RESTRICTED Ft'L E COPReport No. P-9 Public Disclosure Authorized This report is for official use only by the Bank Group and specifically authorized organizations or persons. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report. INTERNATIONAL DEVELOPMENT ASSOCIATION Public Disclosure Authorized REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS Public Disclosure Authorized ON A PROPOSED CREDIT TO THE REPUBLIC OF INDONESIA FOR A SECOND HIGHWAY PROJECT Public Disclosure Authorized June 7, 1971 CURRENCY EQUIVALENTS US$1.00 = Rp 378 1 rupiah US$0.003 1 million rupiah-US$2, 6 46 INTER11'ATIONAL DEVELOPI4ET ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EDXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT TO THE REPUBLIC OF INDONESIA FOR A SECOND HIGHW4AY PROJECT 1. I submit the following report and recommendation on a proposed credit to the Republic of Indonesia in an amount in various currencies equivalent to US$34 million on standard IDA terms for a second highway project. PART I - HISTORICAL 2. Indonesia has received fourteen IDA credits for a total amount of US$178.4 million. The IDA program for Indonesia reflects the priorities for rehabilitation and development established by the Government and fully supported by the Bank Group. To support the Government's program for increasing food production the Association has made several credits for agriculture, mainly for the rehabilitation of irrigation systems and of rubber and palm oil estates. These account for nearly half of IDA lending for Indonesia, and for close to two-thirds if the Association's share in the PUSRI fertilizer project is included. In addition, to facilitate rapid rehabilitation in these sectors credits for highways, power, telecommuni- cations and education have been made. In recognition of the urgent need for institutional reforms, a number of IDA projects have included major steps to reorganize existing institutions or establish new ones. At the same time, to supplement the Government's efforts in improving admini- stration and management each credit has included provision for consultant services and technical assistance. A summary statement of IDA credits and IFC investments is at Annex I. 3. In addition, two technical assistance credits have been made to finance part of the cost of pre-investment studies undertaken by the Government during the last two years. These studies are now helping to establish investment priorities over a wide range of activities, and as a result, it is becoming possible to consider project aid in priority fields not yet assisted. The Association's plans for FY72 take such possibilities into account. While there is provision for further lending for irrigation rehabilitation, highways, power distribution and education, projects are also being considered in six new fields: family planning, development finance, marine transport, smallholder rubber, industrial estates and tourism. Each involves difficult issues and new administra- tive problems, and not all may be ready for the Executive Directorst consideration in the next fiscal year. In any event, the IDA allocation for Indonesia may not suffice to cover all. Special emphasis is being placed, however, on the family planring and development finance projects which are being appraised in June and September respectively. Each wiould represent an important step in the institution-building process and, as with most IDA credits, could set the stage for additional aid to these sectors from bilateral donors. 4. The first IDA credit to Indonesia was made in September 1968 and nine of the fourteen credits have been made since June 1, 1970. As project authorities were unfamiliar with the Association's procedures and requirements there have been initial delays on some projects. The implementation of the first and second Agricultural Estates Projects (Credits 155-IND and 194-IID) has been delayed, mainly due to problems of organization; progress is being made and the problems are gradually being resolved. Disbursements from Credit 155-IND are behind schedule, but the position is expected to improve soon since contracts have been awarded for US$4.1 million against which no disbursements have yet been made. Credit 194-IND was made effective on February 9, 1971 and dis- bursements are expected to start shortly. Progress in executing the first Highway Project (Credit 15h-IND) is satisfactory even though disbursements are lower than forecast at appraisal. The major items of equipment are now being delivered, after some delays due to un- familiarity with the Association's procurement procedures, and dis- bursements are expected to speed up. The Third Irrigation Rehabili- tation Project (Credit 220-IND) was declared effective on Play 28, 1971 and disbursement will start shortly. The Seeds Project (Credit 246-IND) was approved by the Board on May 11 and has not yet been declared effective. After a slow start disbursements on the balance of the credits are now satisfactory. As of May 31, 1971, of a total commit- ment of US$178.4 million, US$161.9 million remained undisbursed. The improving disbursement situation is evidenced by the fact that of the total disbursement of US$16.5 million, US$7.8 million has occured during the months of April and May. The pace of disbursements is likely to quicken further. PART II - THE ECON0OiY 5. The Indonesian economy is still recovering from the damage, physical and institutional, caused by years of mismanagement, hyper- inflation and civil unrest during the latter years of the Sukarno regime. Initially the Soeharto Government was forced to concentrate on immediate objectives: halting inflation, increasing food produc- tion, rehabilitating infrastructure, attracting foreign investment and promoting primary exports, particularly minerals and estates crops. 6. The stabilization has not only brought prices under control but has also succeeded in establishing an environment conducive to development. Among measures taken to remove controls and open the economy to market forces has been the progressive simplification of the exchange system which is now virtually free of controls. A selective credit policy has encouraged production from existing capacity and, more recently, investment in new capacity. A new foreign investment law has encouraged the inflow of private capital and has been complemented by a domestic investment law with similar provisions. External and internal balance has been maintained and, wihere necessary, reinforced by measures such as the introduction in 1970 of a price support policy which appears to have had substantial effects on rice production. 7. A special economic report (EAP-22), prepared for the April 1971 meeting of the Inter-Governmental Group for Indonesia (IGGI), was distributed to the Executive Directors on April 16, 1971. This report bears evidence of the continued economic improvement described in more detail in the last full economic report on Indonesia (EAP-19a of November 27, 1970). Economic and social data are contained in Annex II. IJhile reliable statistics are scarce, economic progress is evident in the marked increased in the production of textiles and other manufactured goods, in accelerated construction activities and in continuing export growth. Exports, led by oil, were 15 percent higher in 1970/71 than in the previous year in spite of lower prices for rubber. Rice pro- duction appears to have increased by over 5 percent in each of the last two years and foodgrains imports, which have been approaching a million tons annually, could be substantially lower this year. The available data on production, investment and imports indicate a growth in GDP in 1970/71 of approximately 8 percent. 8. The Government has a Five-Year Development Plan (1969-7h) which appropriately reflects the short-term needs of the economy and is being implemented as a series of annual programs. Highest priority is assigned to agriculture for both food production and export crops. Special emphasis is also placed on the rehabilitation of infrastructure, including transport and communications, power and irrigation systems. Programs covering the more urgent needs for physical rehabilitation have been drawn up, substantial external aid has been committed, and many of the works are in progress. More attention is now being given to new construction. In addition, the Government's energies are being directed increasingly to other major development problems, including the population pressures on Java and Bali, the requirements of the social sectors and the needs for regional balance in development. 9. Among the most serious and urgent problems at present, for the public sector as a whole, are those resulting from the deteriora- tion of the administrative system and of its public institutions and agencies under the previous regime. The first steps towards the re- organization of the civil service have recently been taken and suggest a growing determination to make progress in this difficult field. Action is also underway to increase the efficiency and viability of some state enterprises, but there is still scope for considerable improvement. - 4 - 10. Bank Group assistance to Indonesia is part of the international support being given in increasing amounts through the Inter-Governmental Group for Indonesia. Commitments of aid have risen from $200 million of program aid in 1967 to over $600 million in all forms of aid for