Indonesia Country Partnership Strategy Final Review Validation,

Transcription

1 CPS Final Review Validation Indonesia Country Partnership Strategy Final Review Validation, Independent Evaluation

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3 Validation Report May 2015 Indonesia: Validation of the Country Partnership Strategy Final Review, This document is being disclosed to the public in accordance with ADB's Public Communications Policy Reference Number: FRV: INO Independent Evaluation: VR-16

4 NOTES (i) (ii) (iii) The fiscal year of the government ends on 31 December. In this report, $ refers to US dollars. For an explanation of rating descriptions used in ADB evaluation reports, see: ADB Guidelines for the Preparation of Country Partnership Strategy Final Review Validation Report. Manila. Draft. Director General Director Team leader Team members V. Thomas, Director General, Independent Evaluation Department (IED) W. Kolkma, Director, Independent Evaluation Division 1, IED H. H. Son, Principal Evaluation Specialist, IED F. Ahmed, Lead Results Management Specialist, IED L. Ocenar, Evaluation Officer, IED V. Melo-Cabuang, Senior Evaluation Assistant, IED The guidelines formally adopted by the Independent Evaluation Department on avoiding conflict of interest in its independent evaluations were observed in the preparation of this report. To the knowledge of the management of the Independent Evaluation Department, there were no conflicts of interest of the persons preparing, reviewing, or approving this report. In preparing any evaluation report, or by making any designation of or reference to a particular territory or geographic area in this document, the Independent Evaluation Department does not intend to make any judgment as to the legal or other status of any territory or area.

5 Abbreviations ADB Asian Development Bank ANR agriculture and natural resources BAPPENAS Badan Perencanaan Pembangunan Nasional (Ministry of National Development Planning) CPS country partnership strategy CPSFR country partnership strategy final review DMF design and monitoring framework EIRR economic internal rate of return GAP gender action plan GDP gross domestic product IED Independent Evaluation Department NGO nongovernment organization PNPM Program Nasional Pemberdayaan Masyarakat (National Community Empowerment Program) PPP public private partnership PSM public sector management RPJMN Rencana Pembangunan Jangka Menengah Nasional (National Medium Term Development Plan) RRP report and recommendation of the President SUSENAS Survei Sosial Ekonomi Nasional (National Socio-Economic Survey) TA technical assistance Currency Equivalents Currency unit rupiah (Rp) (as of 30 April 2015) Currency Unit Indonesia rupiah (Rp) Rp1 = $ $1.00 = Rp12,923

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7 Contents Acknowledgments Executive Summary Page vii ix Chapter 1: Introduction 1 A. Validation Purposes and Procedures 1 B. ADB s Development Plan 3 C. Government Development Plans in the Context of the Country Partnership Strategy, Chapter 2: Country Context 5 Chapter 3: Validation of the Country Partnership Strategy Final Review 12 A. Strategic Positioning 12 B. Program Relevance 14 C. Effectiveness 21 D. Efficiency 30 E. Sustainability 33 F. Development Impacts 36 G. ADB and Borrower Performance 38 H. Assessment of the Quality of the Final Review 40 I. Overall Assessment 40 Appendixes 1. Tables List of linked documents 51 Tables Table 1: Household Welfare in Indonesia, Table 2: Explaining Changes in Poverty by Growth and Inequality Effects, Table 3: Average Deprivation and Its Contribution 6 Table 4: Impact on Household Welfare of 30% Increase in Fuel Prices in Table 5: Planned Versus Approved Sovereign Loans, Table 6: Unplanned but Approved Programs and Projects, Table 7: Planned Versus Actual Loans and Technical Assistance by Sector Share, Table 8: Continuity in ADB Objectives, Strategic Focus, and Sectors of Engagement 20 Table 9: Project-Related Cases in Indonesia Handled by the Office of Anticorruption and Integrity 30 Table 10:Rating Comparison between Country Partnership Strategy Final Review and Its Validation 41 Figures Figure 1: Coverage of Independent Evaluation Department Validation 2 Figure 2: Average Deprivation Suffered by the Population Across Provinces in 2010 and

8 vi Indonesia: Validation of the Country Partnership Strategy Final Review, Figure 3: Change in Welfare by Quintile due to a 30% Increase in Gasoline Prices in Figure 4: Deviations between Planned and Delivered Investment Projects and Program Loans, Box Sustainability Issues in ADB s Vocational and Polytechnic System Support 35

9 Acknowledgments This validation study was prepared by a team led by Hyun H. Son, principal evaluation specialist, Independent Evaluation Department (IED), under the overall guidance of director general Vinod Thomas and director Walter Kolkma. The study team comprised Farzana Ahmed, Lucille Ocenar, and Valerie Melo-Cabuang. Consultants provided useful inputs for this study, particularly on the sector analyses: Gabe Ferrazzi (public sector management) and John Weiss (energy and transport). Rizza Leonzon provided excellent research assistance. The draft of this study was reviewed externally and internally. The external peer reviewer was Peter McCawley, former dean of the Asian Development Bank Institute. Tomoo Ueda and Emile Gozali, principal evaluation specialists of IED, served as the internal peer reviewers. IED s Hemamala Hettige, Bob Finlayson, and Jiro Tominaga also provided comments on an earlier draft of this study. Valuable comments were received from the Asian Development Bank s Southeast Asia Department and Indonesia Resident Mission. IED retains full responsibility for this study.

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11 Executive Summary The Independent Evaluation Department (IED) of the Asian Development Bank (ADB) has validated the country partnership strategy final review (CPSFR) prepared by the Southeast Asia Department for Indonesia s country partnership strategy (CPS), The CPSFR rated the CPS successful. Self-evaluation assessed the program as satisfactory in strategic positioning, relevant, partly efficient, but effective, and likely sustainable with satisfactory development impacts. The CPSFR and this validation aim to contribute to the development of ADB's CPS for Indonesia for The validation is based on (i) the review of relevant documents and reports; (ii) analysis of the Indonesian National Socio-Economic Survey for 2010 and 2014; and (iii) interviews with government officials, development partners, and ADB staff at the Indonesia Resident Mission and headquarters. This study is consistent with both the 2011 CPSFR validation guidelines and 2010 country assistance program evaluation guidelines. Country Context Indonesia s growth in contributed to improvements in welfare, as made evident in greater consumption. Per capita expenditure increased 5.6% annually during the period. At the same time, growth helped reduce poverty, with 1.0% growth in per capita expenditure reducing the poverty headcount ratio by 1.4% on average. Growth was the main driver of poverty reduction in Had inequality not risen, however, the reduction in poverty would have been greater. Indonesia s Gini index increased sharply, from 35.4 in 2010 to 40.6 in 2014, with the poorest quintile of the population suffering the greatest decline in the share of per capita expenditure. Had inequality held steady, and holding everything else constant, this study estimates that the poverty headcount ratio in 2014 would have been 3.6% rather than 11.3%. Inequality is rising in Indonesia, largely because of worsening average deprivation in urban areas and disparities across provinces in The increase in average urban deprivation accounted for 3.2 percentage points (equivalent to 62%) of the 5.2 percentage point increase in Indonesia s Gini index in the period. Urban deprivation rose in part because urban infrastructure did not keep pace with rapid urbanization. Moreover, various subgroups among the urban poor are vulnerable to economic shocks and natural disasters. Slum dwellers, who often reside in disasterprone areas, and informal sector workers, who have no protection or benefits, are among such groups. Disparities across provinces also persist. The findings reveal that Sulawesi Barat (West Sulawesi) and Nusa Tenggara Timur (East Nusa Tenggara) suffered the highest average deprivation in In turn, the Government of Indonesia must have sufficient fiscal capacity to support the provision of such basic services. To increase this capacity, the government in November 2014 raised fuel prices 30%, thus reducing fuel subsidies, a move many economists had

12 x Indonesia: Validation of the Country Partnership Strategy Final Review, long called for. This study finds that reducing fuel subsidies is associated with a decrease in inequality. A 30% increase in the gasoline price would result in a reduction in the Gini index in Indonesia of 0.15%. This is because richer households disproportionately benefit from the subsidies. That is, removing the subsidy results in a larger loss of welfare for richer households, reducing the absolute income difference between them and poorer households. Reduction, if not complete removal, of fuel subsidies is also expected to bolster energy security and environmental sustainability. The use of heavily subsidized fuel discourages the diversification of Indonesia s energy mix into renewable energy sources such as geothermal, solar, and wind power. The country relies heavily on hydrocarbons, particularly oil and coal. ADB Program The overarching objective of the CPS was poverty reduction, in line with government priorities. In close consultation with other partners, ADB support was built on two pillars (objectives): (i) inclusive economic growth, and (ii) environmental sustainability with climate change mitigation and adaptation, both aligned with the objectives of Indonesia s National Medium Term Development Plan (RPJMN), ADB support focused on six sectors: (i) agriculture and natural resources, (ii) education, (iii) energy, (iv) finance, (v) transport, and (vi) water supply and municipal services. During implementation, public sector management was made a priority sector, from a crosssector thematic area initially, raising the number of focus sectors to seven. ADB entered the CPS period with an active sovereign loan portfolio of $1.44 billion from 23 ongoing loans, and a grant portfolio of $27.3 million from six grants as of 31 December The planned envelope for the CPS, stood at $2.96 billion in lending and $25.8 million in nonlending, according to the country operations business plan, Of the lending amount, $1.30 billion was to be program loans and $1.66 billion project loans. ADB support was sourced from ordinary capital resources because the Asian Development Fund has not been available to Indonesia since Assessment This study has generally confirmed the self-assessments found in the CPSFR, except for relevance of the CPS, which is assessed lower. The study s resulting rating for the CPS, is successful, but on the low end of the rating. The strategic positioning of the CPS, is assessed satisfactory. ADB s sector and thematic work in formulating the CPS must be noted given the complexity of Indonesia s economy, and political and social systems. Its extensive support for capacity development through the use of technical assistance and knowledge solutions was aligned with the country s need for technical expertise as a middle-income country. ADB also effectively coordinated and cooperated with other development partners, as made evident in the considerable cofinancing and production of knowledge products. The strategic positioning of the CPS would have been further improved if the delays in initiating the CPS, had been avoided so that the country program would have been better aligned with RPJMN, ; if analysis on binding constraints was better linked with the positioning of ADB; and if inclusive growth was discussed indepth. The CPS program is assessed less than relevant. The notable divergence between planned and delivered investments may have addressed the government preferences

13 Executive Summary xi that changed after the CPS was approved, but compromised its intended objectives. The lack of prioritization of binding constraints meanwhile resulted in an unclear selection of priority sectors and key operations. The insufficient groundwork on activities relating to climate change on the other hand undermined the CPS s focus on environmental sustainability. Irrigation and climate change programs that were deferred or dropped diminished effort in that area and undercut the CPS, which was favoring climate change adaptation. Similarly, the cancellation of certain power projects reduced the potential impact of ADB in the energy sector. In particular, the cancellation of two geothermal projects undermined the CPS climate change pillar. The portfolio is assessed effective in contributing to the intended sector outcomes. In energy, ADB helped improve the country's transmission and distribution systems. Solid progress in extending community water and municipal sewerage systems has also been observed. Progress in transport was difficult to assess, but there was some progress in rehabilitation of roads and operations and maintenance budgets, and interisland shipping. In education, ADB support has contributed to the education system as a whole, through the knowledge and capacity development support in education sector policy, sector management, and the application of minimum service standards. Program loans initiated during the CPS have contributed to their intended improvements in policy and institutional settings. There are caveats associated with the effective rating. The CPS, was implemented over a short period, with 22% of the relevant portfolio value bound in projects that were completed and rated by the Southeast Asia Department and/or IED in the CPS period. Moreover, the availability of monitoring and reporting documents for other projects is highly uneven and weighted toward outputs instead of outcomes. The implementation of the ADB program is assessed less than efficient. Despite high economic internal rates of return for closed and rated projects (which are less than onequarter of the CPS portfolio), challenges were encountered in tracking the results of ADB support, particularly for policy reforms, and there were weaknesses in project design and implementation, causing delays. This study recognizes the factors that hampered program implementation, which raised transaction costs and caused frequent and long delays. These factors often arose because of insufficient attention paid early enough to safeguards, though the CPSFR may be too hopeful about the gains to be made as convergence with country systems is attained. The relatively higher demands of ADB-supported projects on good due diligence have been noted by executing and implementing agencies. The CPSFR rightly points out other hindrances to smooth implementation. These are sluggish onlending and ongranting procedures, failure to budget or allocate sufficient regional government funds, and lack of implementation capacity. The program is assessed likely sustainable. The cost recovery mechanisms in certain projects helped ensure the sustainability of ADB s program. Electricity and water projects have generally recovered the costs of operating and maintaining assets created with ADB support. Investment projects have included covenants to ensure sufficient finance to operate and maintain project assets after projects have been concluded. ADB has supported the regulatory and institutional development that favors more sustainable management of infrastructure, and acknowledges the multiple demands on regional government revenues that place lower priority on operations and maintenance.

14 xii Indonesia: Validation of the Country Partnership Strategy Final Review, The gains in policy and institutional reforms, and legal and policy arrangements also supported the sustainability of ADB s program. ADB support for policy reform has been strategically sequenced and made incremental, with no reversal of ADB-backed policy and institutional reforms during the CPS period. ADB has supported policies and regulations that embed new procedures and approaches. These have affected development practice in certain cases, particularly in land acquisition. Meanwhile, the limited capacity and participation of communities and nongovernment organizations in the maintenance of project assets created, reorganization of key government ministries that hampers project coordination, and the evolving development needs of Indonesia as a lower middle-income country. The program s development impacts are assessed satisfactory. It is difficult to quantify ADB s contribution to country-level development. National targets on growth and poverty reduction have not been met, while the desired unemployment rate has been met. Project performance is better in transport, energy, and finance. In promoting inclusive growth, transport and energy projects comprised the bulk of pillar 1 interventions on high, sustained growth. These infrastructure projects focused on enhancing connectivity within the archipelago. Under pillar 2 on access to opportunities, ADB s contributions in the education sector were relevant to enhancing Indonesia s skills base and vocational training. Meanwhile, ADB s limited support for pillar 3 on safety nets is justified by the strong presence of other development partners in this area. Not every project needs to incorporate inclusion objectives, but overall the inclusion objective of the country portfolio must be visible. Poorer project performance has been noted in agriculture and natural resources. With the cancellation of the irrigation, climate change policy reform and flood management projects in this area, the CPS s focus on environmental sustainability has been weakened. Better monitoring and evaluation systems related to ADB-supported projects and the government s own systems would have made development impact assessments more feasible. This study assesses the performance of both the government and ADB satisfactory. ADB has sought to be responsive to emerging country needs and government demands or preferences. It undertook some diagnostic work to inform the work of government. It was able to leverage the financing of other development partners and it joined multidonor efforts to support the government. ADB raised the visibility of safeguard issues in the government and the need for convergence with country systems. The Indonesia Resident Mission has administered 90% of projects, improving responsiveness and communications with the government. The government continued efforts to raise the quality of project safeguards to international standards. It made strategic use of the modalities ADB offers, particularly program lending and technical assistance. It coordinated well with the Indonesia Resident Mission. But areas for improvement remain. The government can further enhance (i) its coordination with other development partners; (ii) the consistency in its preference for modalities and some policies, such as public private partnership development; and (iii) its monitoring and evaluation of development results.

15 Executive Summary xiii Issues, Lessons, and Recommendations 1. Issues The study identifies the following issues that have shaped the realization of the CPS objectives of inclusive and environmentally sustainable growth: (i) (ii) (iii) (iv) The attainment of inclusive growth is hindered by rising inequality, which in turn is driven by worsening urban deprivation and disparities across provinces. As the study shows, rising inequality slows poverty reduction in the country, impeding inclusive growth efforts. Had inequality held steady, and holding everything else constant, the poverty headcount ratio in 2014 would have been 3.6% rather than 11.3%. Addressing inequality should thus serve as an important component of the inclusive growth strategies of the government and development partners including ADB. Indonesia s susceptibility to environmental shocks hampers its development. Risk of extreme weather events due to climate change, exacerbated by reliance on fossil fuels, threatens the country s development. Indonesia s vulnerability to natural disasters and the adverse effects of climate change pose significant development challenges, as environmental shocks disrupt livelihoods and result in loss of assets. The country s urban slums are often in flood- and disaster-prone areas, where they are highly susceptible to the impacts of extreme weather events. Indonesia s heavy reliance on fossil fuels to meet its energy needs also contributes to climate change risks. Moreover, the country s coal exports stimulate the demand for hydrocarbons elsewhere. As a lower middle-income country, Indonesia faces complex and evolving development challenges. Notwithstanding rapid growth and notable poverty reduction, the country struggles with rising inequality, extensive infrastructure deficit, sluggish achievements in human capital development, and environmental risks associated with its geology and with climate change. Given its fiscal challenges, addressing the backlog in infrastructure, enhancing the provision of basic services, and ensuring environmental sustainability are particularly difficult. Policy and institutional reforms are also necessary to address the bottlenecks in infrastructure, social, and environmental sectors. The evidence-based analysis of development challenges and opportunities in Indonesia is at times not well captured in the CPS. This may reflect the nature of these documents in ADB and government. But it is evident that there is some lost opportunity in not making the most out of the CPS exercises by incorporating a fuller analysis of issues and constraints on economic and social development based on current thinking and the best evidence utilizing the latest, available household surveys.

16 xiv Indonesia: Validation of the Country Partnership Strategy Final Review, Lessons The study draws the following lessons: (i) (ii) (iii) (iv) The realization of inclusive growth largely depends on designing projects that include and mobilize those left out of the growth process. Inclusive growth projects in Indonesia must be designed to temper rising inequality by ensuring that the urban poor or those living in lagging regions have adequate access to services and markets. Environmental sustainability can be integrated in infrastructure and energy projects. Infrastructure must be able to withstand flooding, drought, and other extreme weather events. Reducing dependence on hydrocarbons, particularly oil and coal, and diversifying the energy mix by developing renewable energy resources are also crucial in promoting environmental sustainability and energy security. ADB can tap its previous experience and knowledge in development in Indonesia to help close the gaps in infrastructure and social development, and environmental sustainability, as well as governance reforms. Operating for almost five decades in the country, ADB possesses valuable knowledge on best practices and operational challenges in infrastructure, social, and environmental sectors, and policy and institutional reforms. ADB can utilize such knowledge to help the government select priority sectors and interventions, and implement reforms given the challenges Indonesia faces as a lower middle-income country. ADB s country program must be anchored in a rigorous analysis of development constraints. Empirical- and evidence-based diagnostic analysis of development constraints needs to be purposely incorporated in CPS preparation. Sound diagnosis of development constraints and opportunities must serve as the basis for the CPS s focus and objectives. 3. Recommendations A programmatic approach is crucial in meeting the needs of a middle-income country like Indonesia. Such approach will help address policy and institutional reforms to improve the delivery of infrastructure and social services. The validation agrees with CPSFR s recommendation to develop assistance instruments more suitable for middle income countries. The recommendation to undertake better results tracking, through improvements in government systems, is also on the mark. This study also concurs with the recommendations on improving knowledge management, enhancing project readiness to avoid delays, and leveraging additional resources through cofinancing and private sector support. The validation notes that a focus on sector selectivity per se may not be needed, as long as ADB makes sure there are synergies among its investments in various sectors to maximize their impact.

17 Executive Summary xv This study offers the following recommendations: (i) Inclusion. To foster inclusive growth in Indonesia, projects must incorporate inclusion objectives in their designs or target groups excluded from the growth process. (a) ADB-supported projects including infrastructure need to try to integrate lower-income groups in the growth process by linking them to livelihood opportunities, jobs, and markets. While this does not imply that every project should focus on lower-income groups, ADB-supported projects aimed at inclusive growth need to pay special attention to these groups. This is currently done insufficiently. Interventions in health and education should ensure both access to and equity of these opportunities to foster inclusive growth. Such projects must be accompanied by thorough analysis of the distribution of opportunities to identify gaps in the equitable access to education and health services of various groups, including low-income households. For safety nets, proper targeting mechanisms will help to prevent leakage and exclusion of intended beneficiaries or inclusion of unintended beneficiaries, thereby ensuring that resources are provided to those who need safety nets the most. (b) Fostering inclusive growth in Indonesia demands more attention than is currently given to address worsening urban deprivation and disparities across provinces. Apart from their limited access to basic infrastructure, the urban poor have inadequate access to secure and formal employment. To foster inclusive growth, the urban poor, who are usually engaged in informal work, should benefit from properly targeted social programs to cushion the impacts of income shortfalls, and skills development schemes to improve their employability. ADB s urban development efforts, which are largely focused on basic infrastructure development, can be expanded and complemented with cash transfers and skills development for the poor. Inclusive growth efforts also need to target lagging areas of Sulawesi Barat and Nusa Tenggara Timur, which have the highest average deprivation among the country s provinces. In Nusa Tenggara Timur, ADB has supported decentralized basic education. The province saw notable improvements in secondary net enrollment and completion rate. To steer its inclusive growth agenda in Indonesia forward, ADB can geographically target Sulawesi Barat and Nusa Tenggara Timur, as well as impoverished communities in urban areas. (ii) Environmental Sustainability. Climate-change-resilient infrastructure and renewable energy such as hydropower, solar and geothermal energy need to be the focus of environmental sustainability efforts in Indonesia. This goal has had so far limited traction with the government, but more effort is needed to promote it. (a) Transport and water infrastructure needs to be designed to withstand extreme flooding or water shortages. Drainage systems particularly in urban areas need to be designed to account for extreme rainfall. Sea-walls, levees, emergency underground water tanks, and barrages should be constructed for flood protection. While ADB has encountered difficulties in implementing the planned climate change programs during the CPS period, it should re-engage to support such investments as part of its

18 xvi Indonesia: Validation of the Country Partnership Strategy Final Review, environmental sustainability efforts in Indonesia. ADB is well positioned to incorporate climate change into its energy support mix and in the transport and urban infrastructure investments. It recently took steps to clarify what that may mean in the context of large-city development. This incremental and integrative approach is best suited to ADB capabilities and focus. (b) ADB needs to help diversify the country s energy portfolio with a focus on renewable energy particularly hydropower, solar and geothermal energy. This can reduce the dependence on oil and coal, which exacerbates climate change impacts, while it also contributes to energy security. ADB can continue supporting hydropower, solar and geothermal energy projects. ADB has assumed an important role in Indonesia s geothermal development with the implementation of two geothermal exploration projects during the CPS period. ADB s efforts to unlock Indonesia s geothermal potential can deal with the underlying challenge of mobilizing equity given that geothermal exploration is more costly in Indonesia than in other countries. To ensure the competitive selection of private sector developers, improvements in the tendering process and a regular review of feed-in tariffs are imperative. ADB can provide capacity building support in these areas to ensure that efforts in geothermal development materialize. (iii) Knowledge. ADB s knowledge solutions need to focus on more innovative approaches in development. The value of ADB support can be sharpened by its capacity to produce transformative knowledge solutions that are attuned to the evolving development challenges confronting lower middle-income countries like Indonesia. ADB s more defined and secure niche may lie in its experience and capacity to develop knowledge solutions for effective interventions in infrastructure, social, and environmental sectors, as well as governance reforms. ADB took an important first step in piloting a country knowledge development plan for for Indonesia. Subsequent country knowledge development plans can include more impact evaluations of ADB and/or government programs so as to identify best practices that can help improve ADB s operations in the country. Impact evaluations can help uncover what interventions work and what do not, and identify the factors that hamper or contribute to the success of programs, which in turn can then be avoided or replicated in future programs. This will help to link knowledge on operations to ADB s country program. (iv) Diagnostics. In finalizing the new country partnership strategy, ADB can maximize the utilization of latest available and relevant household surveys (SUSENAS) in conducting analysis of development challenges, including poverty and inequality. Through such analysis, the causes and roots of these need to be identified to properly design projects and programs. The implementation of the country program ought to be based on empirical diagnostic work so that any deviation or change in the course of implementation can be properly justified. The selection of priority sectors or activities also needs to be grounded in such rigorous diagnostic analysis.

19 CHAPTER 1 Introduction A. Validation Purposes and Procedures 1. The Southeast Asia Department of the Asian Development Bank (ADB) prepared a final review of the Indonesia country partnership strategy (CPS), , and is preparing a new CPS for The CPS final review (CPSFR) rated the program as successful overall, including operations started before 2012 but still active over ADB performance and borrower performance were assessed as satisfactory. The CPSFR provided lessons and recommended a sharper sector focus, more policy-based lending, reduced project delays, improved ADB knowledge management, direct lending to state owned enterprises, more leveraging and private sector financing, and more results tracking. The CPSFR aims to inform the new CPS, the timing and focus of which should be aligned with the new National Medium Term Development Plan (RPJMN), The Independent Evaluation Department (IED) prepared this study to validate the CPSFR s findings, assess the quality of self-evaluation, and identify lessons and recommendations to improve the design and implementation of the new CPS This validation is based on the following: (i) A desk review of relevant documents and reports. (ii) Consultations with government agencies, development partners, nongovernment organizations (NGOs), and ADB staff based at the headquarters and the Indonesia Resident Mission conducted during an independent evaluation mission. (iii) Analysis of growth, poverty, and inequality using Indonesia s National Socio-Economic Survey (SUSENAS) for 2010 and This study also includes sector analyses on public sector management (PSM) and infrastructure, with a focus on energy and transport. 5 The corresponding issues, lessons, and recommendations are discussed in the executive summary. 5. The scope of the validation conforms to both the 2011 CPSFR validation guidelines and 2010 country assistance program evaluation guidelines. 6 It covers the 1 ADB Country Partnership Strategy: Indonesia, Manila. The strategy was originally prepared in May ADB Country Partnership Strategy Final Review: Indonesia, Manila (accessible from the list of linked documents in Appendix 2). 3 The findings and recommendations of the CPSFR are accessible from Linked Document 1 in Appendix 2 4 The independent evaluation mission was fielded on November The sector analyses for PSM, energy, and transport are presented as linked documents in Appendix 2. 6 The 2011 CPSFR validation guidelines and 2010 country assistance program evaluation guidelines use the same set of six evaluation criteria: strategic positioning, program relevance, efficiency, effectiveness, sustainability, and development impacts. Both guidelines also assign the same weights to each of the six criteria and use the same set of subcriteria for each of the six evaluation criteria. The 2015 Guidelines for the Preparation of Country Assistance Program Evaluations and Country Partnership Strategy Final Review Validations were released in March 2015 and were not yet available at the time of the preparation of the

20 2 Indonesia: Validation of the Country Partnership Strategy Final Review, CPS, the country operations business plans prepared in , and the ADB support program provided during The validation encompasses the program that was approved prior to the CPS but was implemented during the CPS period in accordance with the scope explicitly mentioned in the CPSFR. 6. Some projects reviewed had substantial evaluative documentation, as listed in Tables A1.1 A1.4 in Appendix 1. Table A1.1 contains the rated loan operations for Table A1.2 lists the ratings for technical assistance (TA) projects closed in the relevant period that were accompanied by a technical assistance completion report. Table A1.3 lists the active unrated loan and grant projects and Table A1.4 lists the unrated TA projects; these were all reviewed on the basis of the review mission reports (back-to-office reports, aide-mémoires, or memoranda of understanding) or on the basis of information found in the CPSFR or obtained from key informants. This study focuses on the key sectors of energy, transport, water, PSM, and education, and on operations with sufficient information to draw conclusions on performance. A few projects referred to in the CPSFR tables or narratives are not included in the abovementioned tables as they fell outside of the agreed scope because they were closed before the start of the CPS, Focusing on the timing of the approvals and closings for the loans and grants (excluding TA projects) covered in Tables A1.1 and A1.3, 52% of the value of the approvals is tied to operations approved during the CPS period (Figure 1). About 22% of projects covered in the validation were formally rated, and these were all approved before the CPS period. This distribution, combined with the relatively short duration of the CPS, , presents challenges to assessing ADB s efforts in the CPS period. The rest of this study discusses ADB and country development plans, country context, and validates the assessments of the CPSFR. Figure 1: Coverage of Independent Evaluation Department Validation Report $ billion Approved prior to CPS/closed during CPS Approved prior to CPS and active for all or part of CPS Approved in CPS CPS = country partnership strategy. Source: Independent Evaluation Department. final review and this study. See ADB Guidelines for the Preparation of Country Partnership Strategy Final Review Validation Report. Manila: Independent Evaluation Department (draft); and ADB Guidelines for the Preparation of Country Assistance Program Evaluations. Manila: Independent Evaluation Department. 7 These are the Sustainable Capacity Building for Decentralization Project, Development Policy Support programs, and Decentralized Basic Education Project. All ADB supported projects and TA discussed in this report are reflected with their full titles, amounts and dates in Appendix 1.

21 Introduction 3 B. ADB s Development Plan 8. The CPS, was built on two strategic pillars: inclusive growth, and environmental sustainability with climate change mitigation and adaptation. In supporting the government to foster inclusive growth, the CPS addressed key policy and institutional constraints on growth, particularly in the areas of connectivity, financial market development and skills to widen participation in the growth process, keeping inequality in check, and helping to create jobs. The emphasis on environmental sustainability aimed to attenuate threats to natural resource management from deforestation and forest degradation, overexploitation of coastal resources, and unsustainable use of water resources, along with the risks that climate change poses to the livelihoods of coastal populations, agriculture, and water resource availability. 9. The CPS results framework for shows ADB s commitment to provide support in six sectors: (i) agriculture and natural resources (ANR), (ii) education, (iii) energy, (iv) finance, (v) transport, and (vi) water supply and municipal services. In the course of implementation, PSM was designated a priority sector, bringing the sector spread to seven areas. ADB support was sourced from ordinary capital resources because the Asian Development Fund has not been available to Indonesia since ADB entered the CPS, period with an active sovereign loan portfolio of $1.44 billion from 23 ongoing loans and a grant portfolio of $27.3 million from six grants (as of 31 December 2011). 9 The CPS, planned envelope stood at $2.96 billion in lending and $25.8 million in nonlending, according to the country operations business plan, Of the lending amount, $1.30 billion was to be program loans and $1.66 billion project loans. C. Government Development Plans in the Context of the Country Partnership Strategy, The RPJMN, envisioned an Indonesia that is prosperous, democratic, and just. A four-track development strategy was pursued: to be pro-poor, pro-job, pro-growth, and pro-environment. The RPJMN, identified 11 national priorities, with environmental sustainability, good governance, and gender equity mainstreamed in all areas. The RPJMN, also gave attention to the cross-sector themes of climate change and connectivity among and within Indonesia s islands. These directions were further elaborated in the Master Plan for Acceleration and Expansion of Economic Development , National Action Plan to Mitigate Greenhouse Gas Emissions, Indonesia Climate Change Adaptation Strategy, and Climate Change Sector Road Map. 12. The government aimed to achieve inclusive growth through (i) improved infrastructure and logistics to enhance connectivity and reduce regional disparities, (ii) better quality and more relevant education, (iii) an enhanced business environment, (iv) improved micro and small enterprise access to finance, (v) a strengthened nonbank finance sector and capital markets, 8 As of the writing of this study, 11 operations funded by the Asian Development Fund (approved before 2008) were still active. 9 ADB Background Paper for 2012 Country Portfolio Review, Indonesia Resident Mission. Manila. p.1 (April). 10 ADB Country Operations Business Plan: Indonesia, Manila.

22 4 Indonesia: Validation of the Country Partnership Strategy Final Review, (vi) (vii) reformed social assistance programs, and increased community-driven development. 13. Greener growth was to be fostered by (i) improving environmental and natural resources management; (ii) strengthening control of wastewater pollution and emission from industries; (iii) supporting climate change mitigation by reducing deforestation and improving capacity in peat land management, and promoting renewable energy and energy efficiency; and (iv) climate change adaptation programs focusing on integrated management of river basins, flood risk, and coastal resources. 14. The RPJMN, projected average gross domestic product (GDP) growth of 6.3% 6.8% per year, a decline in the open unemployment rate to 5.0% 6.0% in 2014, and a fall in poverty to 8.0% 10.0% by The vast majority of the investment required to achieve these targets was to come from state-owned enterprises, the private sector, and public private partnerships (PPPs). Foreign borrowing was to focus on investment projects, emphasizing infrastructure and energy investments through PPPs, transfer of technology and knowledge, capacity development, and greater use of country systems. 15. The above objectives of the RPJMN, were aligned with Strategy 2020 s goals of enhanced economic growth, a more inclusive growth process, and environmental sustainability, with an emphasis on climate change mitigation and adaptation. 11 The RPJMN, shares with Strategy 2020 the priority areas of infrastructure, education, and environment. The basic assumption found in both directional documents is that an improved investment climate will enhance private sector participation in the economy. 16. The next RPJMN, covering , will focus on new priorities or emphasis. The new RPJMN, recent government announcements, and Indonesian President Joko Widodo s own speech at the Asia-Pacific Economic Cooperation conference indicate that the new administration is combining economic, institutional, and social goals in a bid to accelerate development. 12 After initially increasing fuel prices by 30% in November 2014, the government entirely scrapped the subsidy on premium gasoline in January 2015 following a plunge in world fuel prices. 13 The removal of the subsidy is expected to free up an additional Rp200 trillion for the 2015 budget. 14 Emphasis has been given to the maritime sectors, which now have a coordinating minister on top of several related ministries. Funds previously spent on subsidies will help bolster infrastructure spending by upgrading facilities at 24 ports. President Joko Widodo has vetted his ministers through the Anti-Corruption Agency to set the tone for their integrity and performance. The revamped provision of health cards for the poor is to cushion the price rise of reforms and reduce poverty. It is not yet clear if this will mean substantially new funding infusions, but there is the intention of at least achieving better targeting, such as a social assistance scheme designed for fishers and farmers ADB Strategy The Long-Term Strategic Framework of the Asian Development Bank, Manila. 12 Remarks by Indonesian President Joko "Jokowi" Widodo at the Asia-Pacific Economic Cooperation Summit of 10 November 2014, in Beijing. 13 Hasyim, W Government slashes fuel subsidies. The Jakarta Post. 18 November. p Raras, C Subsidy for widely used Premium scrapped, what s next? The Jakarta Post. 5 January. 15 Satria, S. and E. Samboh Fuel-hike social programs planned. The Jakarta Post. 30 October.

23 CHAPTER 2 Country Context 17. Classified as a lower middle-income country, Indonesia is the 16 th largest economy worldwide. The country has achieved notable gains in growth and poverty reduction, but challenges persist in inequality, infrastructure and social development, environmental sustainability, and governance. The CPS, was framed in the context of a rebounding Indonesian economy following the 2008 global financial crisis. GDP growth dropped to 4.6% in 2009 before averaging 6.3% in Growth moderated to 5.8% year on year in 2013 and is forecast to have grown less than 5.1% in The unemployment rate was 5.7% during the first quarter of During , growth translated into greater consumption. Per capita expenditure increased 5.6% annually during (Table 1). Growth in this period was also the primary driver of poverty reduction. The percentage of people living below the national poverty line dropped from 15.6% in 2010 to 11.3% in 2014, falling at an annual rate of 7.6% over the period. Given this drop, the poverty elasticity of growth for the headcount ratio is about 1.4%, indicating that 1.0% growth in per capita expenditure reduced the poverty headcount ratio by 1.4%. This indicates that growth was the main contributor to the reduction in poverty in Indonesia during Poverty reduction would have been greater if inequality had not worsened during Inequality, measured by the Gini index, increased sharply from 35.4 in 2010 to 40.6 in This is consistent with the changes observed in quintile share. The poorest 20% of the population suffered the biggest fall in the share of per capita expenditure, at 3.5% annually during A similar decline, albeit smaller, can be observed for all but the richest quintile. For the top 20% of the population, the share of per capita expenditure rose 2.1% annually during the period. Table 1: Household Welfare in Indonesia, Annual Growth Item (%) Per capita expenditure (Rp) 611, , Quintile 1 (poorest) Quintile Quintile Quintile Quintile 5 (richest) Gini index Headcount ratio Poverty gap ratio Severity of poverty Note: Per capita expenditure is monthly figure and expenditure in 2010 is expressed in 2014 prices. Source: Independent Evaluation Department staff calculations based on National Socio-Economic Survey 2010 and Estimates by the World Bank. Accessed 28 December 2014 at 17 OECD OECD Employment Outlook Paris Accessed 24 April 2015 at

24 6 Indonesia: Validation of the Country Partnership Strategy Final Review, The rise in inequality led to the increase in the poverty headcount ratio by 14% in , assuming growth is constant (Table 2). In contrast, the increase in per capita household expenditure contributed to a reduction in the headcount ratio by 21.6% during , holding the distribution of expenditure constant. While growth dominates changes in inequality in explaining the change in poverty, the inequality effect is large enough to substantially slow the reduction in poverty. Indeed, this study estimates that if inequality had not changed, the headcount ratio in 2014 would have been 3.6% rather than 11.3%. This indicates that the percentage of poor people living below the poverty line would have been 7.7 percentage points lower than the current level; therefore 7.7 percentage points of poverty reduction have been forgone because of rising inequality in the country during Table 2: Explaining Changes in Poverty by Growth and Inequality Effects, Item Total Growth Effect Inequality Effect Headcount ratio Poverty gap ratio Severity of poverty Source: Independent Evaluation Department staff calculations based on National Socio- Economic Survey 2010 and The findings show that growing inequality runs counter to promoting poverty reduction and inclusive growth in Indonesia. To address inequality, a first important step is to determine the nature or pattern of disparities across groups. This study explores disparities in Indonesia s rural and urban populations and across provinces by examining the average deprivation in these groups. The average deprivation suffered by the society can be represented by the Gini index. Different socioeconomic and demographic groups can suffer varying degrees of average deprivation. The average deprivation suffered by the society is equal to the weighted average of deprivations suffered by different groups. The average deprivation of any group informs the extent to which a group is deprived relative to the average deprivation suffered by the society. 22. Table 3 presents the average deprivation in rural and urban communities in the country. People in the rural areas of Indonesia suffer greater deprivation than their urban counterparts. In 2014, rural people suffered 13% more deprivation than the national average, while urban people suffered 13% less than the national average. The corresponding figure for 2010 was 19%. This suggests that the gap between the two areas narrowed between 2010 and 2014, which is mainly attributed to a greater increase in average deprivation within urban areas. Table 3: Average Deprivation and Its Contribution Average Deprivation Contribution % Contribution Item Urban Rural Total Source: Independent Evaluation Department staff calculations based on National Socio-Economic Survey 2010 and This finding also suggests that the increase in inequality in Indonesia has been largely caused by worsening average deprivation in urban areas over the period; the Gini index has increased by 5.2 percentage points, of which 3.2 percentage points (equivalent to 62%) resulted from the increase in average deprivation in urban areas. The results also reveal that total deprivation is mostly explained by deprivation suffered