Documentof The World Bank and InternationalFinanceCorporation FOR OFFICIAL USE ONLY ReportNo: 48639-ID PROJECTAPPRAISAL DOCUMENT ON A PROPOSEDLOAN INTHE AMOUNT OF US$l00 MILLION TO THE REPUBLIC OF INDONESIA AND A PROPOSED INTERNATIONALFINANCECORPORATION EQUITY INVESTMENT OF UP TO US$40 MILLION INTHE INDONESIA INFRASTRUCTURE FINANCE FACILITY INTHE REPUBLIC OF INDONESIA June 2,2009 Poverty Reduction& Economic Management/ Infrastructure Department & Finance & Private Sector Development Department Global Financial Markets Department IndonesiaCountry Unit East Asia Region East Asia & the Pacific Region International FinanceCorporation The World Bank This document has a restricted distribution and may be usedby recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. REPUBLIC INDONESIA GOVERNMENT OF - FISCALYEAR January 1- December 31 CURRENCY EQUIVALENTS (Exchange Rate Effective as of May 27,2009) Currency Unit = Rupiah (Rp) Rp10,320 = US$1 Vice President: James Adams Country Director: Joachim von Amsberg Sector Director: Vikram Nehru Sector Manager: Tunc Uyanik Task Team Leader: P.S. Srinivas Vice President: RashadKaldany Vice President: Jyrki Koskelo Director: Anita George Director: Georgina Baker Manager: Usha Rao-Monari/ Ali Manager: Serge Devieux Naqvi Co-Team Leader: Arun Sharma Co-Team Leader: Denis Clarke Senior Investment Officer: Matthias Hedinger The Indonesia InfrastructureFinance Facility Loan and Equity Investment is a collaborativeBank Group effort. The Bank's loan is being prepared by a team supervised and task managed by P. S. Srinivas (EASFP), and consisting of Jeffrey John Delmon (FEU), The Fei Ming (EASFP), Djauhari Sitorus (EASFP), Neni Lestari (EASFP), Tim Bulman (EASPR), Shubham Chaudhuri (EASPR), Rajat Narula (EAPCO), Unggul Suprayitno (EAPCO), Yogana Prasta (EACIF), Imad Saleh (EAPCO), Amien Sunaryadi (EACIF), Indira Dharmapatni (EASIS), Andrew Daniel Sembel (EASIS), MelindaGood (LEGES), Jose Zevallos (EAPCO), Andri Wibisono (EASIS), and Shienny Lie (EACIF). The IFC equity investment is being co-led by Denis Clarke (CINUT) and Arun Sharma (CGFTG) and includes Mathias Hedinger (CGFP6), Marina Feldman (CLEFM), Robin Sandenburgh(CESI2), and Yoshiko Saito (GCMSM). The joint Bank-IFC team has also worked closely with a number of colleagues from other institutions: V. Subramanian, Adiwarman Idris, Howard Brooke, and Noraya Soewarno (ADB); Manfred Kiefer and Dirk Steinwald (KfW); Hans-Jurgen Hertel, Stephan Blanke, and Rena Haynes(DEG); Peter Dirou, David Hawes, Andrew Dollimoreand RobinTaylor (AusAID). The World Bank team is working under the overall guidance of Vikram Nehru (Sector Director), Tunc Uyanik (Sector Manager) and Joachim von Amsberg (Country Director, EACIF). The IFC team is guided by Georgina Baker, Director CGF, Adam Sack, Country Manager, Indonesia, and the management teams of both the Infrastructure and FinancialMarkets deDartments. FOROFFICIAL USE ONLY ABBREVIATIONSAND ACRONYMS I ADB Asian DevelopmentBank ILFS Private InfrastructureFinancing I Facility APBN National ExpenditureBudget ! Infrastructure,Leasing & Financial Services AMDAL EnvironmentalImpactAssessment .ILkFS IMF InternationalMonetaryFund I ASK1 Indonesian FinancialSystem , IPDP IndigenousPeopleDevelopmentPlan , Architecture AUM Asset Under Management IPO Initial Public Offering 1 AusAID ' AustralianAgency for International Develoument IRh4 , InvestmentReview Meeting * 2 BAPPENAS National DevelopmentPlanning Agency Jamsostek Jaminan Sosial Tenaga Kerja (EmployeeSocial Security) Indonesian Capital Market and Bapepam-LK FinancialInstitution Supervisory JIBOR Jakarta InterbankOffered Rate Agency BAPINDO Bank Pembangunan Indonesia KfW Kreditanstaltfur Wiederaufbau BBD Bank Bumi Daya KIK Kredit Investasi Kecil (Small InvestmentLoan) I National Committeefor the BCA Bank CentralAsia ' KKPPI 1Acceleration of Infrastructure Development , BD Business Development ' KUPEDES : General RuralCredit BDN Bank DagangNegara KUR People's BusinessCredit I BI Bank Indonesia KWh Kilo-wattper hour B11 Bank InternationalIndonesia Land Acquisition & Resettlement LARAP . Action Plan BNI Bank Negara Indonesia LDR Loan Deposit Ratio I BPJT Indonesian Toll RoadAuthority LOC Line of Credit BPN National Land Agency LPS Deposit InsuranceCorporation BPPSPAM Water Sector Advisory Body MIC Middle-Income Country BRI Bank Rakyat Indonesia MIT MassachusettsInstitute of Technology CAR Capital Adequacy Ratio MOPW . Ministry ofPublic Works CAS Country Assistance Strategy MoU Memorandumof Understanding CEO Chief ExecutiveOfficer Mw Megawatt CFO Chief FinancialOfficers NAV Net Asset Value CoordinatingMinistry for Economic CMEA NBFl Non-Bank FinancialInstitution Affairs COI Conflict of Interest NIM Net InterestMargin CPS Country Partnership Strategy NPA Non PerformingAssets , CRISIL Credit Rating& Information Systems of India Ltd. NPL Non PerformingLoan DA DesignatedAccount OM Operations Manual DEG DeutscheInvestitionsund Entwicklungsgesellschaft PDAM Public Water Utilities DGH DirectorateGeneralof Highways PEMDA Local Government Entity DJLK DirectorateGeneral of Financial Institution Perpres PresidentialRegulation DlPA Budget Activity Lists PKSK Financial Sector Policy Package DPL Development Policy Loan PLN State Electricity Company Development Policy Loan- Deferred DPL-DDo DrawdownOption PPI Private Participationin Infrastructure EPF Employer PensionFunds PPP Public-PrivatePartnership E & S Environment& Social PSO Public Service Obligations This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization. ESMS Environment & Social Management , QAG Quality Assurance Group Svstem I ESW ic and Sector Work RDB FEC Fondd'Equipment Communal RoA FIL FinancialIntermediary Loan ROE FIPF FinancialInstitutionPension Fund RPJM Government's Medium-Term Development Plan FSAP FinancialSector Assessment Program SBI !' Central Bank Policy Interest Rate i FSSF FinancialSystem Stability Forum SMI P.T. Sarana Multi Infrastructure , GDP Gross Domestic Product SMIE ' Small MediumIndustrialEntreprises I GO1 Government of Indonesia jSME ISmall MediumEntreprises GWM ' 1Minimum Reserve Requirement SMF Sarana Multigriya Financing t IBRD InternationalBank for Reconstruction and Development SOB State Owned Bank IC Investment Climate SOE State Owned Enterprise IDFC InfrastructureDevelopmentFinance I Company SoE Statement of Expenditure IDR Indonesian Rupiah SPM PaymentOrder IDPL Infrastructure DevelopmentPolicy Inan SPV iSpecialPurpose Vehicle IDX Indonesian Stock Exchange TA Technical Assistance IEG IndependentEvaluation Group ULB Urban Local Business 1 IFC InternationalFinance Corporation , US$ UnitedStates Dollar I IF1 InternationalFinancialInvestment YOY Year on Year , 1G Inspector General YTD Year to Date I IHSG Jakarta Composite Index + IIFF IndonesiaInfrastructureFinance 1 Facility , INDONESIA INDONESIAINFRASTRUCTUREFINANCEFACILITY TABLE OF CONTENTS Page 1. STRATEGIC CONTEXT AND RATIONALE ............................................................................................... 1 A. COUNTRY AND SECTOR ISSUES ........................................................................................................................ 2 B. RATIONALE FOR BANKGROUPINVOLVEMENT ....... ............ c. LINKTOTHE COUNTRY PARTNERSHIPSTRATEGY .. ............................................................. 10 D. HIGHERLEVELOBJECTIVES TO WHICH THE PROJECTCONTRIBUTES ........... ...................................... 11 I1. PROJECT DESCRIPTION ............................................................................................................................ 12 A. THEBANK'SLENDING IFC'S INVESTMENTINSTRUMENTS AND ..................................................................... 15 B. PROJECT DEVELOPMENT OBJECTIVES AND KEY INDICATORS ........................................................................ 16 C. PROJECT COMPONENTS .................................................................................................................................. 17 D. LESSONS LEARNED REFLECTED INTHE PROJECTDESIGN...................................................................... AND 17 E. ALTERNATIVES CONSIDERED AND REASONS FOR REJECTION ........................................................................ 19 111 . IMPLEMENTATION ................................................................................................................................. 20 A. PARTNERSHIPARRANGEMENTS ..................................................................................................................... 20 B. INSTITUTIONAL AND IMPLEMENTATION ARRANGEMENTS ........................................ 20 C. MONITORING EVALUATIONOFOUTCOMES AND RES AND .................................................................... 26 D. SUSTAINABILITY ............................................. .................................................................... 26 E. CRITICAL RISKS AND POSSIBLE CONTROVERSIAL ASPECTS .............................................. F. LOAN CONDITIONS AND COVENANTS ................................ IV. APPRAISAL SUMMARY .......................................................................................................................... 33 A . ECONOMICAND FINANCI NALYSES ......................................................................................................... 33 B. TECHNICAL .................... ........................................................................................................................ 38 C. FINANCIALMANAGEMENT ............................................................................................................................ 38 D PROCUREMENT.............................................................................................................................................. 39 E.. SOCIAL AND ENVIRONMENT .......................................................................................................................... 40 F. SAFEGUARD POLICIES .................................................................................................................................... 41 G. MAINFEATURES THE PROPOSEDIFC INVESTMENT................................................................................... OF 44 ANNEXES ANNEX 1:RECENT MACROECONOMICDEVELOPMENTS ....................................................................... 45 ANNEX 2: THE GOVERNMENT'S INFRASTRUCTUREAGENDA ............................................................... 54 ANNEX 3: INDONESIA'S FINANCIAL SYSTEM .............................................................................................. 61 ANNEX 4: MAJOR RELATED PROJECTSFINANCEDBY THE BANK AND/OR OTHER AGENCIES.70 ANNEX 5: RESULTSFRAMEWORK AND MONITORING ............................................................................. 72 ANNEX 6: DETAILEDPROJECT DESCRIPTION ............................................................................................ 76 ANNEX 7: PROJECTCOSTS .................................................................. ERROR! BOOKMARK NOT DEFINED. ANNEX 8: IMPLEMENTATIONARRANGEMENTS ........................................................................................ 90 ANNEX 9: PROCUREMENT ARRANGEMENTS ............................................................................................... 94 ANNEX 10: FINANCIAL MANAGEMENT ASSESSMENT ............................................................................... 99 ANNEX 11: GOVERNANCEACTION PLAN .................................................................................................... 109 ANNEX 12: ECONOMICAND FINANCIAL ANALYSIS ................................................................................. 116 ANNEX 13: APPROACHTO ENVIRONMENTALAND SOCIALSAFEGUARDS ..................................... 126 ANNEX 14: PROJECTPREPARATIONAND SUPERVISION ....................................................................... 131 ANNEX 15: DOCUMENTSINTHE PROJECTFILE ....................................................................................... 132 ANNEX 16: STATEMENTOF BANK LOANSAND CREDITS ....................................................................... 134 ANNEX 17: STATEMENTOF IFC'S ................................................................................................................... 135 ANNEX 18: INDONESIAAT A GLANCE ........................................................................................................... 137 FIGURES FIGURE 1:INVESTMENTININFRASTRUCTURE ............................................................................................ 3 FIGURE2: FINANCIAL STRUCTURE .................................................................................................................. 6 FIGURE3: STRUCTUREOF THE IIFF ............................................................................................................... 15 FIGURE4: FUNDSFLOW ...................................................................................................................................... 22 FIGURE5: PROJECTEDASSET AND LOAN BOOKBUILD-UP .................................................................. 35 FIGURE6: GDP GROWTH .................................................................................................................................... 46 FIGURE7: REGIONALGDP GROWTH ............................................................................................................. 46 FIGURE8: EXPORT VALUES .............................................................................................................................. 46 FIGURE9: TRADEBALANCE .............................................................................................................................. 46 FIGURE 10: CONSUMERCONFIDENCE ........................................................................................................... 47 FIGURE 11: DEMANDFOR CONSUMERDURABLES .................................................................................... 47 FIGURE 12: IDRVS USD EXCHANGERATE . ................................................................................................... 48 FIGURE 13: REGIONALEXCHANGERATES ................................................................................................. 48 FIGURE 14: INDONESIANDOMESTICBONDYIELDS .................................................................................. 48 FIGURE15: INDONESIANGLOBAL BOND SPREADS .................................................................................... 48 FIGURE16: CREDIT APPROVALS ...................................................................................................................... 49 FIGURE17:BANKING INDICATORS .................................................................................................................. 49 FIGURE 18: INFLATION........................................................................................................................................ 50 FIGURE 19: CAPITAL OUTFLOWS .................................................................................................................... 50 FIGURE20: NATIONAL BUDGETS ..................................................................................................................... 51 FIGURE21:INDONESIA'S GDP GROWTHPROJECTIONS .......................................................................... 52 FIGURE22: FINANCINGNEEDSIN2009 ........................................................................................................... 53 FIGURE23: FINANCIAL STRUCTURE ININDONESIA ................................................................................. 61 FIGURE24: STRUCTURE OF FINANCIAL SECTOR REGULATIONAND SUPERVISION .................... 62 FIGURE25: BROADORGANIZATION STRUCTUREOF THE IIFF ............................................................ 81 FIGURE26: THE IIFFPRODUCTSCHART ....................................................................................................... 83 FIGURE27: FUNDSFLOW .................................................................................................................................... 91 FIGURE28: PROJECTEDASSET AND LOAN BOOKBUILD-UP(INUS%MILLION) ........................... 118 TABLES TABLE 1 KEY FINANCIAL INDICATORSOFCOMMERCIAL BANKS . ....................................................... 5 TABLE 2: INVESTORSINIIFF: OWNERSHIP STRUCTURE(%) ................................................................. 12 TABLE 3: FINANCIAL AND ECONOMICRETURNS ...................................................................................... 16 TABLE 4: DEVELOPMENTIMPACT INDICATORS ....................................................................................... 17 TABLE 5: ALLOCATION OF LOANPROCEEDS ............................................................................................ -23 TABLE 6: SUMMARY OF BALANCESHEETPROJECTIONS ..................................................................... 34 TABLE 7: SUMMARY OF INCOMESTATEMENTPROJECTIONS ............................................................ 36 TABLE 8: SENSITIVITYANALYSIS ................................................................................................................... 37 TABLE 9: SUMMARY OF INFRASTRUCTUREPROJECTPIPELINE ININDONESIA(US$MN) ..........86 TABLE 10: PROJECTEDSANCTIONBY THE IIFFFORPOWER SECTOR PROJECTS ......................... 87 TABLE 11:PROJECTED SANCTIONBY THE IIFFFORTOLL ROADPROJECTS ................................. 87 TABLE 12: PROJECTEDSANCTIONBY THE IIFFFOR OTHERSECTORS ............................................. 87 TABLE 13: ESTIMATEDOPPORTUNITYAND EFFECTIVEMARKET SHARE ASSUMED FORTHE IIFF ............................................................................................................................................................................. 88 TABLE 14: SUMMARY OF BALANCESHEET PROJECTIONS .................................................................. 117 TABLE 15: SUMMARY OF INCOMESTATEMENTPROJECTIONS ........................................................ 119 TABLE 16: SENSITIVITYANALYSIS ............................................................................................................... 120 INDONESIA INDONESIA INFRASTRUCTUREFINANCE FACILITY PROJECT APPRAISAL DOCUMENT EAST ASIA AND PACIFIC EASFP Date: May 28, 2009 Team Leader: SubrahmanyaPulle Srinivas Country Director: Joachimvon Amsberg Sectors: General finance sector (100%) Sector ManagedDirector: Tunc Tahsin Uyanik Themes: Other financial and private sector NikramNehru development (100%) Project ID: PO92218 Environmental screening category: Financial Intermediary Assessment Lending Instrument: Financial Intermediary Loan [XI Loan [ ] Credit [ ] Grant [ ] Guarantee [XI Other: Equity For Loans/Credits/Others: Total Bank financing (USsm.): 100.00 Proposedterms: Variable Spread Loans, standardterms for 24.5 years including9 years grace. Borrower: Republic of Indonesia Indonesia ResponsibleAgency: Director General of State Assets Ministry o f Finance Government of Indonesia Indonesia Ministry o f Finance J1. LapanganBanteng2-4 Indonesia Tel: (62-21) 251-2222Fax: (62-21) 572-2446 suyatno-hamn@yahoo.com Director, Directorate General of Asset Management Ministry o f Finance Indonesia Tel: (62-21) 385-2143Fax: (62-21) 384-4784 Project implementation period: Start July 2009 End: June 2013 Expected effectiveness date: July 3 1, 2009 Expected closing date: December 3 1,20 13 Does the project depart from the CAS in content or other significant respects? Re$ PAD I.C. [ No Does the project require any exceptions from Bank policies? Re$ PAD IKG. [ ]Yes [XINO Have these beenapproved by Bank management? [ ]Yes [XINO I s approval for any policy exception sought from the Board? [ ]Yes [XINO Does the project include any critical risks rated"substantial" or "high"? Re$ PAD III.E. [XIYes [ ] N o Does the project meet the Regional criteria for readiness for implementation? Re$ PAD I% G. [XIYes [ ] N o Project development objective Ref: PAD ILC., TechnicalAnnex 3 The objective o f the Project is to strengthen and further develop the institutional framework o f the financial sector to facilitate financing of commercially viable infrastructure projects and thereby increase provision ofprivate infrastructureinIndonesia. Key performance indicators to judge IIFF#s success include the following outcomes: (i) increase inthe number of commercially viable infrastructure projects achieving financial closure through long-term debt financing, other financial products, and advisory services from the IIFF over the life o f the project; (ii)Increase in the amount o f private capital (including long-term debt and equity) available for infrastructure projects over the life o f the project; (iii)Increased support to government's policy making in private provision o f infrastructure through advisory services from IIFF; and (iv) Increase in privately financed infrastructure in Indonesia. Quantitative targets for these indicators have been incorporated in the results matrix attached to the PAD. Project description [one-sentence summary of each component] Ref: PAD II.D., Technical Annex 4 The IIFF will provide predominantly long-term loans, guarantees, equity investments and other financial products as well as advisory services to commercially viable infrastructure projects. The Bank will provide an investment loan to the Republic o f Indonesia as the Borrower. The Borrower will in turn provide these funds to the IIFF - the sole participating financial intermediary - through SMI (a vehicle established by the Government to channel its equity investmentsand loans to the IIFF). These funds will provide the basis for long-term finance and other financial products offered by the IIFF. The ADB i s also providing a loan to the Republic of Indonesia for the same purpose. Inaddition, IFC, DEG, and ADB are also taking equity stakes in the IIFF. The IIFF will leverage its initial capital base to mobilize capital from domestic and international sources. Which safeguard policies are triggered, if any? Ref: PAD IKF., TechnicalAnnex 10 IIFF complies with OP 8.30 for financial intermediary (FI) lending. The environmental assessment category o f the Project i s "FI". The Bank's safeguard policies that may be triggered by subprojects that IIFF i s likely to finance include OP 4.01 (Environmental Assessment), OP 4.04 (Natural Habitats), OP 4.1 1 (Physical Cultural Resources), OP 4.12 (Involuntary Resettlement), OP 4.10 (Indigenous Peoples), OP 4.36 (Forestry), and OP. 37 (Safety o f Dams). As IIFF will not finance irrigation or agriculture projects, OP 4.09 (Pest Management) is not triggered. As an FI operation, an environmental and social safeguards framework (ESSF) and management system (ESMS) approach is being followed to comply with applicable WBG Policies and IFC Performance Standards on Environmental Social Sustainability (IFC PS). Significant, non-standard conditions, if any, for: Ref: PAD III.F. Board presentation: None. Loadcredit effectiveness: July 2009. Covenants applicable to project implementation: It i s important to highlightthat IIFF can only be established after approvals o f equity investments and loans o f the Bank/IFC and other IFIs involved have been obtained. In this situation, as is normal for project financing which relies on simultaneous conditions precedent beingmet across various sources o f loan and equity financing, it i s clear that there will be a set o f effectiveness conditions prior to disbursement o f the Bank's loan. The World Bank will enter into a Loan Agreement with the Republic o f Indonesia and a Project Agreement with SMI and IIFF. The following are expected to be Conditions o f Effectiveness: 0 the Subsidiary LoanAgreement, acceptable to the Bank, shall have beenduly executed and delivered on behalf of the Borrower and SMI and shall have become effective and binding upon such parties in accordance with their respective terms, subject only to the effectiveness o f the Loan Agreement; 0 the Subordinated LoanAgreement acceptable to the Bank, shall have been duly executed and delivered by or on behalf o f SMIand the IIFF and shall have become effective andbinding uponsuch parties in accordance with their respective terms, subject only to the effectiveness o f this Loan Agreement; 0 the IIFF shall have been legally incorporated pursuant to the Borrower's laws and regulations and the Articles o f Association o f the IIFF shall have been executed by the founding Shareholders and approved by MLHR. 0 the Borrower, through the MOF, shall have issuedthe Business License to the IIFF; 0 the Co-financingAgreement(ADB LoanAgreement) shall have been executed anddelivered and all conditions precedent to its effectiveness or to the right o f the Borrower to make withdrawals under it (other than the effectiveness o f this Agreement)have been fulfilled: the Shareholders Agreement, and any related share subscription documents to be enteredinto by and among the founding Shareholders and/or betweenthe IIFF and the founding Shareholders shall have beenexecuted and deliveredon behalf o f the parties and shall have become effective and binding upon such parties in accordance with their respective terms; the Project Agreement, shall have beenduly executed and delivered on behalf of SMIand the IIFFand shall have become effective and binding uponthe SMIand the IIFF inaccordance with their respective terms; the Operations Manual, includingthe ESSF, acceptable to the Borrower and the Bank, shall have beenadopted by the IIFF; each founding Shareholder shall have subscribed and paid up its respective initial capital contribution in such amount as requiredby the Shareholders Agreement; SMIshall have made available and disbursedfinancing inanamount ofnot less than IDR 600 billion (equivalent to about USD60 million) (less the amount o f the initial equity contribution o f SMIas required under the Shareholders Agreement); and the IIFF shall have appointed and employed a chief executive officer, a chief financial officer and an environment and social safeguards staff acceptable to the Borrower and the Bank. In addition to standard terms and conditions, the Loan Agreement and Project Agreement will contain the following covenants: Except as the Bank and the Borrower shall otherwise agree, the Borrower shall ensure that the IIFF shall not incur any subordinated debt (referring to the loans from the Bank and ADB), ifafter the incurrence of such subordinated debt the ratio of subordinated debt to equity shall be greater than 2.5 to 1. Additional suspension events include the failure o f any o f GoI, SMI or IIFF to perform their obligations under the Subsidiary Loan Agreement, the Subordinated Loan Agreement or the Shareholders Agreement; the failure if IIFF to maintain its business license, the amendment, suspension, abrogation, repeal or waiver o f any o f the Go1regulations that allow the establishment and operation o f IIFF, the Subsidiary Loan Agreement, the Subordinated Loan Agreement, the Shareholders Agreement, the Articles of Association, the Business License or the Operations Manual so as to affect materially and adversely the carrying out o f the Project. I. STRATEGICCONTEXTANDRATIONALE 1 . The proposed project aims to support the Government's efforts to establish a non-bank financial institution - the IndonesiaInfrastructureFinanceFacility (IIFF) that - will assist in the development of, and provide long-term local currency financing to commercially-viable infrastructure projects. The IIFF will support the efforts of the Government of Indonesia to improve the enabling and regulatory environment for infrastructure projects, especially those structured as public-private partnerships. It is anticipated that this will help increase the number of infrastructure projects that can be financed primarily with private sector resources. Initially, the new institution will be owned by the Government of Indonesia (as a minority investor) and a group of International FinancialInstitutions(IFIs), but the expectation is that they will bejoined as shareholdersby at least two commercial banks (probably one international and one domestic) within its first year. It will be managed on a commercial basis to provide a return to its shareholders by financingsound, well-financedprivate infrastructure ventures'. The IIFF will be established after Board approval and its staffing and final operations manual will be put in place prior to project effectiveness. 2. The IIFF is an integral part of a comprehensive Government strategy to accelerate investment in infrastructure as Indonesia further establishes and enhances its middle-income country (MIC) status. The Government has requested the Bank Group to support its efforts in establishing the IIFF as part of its own development priorities and poverty-reduction agenda through the release of a key constraint on the country's economy growth - inadequate infrastructure. This innovative Bank Group initiative has featured the participation of both the Bank and the IFC throughout the preparation process, and is expectedto result in both institutionsprovidingfinancial support to the IIFF. This may provide a model for future joint Bank/IFC support to important Government initiatives in Indonesia. 3. This financial sector initiative complements several sectoral and macroeconomic initiatives aimed at accelerating infrastructure development in Indonesia. It grows out of sustained efforts by the Government and the Bank to return infrastructure investment to the required levels since Indonesia began to recover from the Asian financial crisis in the early years of this decade. This section providesbrief descriptions o f and interplay between the broad country context, the infrastructure sector context, the financial sector context, providingthe rationalefor setting up such a new institution'. ' IIFF is modeled on similar institutions elsewhere, notably the Infrastructure Development Finance Corporation in India (in which IFC was an early investor) which succeeded in raising the quality of infrastructureinvestmentand the confidence of domestic lendersin supporting it. 'Detailed discussions of the overall reform agenda in Indonesia are available in the recent Country Partnership Strategy (Indonesia: Country Partnership Strategy FY09-12 (Report No. 44845-IND), 2008), Fifth Development Policy Loan (Indonesia: Fifth Development Policy Loan (DPL 5) (Report No. 46332-ID), 2008), and Public Expenditure Support Facility (DPL-DDO) (Indonesia: Public Expenditure Support Facility (PESF) Development Policy Loan with Deferred Drawdown Option (DPL-DDO) (Report No. 47280-ID), 2009). Detailed discussions of the overall infrastructure sector issues are available in the Second Infrastructure Development Policy Loan (Indonesia: Second InfrastructureDevelopmentPolicy Loan (Report No. 46328-ID), 2008) documents. 1 A. Country and Sector Issues Country Context 4. Indonesia's economy has rebounded from the 1998199 crisis. Supported by sound policies and a favorable external environment, output has grown strongly, inflation has been reduced, and international reserves continue to be close to all time highs. The government, banking, and corporate sectors have reduced balance sheet vulnerabilities. Indonesia's economy grew 6.3% in 2007 and 6.1% in 2008 despite the impact of the global slowdown in the second half of 2008. High commodity prices and the rapid growth of coal and palm oil exports have played their roles, but strong domestic investment and consumer demand have also been drivers of growth. Indonesia has had a primary budget surplus in each of the last three years and has maintained its overall budget deficit at low levels - 1.3 % of GDP in 2007 and a near balancedbudget in 2008. Indonesia's debt-to-GDP ratio has declined significantly from 55 % in 2004 to 33 % in 2008. The country entered the ongoing global financial crisis in a relatively strong position. Annex 1 provides further details of recent economic developments. 5. Indonesia's economic improvement has been recognized by the rating agencies. In February 2008, Fitch upgraded the country's sovereign rating from `BB-' to `BB', two notches below the Investment Grade for foreign and domestic currency debt, praising Indonesia's aggressive structural reforms. In October 2007, Moody's upgraded Indonesia's ratings to reflect the country's track record of fiscal prudence and improvements in its external position, as well as ongoing structural reforms and sound policy management. The government's foreign- and local-currency bond ratings were upgraded by one notch to Ba3 from B1, while Indonesia's foreign-currency bond ceiling was upgraded to Ba2 from Ba3. Moody's also upgradedthe country ceiling for foreign-currency bank deposits, from B2 to B1. This positive trend was reflected in a substantial reduction in IFC's country spread for Indonesia earlier this year. 6. Recent turmoil in financial markets has affected Indonesia. Because of its relatively open capital account, the significant foreign presence in Indonesia's stock and bond markets and the legacy of the 1997198,crisis(which has left Indonesian investors sensitive to exchange rate movements and prone to capital flight), Indonesia was hit hard last October and November. The Government has taken a series o f steps including arranging a US$5.5 billion contingent facility with the World Bank, the ADB, Japan, and Australia. The 2009 budget, approved in November 2008, expands the planned deficit from 1 % of GDP to 2.5 %. These measures appear to have restored stability to financial markets and prospects of renewed growth. The Bank expects growth to slow to 3.4% in 2009, before gradually recovering to the 5% range in 2010. Indonesia is expected to weather the global slowdown relatively well. Political Considerations 7. Susilo Bambang Yudhoyono became the first directly elected President of Indonesia in 2004. His party has received just over 20% o f the vote in parliamentary elections in April 2009 making it the single largest party in the new parliament. Polls currently show that the incumbent in the lead in Presidential elections in July (or September, should a run-off election be necessary). The consolidation of democracy and the re-election of a reformist government in sufficient strength to press forward with its reform mandate over a new term, is encouraging. During its current term, the Government has demonstrateda willingness to make difficult decisions to ensure sound governance in the financial sector. Actions included the investigation and conviction on corruption charges of senior executives o f state-owned enterprises. This focus on sound governance i s in line with the Government's desire for the IIFFto have operational independence. 2 InfrastructureSector context3 8. Indonesia has among the lowest levels of access to infrastructure investment in the region. Following the 1997/98 financial crisis, infrastructure investment fell from over 7% of GDP tojust over 2% in 2001 (see Figure 1). Since then, infrastructure investment has risen to over 3% of GDP, insufficient to meet the growing demand from existing infrastructure users, or to address the needs of the large parts of the populationwho do not have access to basic infrastructure services. The decline in investment was particularly dramatic in the energy sector, resulting in widespread blackouts and load shedding. Investment in water and sanitation has long been insufficientto expand access to piped water or to begin developing adequate sewerage systems. Transport investment has held relatively steady as a proportion of GDP, but realizingthe potentialbenefits o f an expanded highways network and urban mass transport systems is likely to require significant additional resources beyond current investment levels. Inadequate infrastructure is now widely seen as a key constraint to sustained economic growth and poverty reduction in Indonesia. The Government's infrastructure program addresses several challenges facing public and privateinfrastructure investment, and the Bank has supported progress in the most significant elements of the Government's reform programthrough its IDPL series. Further details of the Government's infrastructure developmentprogramare available in Annex 2. 9. While public spending on infrastructure has increased since 2000, private sector interest has yet to return. The Government is drafting its 2010-2014 five-year plan, during which it estimates it will require infrastructure investmentsworth roughly 5 % of GDP - approx. IDRl800 trillion or US$170 billion. Given limited fiscal space, encouraging substantial private sector investment in infrastructure is one of the Government's highest priorities. It aims to secure IDR365 trillion or US$33 billion worth of private infrastructure inve~tments~overthe next five years. However, past attempts have consistently fallen far short of expectations.Significantprogress must be made on several fronts to mobilizeprivate sector investment, includingthe creation of good infrastructure sector policies, well-designed projects and concession contracts, and a transparent investor selection process. The capacity of the financial sector to provide the long-term local currency financing without which such projects cannot offer competitively-priced infrastructure services must also be developed. The proposedproject is at the heart of a suite of new initiativesto address these constraints. Figure 1: Investment in Infrastructure ( O hof GDP) 6 - .. 6 -~ ~-~ ~ 5 . 5 ______ __ 4 -~ - 4 3 3 2 2 1 1 0 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 10Water and Sanitation Energy EJTransportOTelecornsj 10NationalGov't Sub-national Gov't EiSOE 0 Private] Sources Indonesian Government statistics for national and sub-national governments, Annual reports for state-owned enterprises, with data for PT Telkom in 1997 and 1998 interpolated from the data for 1996 and 1999, World Bank's PPI database for private investment,excluding cancelledprojects For more details, see Indonesia: Second InfrastructureDevelopment Policy Loan (Report No. 46328- ID),2008. Presentationby Bappenason February 10,2009. 3 10. The Government is pursuing PPP transactions in all infrastructure sectors, including toll-roads, power plants, natural gas pipelines, railways, ports, bulk water plants, airports, and telecommunications projects. Modest results are beginning to show. Some short sections of toll-roads and small bulk water treatment plants have begun operation. Construction has commenced on over US$2 billion worth of new PPP projects, including power plants, toll-roads, and water treatment plants. Slow progress has generally been the result of poor project preparation and inadequate background analysis prior to tendering, resulting in unrealistic expectations by tendering agencies. Over the past year the Government has strengthened the project preparation process and placed greater emphasis on the use o f qualified external advisers. For example, an electrical plant in Central Java i s being prepared with the assistance of an IFC advisory mandate. The ADB has mobilized a PPP project development facility funded by a US$26.5 million loan and a US$7.5 million grant provided by the Netherlands. The facility supports 20 national and sub-national PPP projects, including toll-roads, ferry terminals, bulk water supply systems, railways, an airport, and atelecommunications project. Current support emphasizes improving the quality of feasibility studies prior to bidding. The Bank i s undertaking a review o f the PPP program, to identify areas for additional technical assistance. 1 1 . The Ministry of Finance currently only authorizes guarantees or direct financial support for PPPs that comply with Perpres 67. This requires three bids from a competitive tendering process, and does not allow for the "Competitive Dialogue'' process that is used to develop PPPs in most countries successfully applying this model. Given the infancy o f Indonesia's PPP program, the inability to develop projects through a dialogue with those investors capable and potentially interested in delivering the services has proven a practical barrier. Revisions to Perpres 67 are being considered that would authorize negotiations with bidders in cases where fewer than three bids are received. This would open the way for the provision of Government support to a wider range o f transactions and increase the number of bankable projects. 12. The Government is also taking measures to address land acquisition issues that have blocked private toll-road development. The Ministry o f Public Works established arevolving land fund in January 2007. The fund finances land acquisitions for toll-roads, and i s reimbursed by the concessionaire when land acquisition is completed. The fund has been accessed by eight toll-road concessionaires, of which six have now commenced construction: one toll-road section is already operational. 13. Fourteen toll-road concession contracts awarded prior to the financial crisis in 1997/98 have not moved to financial close in part because of an escalation in the cost of land acquisitions. The Government has developed a "land-capping'' scheme, under which the concessionaires will pay 110% of the land costs initially envisaged, with the Government to pay for the remaining land acquisition costs. The Government funds available for this scheme are capped at IDR4.9 trillion. The Government intends to terminate transactions that do not move to financial close after accessingthe land-capping funds. 14. In addition to the IIFF, the Government is also developing other institutions to support infrastructure financing. A Guarantee Fund is being prepared to ensure the availability of government money to honor guarantees made to private infrastructure projects. The amount of money available in the fund will cap the level o f contingent liabilities the Government may assume. The Bank is providing technical assistance in the development of the Guarantee Fund. 15. The IIFF aims to draw many of these initiatives together and apply focused policy advice, project finance expertise, commercial-drive and the advantages o f access to attractive long-term finance to raise private investment in infrastructure over the next five years to several times its current levels. 4 FinancialSector Context 16. Banking continues to be the largest subsector in the Indonesian financial sector, representing about 80% of all financial assets (about IDR2942 trillion, 59.4% of GDP) in 2008. Bank Indonesia data for February 2009 indicates the banking sector's financial performance remains sound, despite ongoing volatility in global financial markets and its adverse impacts on Indonesia. The gross Non-Performing Loan (NPL) ratio at the end of February 2009 was 3.7%, up from 3.2% in December 2008. The banking sector's Capital Adequacy Ratio (CAR) was 18.1% as o f February 2009. Profitability as measured by the ratios of annual return on assets (ROA), return on equity (ROE), and net interest margin (NIM)are quite high, at 2.6%, 10.5%and 5.4% respectively. Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Feb-09 I CAR(%) I 1930 I 2052 I 1758 I 1726 I 1 6 7 6 I 1804 I I NIM(%) I 570 I 564 I 565 I 573 1 566 I 536 I ~ ~~ YPL (Gross)( O h ) 4 07 375 3 5 4 3 3 2 3 2 0 372 ROA ("0) 2 78 272 253 2 6 4 253 2 6 ROE ( O h ) 1798 1900 1908 1840 1438 1045 Op Ex/Op Inc (YO) 8405 85 19 8530 8372 8859 9654 LDR(Yo) 6632 7066 73 89 7772 7458 735 Earning Assets Provision(YO) 19395 14779 12077 14704 16812 15453 1 Deposits(IDR Trillion) I 1,5108 I1,4662 I 1,5542 1 1,6035 11,7533 I1,7711 1 YoY Growth (%) 1740 135 147 I 4 5 161 199 Loan (IDR Trillion) 1,002 0 1,036 1 1,148 4 1,246 1 1,307 7 1,301 8 YoY Growth (YO) 26 5 2 9 4 333 363 305 298 I Assets I 1,986 5 I1,944 7 I2,040 8 I 2,125 4 I 2,310 6 I2,343 7I YoY Growth (YO) I 7 3 14 I I 5 2 148 163 208 5 Figure 2: Financial Structure Mutual Funds Secunties Firm 2% Finance Companies 2% Rural Inst, 5% \i\ , Pension Funds 4Yo 4 . % ProportionofDepositsper Febtuari2009 (Total BreakdownLoanBasedonPurposeof Deposits:tDR1,771,09&Billiofis] Borrowings per Februari2009{TotalLoans:ID? 1,301,844 Billions) 1month Deposits -... Source: Staff estimates using official data from BI and Bapepam-LK 18. The assets of NBFIs remain small relative to overall financial assets and GDP. However, this group of institutions has recorded substantial growth rates in recent years. The mutual fund and life insurance industries are the major contributors to the growth of NBFls, recording particularly strong growth in 2007. The Net Asset Value (NAV) of the mutual fund industry grew by 79% in full-year 2007 to reach IDR92.2 trillion -this after the sector experienced a crisis in 2005 that nearly devastated the sector. Bapepam-LK has made serious efforts to avoid a repeat of that crisis, and investor confidence has returned to the mutual fund industry. In addition, life insurance assets also posted a significant increase - 43.9% annually - to reach IDR102.2 trillion in December 2007. The investment portfolios and gross premiums also increased significantly, by IDR91.8 trillion (47.6% YoY) and 1DR45.6 trillion (65.8% YoY) respectively. This impressive growth has been attributed to the public's increasing awareness of life insurance and the popularity o f investment-linked products: this market had reached IDR29.3 trillion or 3 1.9% of life insurance investment by the end of 2007. 19. NBFIs do not have adequate long-term instruments in which they can invest. Their asset allocation i s skewed towards sovereign bonds and short-term debt instruments. 6 The growth of the NBFI sector indicates that there is a significantpotential demand for well- structured long-term investment alternatives, as NBFIs' liabilities are typically long-termand they look to minimizematurity mismatchesthrough investments in long-term assets. 20. The financial sector in Indonesia is regulated by two separate entities: (a) BI, the country's Central Bank, has been independentofthe government since 1999 and is responsible for the supervision and regulation of deposit-taking financial institutions (Le. banks) and authorized money changers; and (b) Bapepam-LK which i s responsible for the supervision of all non-bank institutionssuch as capital markets, pension funds, insurance, venture capital, multi-financeileasing companies. Bapepam-LK is part of the Ministry o f Financeand will be responsiblefor regulatingthe IIFF. 21. Indonesian financial institutions are beginning to feel the impact of the global financial crisis although the sector is still consideredstable and sound. Indonesianbanks' direct exposure to troubled American- and European-domiciled banks is limited. Far fewer new loans are being approved and disbursed by Indonesian banks as they adopt more stringent credit norms and maintainhigher liquidity. Consequentlyanecdotal reports suggest that new customers are having difficulty accessing credit from banks. Interbank lending improved between late 2008 and March 2009, and there is sufficient overall Rupiah liquidity in the system.However, the liquidity is not well distributed, with larger bankstypically being liquid and smaller banks less so. Further details are provided in Annex 3. There have been some signs of stress in the quality of loans starting from September 2008 that resulted in a slight increase inNPLs. However, this is unlikelyto have a substantial impact on the financial health of banks as provisioningand capital is adequate. Credit risk may rise as weakening revenues (especially in export companies) coupled with difficulties in rolling over debt payments adversely affect the financials o f some companies. The NAV of mutual funds fell by 20% to IDR74 trillion (throughout 2008). A more substantial decline is seen in life insuranceindustry with gross premiumgrowth decliningfrom 66% to only 5% (over 2008). Impact of financial sector structure on infrastructure financing 22. A major challenge in Indonesia is the shortage of long-term resources needed to appropriately finance infrastructure investment. Infrastructure projects typically require almost all capital investment to be made before any revenue is generated and may have a "working" life of positive cash flows measured in decades. Even with debt tenors of I O years and above, debt service will often be the single largest annual project expense and with shorter tenors, debt service can only be met by very high tariffs. Without long-term debt, private infrastructure is unlikely to be competitive. Even if long-termdebt is available in foreign currency, the additional risk of foreign exchange losses will dissuade many potential private investors, particularly in Indonesia which has experienced dramatic devaluation in the past (for example: from IDR3,000/US$ to a low of nearly IDRl7,000/US$ during 1998- '99). However, long-termRupiah financing is scarce in Indonesia and limited largely to corporate lendingto a few "blue chip" companies. Given the expected stability of their cash flow once they are operational, infrastructure projects must be relatively highly geared to combine low unit costs of delivery(Le. tariffs) with a reasonablereturnto the equity investors. In these circumstances, fixed rates are highly desirable as interest rate "spikes" couldthreaten project viability. 23. The Government recognizes that local currency financing can be an important public sector risk-mitigation mechanism. Local currency financing often also requires less public support to mobilize than foreign currency financing. It removes exchange risks from both public and private investors that may act as a significant deterrent to long-term investment commitments to infrastructure. It is therefore in the Government's best interest to develop sound infrastructure financing facilities and bond markets to tap into local currency resources for projects, particularly in sectors where foreign exchange risk is perceived to be high(e.g., transport and water and sanitation). 7 24. Through the IIFF, the Government acknowledges that an institutional solution is needed to address the lack of long-term financing for infrastructure projects and to mobilize and lead private capital into commercially-viable infrastructure projects at the national and local level. A specialized private, non-bank financial institution, the IIFF will expand the role of the private sector in financing and operating infrastructure as similar institutionshave done inother countries. B. Rationalefor Bank Group Involvement 25. The Bank Group is working closely with the Government and key development partners to expand infrastructure provision in Indonesia. To date, the Bank's focus has been to improve sectoral policies, establish appropriate public institutional mechanisms to support privateinfrastructure, and improve the overall investment climate. The IFC's work in the infrastructure sector in Indonesia has focused on advisory work (notably in the power sector) to create good-qualitycontractual structures and an appropriate format for awarding concessions. The creation of a financialinstitutionlike the IIFF is the logical extensionof the work done to date. As a technically strong independent Indonesian national institution, the IIFF is expected to be particularly effective in pressing for the needed reforms and quality improvements. Even with better concessions, long-term domestic currency financing will continue to be an essential ingredientthat the IIFF can provide. The IIFF's ability to support the equity requirements of pioneering projects in itself may prove an important catalyst for other institutionalinvestors. 26. The Bank Group can leverage its own relatively modest financial support for the IIFF to encourage infrastructure investment, First, the involvement of the Bank Group brings credibility to such a financial institution and improves private investor confidence. These are key issues in an environment such as Indonesia, where private investors are wary of committing significant long-term resources to infrastructure. Discussions with potential investors indicate that they are willing to consider investing in Indonesian infrastructure if the Bank Group plays a lead role. Secondly, the Bank Group's involvement provides it with a platform to encourage key reforms in the financial infrastructure and capital markets that can ease private financing of infrastructure. Thirdly, through its structuring of the project and ongoing involvement, the Bank Group can help build infrastructure- and project finance skills, areas in which the financial sector is weak, Finally, the catalytic presence of the Bank Group has already helped mobilize other IFIs and development partners inthis effort and will also be key to mobilizing resourcesfrom private investors. The Bank's role and expected contribution 27. The Government has requested the Bank to support its efforts to establish the IIFF. Close cooperation between the Go1 and the Bank on alternative approaches to stimulating private investment in infrastructure led to the formulation of the IIFF concept. The Government values the Bank's continued leadership and ongoing engagement with the IIFF to ensure its success. Given some of the controversy associated with private infrastructure in Indonesiainthe past, the Government is looking to the Bank Groupto ensure the strongest possible corporate governance standards for the IIFF, as well as ensuring that the IIFF implements strong internal policies and procedures. A reputation for professional excellence and transparency, as well as a long-termdevelopment focus is essential ifthe IIFF i s to assume its expected leadershiprole. A leadership role i s essential if it i s to achieve the necessary enhancements in project design and contractual structures that will ensure a pipelineof infrastructure projects. 28. The Bank has already played a significant role in the development of the IIFF. The Government first raised the idea of establishing an infrastructurefinancing institutionin early 2005, shortly after comingto office. The Go1requestedthe Bank to support its efforts 8 to establish the IIFF, and Indonesia's Finance Minister has closely monitored its progress. Because of this high-level engagement, the Project has received strong endorsements from within the Government, the international donor community and multilateralorganizations. 29. The Bank has provided intellectual leadership throughout the project development process. The Bank is the principal liaison with the Government and has been effective in translating high-level government support into active decision-making at the operational level. The Bank with the Government co-chairs the stakeholder Working Group that has developed the project, and coordinates all grant-funded activities that have been financed by other donors. The Bank has also coordinated the process of bringing to the project several of Indonesia's development partners - AusAID, ADB, and KfWDEG with IFC leveraging its wealth of experience creating and supporting similar institutions abroad. These development partners, along with the Bank Group, have providedthe Governmentwith input on international best practice in this area and provideddetailed guidance and advice. The IFls as a whole have mobilizedsubstantial amountsof grants for the projectdevelopment effort. 30. The IIFF will benefit from long-term debt provided by the Government through loans provided by the Bank (and the ADB). These loans will allow the IIFF to undertake early operations and start hnding projects as soon as the right opportunities become available despite turbulence in capital markets. They also provide a layer of capital that can be leveragedthrough borrowing in capital markets providinga significant multiplier effect to the Bank's loan. IFC'sRole and Expected Contribution 3 1. IFC has already played a major role in helping structure the project according to international best practice based on its experience with similar institutions in other countries. IFC has played a lead role supervising the project's feasibility study, developing the business plan, identifying potential private sector investors and developing an implementation strategy for the Project. Several other benefits are expected from IFC's participation: 0 Seed Capital; IFC's equity contribution to the IIFF's minimum regulatory capital will help the Project to come into existence and will serve as the basis for further capital increases, which in turn will enable the IIFF to leverage its share capital and build a substantial loan portfolio. A relatively small equity investment will have a significant multiplier effect when it comes to providingfinancingfor the infrastructure sector. 0 Demonstration Effect: The Bank Group's participationwill have a positive signaling effect on other IFIs and the GoI. IFC experience in both the private infrastructure space and in establishing greenfield infrastructurefinance institutions are compelling reasons for other investors to participate in the Project, and IFC has provided significant support to the Government on approachingpotentialprivate investors. ZFC's Technical Expertise is contributing to the design of the IIFF's shareholding structure and implementation plans. The IIFF's Environmental and Social safeguards Framework (ESSF) will be consistent with IFC's Performance Standards for Social and Environmental Sustainability (IFC PSs), the Bank's safeguard policies, and relevant Government laws and regulations.This is expectedto raise E&S standards in Indonesia's new private infrastructure investments. IFC's Integrity Due Diligence (IDD) processes will be factored into IIFF's own processes with regard to subprojects. The selection of the IIFF's management team, the design of credit processes and risk management systems, and the implementingof the IIFF are all areas where IFC, working with the other stakeholders, is playinga leadership role. 9 Guidance through Operations: IFC will have a seat on the IIFF's Board of Commissioners and will provide guidance and close supervision to the IIFF, particularly inthe early operations stage. C. Link to the Country PartnershipStrategy 32. The proposed project is in line with the Bank Group's Country Partnership Strategy (CPS) for FY2009-12 to invest in Indonesia's institutions. The CPS explicitly identifiesprivate sector development and infrastructure as two of the five thematic areas that form the core of the Bank Group's engagement in Indonesia5.The proposed project is a key component of the Bank's CPS and complements other Bank lending and non-lending activities to significantly improve infrastructure provisionand strengthenthe financial sector. The establishment of the IIFF is also closely linked to the program of infrastructure reform actions that is supported by the Bank's IDPL series. 33. The proposed project supports the CPS strategy of "...strengthening the institutions involved, both state and non-state". The IIFF is a new financial institutionthat complements the existing financial sector, but at the same time is a unique partnership between the Government, multi- and bi-lateraldonors/investors and the private sector, to be managedprivately and run alongcommercial lines with independenceand full accountability. Such institution-buildingis fully consistent with the CPS argument that "Indonesia's main constraint today is ..,.theneed for effective and accountable institutions that can translate available resources into better development outcomes". One of the specific areas of support laid out in the CPS is the IIFF "the WBG is furthermore supporting the establishmentof an - innovative infrastructure financinginstitutionthat will helpto accelerate privateinvestment in infrastructure". 34. The IIFF fits firmly into IFC's Infrastructure Dept (CIN) strategy for Indonesia. It reinforces the capacity to structure infrastructure projects, develops long-term local currency lending, and provides for direct financing o f infrastructure projects at sub- national levels. This is in line with CIN's strategy in Indonesiato focus on: (i) Sub-sovereign sectors; (ii) Select opportunities in power generation (particularly renewables), coal logistics and transportation, and water; (iii) Providinglonger tenor debt, equity and quasi-equity on an opportunistic basis to help sponsors meet strategic objectives; (iv) Investments in an Indonesia infrastructure fund; and (v) collaboration with Advisory Services on financing solutions for infrastructure projects. 35. The IIFF is also in line with IFC's Global Financial Markets (CGF) department's strategic objectives. The proposed project will increase the direct flow of financing to a sector that is a critical constraint to growth and raise environmental and social standards in Indonesia's new private sector infrastructure investments. Moreover, the IIFF will make an important contribution to developing long-term lending in local currency, thereby helpingto balance maturity mismatches. Through its high local rating and need for long-term funding, the IIFF will also offer alternative long-term investment instruments (e.g. local currency bonds) to institutional investors. This is in line with CGF's five strategic objectives in Indonesia: (i)IncreaseAccess to Finance, (ii)ImproveFinancialIntermediation, 'Indonesia: Country Partnership Strategy FY09-12 (Report No. 44845-IND), 2008. In addition to its cross-cuttingengagements to strengthencentral and sub-national government institutions and systems, this CPS identifies five thematic areas that are expected to form the core of the WBG's engagement: (i) Private Sector Development; (ii) Infrastructure; (iii) Community Development and Social Protection; (iv) Education; and (v) Environmental Sustainability and Disaster Mitigation. 10 (iii)Strengthen and Expand the Social Safety Net, (iv) Develop Capital Markets and (v) Improvethe Environment and Environmental Sustainability. D. Higher Level Objectives to Which the Project Contributes 36. The project is aimed at helpingIndonesia sustain economic growth and poverty reduction in line with the Government's 2004 - 09 medium-term development strategy (RPJM) as well as its commitments under the Millennium Development Goals. Infrastructure is a key constraint to growth and poverty reduction in Indonesia. Gettingsubstantial investment into infrastructure - in particular private investment requires - significant progress in parallel in several areas: sectoral policies, well-designed projects and concessions, an improved investment climate and institutional capacity in the financial sector that can finance infrastructure. The Bank is already assistingthe Governmentof Indonesiain the first three areas. Ongoing work by the Sustainable Development Unit of the Bank - supported by a series of Infrastructure Development Policy Loans is aimed at improving - infrastructure sector policies, identifying and structuring sound projects, and putting in place a responsiblerisk managementframework. ImprovingIndonesia's overall investment climate i s the focus o f the work done by the Bank's Private Sector Development unit. IFC i s providingAdvisory Services on financingsolutions for infrastructure projects. This proposed project aims to complement and reinforce all of these on-going efforts to design and invest in sound private infrastructure ventures. 11 11. PROJECTDESCRIPTION 37. The IIFF is the Government's response to the lack of long-term financing for infrastructure projects. The IIFF will catalyze private investor interest in commercially viable infrastructure projects at boththe national and local level by addressing(i)the shortage o f specialized project finance and infrastructure expertise; (ii) the design and quality o f infrastructure concessions and (iii)ensuring the availability of long-termdebt while offering additional sources of equity. It will be majority privately-ownedand is expected to earn a commercial rate of return for its shareholders. The IIFF will be established after Board approval and its staffing and final operations manual will be put in place prior to project effectiveness. Investors: Equity Shareholdingat Incorporationin US$million: US$million equivalent: Note: IIFF will be incorporatedby the IFIs and Go1 with 6 regulatory minimum capital of IDR 100 billion (equivalent to about US$lOmillion). Equity is expected to reach $200 million equivalent at ramp-up which could occur between year 5 and 7. During this period, private-sector investors are expected to join IIFF and take up a sizeable portion of IIFF's shares. IFIs and Go1 are expected to be diluted as private-sector investors acquire stakes in IIFF. 38. The IIFF will be commercially oriented with private sector governance, mandated and equipped to mobilize local currency private financing of the right tenor, terms and price for the development of creditworthy infrastructure projects in Indonesia in at least three ways: 1) by using its balance sheet structure and good credit rating to borrow from the private debt market, in particular from institutional investors and then lendingthese funds to individual projects on terms appropriate for private, commercially funded infrastructure projects, preferably on a co-financingbasis mobilizing other sources of financing; (2) by providing financial products to enhance the credit of individual infrastructure projects and thereby mobilize additional financing for those projects, and (3) providing advisory services and assisting in the creation of bankable infrastructure projects as well as policy support, where necessary. 39. The challenge for the IIFF is to convert a set of potential projects into a pipeline of projects eligible for the IIFF financing. Some of the constraints are already being addressed (e.g. through the land acquisition initiatives and better adapted bidding procedures) although implementation of some is still an issue. Others such as the development of a strong indigenous infrastructure advisory capacity and long-term, fixed-rate Rupiah financing, have barely begun. The IIFF will combine access to long-term financing with technical expertise and a strong commercial focus to support increasedlevels of private investment in infrastructure. A preliminary assessment ofthe pipelineof potential projects for 12 IIFF indicates a total universe o f 340 projects, with a value of over US$76 billion that would intheory fall within the mandateofthe IIFF6. 40. The IIFF's advisory role is expected to be an important element of its business strategy, leading to the emergence of bankable projects for funding. The IIFF will work to create bankable infrastructure projects that can reach financial close by offering advisory services relating to policy reform, project preparation, transaction and bidding structures. Asan entity with the active support of Go1 and the IFIs promoting policy reforms in infrastructure, IIFF is expected to establish itself as the preeminent focus of expertise in lndonesia on infrastructure policy and regulation, and on the requirements of commercial transactions. IFC's experience in the sector in Indonesia suggests that this will be a critical factor in building a project pipeline. The IIFF will help generate commercially viable infrastructure projects through its advisory arm, providing practical advice to the Government on issues such as the design of "model" concession contracts for various sub-sectors (e.g. ports, municipal water). The IIFF is expected to contribute to ongoing policy reform initiatives, play a role in project development, establish itself as a national repository o f skills and experience relating to PPP projects and create funding opportunities for other investor classes. Indeed it i s possible that the advisory activities of IIFF may be its principal business inthe initial phaseof its operations. 41, The IIFF will hire experienced infrastructure finance specialists to manage its operations and will implement international best practices in relation to risk and financial management and advisory services. It will adopt corporate governance practices to confirm its position as a credible institution in the eyes of all stakeholders. The infrastructure projects the IIFF finances will also conform to and implement social and environmental safeguard policies and standards, and other key issues specific to the sustainability of its project portfolio that have jointly been agreed upon between the institutions involved in its establishment, including the GoI. The presence of commercial banks or other private financial institutions in the equity and on the Board of the IIFF will further help it maintain a commercial focus. 42. To ensure high quality senior management and human resources, the IIFF will offer compensation that is in line with the market and effectively linked to performance. The IIFF will seek professionals who are passionate about making a difference and committed to meeting the challenge of leading private capital to infrastructure. Having a passionate, skilled and self-motivated President Director and core teams is important. IFC has provided grant financing for an executive search firm to hire this initial team. To the extent that it is not possible to house the entire set o f skills required for the development and implementation o f private infrastructure projects in-house, the IIFF will actively develop a database of external experts with whom the company will develop a working relationship in the course o f its operations. 43. The current global financial crisis and credit crunch may, in certain important respects, support the launch of the IIFF. The capacity o f local banks to provide long-term financing is limited. The subordinated financing being made available now through the Bank and ADB places the IIFF in a particularly advantageousposition. Initially seen as one of the great challenges facing the IIFF, the recruitment of key executives and particularly o f a CEO with a strong reputation with infrastructure investors, the financial sector and the Government, is now easier. `An AusAID funded consulting firm undertook a detailed feasibility study for the project, part of which was the estimation of the potential pipeline of projects for IIFF. The full feasibility study is available in the project files. 13 44. The IIFF will mobilize local currency debt, reassure local financial markets and help institutional investors place their funds in credit worthy long-term Rupiah investments which have not been available to them until now. While international private investors may take a more cautious view of the IIFF due to the global financial crisis, preliminary discussions suggest that once the IIFF is established, investor interest will be there. At a later stage, investors with resourcesto commit to infrastructure, but without the internal capacity to develop or arrange infrastructure projects, (insurance companies, other institutionalinvestors, possibly Sovereign Wealth Funds) will providethe opportunity for the founding investors, including the Government, to reduce their holding with an attractive return. Such returns will also stimulatenew sources o f private participationin infrastructure. As its market becomes more competitive, the business model of the IIFF will evolve, with early stage equity investment, syndication and management of infrastructurefunds likely to providenew sources of revenue. 45. Overall, the IIFF is designed to be a transformational constraint-alleviating entity that will have a significant impact on development. The IIFF will address key weaknesses in Indonesia's financial sector and complement the role of existing financial institutions. Through its lending products, it will catalyze long-term financing for commercially viable infrastructure projects. It will provide Indonesia with a domestic center of project finance expertise and thereby address a key capacity constraint in the market. Usingthese high quality skills, the IIFF will also support ongoing and future Government initiatives by providing advisory services in key areas including in the development of a soundproject pipeline. 46. While it will begin small, over a 3-5 year period the IIFF projects an equity base of US$200 million, and long-term subordinated debt of US$200 million from the Government. The IIFF is projected to leveragethis total capital of US400 million to raise more than US$1billion more from domestic and internationalcapitalmarkets over 4-6 years. The IIFF will primarily finance commercially viable private infrastructureprojects. It may also consider financing commercially viable projects with the participation of sub-sovereign governments and SOEs, up to an aggregatecap of 20% o f its assets size for such investments. It will take project-related risks on its own balance sheet with no further recourseto any o f its shareholders(includingthe Government). 47. The Government is well advanced in the establishment of the IIFF and has obtained parliamentary approval to invest up to IDRl trillion in infrastructure financing institutions. Of this amount, it will invest up to IDR 600 billion (US60 million equivalent) in the IIFF - which would make it a significant minority, stakeholder. It has committed itself from the outset to ensuringthat the IIFF will be a commercially-runprivate sector entity. A substantial minority stake (Government is aiming at around 30 % after inducting private investors) will be retained to reflect the Government's commitment to the new institution. It has formally approached IFC and KfW/DEG for equity investments in the IIFF, and the ADB and the Bank for a total loan of $200million ($100 million from each) to provide a subordinated loan to the IIFF. The Government has established PT. Sarana Multi Infrastruktur(SMI) as the vehicle through which the Government's investments in loans and equity to the IIFF are to be channeled, and transferred IDRl trillion to SMI as its equity contribution'. A presidential regulation that enables the establishment o f infrastructure financing companies- that will also govern the IIFF - has been issued*. It has expressedits intentionto have the IIFFestablishedmid-2009. See Para 64 for details on SMI. * Peraturan President No. 9/2009 dated March 18, 2009. 14 Figure 3: Structure of the IIFF US$100 million Loan \ / $ 100 million US$IOO million Loan US$200 million US$40 million Private Vote US$ 40 million in GO1equip,provided to SMI?will remain in SMIfor other purposes, US$ 60 million will be invested by SMI in IIFF A. The Bank's Lendingand IFC's InvestmentInstruments 48. The Bank's lending instrument for this project is a Financial Intermediary Loan, or "FIL". The Bank will provide an investment loan to the Republic of Indonesia as the Borrower. The Borrower will in turn provide these funds to the IIFF - the sole participating financial intermediary- through SMI. The IIFF will in turn, use these funds to provide predominantly long-term loans, guarantees, equity investments and other financial products as well as advisory services to commercially viable infrastructure projects. Under applicable local regulations, the IIFF will be able to count the funds provided by the Bank (and the ADB) as part of its overall capital base and leverage the funds (up to 5 times) through borrowings from the local financial markets and on-lend borrowed funds to infrastructure projects. The Borrower has requested an IBRD variable-spread loan denominated in US dollars with a final maturity of 24.5 years including a grace period of 9 years. 49. IFC will invest up to an equivalent of US40 million in the IIFF's common equity. This equity investment will be carried out over an expected time period of 5 years. At the incorporationof the IIFF, IFC will participate in the initial subscription with around US$2.0 million (equivalent). This will give IFC a 19.9% ownership stake and equip the IIFF with the minimum regulatory capital of IDR 100 billion (equivalent to about US$lOmillion). As the IIFF's asset base grows over time, IFC and other investors will subscribe in subsequentrights issues until the IIFF's capital reaches US$200 million. Subsequent capital calls will be triggered if the IIFF reaches certain financial benchmarks (e.g. leverage ratios, growth targets), and if the IIFF needs to buttress its asset growth with additional capital. At no time during its investmentwill IFC own more than 19.9%ofthe IIFF's shares. 15 B. ProjectDevelopmentObjectivesand Key Indicators 50. The objective of the Project is to strengthen and further develop the institutional framework of the financial sector to facilitate financing of commercially viable infrastructure projects and thereby increase provision of private infrastructure in Indonesia. The IIFF is expected to achieve the objective by building the necessary capacity and skills, and providing long-term financing, innovative financial products, and advisory services. The IIFF's ultimate objective is to increase the provision o f infrastructure in Indonesia to support a more inviting investment climate, sustained growth, and poverty reduction in the long-term. The project aims to support the establishment of the IIFF to mobilize capital from domestic and international sources and make it available to commercially viable infrastructure projects. The IIFF will provide direct financing and credit enhancements to mobilize private participation. The project also aims to improve the institutional and legalhegulatory framework within which private infrastructure financing occurs on a sustainable basis. This will be accomplished through the incentives created by the availability of debt for well-designed projects and through the IIFF's advisory function, which provides access to the IIFF's infrastructure financing experts with good knowledge of the Indonesian context. 5 1. A detailed Results Framework has been developed (Annex 6). Examples o f key performance indicators to judge the IIFF's success include: (i)an increase in the number of commercially viable infrastructure projects achieving financial closure through long-term debt financing, other financial products, and advisory services from the IIFF over the life of the project; (ii)an increase in the amount of private capital (including long-term debt and equity) available for infrastructure projects over the life of the project; (iii)increased support to the Government's policy-making relating to the provision of infrastructure by the private sector through the use of the IIFF's advisory services; and (iv) an increase in privately financed infrastructure in Indonesia. 52. The IIFF's development impacts will also be tracked by IFC through the development indicators listed in Table 3 below: Table 3: Financial and Economic Returns st of equity by 6.9% within FinancialStatements s (2009 through 2015) of FinancialStatements 13.9% within 6 years (2009 through 2015) of IFC's 53. In addition, the IIFFwill have a number of development impacts not captured in the ROE and EROE calculations. Indicators related to these development dimensions will also be tracked in IFC's Development Outcome Tracking System ("DOTS") during supervision (see Table 4 below). 16 Impact ImpactIndicators Frequencyof Source Monitoring Increasethe infrastructureloan portfolio to US$300 million by 2014 InfrastructureLoan and to US$1.5 billion by 2019. Annually Audited Financial Growth Statements Keepthe NPL ratio below 6% and Audited Financial reduceto 3% by 2014. Statements Loan Portfolio Quality Annually Improve Regulatory Engage with Go1to reform the Framework for Private regulatory framework and work on at Infrastructure least three initiatives per annum in Annually Annual Participation each ofthe years up to 2012. OperationsReport Implement and Operate Introduction and applicationof a E&S Management common ESSF acceptableto the System Bank Group in the IIFF's operations Annually EMS Report by the end of 2010.9 C. Project Components 54. The project will have one component each from the Bank and the IFC: an investment loan by the Bank that will be made available to the IIFF as subordinated debt to be used for eligible infrastructure projects and an equity investment by IFC in the IIFF. The Bank Group - along with other development partners involved in the project - will approve an Operations Manual that will form the basis for the IIFF's decision-making regarding the specific projects it chooses to support and the instruments that it selects to provide such support. The Bank Group will not be involved in approving individual IIFF sub- projects. However, intensive supervision will be conducted over the life of the project. (see Paragraph 81-82 for details). The Bank's loan i s expected to be fully disbursed over a four-year period (FY 2010-2013) while IFC's equity investment is expected to be fully made over five years (See Annex 12). D. LessonsLearnedand Reflected in the ProjectDesign 55. The project design reflects lessons learned from recent analysis of the investment climate, infrastructure provision, and the financial sector. Specifically, Bank analytical work in the financial sector shows that there is limited capacity to provide long- term local currency debt to private infrastructure projects. This capacity is likely to be built only gradually as Indonesia's financial sector becomes more diversified from a bank- The adoption of an Operations Manual by IIFF based upon a commonly agreed ESSF that is in compliance with Bank Policies and IFC PSs, the GOI's applicable laws and regulations and in accordance with the recently approved "Environment and Social Policy and Procedural Guidelines for Projects Financed Jointly by Bank, IFC, and/or MIGA" (dated January 21, 2009) is a condition of effectivenessof the Bank's loan. 17 dominated system to one that has a greater role for capital markets and non-bank financial institutions. In the interim hawever, there is a need for an institution such as the IIFF to provideappropriatefinancing to commercially viable projects. 56. The project design also incorporates lessons learned from the Financial intermediary (FI) lending review completed by the Bank's Internal Evaluation Group". The key success factor attributed to such loans by IEG is adherence to OP8.30 guidelines, with which the project complies". Key areas of guidance provided by OP 8.30 have been taken into account. The proposedbuild up of assets by the IIFF has beenjointly developedby the Bank-IFC teams and is conservative with regard to the adequacy of capital and risk management policies and the capacity of the IIFF. The Government is putting in place specific regulations governing the activities of infrastructure financing institutions under which the IIFF will be regulated and supervised. The capacity of Bapepam-LK is being strengthened through on ongoing program of assistanceby AusAID, who are also funding a significant portion of the IIFF's project preparation costs. The Bank will continue to coordinate with AusAID and other partners on key issues in NBFI sector development. Capacity building o f IIFF will occur primarily with its own funding complemented by any available financing from development partners. The Bank's ongoing analytical work on improvingthe environment for infrastructure PPPs, and capacity building for PPP in various line agencieswill also support the Project. 57. The project design also benefited from lessons learned from similar infrastructure financing projects financed by the Bank in India, Bangladesh, Morocco, and Poland (Annex 4).12 One important lessonfrom these projects i s the need for the IIFFto have a pipeline of potential projects. The Bank Group team's detailed review of the potential project pipeline(Annex 6) concludesthat there are significant IIFF investment opportunities. Taking into account that Indonesia's private sector infrastructure program is still in its infancy, and the fact that the IIFF is itself expected to play a significant role in the future development of the pipeline, the team has deliberately assumed a slow rate of growth for the IIFF's balancesheet. 58. The IFC team has drawn lessons from experience with bottlenecks in infrastructure provision in other markets and from establishing greenfield financial institutions. India's experiences with the IDFC are considered particularly relevant. Infrastructureexperience highlights the importance of well-structuredprojects and contracts, the contribution that advisory services can make at both the Government level and through individual transactions, and the value of long-term, fixed rate, domestic currency financingto privateinfrastructure financing and to the development of an economy's financial sector. The critical importance of the choice of a CEO, the need for flexibility to adapt to changing circumstances and the capacity of a well-selectedBoardto steer the new institutionstand out as important lessons learnedfrom the creation o f new financial institutionsin the past. Io"World Bank Lending for Lines of Credit: An IEG Evaluation," 2006, httu:l'si teresources.worldban k.ore/EX I`I:INS~C/Kesources/lines of credit.pdf " Documents relatingto the OP 8.30compliance and clearance ofthe Regional reviewer are available in the project files. '*India Tamil Nadu Urban Development Project (I,11, 111) - -(P009872), (P050637), (P083780), India - ILFS Private Infrastructure Finance (P039935), Bangladesh -Investment Promotion Financing Facility (P089382), Colombia - Private Infrastructure Financing Facility (PO5268I),Morocco - Municipal Finance (P005523), China - Energy Efficiency Project (P084874) ,Poland- Municipal Finance (P035082), Russia- Coal and Forestry Sector Guarantee Facility (RU-GU-57893, RU-GU-60045) 18 E. Alternatives Consideredand Reasonsfor Rejection 59. Given past experience and the needs of the GoI, a number of alternatives were considered and rejected, in particular: 0 A state owned enterprise providing financing directly to projects. This "DFI" approach was rejected due to challenges in insulating the entity from political interference, or perceptions thereof, and creating a management function with relevant experienceand resources. Usingan existing bank, financial institutionor fund manager to on-lend public funds to projects. This was rejected as it fails to achieve leverage from other sources of debt, there is a distinct shortage of capacity and infrastructure finance experience in Indonesia, and the approachmight create conflicts of interest for the chosen entity, which will likely be a key potential investor. It may be a viable alternative for smaller economies that do not have sufficient volumeto support a new specialist institution. 60. The decision to support the IIFF was also driven by the fact that the Government views it as a key national institution that will facilitate long-term financing for commercially viable infrastructure projects. The fact that the Government has agreed to take a significant minority equity stake, invited a number of development partners to support the IIFF, and has committed itself to the establishment of the IIFF in a number of policy pronouncementsand IDPLs, all indicate its ambitious mandatefor the IIFF. 19 111. IMPLEMENTATION A. PartnershipArrangements 61. The Bank Group has collaborated closely with various development partners on this project. It should be seen as an integrated package o f support by the Bank Group. The Bank has taken the lead in infrastructure and financial sector policy reform efforts, both of which are an integral part of the Bank'scountry dialogue. IFC focused in particular on the shareholding structure, the development of the business model and attraction of private investorsto the IIFF, andthe challenge of launchingthe new institution. 62. Development partners have contributed significantly in the preparatory phase of the IIFF. An IIFF feasibilitystudy, detailed institutional design (includingpreparationo f the Operations Manual) and the early coordination of investors was funded by AusAid grants totalingover A$1 million. The establishment ofthe IIFF requiresa new regulatory framework and the resolution of several outstanding legal issues that are being addressed through a US$lOO,OOO ADB grant. Recruitment of the CEO, and the rest of the senior management team is likely to have a significant impact on the success of the new institution.Recruitment of a CEO with the stature requiredbefore a Shareholders' Agreement has been signed and the new institution legally established, will be difficult. IFC has provided grant funding of US$150,000 to identify and hire the IIFF management team. A shortlist of candidates has been circulated to the stakeholders and discussions and selection will follow Board approval. Meanwhile, a Project Management Office (PMO), funded initially by DEG and AusAid and run by a small international team already familiar with both Indonesianinfrastructure and the operation o f PMOSfor infrastructure programs, will soon begin coordinating the many elementsrequiredfor the launchof the new institution. 63. Development partners have also indicated a willingness to make significant financial commitments to the IIFF. The ADB proposes making an equity investment of US$40million and a loan of US$100 million in support of the IIFF: its Board has approved these investments on March31, 200913. DEG is inthe processof obtaininginternal approvals for an equity investment of up to US$20 million. The Government is contacting private investors- domestic and international - and some positivepreliminary indicationsof interest in providing equity investments have been obtained. However, even without the current global financial crisis (which makes obtainingequity investment from private investors more challenging), it is realisticto expect that the IFIs and the Government will establishthe IIFF, and that private sector investment will follow. The team expects that within a year of its launch, the IIFF will have some private equity participationand representation on its Board, andthe Shareholders' Agreement is beingdesignedto accommodatethis. B. Institutionaland ImplementationArrangements The Role of PT. Sarana Multi Infrastruktur (SMI) 64. The Government has established the fully publicly-owned holding company PT. Sarana Multi lnfrastruktur (SMI) as the vehicle through which it will invest in the IIFF. SMI is a 100% State Owned Enterprise under the Ministry of Finance whose purpose is to invest in infrastructure financing institution(s) or otherwise provide funds for infrastructure financing. The Government has allocated an initial capital commitment of IDR 1 trillion to SMI through the national budget approved by parliament. Of this amount, SMI will invest l3 ADB document No. P42109-01, Report of Recommendation of the President to the Board of Directorson Proposed Loan and Equity Investments, Republic of Indonesia: IndonesianInfrastructure Financing Facility. 20 IDR 600 billion(equivalent to about US$60million) inthe IIFF for a minority equity stake on behalf of the Government. This will be investedinitially pro-rata with the IF1investors, with a combined initial investment of IDR 100 billion(approximately US$10 million eq~ivalent)'~. With IFC, ADB and DEG initially investing 19.9% each, SMI will initially contributejust over 40% of the common equity.The balanceof the US$60million, pending its being paid in as equity, will be contributed as convertible subordinated debt, earning a return based on current market rates. As private investorsjoin the equity, SMI will reduce its percentage stake (in absolute terms, its equity contributionwill grow) to 30%. Further private investment beyond that point will lead to a dilution of the IF1holdings,The balance of SMI's funding will be applied in complementary efforts to develop private investment in infrastructure. The equity investors are developing an approach for such efforts of SMI for discussion with the Government. It is likely that SMI would potentially support project preparation (eg. In the municipal water sector) that could be considered by IIFF. SMI could also potentially make some investmentsalongside IIFFas a meansto develop expertisein infrastructure sectors. 65. SMI will also channel the Bank's and ADB's sovereign loans to the IIFF. The terms and conditions of this pass-through will be back-to-back, with fees, margins and other costs at cost-recovery levels with no subsidies involved. They will also include fiduciary and implementationundertakings by SMI commensuratewith those containedinthe Bank's legal agreements with the GoI. SMI has been established with a lean staffing and managementstructure, with a Boardof Commissioners and a Boardof Directors reflectingits role as an investment vehicle for the Government. Regulation of IIFF 66. The IIFF will be regulated by Bapepam-LK within the broad framework of regulation of non-bank finance companies. A Presidential decree authorizing the establishment of infrastructure finance companies in Indonesia has been issued. A Ministerial decree that operationalizesthe Presidential decree and sets out requirementssuch as minimum capital, reporting requirements, lines of business that can be undertaken, etc. has also been issued. Executing Agency 67. The office of the Directorate General of State Assets, Ministry of Finance, will be the Executing Agency for the Bank's loan. DG Treasury will be responsible for the execution of the subsidiary loan agreement betweenthe Go1and SMI and for processingand transferring loan funds to SMI. Funds Flow and Disbursement Arrangements 68. Drawdowns from the loan will be made on the basis of requests from the IIFF to SMI, which in turn will be transmitted to the Government, and the Government will request the Bank for drawdowns. Bank funds will be providedto the Government, which will on-lend to SMI (see Figure 4 below) through a subsidiary loan agreement. The SMI will provide these funds to the IIFF through a subordinatedloan agreement. Indonesiawill borrow from the Bank in US$usingthe VSL: the Go1will provideequivalent IDR funds to SMI at its standard interest rate for such subsidiary loans (applicable to all state owned enterprises) at 1 month SBI+ 1%. The difference between this rate and the Bank's lending rate to Indonesia effectively represents the premium charged by the Government for taking on the exchange rate risk. SMI in turn will add a spread (0.5 percent) towards its administrative expenses and l 4In line with the businessgrowth o f IIFF, this equity will be built up to $200 million. 21 on-lend these IDR funds to the IIFF". There are no subsidies being provided to the IIFF and it will raise its funds at rates comparableto the market. 69. The subsidiary loan agreement and the subordinated loan agreement will contain undertakings by SMI and IIFF, respectively, to implement all fiduciary and implementation undertakings made by Go1 to the Bank. The Bank's loan to GoI, as well as the subsidiary loan agreements will also contain a subordinated debt to equity ratio of 2.5 to 1 that will contractually ensure that sufficient equity capital i s provided to the IIFF by its shareholdersi6. Figure 4: Funds flow 70. The applicable disbursement methods include: 1) Advance, 2) Reimbursement, and 3) Direct Payment as referred to in the WB Guidelines for projects dated May 1, 2006. In order to facilitate disbursements under the Advance method, SMI will open a deposit account" in a commercial bank acceptable to the Bank. The account will be denominated in Rupiah and will be solely used to finance eligible subproject loans, equity, guarantees and/or other financial products expenditures. The ceiling of the advance to the account i s fixed at US$]0 million. At the initial stage of the project, a smaller advancemay be depositedto the account, but should there be a need to have an advance beyond the applicable ceiling at later stage, SMI should request to the Bank to increase the ceiling with justifications. The IIFF will submit request for payments to SMI against subproject loans, equity, guarantees andor other financial products and will be paid by SMI from the deposit account. SMI will ensure that the account will only be used to finance eligible subproject loans. SMI will be responsible for reporting the use of funds in the account and preparing the application for withdrawal for advances, duly approved by MOF DG Treasury (DSMI)and KPPN Jakarta V I before their submissions to the Bank. Applications for reporting the use of the funds would be supported by a: (i)statement for the subproject loans' drawdown, (ii)reconciliation statement of account; and (iii)a copy o f the bank account statement. Reporting on the use of the account and application for an advance to the account may be submitted in a single monthly application. 71. SMI may at its option, make payments against a eligible subprojects' loan, equity, guaranteesand/or other financial products and request reimbursement from the Bank by submitting the relevant application for withdrawal supported by (i)a statement for the subproject loan's drawdown and (ii)evidence of payments made. SMI may also forward requests for larger payments for subproject loans drawdown to the Bank for payment to be made directly to the subproject loan, equity, guarantees and/or other financial products 15 The net spread charged by SMI to IIFF will be 0.5 percent over the cost of funds that SMI receives from the Government. In addition, the subordinated loan agreement will specify a formula by which SMI will be entitled to recover any actual tax paymentsthat it may incur as a result of the lending to IIFF. l6This ratio is based on the financial projections for IIFF, "ThisaccountisdefinedastheDesignatedAccountreferredto in Section5oftheWB Disbursement Guidelines for Projects, May 1, 2006 22 Category Description Amount of O/O of expenditures Loan(US%) to be financed IIFF investments in sub-projects 100,000,000 100% TOTAL 100,000,000 Governance and Accountability 73. A sound governance structure is key to the success of the IIFF. Substantial multi-, bi-lateral, and private sector (domestic and international) equity participationwill drive sound governance. The IIFF will adopt corporate governancepractices to confirm its position as a credible institution in the eyes of all stakeholders. To improve transparency, the IIFF will also voluntarily comply with the listing requirementsof the IDX from the outset, even though it is expected to be listed only in the medium-term. Annex 11 describes a detailed Governance Action Plan. 74. The project design recognizesthat the infrastructure industry in Indonesia is at high risk for corruption. A study done by the Commission for the Supervision of Business Competition (KPPU) finds that corruption risks in infrastructureare high, particularly in the water and sanitation, and transportation sectors. Law enforcement investigations into corruption cases in the electricity, oil and gas, and telecommunication sectors have proven them also to be at risk. To prevent the IIFF being tainted by corruption, appropriate prevention measures need to be designed and implemented. Given that the IIFF will be a private company established under Indonesian Company Law and will operate in the Indonesian business environment, the corruption prevention measures will be designed accordingly. These measures will be incorporated into the IIFF's Articles of Association (to the extent permitted by Indonesian law), Shareholders' Agreement, Operations Manuals (including the sections on Human Resources, Procurement and Credit), all of which will be adopted by the IIFF prior to project effectiveness. 75. As the IIFF is a private company, the Board of Commissioners (BOC) will be tasked with reviewing company risks, developing recommendations for risk mitigation and overseeing their implementation on a regular basis. To execute the task, the BOC will be authorizedto establish committees under its control comprising people with relevant expertise. The risks considered will cover governance and corruption risks''. It is expected that the IFC, ADB, and DEG will nominate one member each and SMI will nominate two Governance mechanisms to address procurement, financial management, and environmental and social issues are addressed in the respective sections below. 23 membersto the IIFF Boardof Commissioners,supplementedby highly reputable independent Commissioners as necessary.This Board will provide credibility to the IIFF and play a vital role in corporategood governance. 76. Corruption-related issues will be addressed in at least two ways. First, the founding Shareholders are ensuring that the IIFF is subject to high standards of governance and that it institutes anti-corruption processes and systems. A Shareholders' agreement currently being drafted will be signedby all the shareholders-the ADB, IFC, DEG, and SMI - after Board approvals are obtained.This agreement providesthat the shareholdersshall ensure that the IIFF is not involved in "sanctionable" practices- which by definition includes "Corrupt Practices", "Fraudulent Practices", "Coercive Practices", "Collusive Practices" and "Obstructive Practices" and contains references to compliance of the IIFF with Indonesian law. These definitions are in line with the Bank's guidelines as well as relevant Indonesian laws. The adoption of this Shareholders' agreement is an effectiveness condition for the Bank's loan. 77. Secondly, the subsidiary loan agreements between the Government and SMI, and the subordinatedloan agreementbetween SMI and the IIFF will include all fiduciary and implementation undertakings made by the Government to the Bank. The Bank retains the standard remedies that it has in its agreement with the Government in the event that Bank funds are found to have been abused either by SMI or by the IIFF. 78. The IIFF will have mechanisms to insulate it from political pressures. The Government has recently demonstrated its willingness to make difficult decisions to ensure sound governance in the financial sector. Specific actions have included corruption investigations - and convictions - o f senior management of a large state owned bank and senior officials of the central bank (some investigations are ongoing). The IIFF will build on the momentum that has been generated as a result of these actions. The Government has repeatedly indicated that it would like to ensure the operational independenceof the IIFF and that the strong presenceof institutionssuch as the Bank Group - and others involved- would greatly help inthe process. 79. To ensure no conflicts of interest between the different functions the IIFF will perform (e.g. broad advice to the Government on contractual structures, project advisory, and project equity and debt financing), the IIFF will create fire-walls between functions with potential conflicts of interest to ensure that no employee involved in the project finance function simultaneously works on policy advisory or project development mandates. The teams involved in policy reform and project development will be discrete and separated from the teams involved in project finance operations, reporting to separate top-level directors. IFC's experience separating advisory from financing roles is expected to be particularly relevant. Operations Manual 80. An OM acceptable to the Bank is being prepared for adoption by the IIFF. The OM will include, inter alia; the policies and procedures to be followed by the IIFF to address operational, credit and foreign exchange risks in its day-to-day operations; agreed financial management, procurement, and disbursement policies and procedures; environmental and social policies and procedures to be followed in line with the Bank's policies, IFC's Performance Standards and applicable Indonesian laws and regulations; a detailed framework for the measurement and monitoring o f outcomes; guidelines on preventing fraud and corruption in line with WBG policy; the supervisory arrangements for the project; and terms and conditions for agreementsbetween IIFF and subproject companies reflecting all the above. These are all key elements in ensuring effective project implementation.The adoption of an Operations Manual acceptableto the Bank is a condition for effectivenessof the loan. The adoption and on-going application o f the operations manual 24 i s a covenant in the Loan Agreement betweenthe Government and the Bank and the Project Agreement among SMI, IIFF and the Bank, and will be included in the subsidiary loan agreement and subordinated loan agreement from the Government to SMI and from SMI to IIFF, respectively. Project Supervision 8 1. The IIFF will be establishedonce the approval of all development partnersfor their equity and loan commitments has been obtained. While the OM will lay out the procedures that the IIFF will follow, and while this obligation will be included in the legal agreements, project supervision will have to ensure that it is following the established norms. It is expectedthat in the initial stages this project will need intensive supervision, at least until the IIFF has established itself. Bank supervision will need to focus on (i) the Government's role in the IIFF and in its requeststo the Bank for drawdowns of loan funds (ii) SMI's role in the IIFF and in passing-throughBank funds to the IIFF (iii) the IIFF's adherence to the OM and its overall functions and (iv) development outcomes in the form of the performance of projects financed by the IIFF. To provide the context for this supervision, the Bank's project supervision team will need to coordinate closely with the team working on broader infrastructure sector issues, especially as they relateto the framework for privateparticipation in infrastructure, and with the IFC supervision team. 82. IFC's supervision will begin from first equity disbursement and continue on a quarterly basis for as long as IFC remains an equity investor.It will focus on the detailed monitoring of operational performance, management quality, environmental outcomes, compliance with each covenant of the Shareholders' Agreement (and by association, the Articles of the IIFF), adherence to integrity standards, financial results, the evolution of the valuation of the equity holding, and a comparison of expected and actual development outcomes. BanWIFC Conflicts of Interest 83. The Bank and IFC teams are consultingwith the World Bank Group Conflicts of Interest Office (WBGCOI) regardingthe possibilityof potentialor perceived conflicts of interest arising in relation to the two institutions' participation in the Project, viz. establishment of the IIFF. The Bank's funds will be provided to Indonesia;these will in turn be on-lent to IIFF (through SMI) as subordinated debt. IIFF will on-lend these funds to eligible infrastructure subprojects. The terms and conditions of the Government's subordinated debt to IIFF will mirror the terms and conditions of the Bank`s loan to Indonesia. IFC, on the other hand, plans to invest $40 million directly in the common equity of the company. In the view of WBGCOI, the collaboration of the Bank and IFC in the Project is not likely to raise significant conflicts of interest risk, except in circumstances where financial condition of the IIFF materially deteriorates. Under such circumstances, given that the terms and covenants of the Bank's loan to Indonesia, and Government's sub- debt to the IIFF (through SMI) are substantially the same, any requests for waivers of covenants and terms under the subordinated debt by the IIFF would likely trigger a de facto mis-alignment of interest between the Bank and IFC. Accordingly, the WBGCOI Office advised the Bank and IFC teams to put in place conflict mitigation measures, including establishing separate teams with no overlapping members to handle the Bank's and IFC's respectiveinvestmentsin the Project, and adopting appropriate informationbarriersto prevent sharing of confidential information between the teams without appropriate consents. In responseto this advice, the Bank and IFC have agreed that there will be separate teams as suggested.The teams would continue discussions with WBGCOI and arrive at agreementson appropriate information sharing keeping in mind confidentiality and conflict of interest aspects on one hand and the synergies and reduced transactions of joint-supervision(to the extent practical) on the other. WBGCOI also advised the teams that these arrangements be disclosed to the Government, IIFF and other stakeholders in writing and the teams have 25 agreed to do so after these arrangements have been agreed upon. The team will continue consultingwith the WBGCOIOffice as the project progresses and will implement appropriate conflicts of interest mitigationmeasures basedon WBGCOI Office recommendations. C. Monitoringand Evaluationof Outcomes and Results 84. A sound monitoring framework to track inputs, outputs and outcomes in a systematic and timely fashion has been developed and has been agreed with GoI. Project outcomes and outputs will be monitored via project supervision using administrative data from several sources. The IIFF will have its own dedicated M&E unit, but may be required to hire external, IIFF-funded M&E agencies to examine all aspects of the Project (Annex 5). IFCwill track several financial, economic, and development indicators as discussedin Section I1B above. D. Sustainability 85. The sustainability of the project's outcomes - in terms of stimulating the development of a long-term debt financing market for infrastructure and facilitating private infrastructure projects - will depend on two main sets of factors. First, the project's sustainability depends on how well the IIFF performs its tasks. For the Government, the IIFF is its flagship interventionto get long-term financingfor infrastructure projects. It is therefore highly committed to makingit a success - and it has demonstratedthis commitment during project preparation. The development partners involved in the establishment of the IIFF are also highly committed to its the success and are taking steps to work with the Government to put in place a management team for the IIFF that is committed to its sustainable operation. Secondly, the projects sustainability will also depend on the demonstration effects of producing successful commercially viable infrastructure projects supported by the IIFF. Ifsuccessful, these projects will help stimulate greater interest among private financiershstitutional investorsto providelong-term funds for future projects at more competitive prices and reduce risk perceptions related to infrastructure investment. Their success will in turn, depend on how well they are designed, how transparently they are procured, and on the robustness of their E&S management plans, all of which are goals to which the Indonesiangovernmentis committed. E. Critical Risksand PossibleControversialAspects 86. The following important risks that need to be addressed to ensure that the project objectives are achieved have been identifiedalong with appropriaterisk mitigationmeasures:. 26 A 2 - e I -1 z d E z E n 5: VI 0 M x F. LoanConditionsand Covenants 87. I t is important to highlight that IIFF can only be established after approvals of equity investments and loans of the BanMIFC and other IFIs involved have been obtained. In this situation, as is normal for project financing which relies on simultaneous conditions precedentbeing met across various sources of loan and equity financing, it is clear that there will be a set of effectiveness conditions prior to disbursement of the Bank's loan. The World Bank will enter into a Loan Agreement with the Republic of Indonesia and a Project Agreement with SMI and IIFF. The following are Conditions of Effectiveness: the Subsidiary Loan Agreement, acceptable to the Bank, shall have been duly executed and delivered on behalf of the Borrower and SMI and shall have become effective and binding uponsuch parties in accordancewith their respectiveterms, subject only to the effectivenessof the LoanAgreement; the Subordinated Loan Agreement acceptable to the Bank, shall have been duly executed and delivered by or on behalf of SMI and the IIFF and shall have become effective and bindingupon such parties in accordancewith their respectiveterms, subject only to the effectivenessofthis LoanAgreement; the IIFF shall have been legally incorporated pursuant to the Borrower's laws and regulations and the Articles of Association of the IIFF shall have been executed by the founding Shareholdersand approved by MLHR. the Borrower,through the MOF, shall haveissuedthe BusinessLicenseto the IIFF; the Co-financingAgreement (ADB Loan Agreement) shall have been executed and deliveredand all conditions precedent to its effectiveness or to the right of the Borrower to make withdrawals under it (other than the effectiveness of this Agreement) have been fulfilled; the Shareholders Agreement, and any related share subscription documents to be entered into by and among the founding Shareholders andor between the IIFF and the founding Shareholders shall have been executed and delivered on behalf of the parties and shall have become effective and binding upon such parties in accordancewith their respectiveterms; the Project Agreement, shall have been duly executedand delivered on behalfof SMI and the IIFF and shall have become effective and binding upon the SMI and the IIFF in accordancewith their respectiveterms; the Operations Manual, including the ESSF, acceptable to the Borrower and the Bank, shall have beenadoptedby the IIFF; each founding Shareholder shall have subscribed and paid up its respective initial capitalcontributionin such amount as required by the ShareholdersAgreement; SMI shall havemadeavailable and disbursedfinancing inan amount of not less than IDR 600 billion (equivalent to about USD60 million) (less the amount of the initialequity contributionof SMI as requiredunder the Shareholders Agreement); and the IIFF shall have appointed and employed a chief executive officer, a chief financial officer and an environment and social safeguards staff acceptable to the Borrower and the Bank. 88. In addition to standard terms and conditions, the Loan Agreement and Project Agreement will contain the following covenants: Except as the Bank and the Borrower shall otherwise agree, the Borrower shall ensure that the IIFF shall not incur any subordinated debt (referring to the loans from the Bank and ADB), if after the incurrenceof such subordinateddebt the ratio of subordinateddebt to equity shall be greater than 2.5 to 1. 31 0 Additional suspension events include the failure of any of GoI, SMI or IIFF to perform their obligations under the Subsidiary Loan Agreement, the SubordinatedLoan Agreement or the Shareholders Agreement; the failure if IIFF to maintain its business license, the amendment, suspension, abrogation, repeal or waiver of any of the Go1 regulations that allow the establishment and operation of IIFF, the Subsidiary Loan Agreement, the Subordinated Loan Agreement, the Shareholders Agreement, the Articles of Association, the Business License or the Operations Manual so as to affect materially and adversely the carryingout of the Project. Each of PTSMI and the Company shall establishan integrated financial management system, including internal control systems and internal audit function with terms of reference satisfactory to the Bank and the Borrower, by the date which is no later than 120 days after the Effectiveness Date. 32 IV. APPRAISAL SUMMARY A. Economicand FinancialAnalyses Economic and financial analyses 89. As noted earlier, the state of Indonesia's poor infrastructure is widely accepted as a major constraint to accelerating growth and reducing poverty. The Governmenthas set ambitious targets for increasing infrastructure investment to reduce the constraints to growth and continues to develop a framework for private financing of infrastructure where risks can be appropriately shiftedto the private sector, recognizingthe economic and financial efficiencies that can be generated. 90. Economic analysis of sub-projects to be financed by IIFF can only be undertaken after IIFF is established and it identifies a set of projects that it would support. The OM will lay out a methodology for economic assessment of sub-projects by IIFF. The economic analysis of the sub-projects will attempt to quantify their costs and benefits, and measure the net contribution of these sub-projects to society at large. As an example, for any toll-roadprojects that IIFF may finance, some of the key benefitsthat such sub-projects are designed to provide include accommodating higher levels of traffic, reducingtraveltime, and loweringvehicle operating costs. Specifically,the benefits measured by the economic analysis included savings in vehicle operating costs (VOC), and a reduction in vehicle travel time (VOT) due to improved road conditions that would result in improved riding quality and higher travel speeds. At the same time, these sub-projects also impose real costs, including construction costs, routine maintenancecost during construction period, and environmental and social costs. The Economic Internal Rate of Return (EIRR) and the Economic Net Present Value (ENPV) will be estimated by lifecycle costs and benefits to society under the `With' and `Without' project scenarios. The Bank team will monitor such analysis by IIFF and the performanceof sub-projectsduringproject supervision. 91. One set of key economic benefits of the Project, not quantified in the analysis, i s that it will help develop a market for long-term local currency infrastructure financing. The Project aims to enable IIFF to act as a catalyst for mobilizing such financing. IIFF can also help set benchmark rates for long-term infrastructure financing through tapping the domestic and internationalmarkets for longer tenor debt financing. IIFF is also expected to engage in new product development (e.g., domestic and foreign currency denominated interest rate swaps, partial credit guarantees, etc.), which should also assist the development of a domestic market for long-term infrastructure bonds. For infrastructure projects for which IIFF provides advisory services, better structuring and bankability would provide a net economic benefit to society in terms of better quality infrastructure projects, over and above the benefits of IIFF financing. 92. The key driver for IIFF's financial projections is the build-up of its assets, mainly its loan book. This poses a problem in as much as IIFF's asset growth is difficult to estimatepurely on a trend projectionbecause it is IIFF's mission to break that trend and bring about growth in Indonesia's infrastructure development. Therefore, two assessments of the market were conducted: (i) a top-down review which resulted in the identification of a pipeline of US$76 billion up to 2015; and (ii) a bottom-up review of Indonesia's infrastructure projects pipeline whereby details of projects were analyzed, sector by sector. This produced a more specific projects pipelineof US$38 billion for the period2009 - 2011. Based on conservative approach, IIFF market share is estimated below 2.5%.For the time horizon beyond 201 1, the base case assumes an annual growth in infrastructure funding demand of 5 %. 33 Projected BalanceSheet 93. Table 6 summarizesthe basecase of IIFF's balancesheet projections: 94. Loan and Equity Portfolio: In the initial years, .IIFF may acquiringsome existing loans from other banks, refinancing loans on a more appropriate long-term basis for infrastructure projects which are already in operations, particularly where this may free up cash flow for sponsors willing to commit cash flow savings from the refinancing to new infrastructure investment. IIFF may also generate additional fee-based income thru developing advisory business for both Go1 and project developers in the first three years. It is projected that the loan book will grow from US$16 million in year 1 to reach US$ 106 million in year 3. In year 4 and onwards, it i s projectedthat IIFF's loan portfolio will grow in line with the increasedmarket demand and extend its total outstanding loans to US$2.4 billion in year 10. Investments in equity may be trailing the lending operations as IIFF staff will have to gain familiarity and expertise with Indonesia's infrastructure finance market before embarkingon riskier equity investments. Figure5 below shows the build-upof the projectedloan portfolio and its growth(andtotal assets build-up). 34 Figure 5: Projected Asset and Loan Book Build-up (in US%million) I 2,500 - C E 2000 - @ 1500 - 2 1000 - 500 - - I i Year 1 Year2 Year3 Year4 Year5 Year6 Year7 Year8 Year9 Year 10 m?mLoan Total Asset-Loan Growth 95. Asset Growth: In line with the increasing pipeline, IIFF assets i s projected to almost double in year 3, and later steady grow at the range of 27 to 49% from year 7 onwards when the total assets are projectedto reachUS$ 2.97 billion at year 10. 96. Asset Quality: NPA are projectedto be low in the first two years o f operations due to IIFF conservative approach in secured lending, Le. 85% of IIFF financing will be in the form of senior term loan. Starting in Year 3, IIFF will consider investing small part of its equity stake in projects. The rationale behindthis is that infrastructure investmentsare lumpy and one bad loadunsuccessful equity investment can cause the NPA ratio to spike; some unfavorable investment decisions cannot be excluded in the early years when the portfolio remains small although IIFF's important position in Indonesian infrastructure in its early years should allow it to be highly selective. It is recognized however that the infrastructure financing market will be a partly untestedfield. 97. Equitykeverage: Starting with a seed capital of US$lO million as required by the Infrastructure Financing Company's regulation, IIFF `s total equity is projected to reach US$50 million in year 3 and US142 million in year 5. As IIFF's asset base will grow, shareholders will continue to subscribe to new rights issues to support IIFF's growth and maintain a conservative capitalstructure. While the CAR Iis projectedto stay at 40% in the first three years, IIFF will steadily maintainits CAR positionabove 22% level. The projected gearing ratio (total debtitotal net worth) will be relatively high in year 1 at 6.8x, but the gearing ratio will drop quickly as the loan book grows, equity rises, and the CAR Ineeds to be maintained at a conservative level. Most of the time, the gearing will hover at the range of 1.5 to 3 . 7 ~ The logic for that is that IIFF will be able to handle a higher gearing and lower . CAR Iafter buildingsufficient experienceand havingcreated a track record for itself. 98. Funding: In its initial years, IIFF will have two strong funding tools at its disposal; US$ 200 million in subordinated loans from IBRD and ADB, and SMI's convertible debt. It is projected that the convertibledebt will only be fully converted into equity by the end of year 6. The subordinated debt will gradually be drawn down as needed, and the full draw- down is projected for year 5. These three funding instruments will secure IIFF from raising external funding sources in its early years of operations when its risk profile is higher. Not only are these instruments attractivelypricedbut they also allow IIFF to establish itself a name in the market before looking for third party funding. The savings from these two 35 funding sources are quite considerable and will ease any pressure on IIFF's funding side in the early operationalphase. Projected Income Statement A summary of IIFF's projectedincomestatement is shown in Table 7 below: Services I -47.21% 1 -6.17% 1 11.25% 1 ~~ 14.64% ]-14.52% 1 ~~ 16.14% 1 99. Interest Income: While minimal in the first few years, interest income is projected to grow strongly in line with the increase in the loan portfolio. Interest income from loans will represent more than 90% of total interest income (except in the first two years). The net interest margin is weak in the first year as the loan portfolio remains small. As IIFF's capital i s not fully directed towards lending, some of the capital will be invested in short-term instruments with lower rates in year 1. However, along with the growing of IIFF loan portfolio in year 2, the net interest margin reaches a comfortable 8.2% level in year 4. Inyear 5, the net interest margin decreases as a consequence of IIFF effort in raising more expensive funding from market to support the loanbook growth. 100. Advisory Fees: Although advisory services will be a critical area of focus in the early years because o f the need to help create an infrastructurepipeline, revenues generated from this activity are expected to be small as IIFF establishes its value in the market. Consulting for Go1 entities may generate only limited revenues even though it may play an essential role in generating bankable projects. It is anticipated that some of the remuneration from Go1 consulting could be paid through donor-supported programs. Because of this, advisory income will start at a low US$280,000 and increase to US$620,000 and US$].14 million in year 2 and 3, respectively. Beyondyear 3, it is assumedthat IIFF has the capacity to obtain advisory contracts from private-sector developers that boosts its advisory income. 36 101, Profitability: Measuredas RoA, profitability is strongly correlatedwith the level of the net interest margin. Profitability reaches its peak at 5.28% in year 4 and gradually steady at level above 3.5 % in the following year. Meanwhile, RoEs track RoAs with a multiplier of 2.9 - 3 x up to year 6, but as IIFF's gearing increases, the RoEs rise much stronger and reaches a 4 . 6 ~multiplier to RoA in year 10. 102. The base case projects an IRR of 15.4'/0, which is 6.9% above the cost of IFC's equity. This can be considered a fairly good outcome since a conservative base case is presented here to reflect some of the uncertainties in the market better. Apart from the base case, an up-case and a down-case scenario were also run to test the Project's resilience. Table 8 below summarizesthe key variables which were adjusted for the sensitivity analysis: demand NPA ratio 4% peak and decreasing to 3.0% increasing to 3% decreasingto 4.8% Annuaked return on 10% equiry sold US$280K (year 1); US$280K (year 1); US$280K (year 1); US$620K (year 2); US$840K (year 2); US$420K (year 2); Advisory income US$1.14 mn (year 3); US$].69 mn (year 3); US$630K (year 3); then in line with then in line with then in line with demand growth demand growth demand growth interest rates on loans* - 1% on all loan rates -1.s% on all loan rates ~ US$16 mn (year 1); US$29.5 mn (year 1); US$16 mn (year 1); US$44 mn (year 2); US$97.9 mn (year 2); US$39 mn (year 2); Loan portfolio growth US108 mn (year 3); US$244 mn (year 3); U S 9 0 mn (year 3); then in line with then in line with US$167 mn (year 4); demand growth demand growth US265 mn (year 5); then inline with demand growth All 100% loans and take-out Risk Weighting of Loans loans at 50%; rest o f loans at 100% 103. The IRR of the three cases is as follows: Up Case - 18.6% 104. IIFF's profitability is most sensitive to interest margin changes and then to asset growth. However, the sensitivity analysis has shown that even under market conditions where demand for infrastructure financing and advisory services is not as strong as expected, 37 and therefore revenues will fall short of expectations, IIFF will be able to achieve an acceptablefinancial performance. 105. The IIFF's profitability is most sensitive to interest margin changes and to asset growth. However, the sensitivityanalysis has shown that even under market conditions where demand for infrastructure financing and advisory services is not as strong as expected, and therefore revenues fall short of expectations, the IIFF will be able to achieve an acceptablefinancial performance. B. Technical 106. The project's technical design has benefited from an extensive body of analysis including Bank ESW and lending operations, the Government's medium-term and annual plan documents and IFC's experience establishing "green field" financial institutions. The approach has also benefited from international experience with infrastructure financing institutions. Some of the key principles underlying the project's technical design include: (a) the critical role ofthe development of a long-term local currency debt market for the financing of infrastructure projects; and (b) the positive role that well- structured private infrastructure projects can play in increasing total investments in certain key sectors by using a limited amount of public resourcesto leverage a much larger amount o f private investment. They can also help improveeconomic efficiency and lower the capital requirement for projects. Key structural considerationsfor the new institutioninclude a shareholdingstructure designed to accommodate private shareholders and to balance their interests with that of the Government and the IFIs in ensuringthe long-termobjectives of the IIFF are met. The IFC's experience has been particularly relevant in the establishment of key IIFF parametersin terms of its management framework, operational procedures, environmental and social standards, enforcement of high standards o f integrity and transparency, and the managementof potential conflictso f interest. C. Financial Management 107. The main financial management risks for the project at this time relate to whether SMI and the IIFF have sound financial management systems and suitable human reso~rces'~.SMI was established in February, 2009, and has yet to develop a financial management system. The IIFF had yet to be established at the time of this assessment. FM risk in SMI is likely to be lower than in the IIFF as SMI will act as the GoI's fund-channeling agency. The IIFF will manage and use these funds to provide a variety of financial products and services to commercially viable infrastructure projects. Further FM assessmentswill be conductedafter the IIFF has been established. 108. The financial management risks will be mitigated by: i) the provision of technical assistancefor the establishment of the SMI andthe IIFF that is ongoingunder donor funding and will be continued as necessary from SMI's and IIFF's own resources; ii) the provisionof technical assistanceto the IIFF for the recruitment of qualifiedstaff -the IFC has provided grant financingfor the retentionof an executive search firm to headhunt the initial team, and it is expectedthat the IFC, ADB, and DEG will nominate one member each to the IIFF Board of Commissioners; iii)the provisionof technical assistance to develop the l9 A first draft o f the financial management section of the operations manual has been prepared and submitted to the Bank. Further work in strengthening the OM and the proposed framework for the financial managementdepartment is beingundertaken. 38 IIFF Operations Manual covering, among others, financial management and iv) adoption of the Operations Manual by the IIFF which is a condition for effectivenessof the Bank's loan. 109. Overall, the project financial management risk is assessed as being high before mitigation, and substantial after mitigation. This assessment has concluded that with the implementation of the action plan, the risks will be substantially mitigated. The proposed financial management arrangements will satisfy the Bank's minimum requirements under OP/BPI0.02, and be adequate to provide, with reasonable assurance, accurate and timely information on the status o f the grant as required by the Bank. More details of the financial management assessmentare given in Annex 10. D. Procurement 1IO. IIFF is expected to invest in selected infrastructure projects under sub-loans to private sector firms and/or joint ventures of private firms and state owned enterprises. Procurement for Works and Goods will be carried by the recipients of the sub-loans following the World Bank's "Guidelines: Procurement under IBRD Loans and IDA Credits" dated May 2004, revised October 1, 2006 (the Procurement Guidelines); and in particular para. 3.12 "Procurement in Loans to Financial Intermediaries". Procurement will be mainly done in accordance to established private sector or commercial practices acceptable to the Bank. The same principle applies to the selection of consultants under these loans whereby this will follow the Bank's "Guidelines: Selection and Employment of Consultants by World Bank Borrowers" dated May 2004, revised October 1, 2006 (the Consultant Guidelines) and in particular para. 3.12 "Commercial Practices". Selection of Consultants will follow established private sector or commercial practices acceptable to the Bank. Due to the nature of the project, no prior review will be conducted by the Bank. IIFF will hire an independent private audit firm to conduct an annual audit which should cover technical, financial and procurement aspects of the sub-loans. The Bank will review and clear the TOR for this audit. The Bank will also retain the right under the loan agreement to conduct post reviews of contracts should it wish to do so. Annex 9 provides further details. 1 1 I. At this stage, it is not possible to carry an assessment of the procurement capacity of neither IIFF nor any of the specific firms that may apply for sub-loans. IIFF is still under establishment and there is still no specific pipeline for entities that will apply for funds. Accordingly the procurement risk for the proposed project is rated as "High' I . Risk Rating Mitigant Rating Of risk Of residual risk IIFF is not yet established H Create a procurementfunction within IIFFthat M and it is not possible to will have responsibilitiesto assess the 39 Risk Rating Mitigant Rating Of risk Of residual risk assess its capacity in procurement management systems o f the managing the procurement entities in which IIFF will provide loans under sub-loans Prepare a procurementsectionin the operationalmanual for guidance for IIFF Potential recipients of sub- borrowers. loans are not yet identified IIFF to monitor procurementby borrowers and ir is not possible to Training to be conducted for any sub-loan assess their capacity to recipienton procedures for competitivebidding conduct competitive recruit an internationally experienced consultant bidding processes to assistitrainIIFF procurementdepartment E. Socialand Environment Social Aspects 113. The IIFF forms part of the overall development priorities o f the Government aimed at supporting growth and poverty reduction by addressing a key constraint on the country's economy growth -inadequate infrastructure. Projects supported by the IIFF are expected to have primarily positive social impacts. The IIFF i s intended and expected to lead to increased infrastructure investment and delivery of infrastructure services over the medium-long term. In general, the poverty and social impacts of increased infrastructure investment will be positive, through the benefits o f induced economic growth, and through the direct provision of infrastructure services. 1 14. International experience indicates strong direct linkages between infrastructure service provision and poverty reduction. Reliable, affordable and cost- effective provision of infrastructure services can help in improving health and education outcomes (reducing levels of child mortality from waterborne diseases, respiratory illnesses, better access to schools and clinics) and indirectly in reducing the fiscal burden of governments to create space for other expenditures. Indonesian experience matches this international pattern. A recent Bank report Making the New Indonesia Workfor the Poor suggests that better access to roads and telecommunications "are associatedwith significantly lower poverty." Better quality also improves the pro-poor impact of infrastructure. 115. There could, however, be potentially negative social impactsassociated with the IIFF, and these will need to be managed and monitored. For example, increasedusage of roads financed by IIFF could lead to increasedtraffic accidents; social dislocation could occur as a result of land acquisition and involuntary resettlement in projects that IIFF supports; there is a potential for price increases for electricity and water services that are provided by private firms financed by IIFF. While the process o f construction o f infrastructure will yield short-term employment benefits, the full costs and benefits are only realized when construction of new infrastructure is completed. The negative externalities of expanded infrastructure, such as pollution and traffic accidents, often fall disproportionately on the poor. 116. Both policy and project specific mechanisms to assess and manage these adverse consequences are necessary. At a policy level, the Bank (and other development partners) is supporting reforms through its ongoing IDPL loan series aimed at mitigating some of these adverse impacts. Recent years have seen increased efforts by the police to improve reporting o f accidents; increasedefforts by various cities to improve public transport, which may contribute to the reduction of road accidents (about 60% of them involve t 40 motorcyclists); and World Bank road projects included measuresto promote improveddesign standards, helping to reduce the cause of accidents. The Bank is engaging with the Government through the Land Working Group to address issues associated with land acquisition, including social dislocation and inadequatecompensation. The recent history of Indonesia's treatment of fuel price increases suggests a capacity to balance the negative impacts of price increases against other social benefits through democratic processes, and to introducecompensationwhere appropriate 117. At a project level, IIFF's Operations Manual will contain procedures to ensure that the environmental and social impacts of the sub-projects that it finances are assessed, managed and monitored in accordance with the requirements of Bank Policies and IFC's Performance Standards for Social and Environmental Sustainability. IIFF will build up its institutionalcapacity to ensurethat it is able to implementthe Operations Manual effectively. Environmental Aspects 118. Successful implementation of the IIFF project is likely to lead to increased and improved infrastructure services, with both positive and negative environmental consequences. Some types of infrastructure investment will have positiveenvironmental and health outcomes (e.g., water and sanitation facilities and better solid waste management). Increased provision of electricity through IIFF's financing of thermal power plants may be accompaniedby adverse impacts on the environment, such as higher air emissions that may worsen the local ambient air quality and increasedrates of greenhousegas (GHG) emissions that may contribute to global warming. Inthe case of hydropower subprojects however, there would be environmental benefits such as avoidance of air pollutant emissions. Construction of new roadsmay increaseaccess to fragile habitats, such as natural forests and coastal areas, contributingto their degradation. 119. Both policy and project specific mechanisms to assess, manage and monitor these adverse consequences are essential. From a policy perspective, the Government is takingspecific actions, such as encouragingthe connection of natural gas pipelinesto existing combined cycle gas turbine power plants, which will reduce greenhouse gas emissions by permitting substitution away from current diesel fuel; and strengthening environmental standards for national roads projects by the Ministry of Public Works. The Bank (and other development partners)is supportingGovernment efforts in addressingsome ofthese issues. 120. At a project level, as mentioned above, IIFF's Operations Manual will contain detailed procedures to ensure that the potential environmental and social impacts of subprojects financed by IIFF are adequately assessed, managed and monitored over the life of the investment in a manner that conforms to the requirementsof Bank Policies and with IFC's Performance Standards for Social and Environmental Sustainability. IIFF will build up its institutional capacity to ensurethat it is able to implement the Operations Manual effectively, and Bank group staff will provide ongoing guidance to IIFF staff to ensure that the OperationsManual is effectively and consistently implemented. F. Safeguard policies F. Safeguard Policies 121. The IIFF will be established as a non-bank financial institution that will provide a variety of financial products and services to support commercially viable infrastructure subprojects. Sponsorsof such subprojects will approachIIFF for financingor advisory services, and IIFF will make the decision on whether to support a subproject based on its commercial viability, and according to the procedures set out in the Operations Manual that will be agreed prior to Project effectiveness among IIFF, the Bank, IFC, ADB and IIFF's 41 shareholders. IIFF will consider the potential environmental and social impacts and risks of any subprojectthat it finances. 122. IIFF can be established as an institution only after all government approvals have been obtained and all initial shareholders and initial multi-lateral lenders have made their financing available. As mentioned earlier, the Government and the ADB have obtained the necessary approvals for their respective equity holdings in IIFF. ADB has obtained approval for its $100 million loan that will be on-lent by Go1 to IIFF. Subject to Board approval of the Bank's loan and IFC's equity investment, IIFF is expected to be formally established around October 2009. The Bank's loan will not become effective until IIFF management has been hired and a Social and Environmental Unit has been established. Given that this new institution will take some time to establish itself and consider and approve proposals from subproject sponsors, disbursement of Bank funds is not expected prior to May 20IO. 123. IIFF is expected to finance infrastructure subprojects in several sectors such as energy, including power generation, transmission and distribution; water and sanitation; transportation, including roads, rail, ports and airports; industrial and commercial infrastructure; and telecommunications. As discussed in Section E above, it is very likely that many o f the subprojects financed by the IIFF will have moderate to significant short-andor long-termenvironmental and social impacts. However, the scale and locationof impacts can only be identifiedat the time that IIFF screens subproject proposals. Impact minimizationand mitigation measures will have to be preparedby clients of IIFF and approved and monitored by the IIFF basedon an Environmental and Social SafeguardsFramework (ESSF), which will be an integral part of the Operations Manual (OM) to be adopted by IIFF prior to effectivenessof the Bank's loan and IFC's investments. 124. IlFF complies with OP 8.30 for financial intermediary (FI) lending. The environmental assessment category of the Project is "FI". The Bank's safeguard policies that may be triggered by subprojects that IIFF is likely to finance include OP 4.01 (Environmental Assessment), OP 4.04 (Natural Habitats), OP 4.11 (Physical Cultural Resources), OP 4.12 (Involuntary Resettlement), OP 4.10 (Indigenous Peoples), OP 4.36 (Forestry), and OP. 37 (Safety of Dams). As IIFF will not finance irrigation or agriculture projects, OP 4.09 (Pest Management) is not triggered. As an FI operation, an environmental and social safeguards framework (ESSF) and managementsystem (ESMS) approach is being followed to comply with applicable WBG Policies and IFC Performance Standards on Environmental Social Sustainability (IFC PS). 125. Being a joint IFC/Bank operation and involving several other development partners, the project is supporting a common ESSF to identify, mitigate and monitor potential environmental and social impacts in compliance with Bank Policies and IFC PS, the GOI's applicable laws and regulations and in accordance with the recently approved "Environment and Social Policy and Procedural Guidelines for Projects Financed Jointly by Bank, IFC, and/or MIGA" (dated January 21, 2009). This common ESSF will be applied by the IIFF in the selection and supervision of its infrastructure investments irrespective of the source of financing - ADB, DEG, IBRD, IFC, GOI, funds raised from the market, etc. This approach of a common ESSF has already been endorsed by ADB and DEG, and will be agreed to by all development partners and adopted by IIFF prior to effectiveness of the Bank's loan. 126. The current draft ESSF builds upon the ADB-approved Safeguards Planning Document and outlines (1) the types o f subproject investments and the stages at which IIFF may invest (subprojects not yet prepared, subprojects ready for bidding, subprojects under implementation and fee-based advisory services); (2) requirements to comply with the policiesthat will apply to subprojects supportedby IIFF and (3) implementation arrangements (screening, plan preparation, consultation, disclosure and monitoring), organizational 42 structure, and IIFF staffing that will be put in place to ensure that these requirements are implemented successfully and that subprojects meet all applicable requirements of the World Bank Group as well as Indonesianlaws and regulations. 127. The environmental and social policies adopted in the ESSF have been discussed among the key project stakeholders, including IFC, the Bank, ADB, the Borrower (Directorate General of State Assets) and the Borrower's shareholder (SMI). It has been agreed that IIFF will have one common ESSF that complies with the environmental and social safeguards policies of all o f IIFF's strategic investors. The ADB-approved Safeguards Planning Document, which is consistent with the ESSF, has been disclosed on ADB's and MoF's websites. The MoF has also disclosed on its website: (1) its discussion with IFC that IIFF's ESSF will conform to IFC's PS; (2) IFC's PS; and (3) the draft ESSF (in Englishand Bahasa Indonesia). The final version of the ESSF- acceptableto the Bank - willbe the basis for the environmental and social sections of the OM. Since IIFF will be implementing the ESSF and the OM, it will be appropriate for IIFF, once established, to disclose the ESSF as the framework that it will follow. It should also be noted that IIFF itself needs to hold, as required under WBG policies, ongoing consultations and disclosures regarding the subprojectsthat it finances. Disclosureswill be made in the local languageas required. 128. The consultations and disclosure carried out to date are considered appropriate, giventhe fact that IIFF has not yet been established and, as a result, there is no management team in place yet that could adopt and disclose the ESSF as IIFF's own framework. It is also important to note that the subprojects to be financed have not yet been identifiedand the OM has not yet been developed. For these reasons, and the need to have IIFF's management in place to discuss its role in implementing the ESSF, no consultations with civil society have been held thus far. As the ESSF is an evolving document, additional consultations on the revised drafts o f the ESSF will be carried out with a wider range o f stakeholders, including civil society. The Borrower - and IIFF after it is established - will continue to carry out consultations and disclosure activities as the ESSF is updated. Duringproject implementation, subproject specific safeguards instruments will be subject to consultations and disclosure as requiredby Bank Policies. 129. The draft ESSF will continue to be updated to the satisfaction of the Bank Group and included as an integral part of the OM. Completiono f the OM, acceptableto Bank Group staff, will be a condition of effectiveness. The Bank's EAP Safeguards Secretariat will review the final ESSF and the OM, and its approval will be the basis for acceptability of the OM to the Bank. The Bank will not finance any investment until it has assured itself that IIFF has adequate capacity for ensuringthat its subprojects are carried out in accordance with the ESSF and OM that are fully compliant with Bank Policies and IFC's PS. Pest Management (OP 4.09) [I [XI Cultural Property (OPN 11-03, being revised as OP 4.11) [x 1 1 1 Involuntary Resettlement (OP/BP 4.12) [XI [I Indigenous Peoples (OP 4.10) [XI [I Forests (OPIBP 4.36) [XI [I Safety of Dams (OPIRP4.37) [x 1 [I Projects in Disputed Areas (OP/BP/GP 7.60) [I [XI Projects on International Waterways (OP/RP/GP 7.50) [ I [XI 43 G. Main Featuresof the ProposedIFC investment 130. IFC will invest up to US$40.0 million equivalent in common shares of IIFF. At initial subscription, IFC will invest up to about US$2.0 million equivalent as its 19.9% share of IIFF's minimumregulatory capital. Through subsequent subscriptions and by participating in IIFF's rights issues (at IFC's discretion), IFC may increase its investment in IIFF to US$40 millionequivalent, but will always have a shareholdingno greaterthan 19.9%. 131. To accommodate private-sector investors, each of the IFIs', including IFC's, shareholding may be diluted. The IFIs, including IFC, will however retain a minimum shareholding of 5% each in the first five years of IIFF's operations to providesome measure of stability at the ownership level and to remain available to assist IIFF in its first years of operations. 132. There is a risk that the business volumes may not grow sufficiently to justify the capital to be increased to US200 million in 5 years as required by regulations. In this event, IIFF will need to seek a waiver of this requirement, provision for which is contained inthe regulations. 44 Annex 1: RecentMacroeconomicDevelopments A. Indonesiain 2009 1. Indonesia has made remarkable progress over the last decade in terms of macroeconomic and political stability. Macroeconomic performance since the late 1990's has seen consistent output growth and rapid decline in external imbalances. Increasingtax revenues have contributed to the decline in the fiscal deficit. Increased growth has been grounded on increasingprivate sector investments and sustained domestic consumption. Under a scenario of controlled inflation and moderate interest rates Indonesian citizens managed to improve their living standards and reduce poverty levels. In addition, as the result of a sustained decade of relatively successful political and institutionalreforms, Indonesia in 2009 is a highly competitive, decentralized electoraldemocracy. Governments at national, provincial, district and city level are elected in free and fair contests, with an incumbent loss rate of about 40 percent (one of the highest of any competitive democracy). A system of checks and balances between legislative, judicial, and executive branches is increasingly in place, with no one branch of government able to dominate, and few institutional outcomes `guaranteed'. Where power was once radically concentrated around the presidency, it is now shared with the legislature and where power was once concentrated in Jakarta, it is now shared among 500 odd city, district and provincial governments. 2. Although strongly affected by the current economic downturn, growth in Indonesia is expected to hold up relative well. Growth remained near decade-highs up to the third quarter of 2008, before slowing sharply in the forth quarter with the worsening external environment and anticipatory retrenchment in domestic demand. Despite that, public finances remained in good health, with the budget barely in deficit in 2008 (-0.1 percent of GDP) and public debt ratios continuingtheir secular decline. With a strong fiscal position, Indonesiashould be able to cushion the adverse effects of the global crisis on vulnerable groups, and provide additional resources for development priorities. In the period 2010-14, the budget is expected to increase by more than 30 percent in real terms when compared to the 2005-2009 period (about US$500 billion in 2008 prices) creating significant opportunities to improve public services. But in order to seize these opportunities Indonesia will need more effective and accountable institutions that can translate available resources into better development outcomes. This will be particularly important as Indonesia embarks on a period of second generation reforms to provide, for example, more sophisticated services in infrastructure, better education, and a sustainable healthsystem. B. The State of the IndonesianEconomyEnteringMid-2009 3. Indonesia's slowdown has come relatively later and, so far, has been more moderate than for many countries. GDP growth in the fourth quarter slowed to 5.2 percent y-0-y from 6.4 percent in the year to the third quarter. (Figure 6) For 2008 as a whole the Indonesian economy expanded by 6.1 percent, only slightly below 2007's 6.3 percent pace. Indonesia's growth held up longer, and the slowdown at the end of the year, while sharper than generally expected, was less dramatic than elsewhere in the region.(Figure 7). Nevertheless, the slowdown late in the year was broad-based as private consumption, exports and investment all declined, with only weaker imports and expanding government spending providing some offset. A notable outlier was the increase in agricultural production of 4.8 percent, the highest growth since 1992. While agriculture now accounts for 14.4 percent o f total output, it continues to provide most or all of the income for 42 percent of households and solid growth prospects in that sector appear to be feedinginto broader economic confidence. 45 Figure 6: GDP growth Figure 7: Regional GDP Growth 15% 1 I 12% I China 9% J , India ~ 6% i -1ndo. 3% Philipp. 4 0% ' ' ' 1 ' ~ \ -2 , -3% -Thailand -I Private cons'n Gov't cons'n W Net exports I Korea -6 Investment Discrepancy -Total GDP -6% M a r 0 5 Dec 05 Sep 06 lun 07 M a r 0 8 Dec08 Mar07 Sep07 Mar08 Sep08 Mar09 Sources BPS via CkIC and World Bank Soiirces National statistical agencies, CEIC and World Bank 4. After several years of strong and sustained growth, lifted by rising commodity prices, the global downturn hit Indonesia's trade flows in late 2008. Indonesia'stotal exports reached USD 136 billion in 2008, 20 percent above 2007's exports. But, the fall in commodity prices and, to a lesser extent, the compression in global demand had the anticipated impact on exports in the last quarter of 2008. This peaked in January, when exports fell the most in a decade. The dramatic decline in oil prices and associated falls in other commodity prices drove much of this decline in value. Real exports (in the GDP a measure of volume) were only 1.8 percent above the value of a year earlier in the fourth quarter and were down 5.5 percent over the third quarter, and container volumes were down especially in January althoughthere has since been some recovery.By Marchthere were incipient signs of a recovery, due to boththe recovery in some commodity prices and in demand volumes for some items, with export values up 20 percent on February but still down 21 percent on a year earlier. Imports are closely linked to exports and have been falling rapidly as well: values were down 25.6 percent in the forth quarter over Q3 and 11.7 percent lower in GDP (volume) terms, These falls have been concentrated in intermediate and consumptions imports, down 45 percent and 27 percent respectively (y-0-y); more large transport equipment imports led capital import values 13 percent higher in Marchthan a year earlier. The net effect of these falls was some compression of Indonesia's merchandise trade surplus which declined from USD 5.8 bn in Q3 to USD 4.6 bn in Q4. This surplus recovered somewhat in early 2009 as the falls in import values have been even more dramatic than those in exports. Figure 8: Export values Figure 9: Trade balance (year-on-year percentage change) (billions of USD) 'Io011 gas USD i 60 4 Non-oil &gas bn 1I 1- I rota -40 -60 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Q1-OS 42-08 43-08 44-08 41-09 Sources. BPS and World Bank 46 5. With lower global commodity prices cutting profits and weakening demand firms are reducing investment. As noted above, consumption and investment growth both slowed in late 2008 with fourth quarter investment up 9.1 percent y-0-y and construction activity up 5.7 percent, faster than aggregate demand but the slowest rate since 2002. This is evident in a small fall in industrial production (down 2.4 percent in the year to February 2009), and falling demand for cement and industrial use of electricity. Consumer confidence has been lifted by the pause in price growth (discussed below), and recent retail sales indicators have picked up too (seasonally adjusted). (Figure 10) Demand for consumer durables, notably motorcycles and motor vehicles, dipped in the fourth quarter and continued to fall into January before rebounding slightly in February and March, when car sales were down 27 percent and motorcycles down 11 percent over March 2008. (Figure 11) Figure 11: Demand for consumer durables Figure 10: Consumer confidence (year-on-year percentage change) Index- BI letail sales index 100 i 1-200 60% - 90 80 + , ------- 70 7 60 edit approvals (RHS) + _ _ _ - - ~ ~ Danarakesa consumer survey~(LH 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009 Sources B I and Danarakesa via CEIC, and World Bank Sources Astra via CEIC and World Bank World Bank experimental seasonal adjustment 6. Indonesian financial markets have followed the ups and downs of recent global trends. After being severely affected in October and early November, they strengthened with renewed global confidence from late November, before weakening again in mid-January as market participants' perceptions o f the global situation deteriorated. Most recently Indonesian markets have strengthened again in response to policy developments in the major economies, declining global risk averseness, and Indonesian moves to shore up financing including the contingent financing for the budget from development partners. After settling around 11,000 per USD in December, the rupiah depreciated gradually to well over 12,000, before recovering again to below 10,500 by early-May. (Figurel2) Developments in the rupiah reflect both movements in global currency markets and Indonesia-specific factors. Since December 2008 increasing confidence in the country's policy response to the crisis, and in the sustainability of its financing needs, have led to one of the largest appreciations against the USD in the region. (Figure Figure 13) April's orderly parliamentary elections, and the government's early financing of its budget, further supported market confidence. 47 Figure 12: IDR vs. USD Exchange rate Figure 13: Regional exchange rates (IDR per USD and weekly percentagechange) (percentage change to mid-April 2009) 16% 7 12% IDR/ A Appreciation USD 8Yo 11,800 1Mar 09 4Yo 11,100 0% 10,400 -4% 9,700 Y Depreciation -8% 9,000 Jan-08Apr-08 Jul-08 Oct-08Jan-O9Apr-09 IDR KRW THB SGD MYR USD JPY index Source& BI via CEIC, and World Bank Sources FRB via CEICand WorldBank 7. Yields on Indonesian government bonds, which were especially affected by the global instability, have recovered most of their losses. By the end of 2008 Indonesian government bond yields had recovered much of their October and November losses (when, for example, the five year bond yield rose to over 20 percent), but were still at relatively elevated levels. They then retreated again in line with renewed global risk aversion in the first quarter of 2009. As the government filled much of its financing needs early in the year (discussed below), and global risk aversion declined, Indonesian bond yields recovered further. Shorter-tenor bonds have recovered most, as the central bank cut the overnight policy rate and reduced the yields on short-term certificates; longer-dated bonds also benefited from the post-March reduction in risk averseness. The premium on Indonesian government bonds denominated in IDR relative to those denominated in USD narrowed drastically early in 2009. While the yields on USD bonds especially have since recovered somewhat, the premium still remains historically low at 500-600 bps. Non-residents have also recovered some confidence in Indonesian government bonds. They cut their holdings from IDR 107 tr or about 20 percent of the total stock at the end of August 2008 to a low of IDR 78.7 tr in mid-March, but, with the turn-around in global financial markets and especially with growing confidence in Indonesia, they became net purchasers, increasing their holdings to IDR 85.6 tr or 15.5 percent of the total by mid-April. Figure 14: Indonesian domestic bond yields Figure15 Indonesian Global bond spreads bps % YO bPS libyear TOR less 20 200 1200 12 16 100 900 9 12 0 8 -100 600 6 4 -200 300 3 0 -300 Jan-08 AR~-08 Jul-08 Oct-08 Jan-09 Am-09 0 0 2005 2006 2007 2008 2009 Sources BEf via CHC,and World Bank Sources: JP Morgan, BE1via CEIC, and World Bank 8. Indonesia's bankers have strengthened their balance sheets in recent years and have little direct exposure to the financial sector stresses of U S and European banks, but lending growth is slowing. Fewer new loans are being approved, and anecdotal reports suggest that new customers, especially SMEs, are having difficulty accessing credit as bankers become more conservative towards consolidating their balance sheets. (Figure 16) At the same time 48 though, this slowdownin lending is only in contrast with the rapid lendinggrowthofthe first half of 2008, and demand for credit is also slowing, as firms reduce their working capital, or lower commodity prices cut financing needs, leavingcredit lines undisbursed. While interbanklending has been improving since November and there is sufficient overall rupiah liquidity in the system, reports suggest that it is not well distributed with larger banks typically liquid and smaller banks facing problems. Other banking sector indicators continue to suggest the sector remains in relatively good health overall, with banks lifting their capital-to-assets ratio and only a marginal increase in non-performingloans at the start of 2009. (Figure 17) Figurel6: Credit approvals (seasonally adjusted, trillions of IDR) Figuref7: Banking indicators IDR - j tr 1 Consumer 1 Katio 180 A I[Investment ' Working capital 150 -I I 120 1 0 18 90 -II I 0 212~ : --- I 0 0 6 1 < i >-, ~ i _ _ -- 0 OQ - c - - - - ? - - i - ~ ~ ~-.I--- 2005 2006 2007 2008 2009 2002 2004 2006 2008 Sour.ceJ BJ via CEJC, and World Bank Sources BI via CEIC, and WorldBunk 9. Inflation has slowed sharply with the fall in commodity prices. Reductions in international prices are passing into domestic and regulated prices (as fuel prices have been adjusted downward). Consumer prices have stabilized: they were unchanged between November and April, reducingthe year-on-year inflation rate to 7.3 percent from a peak o f over 12 percent in September. (Figure 18) This is despite the rupiah's 25 percent deprecation over this period. The inflation rate has fallen even more for poorer households whose consumptionbasket has a greater weight in food. Consumer inflation expectations are now at their lowest level since early 2005, when actual inflation was running close to 5 percent. Upstream prices have been falling since mid-2008: by February2009 they were down 8 percent from their July 2008 peak, largely due to lower global energy pricesand despite the depreciationinthe rupiah. 10. Indonesia's external position remains sound, though weaker than 2007. Developments in global commodity and financial markets buffeted Indonesia's balance of payments throughout 2008. The current account ended in a small surplus o f USD0.6 bn, despite the bubble in oil prices in the first half of the year, which inflatedfirst Indonesia's fuel import bill and then its net income deficit as oil producerstransferredtheir profits abroad. Portfolio outflows at the end of 2008 moved the overall balance of payments into a deficit of USD 1.9 billion for the whole year, the first annual deficit since 2001. (Figure 19) The year-end portfolio outflows were driven by both residents, who shifted USD 2.7 bn into offshore bank accounts, and non-residents sellingdown their holdingso f debt securities (net outflow o f USD 3.8 bn from both corporate and government securities). Both the current account and capital flows were in surplus in the first quarter of 2009, according to preliminary estimates. Other areas of the capital accounts were relatively untouched by the turbulence on financial markets, and Indonesia recorded its largest 49 inflows of foreign direct investment since mid-2005 in the final quarter of 2008 and the first quarters o f 2009 (based on preliminary data).*' Figure 19: Capital outflows Figure 18: Inflation (balance of payments as percent of GDP; (year-on-year) reserves in billions of USD) % -, , USD I 1 bn 18 1 4 5 l2 1 1 3 0 1 I i 6 1 -4 4 15 I inflation 1 Capital + financial account (LHS) 0 Current account (LHS) -- -- -~ -8 - L O --_? r---- -1 -- 2005 2006 2007 2008 2009 2005 2006 2007 2008 2009 Sources: BPS via CEIC,and World Bank Notes and source: *el49 data preliminary Ministry of Finance estimates. f Q2 reserves data to April 30. BI, BPS via CEIC,MoF,and WorldBank. 11. Indonesia's government is well-positioned to respond to the downturn. In 2008 the budget deficit was just 0.1 percent of GDP, compared with 2.1 percent projected earlier in the year when international oil prices and Indonesia's energy subsidies peaked. Revenues were 9.6 percent above budgeted levels, due to high commodityprices and improvementsin tax office administration, while under-spending continued as it has in recent years. Despite the exchange rate depreciation the debt to GDP ratio continued its secular decline, ending the year under 33 percent. The government also recorded a financing surplus of 1 percent of GDP, due to its lower-than-expecteddeficit and front-loaded borrowing strategy. In the first third of 2009, the central government disbursed 23 percent of its total budgeted expenditure, a slightly higher ratio than in 2008. C. Policy-Makers' Response to the Deteriorating Global Economy and Indonesia's Economic Outlook 12. Indonesia's monetary and fiscal policy makers responded quickly to the deteriorating global economy. Bank Indonesia shifted monetary policy from the anti- inflationary stance of mid-2008, cutting interest rates by 225 bps to 7.25 percent between December and May 2009, their lowest level in four years. BI has also reduced the corridor betweenthe interest rate banks receive on deposits at BI and pay on loans, and, during the peak period of financial market turbulence, injected liquidity into the inter- bank lending market. *'In additionto the USD 900 m investment by Qtel in lndostat in Q1-09, early May brought a surge of FDI announcements, includinga USD 4.6 billion nickel project from France's Eramet and Mitsubishi of Japan; textile buyers from US, EU and Japan shifting USD 0.65 bn of orders from China; and Volkswagen, the German carmaker. announcing plansto open an assemblyplant. 50 2006 7 2 5 0% 5 8% 4 9% 6 1% 1040/0 5 S% 5 1% oiw VAT 3 7% 4 3% 3 9% 4 3% 4 4 K 5 3?fb 47% 43% Oil 8. gas 6 0% 48% 43% 3 6% 5 3% 6 3% 4 ?% 2 4% Other 2 5% 23% 29% 1 9% 2 9% -3 6% 18% 17% ~ x ~ ~ ~ d i ~ u r ~ s20.0% 20.2% 19.1% 19.4% 22.1% 19.9% 14.5% 18.0% Central Govt 13 I% 155% 140% 134% 125% Personnel 3 0% 2 8% 2 3% 26% 26% ~ a ~ e r i a l s 12% 1 5% 1 2% 17% 77% Interest Payments 2 1% 2 19.0 1 8% 19% 20% Subsidies 2 2% 5 2DfO 4 5u/o 3 1% 2 3% SocialAssistance 16% 1 3% 1 1% 1 5?& 1 4% Other CUrFent 0 7% 08% 06% 1 2% 1 0%' &apIiaI 2 4% 18% 3 5 % 14% I3% -0.9% -1.1% -1.3% -1.7% -2.2% -#*1% 4.0% -2.5% GDP (IDR t i ) 3 338 796 3,749 155 3,957,404 4,306,608 4 484 372 4,954.029 5 327,538 5,487,578 GDP growth (%l 5 5% 6 3 % 63% 68% 64?6 6 1% 60% 4 5 % lnfla~io~(%1 8 0% 6 5% 6 6% 6 0% 6 5% 9 8% 6 2% 6 0% Exchange rate (USDI 9 141 9300 9419 9100 9 100 9694 9400 11 000 Oil Price (USDlbl) $6400 $6300 $7800 $6000 $9500 $9680 $8000 $4500 Actual Projected ?& 6.3 6.1 3.4 5.4 6.3 investment O/~chan~e 9 2 117 4 1 8 4 102 Consumer pftces %change 6 5 9.8 5 0 4 0 4 0 3udget deficrt Oio GDP -1 3 -0 1 -2 0 -1 4 -1 2 Poverty rate Ofopop'n 166 154 132 117 -- External sector: Current account balance USD bn 10.4 0.5 -0.1 -1.1 -3.7 Exports GNFS USObn 131 154 113 124 140 lmports GNFS USDbn 110 744 104 I12 124 Growth e n ~ ~ ~ o n ~ e ~ t ~ ~ r a d i n g ~ a ~ e r ~ e r GOichange O P 1 9 3 0 -02 3 3 4 3 Reat effective exchange rate %change 5 7 9 4 -29 0 0 0 0 Export prices %change f 7 8 28 7 -398 -59 0 8 Credit growth % 102 171 120 135 135 52 Trade (GNFS) deficit (+e if surplus) -100 Net income 5 7 ~ a ~ ushort-term FCU debt r ~ n ~ 12.1 57 58 Annex 3: Indonesia's Financial System A. Structure and participants 1. The Indonesian financial system consists of bank and non-bank financial institutions (NBFIs) whose assets were expected to reach IDR2,942.2 trillion or 59.4% o f GDP by the end 2008. Divided into commercial banks and rural banks, the banking sector is the largest segment of the financial system, controlling nearly 80 percent o f its assets (see Figure23). There are currently 124 commercial banks (including 5 state banks and 26 regional government banks) and roughly 1,770 rural banks in Indonesia. NBFIs consist o f pension funds, life insurance, non-life insurance, mutual fund managers, venture capital, leasing companies, pawnshops and micro-finance institutions. Figure 23: Financial Structure in Indonesia Financial Structure in Indonesia Number of Institution Rural Banks 1,772 Insurance Mutual Funds Life 2% Secunties Firm , Non-Life FinanceCompanies 2Yo i Rural inst Social Securitv 5% -\\ I ,,,,-Pawn;: VC / / , Civil Servants Pension Fund 282 PensionFunds Employer 255 4% Institution Securities Multi Finance Venture Caoital 2. Following the 1997/1998 financial crisis, the Government made significant efforts to strengthen the financial system in Indonesia. The central bank law was amended and Bank Indonesia (BI) was made independent from the Government. As the nation's central monetary authority, BI regulates and supervises the banking sector. 3. I n recent years, the Government has focused greater attention on NBFIs in part becauseof the significant growth in this sector. In 2007, NBFIassets increased about 47.8% to IDR664.3 trillion while bank assets grew by only 17.3%. In 2008, NBFI assets were estimated to have fallen 12.5% to IDR581 trillion primarily due to the global financial crisis. Until early 2005, two institutions within the Ministry o f Finance had authority over NBFIs: Bapepam was in charge of capital markets and the Directorate General o f Financial Institutions (DJLK) was in charge o f all other NBFIs. To enhance the coordination and supervision ofNBFIs the Finance Minister combined Bapepam & DJLK to form Bapepam-LK in late 2005. 61 62 63 65 indusiry insested only small a r ~ ~ u nin~cyuitj marlots, The declirrc also reflects the ~ n ~ r ~ a s ~ d S I r ~ i I ~ ~ bob"rpolicy stirrer~de~s. e s Pension Funds 1. topment Challenges 26. 'I'k challenges f'acjrig ~ n d ~ itif uthiss tinxe can be broken down into the ~ ~ ~ ~ f o l l oitig general categories: ~ 67 69 Annex if: Major ~ ~ lProjects ~e j~ n by~the~Bank andfordather Agencies ~ t ~ ~ Sector tsrue rrujeet Name Katirig S 70 Sector Essue Project Name Rating scctor s 71 Project Qurcurne lnificaturs Annuai outcome ~ ~ ~ ~ iiunt r ~ r lfX.I:'s~ ~ ~ ~ t i o ~ ~ financial reports will bc iiscd to track progresstouord the PDO and to make changes in the project if neccssarq during ~ ~ ~ ~ l ~ n ~ ~ n ~ ~ ~ ~ i ~ n . 72 73 Targets ---+--- -c ttzdicator wili bc to 11 u ineasureci through she revenues abta1nd bq the liFF for advisor) s e nices as laid I nut in the f iIlif iaI llC mjcctittns 75 77 78 79 80 24. A sound governance structure is key to the success of IIFF. Substantial multi- and bi-lateral as well as private sector (domestic and international) equity participation will be the driver of sound governance.IIFF will adopt sound corporategovernancepracticesto confirm its position as a credible institution in the eyes of all stakeholders. In addition, to improve transparency, lIFF will voluntarily comply with the listing requirementsof the IndonesianStock Exchange (IDX) from the outset, even though it is expected to be listed only in the medium- term. It is expected that this voluntary compliance will create IIFF transparancy level at the same as best practices level. In addition, being a non-bank financial institution, IIFF will be subject to the Indonesian regulatory requirements for such institutions with supervision being conductedby Indonesia'scentral bank, Bank Indonesia. 25. Board representation by the equity investors will be critical to ensuring that appropriate internal controls, risk management mechanisms including anti-corruption measures, and high quality humanresources are adopted and implemented. IIFF will have atwo tier board structure, Le., the Board o f Directors and the Board of Commissioners.The Board of Directors i s responsible for the day to day management o f the company and the Board of Commissioners is responsible for providing oversight function. It i s expected that the IFC, ADB, and DEG will nominate one member each on the IIFF Board of Commissioners. To supplement the skills available to it, IIFF will induct a number of independentCommissionerswho are highly reputed in areas such as law, accountancy/audit, economics, environmental and/or social issues, civil society organizations, etc. Such independent Commissioners, apart from providing credibility to lIFF and playing a vital role in corporate governance, will also make available to IIFFtheir skills and experiencewhich will be invaluable. 26. The detailed design of the IIFF's organization structure and various policies related to human resources are being developed with funding for consultants from AusAID. These will be finalized leading up to the incorporation of the IIFF. The broad organization structure as envisaged for the IIFF on the basis of its positioning and product offerings is as follows: Figure 25: Broad Organization Structure of the IIFF 81 82 kigurc. 20: I he IIFF Products Chart Senror Debt; Subord~nat~dDebt i Mezzanine Guarantee Loan~ ~ ~ ~ i c a ~ i a ~ ; F ~ n ~ i ~ ~ ; Advisory Equity ~ n v e ~ ~ ~ ~ n ~ ~ BridgeFinance; Take-out Financei Refinance; S ~ c ~ r i ~ i z ~ t i o n 83 13 86 48. '2"helike[) sanction of debt ~ ~ ~ a nby the [IFF based on the sbove asse~smen~ c i n ~ is: 88 Anna 7: Project Costs 89 90 92 93 B. tu ~ ~~ ~ ~ ~and c~ u ~ ~ ~ ~ erciai practices in the countv: 8. At this stage, it is nat possibk to ea f of the ~ r Q c u r c capan ~ ~ ~ . of neither IIFF nor any of the firms that may apply for sub-loans. IlFF is still undcr ~ ~ ~ a h aridi there~is~still no rsprcilic ~ l ~ l ~ ~ ~ ~ ifor entities that~\vi!! ~ apply forl funds.~ ~ ~ ~ 97 98 Qwralt Country Risk 101 OvetatX Prqject Risk EI B. Conkrid Risk Bttdget 102 t ccptabIe to the f3:trrk. The audit TORS ~iIiinlinewiththeagreedtermsof be refcrence. Overall ControlRisk S M 106 t 09 110 1 1 1 I32 ...... II.... I Organimtion control.risks Mstnageme'n1. Fvl 1.. K1sks II3 114 ' Rating OS risks on a ~ou~-poinr ~ I " scale - High, St 115 116 ............ "- Gcnring .................".."-""."-__I- Gross Noti- Performing Assct 117 in equity may be trailing the lendingoperations as IIFF staff will have to gain familiarity and expertise with Indonesia's infrastructure finance market before embarking on riskier equity investments. Figure28 below shows the build-up of the projected loan portfolio and its growth (and total assets build-up). Figure 28: Projected Asset and Loan Book Build-up (in US$ million) 3,500 180 1 1 3,000 160 , 140 2,500 120 P 2,000 C E 100 8 8 1,500 80 3 60 I 1,000 f I 40 I 500 1 20 I 0 0 I Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 1 I0Loan TotalAsset -Loan Growth 6. Asset Growth: In line with the increasing pipeline, IIFF assets is projected to almost double in year 3, and later steady grow at the range of 27 to 49% from year 7 onwards when the total assets are projectedto reachUS$2.97 billion at year 10. 7. Asset Quality: NPA are projected to be low in the first two years of operations due to IIFF conservative approach in secured lending, i.e. 85% of IIFF financing will be in the form of senior term loan. Starting in Year 3, IIFFwill consider investingsmall part of its equity stake in projects. The rationale behind this is that infrastructure investments are lumpy and one bad loan/unsuccessful equity investment can cause the NPA ratio to spike; some unfavorable investment decisions cannot be excluded in the early years when the portfolio remains small although IIFF's important position in IndonesianInfrastructurein its early years should allow it to be highly selective. It is recognizedhowever that the infrastructurefinancing market will be a partly untestedfield. 8. EquityLeverage: Starting with a seed capital of US$lO million as required by the InfrastructureFinancingCompany's regulation,IIFF `s total equity is projectedto reach US$50 million in year 3 and US$142 million in year 5. As IIFF's asset base will grow, shareholders will continue to subscribe to new rights issues to support IIFF's growth and maintain a conservative capital structure. While the CAR Iis projected to stay at 40% in the first three years, IIFF will steadily maintainits CAR positionabove 22% level.The projected gearing ratio (total debthotat net worth) will be relatively high in year 1 at 6.8x, but the gearing ratio will drop quickly as the loan book grows, equity rises, and the CAR Ineeds to be maintained at a conservative level. Most of the time, the gearing will hover at the range of 1.5 to 3 . 7 ~. The logic for that is that IIFF will be able to handle a higher gearing and lower CAR Iafter building sufficient experience and havingcreated a track record for itself. 9. Funding: In its initial years, IIFF will have two strong funding tools at its disposal; US$200 million in subordinated loans from IBRDand ADB, and SMI's convertible debt. It is 118 I O . Interest h o m e : Uhitc minimal in the first few years, interest incornc is prctjcctcd to grow strongly in line uith the increaw in the loan ~ ~ r t ~Interest iincome. from loans will ~ l ~ , 1 I 9 "1 11- Startingat IU,G and 696 peak arid dccreasiiig xricreasing to 3% to 3.8% 120 14, 'I'he IRK of the three cases is as follows: 121 w a c Lo 0 r- P 0 N .a 0 03 m a m 0 m N Q R 0 N w 0 c? 0 ."a ss m m or- %- 0 0 0 , F a 0 0 g ai T N, CL m " O R F: s? m " a g 4 ..., m uf " EQ 127 130 Draft OM from f.tISIL I, 2. 3 . 4* 5. 6. 132 133 41 4 i 19 3s 135 30 1006 Harrl, NfSP Swap 0.00 0 DO 0 DO 0 00 0.08 0.00 0.00 0.00 136 18 40 7t 69 24 4 l 13 25 95 93 a? 85 1'11 :is 1CS 'OB 97 se 68 54 L zoo0 2007 2008 1654 1605 72 3ic 174 1 BO 39 13: i: 04 d B 1.' I 283'J a 5 III 1* 5 8 422 Y t43 9 %% 100 95 206 3 225 ti i64.022 432 617 9b 2 c 3 2 '9 ' 2 4 ' 128 5- 5 ' e a 4 c 6 8 5 2 8 8 4 8 5 5 0 1 '3 ? % 36 $ 7 7 ' 5 9 8 3 l., 5 7 9 8 137 Indonesia 2000 2007 $2 i24 114102 36 296 81 724 29 662 21 981 23Y8Z 1 I a10 1 4 5 2 5 I CGPtfO C'CO 197 179 2 1 1 1 2 4 156 11 I 2W7 -1 8 -1 3 55 3 35 35 44 30 30 If 2 $44 288 240 783 26 16522 - 14647 - 48 # 14 3 8 7 4 3 2 5 '2 867 2 3 2 200 "4550 5580 i* 1 0L1 1 #b8 3Y # f 4 2007 6 $21 767 1 369 4x5 159a 219 3% 657 527 22% 38 50 0 @&especified 2007 aats am prelrntirwy 1/26/09 IDEcnG1 primaryschooling 86 m 96 94 %3 $6 99 45 55 64 96 99 93 98 98 29 25 32 12 f3 B 11 420 31 37 64 72 4; 55 67 7 9 363 5 8 i# I O I39 8002 TSUGUA 11 10 9 8 7 6 5 4 3 2 1 PROVINCES: 10 15 Banda D.K.I. 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