use of life-cycle costing, issuing technical guidance on its application throughout the procurement cycle. 5. Complaints review mechanism: review of routes and process for appeal against decisions on objection: Consider undertaking a critical review of the various routes currently available to bidders who are unhappy with a final decision on objection, with the aim of identifying whether one of the existing routes may be adapted to meet the MAPS methodology requirements for an efficient and functionally independent administrative review process, or whether a new approach is required such as the establishment of a specialist independent procurement review body. In preparation for the critical review, identify information and data required in order to better understand the functioning of the current arrangements. 6. Procurement performance Audit: Issue written standards and procedures for procurement performance audit, widely disseminate procurement audit guidelines to all inspectors general of line ministries and include targets for specialized procurement audit in the audit plan of BPK (Supreme Audit Institution) and BPKP (Finance and Development Supervisory Agency). 7. Bring Clarity on definition of procurement related Fraud and Corruption and availability of related data: Consider implementing activities at inter-ministerial/agency level to ensure full alignment with UNCAC definitions of corruption, to review and update bribery offenses, clarify definition of KKN and to address and remedy issues raised, including in the context of administrative debarment (blacklisting) in procurement. 8. Improve accessibility of legal framework documents: Consider ways to improve presentation of procurement legal framework documents and search functions to assist identification of relevant documents and specific parts of documents pertinent to particular issues, for practical use and application by stakeholders. Consider also broadening the LKPP’s central collection of procurement legal framework documents to provide access to and search functions for procurement related regulations and guidelines issued by ministries and other organizations. ANNEX 4. Required Accompanying Documentation Letter of Development Policy Fund Relations Note Indonesia—Assessment Letter for the World Bank May 9, 2025 This note provides the IMF staff’s assessment of Indonesia’s macroeconomic conditions, prospects, and policies, based on the latest information available. The assessment is linked to the World Bank’s Indonesia Productive and Sustainable Investment Development Policy Loan (IPSI DPL, P508323). The letter updates IMF staff’s assessment contained in the 2024 Article IV staff report for Indonesia and is based on information available as of April 30, 2025, with projections in line with the reference scenario published in the 2025 Spring World Economic Outlook. Recent Developments, Outlook, and Risks 1. Indonesia’s growth is slowing but remains strong amid external shocks. Growth in 2024 was 5 percent, led by domestic demand. In a reference scenario where tariffs (32 percent, as per April 2) go into effect and remain in place, growth is projected at 4.7 percent in 2025-26, reflecting the direct tariff impact, lower import demand by trading partners, softer commodity prices, tighter financial conditions and high uncertainty affecting investment. A post-April 2 pause on tariffs is unlikely to shift the 2025 outlook, given the adverse spillovers from even higher U.S.-China bilateral tariffs. A pre- existing small negative output gap is projected to widen amid the tariff shock. Inflation is well contained; headline inflation is projected to reverse towards the midpoint of the 2.5±1 percent target range after a sharp drop due to one-off electricity subsidies in January-February 2025, and core inflation is within the target range. Medium-term growth is projected to recover to around 5 percent under current policies. Key elements of the policy agenda are still being defined. Earlier key elements of investment in human capital, expansion of industrial policies (IP), and efforts to boost self-sufficiency in food and energy are now being complemented with plans to step up efforts to improve the business climate and facilitate trade. 2. Near-term risks to the outlook are tilted to the downside. Key external risks include an even more elevated global trade policy uncertainty and potentially tighter-than-expected financial conditions. Domestically, implementing large policy shifts without sufficient guardrails may build up vulnerabilities; maintaining long-standing prudent macroeconomic frameworks, safeguarding policy predictability, and ensuring clear policy communication will help ameliorate these risks. Policy Framework and Settings 3. Prudent fiscal policy settings remain in place. Staff projects a deficit of 2.6 percent of GDP in 2025, broadly in line with the budget (2.5 percent of GDP) approved last October. Measures since then—including a VAT hike with narrower coverage than planned, temporary electricity discounts, and an expanded Nutritious Meal Program (NMP)—would be offset by spending cuts (mainly in infrastructure, though details are pending) to help ensure the budget target is achieved. The projected deficit appropriately provides a moderately expansionary fiscal impulse given the open output gap while preserving needed space to respond to shocks within the fiscal rule’s deficit cap of 3 percent of GDP. The debt-to-GDP ratio would remain at around 41 percent in the medium term, below the 60 percent debt ceiling, and the relatively high debt service-to-revenue ratio around 34 percent would be contained35. Indonesia’s fiscal rules are well-suited to support higher development spending, especially if paired with ambitious revenue mobilization and the rationalization of non-priority outlays. 35 According to the Debt Sustainability Assessment in the 2024 Article IV, Indonesia is at a low overall risk of sovereign stress and debt is sustainable. Public sector debt remains low—at around 40 percent of GDP—as of end-2024. 4. Emerging fiscal priorities require robust guardrails to fend-off risks. Discussions are ongoing on new on-budget spending beyond the NMP, which may be feasible within the fiscal rule, but details on the magnitude and offsetting measures are pending. The budget will also lose some ½ percent of GDP in SOE dividend revenues to the new super-holding SOE company (Danantara), a vehicle intended to finance the government’s strategic projects by leveraging SOE assets and dividends via a range of operational modalities. The new spending and revenue losses pose risks to the fiscal deficit if they cannot be fully offset; possible execution delays as cuts are implemented and new programs come on stream could slow growth. Danantara would expand off-budget fiscal operations and may raise explicit and/or contingent public liabilities. Containing risks will require, inter alia, enhancing policy communication and predictability, establishing robust and transparent governance frameworks for project selection, implementation, and financing, securing a balanced risk-sharing with investors, and running SOEs and public banks based on strict best practices. 5. Monetary policy has been appropriately easing. With softer-than-expected inflation, BI cut the policy rate in January 2025 by 25 bps (to 5.75 percent) to support growth, while holding since then. With the policy rate above its neutral level, BI has supported liquidity and credit growth by loosening its growth-oriented macroprudential tools, as well as through purchases of government bonds in the secondary market planned for the year. A data-driven approach for monetary policy is appropriate, with scope for further rate cuts absent inflationary shocks. 6. Foreign exchange reserves remain adequate. Gross international reserves (GIR) reached US$157.1 billion in end- March, aided by sovereign debt issuance, and remain comfortable; the current account deficit is expected to widen somewhat in 2025, while remaining well contained and sustainable. In early 2025, the rupiah has faced episodes of high volatility, largely in reaction to global market uncertainties, and as domestic policy settings continue to be clarified. While the exchange rate has remained a shock absorber, BI has sought to stem intense exchange rate pressures via FXI (to limit passthrough to inflation) and deployed its local currency short-term instrument (SRBI) to attract FX inflows. The exchange rate should continue to be allowed to move in line with market forces. FXI is appropriate under certain shocks and circumstances given Indonesia’s shallow FX markets; their usage should be judicious to preserve buffers in a shock -prone environment. In March 2025, the government tightened the export repatriation requirement for natural resources exports earnings, which is classified as a Capital Flow Management (CFM) measure. This may be cumbersome to exporters, though operational deductions and some flexibility on investment options by BI offer partial relief. 7. As BI continues to pursue its multiple objectives amid uncertainties, potential trade-offs would need to be carefully managed. BI’s continuing monitoring of any spillovers from the SRBI—the stock of which is stabilizing from its peak—on private sector credit and government securities is welcome. Continuing to anchor BI’s participation in the treasury bond market to monetary policy operations while supporting the gradual recovery of private sector participation in this segment, along with clear communication, will help safeguard BI’s independence. 8. The financial system remains broadly resilient. Indonesia’s banking system is profitable and well capitalized, with a regulatory capital ratio of 25.1 percent as of 2024Q4. Bank credit growth has been robust (10.3 percent y/y in Feb.), with the effects of a higher-than-neutral monetary policy rate diluted by accommodative macro-prudential policy settings. Systemic risks are assessed as moderate and broadly unchanged since the 2024 FSAP. A gradual tightening of macroprudential tools could be considered as the credit gap closes. Clarifying that financial system resilience takes priority amongst objectives as the macroprudential toolkit is calibrated would enhance communication and effectiveness. Policies to enhance the credit infrastructure and support capital market development are key to financial system deepening; other efforts (e.g., on financial supervision and regulation) will support resilience. As the financial sector is mobilized through specific programs under the new government’s priorities, it will be important to ensure that these are carefully designed and ringfenced to safeguard financial resilience and avoid credit misallocation. 9. Carefully designing and monitoring industrial policies would support sustained gains and limit risks. IP for Indonesia’s commodities (“downstreaming”) was first deployed for nickel, which led to an increase in FDI—in refining capacity and most recently in the electric-battery and vehicle industry, and exports of refined nickel. Amid expansions plans, it will be important to regularly assess trade-offs. IP should be designed to tackle identified market failures, avoid hindering competition and innovation, rely on market signals to prevent misallocation risks, and minimize negative cross- border spillovers. To this end, considering domestic policies that help achieve their objectives of raising value added in production and monitoring fiscal costs would be key. Recently announced plans by the President to promptly engage with a wide range of Indonesia’s main trading partners to pursue further integration efforts, and to implement far reaching structural reforms and deregulation measures in response to the U.S. tariff shock—including by reducing or eliminating existing Non-Tariff Measures (NTMs)—and, more generally, to improve the investment climate, are welcome. A decisive, comprehensive, broad and sound implementation of these reforms to reduce trade and investment barriers could strengthen trade, investment, and growth. 10. Structural reforms and closing physical and human capital gaps are critical steps for boosting long-term growth. Given Indonesia’s diversified economic structure, relying mostly on sector-based policies to enhance real GDP growth without accompanying ambitious broad-based structural reform could present challenges. Key structural reform priorities include reducing labor market rigidities, enhancing trade in goods and services, financial sector development, and boosting the investment climate. The focus on human capital, including through the NMP, is welcome; a targeted design could free resources to tackle other human capital gaps. The government is taking steps towards climate change mitigation and energy transition, including through a plan outlining transition steps for on-grid coal-based power generation and lowering local content requirements for renewables. In the long run, a fuller transition out of coal-based power generation, energy subsidy reform and carbon pricing can play an important role to achieve net zero emissions by 2060. IMF Relations 11. Indonesia is on the standard 12-month Article IV consultation cycle. The 2024 Article IV consultation was concluded by the IMF’s Executive Board on July 22, 2024. Table 1: Indonesia: Selected Economic Indicators Bibliography Prior Operational Support Bibliography Actions Pillar A: Mobilizing finance for productive and sustainable investments. World Bank Enterprise Surveys, Indonesia, 2023. Indonesia Third Financial Sector https://www.enterprisesurveys.org/content/dam/enterprisesurveys/ Reform Development Policy Financing PA #1 documents/country/Indonesia-2023.pdf (P173233) Indonesia Financial Sector Technical Assistance (P163296) World Bank. Indonesia - Financial Sector Assessment Indonesia Third Financial Sector (English). Washington, D.C. : World Bank Group. Reform Development Policy Financing http://documents.worldbank.org/curated/en/099103024111024730 (P173233) PA #2 Indonesia Financial Sector Technical Assistance (P163296) World Bank. Indonesia - Financial Sector Assessment Indonesia Third Financial Sector (English). Washington, D.C. : World Bank Group. Reform Development Policy Financing http://documents.worldbank.org/curated/en/099103024111024730 (P173233) PA #3 International Organization of Securities Commissions (IOSCO) Objectives and Principles of Securities Regulation https://www.iosco.org/library/pubdocs/pdf/ioscopd561.pdf World Bank. Indonesia - Financial Sector Assessment Indonesia Third Financial Sector (English). Washington, D.C. : World Bank Group. Reform Development Policy Financing PA #4 http://documents.worldbank.org/curated/en/099103024111024730 (P173233) Indonesia Finance and Private Sector Program (P507301) Indonesia Disaster Risk Finance & Insurance Investment Project PA #5 Indonesia Financial Sector Technical Assistance (P163296) Financing (P173249) Pillar B: Enabling markets for productive and sustainable investments. Montfaucon, A.F., C. Lakatos, B. Agnimaruto, and J.M. Silberring, Indonesia Investment and Trade 2023. “Trading Towards Sustainability: The Role of Trade Policies in Reforms Development Policy Financing Indonesia’s Green Transformation.” Washington, DC: World Bank. (P172439) https://www.worldbank.org/en/country/indonesia/publication/green -trade PA #6 Indonesia Energy Transition and “The Comprehensive Investment and Policy Plan”, Just Energy Sustainable Access to Modern Energy Transition Partnership Indonesia (JETP Indonesia), 2023. for All (P173293) https://jetp-id.org/storage/official-jetp-cipp-2023-vshare_f_en- 1700532655.pdf Indonesia Financing Green Indonesia Country Climate and Development Report (CCDR), 2023 Transformation Investment Project https://www.worldbank.org/en/country/indonesia/publication/indone Financing (P179433) PA #7 sia-country-climate-and-development-report Indonesia Investment and Trade Reforms Development Policy Financing Indonesia Investment & Competitiveness PASA (P177203) (P172439) Advisory Services for Examining Implementation Context and National Urban Development Project Opportunities for Land Value Capture (LVC) in Indonesia, 2022 (P163896) PA #8 Enabling the diversification of financing sources for SNGs to build and Integrated Urban Management and maintain urban infrastructure, 2025 Resilience (P179406)