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I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T I E A S T A SI A PAC IFIC INDONESIA COUNTRY CLIMATE AND DEVELOPMENT REPORT APRIL , 2 0 2 3 II CONTENTS 01 21 38 Climate & Development in Commitments & Capacities Enabling Economic Indonesia Policies & Institutions 59 77 Economic Impacts of Climate & Development Climate Actions Policy Framework I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T III FIGURES Figure 1 Important Development Transitions.........................................................................................................................................................3 Figure 2 Acceleration in Income Convergence.......................................................................................................................................................3 Figure 3 GHG Emissions High but Slowing..............................................................................................................................................................4 Figure 4 Per Capita GHG Emissions Starting to Decline........................................................................................................................................4 Figure 5 Per Capita Emissions Remain Below Those of Major Developed Economies and in Line With Developing Country Peers........5 Figure 6 Growth Becoming Less Carbon Intensive.................................................................................................................................................5 Figure 7 Some Signs of Relative Decoupling..........................................................................................................................................................5 Figure 8 Sources of Indonesia's Emissions over Time...........................................................................................................................................7 Figure 9 The Rate of Deforestation Has Fallen in Recent Years..........................................................................................................................8 Figure 10 Coal in the Energy Mix has Increased.......................................................................................................................................................8 Figure 11 Energy Supply Driven by Electricity ..........................................................................................................................................................9 Figure 12 Coal Dominates Power Generation...........................................................................................................................................................9 Figure 13 Manufacturing Emissions Increased along with Efficiency...................................................................................................................9 Figure 14 Peatland Agriculture: Costs and Benefits............................................................................................................................................. 10 Figure 15 Income Loss from Premature Deaths.................................................................................................................................................... 10 Figure 16 Rising Incidence of Climate-related Disasters...................................................................................................................................... 12 Figure 17 Climate Change will Reduce Agricultural Yields Without Adaptive Measures................................................................................. 15 Figure 18 Deforestation extent per year (mil. ha).................................................................................................................................................. 15 Figure 19 Oil Palm Livelihoods are Concentrated in Kalimantan and Sumatra Lowlands.............................................................................. 17 Figure 20 Lending Exposure of Indonesian Banks to Transition-sensitive Sectors is High.............................................................................. 18 Figure 21 Indonesia’s Stock Markets are Weighed Toward Emissions-exposed Sectors................................................................................ 18 Figure 22 Reducing Supply of, and Demand for, Carbon-intensive Resources................................................................................................. 19 Figure 23 Potential to Accelerate Convergence in Per Capita Wealth................................................................................................................ 20 Figure 24 Including Through Faster Growth in Human Capital Stock................................................................................................................. 20 Figure 25 Per Capita Emissions of Major Economies under Stated Targets .................................................................................................... 23 Figure 26 Absolute Emissions of Major Economies under Stated Targets........................................................................................................ 23 Figure 27 2030 Commitments Per Capita: Top-10 Emitters............................................................................................................................... 24 Figure 28 Possible Post-2030 Pathways for Indonesia........................................................................................................................................ 24 Figure 29 Conditional and Unconditional 2030 NDC Targets.............................................................................................................................. 25 Figure 30 Planned Sectoral Contributions to 2030 NDC Targets........................................................................................................................ 25 Figure 31 The Land Use Policy Framework: A Chronology................................................................................................................................... 28 Figure 32 Renewables as a Share of Total Energy Consumption........................................................................................................................ 29 Figure 33 Emissions from Land Cover Changes in Rapidly Developing Cities.................................................................................................. 34 Figure 34 Emissions from Provision of Urban Services........................................................................................................................................ 34 Figure 35 High but Decreasing Fossil Fuel Support............................................................................................................................................... 41 Figure 36 Most Support is Geared to Consumers.................................................................................................................................................. 41 Figure 37 Most Support Goes Toward Petroleum.................................................................................................................................................. 41 Figure 38 Resulting in Low Petrol End-user Prices................................................................................................................................................ 41 IV Figure 39 And Low Residential Electricity Prices .................................................................................................................................................. 41 Figure 40 Expected Contingent Liabilities from Natural Disasters..................................................................................................................... 43 Figure 41 Green Debt Market Size .......................................................................................................................................................................... 49 Figure 42 Maturity of Green Debt ............................................................................................................................................................................ 49 Figure 43 Types of Green Debt ................................................................................................................................................................................ 49 Figure 44 Use of Green Debt Proceeds................................................................................................................................................................... 49 Figure 45 Tariffs on Green Goods are Low.............................................................................................................................................................. 53 Figure 46 But NTMs can be Burdensome............................................................................................................................................................... 53 Figure 47 Contributing to Higher Import Costs...................................................................................................................................................... 53 Figure 48 And Loss of Competitiveness ................................................................................................................................................................. 53 Figure 49 Good Signs on the Prevalence of Some Green Practices in Indonesia............................................................................................. 55 Figure 50 Foreign and Large Firms have Higher Green Practice Scores in Indonesia..................................................................................... 55 Figure 51 Indonesian Firms Perform Well Relative to Firms in Selected ECA Countries................................................................................. 55 Figure 52 Electricity and Energy Use are Weakly Associated with Green Practices......................................................................................... 55 Figure 53 Reasons for Firms' (Lack of) Adoption of Energy Efficiency Measures............................................................................................. 56 Figure 54 Payback Periods for Energy Efficiency Measures................................................................................................................................ 56 Figure 55 Green Tasks by Occupation Category..................................................................................................................................................... 58 Figure 56 Women are Under-represented in Green Jobs...................................................................................................................................... 58 Figure 57 Overview of Modelled Scenarios............................................................................................................................................................. 61 Figure 58 Policies to Reduce Land-based Emissions have Significant Economic Co-benefits....................................................................... 64 Figure 59 Accelerated Decarbonization is Consistent with Net Zero Emissions Before 2060 ...................................................................... 65 Figure 60 This Would Require 50 percent Higher Investment Compared to BAU............................................................................................ 65 Figure 61 Renewable Generation Capacity Increases Strongly after 2030....................................................................................................... 65 Figure 62 Fossil Fuels Remain in the Generation Mix but at Greatly Reduced Levels through 2040............................................................ 65 Figure 63 Achieving Decarbonization Objectives................................................................................................................................................... 69 Figure 64 With Potential Positive Growth Payoffs................................................................................................................................................. 69 Figure 65 Foreign Investments can Alleviate Trade-offs in More Ambitious Scenarios................................................................................... 70 Figure 66 There Will Be Gains and Losses Across Sectors.................................................................................................................................. 70 Figure 67 Impacts on Employment ........................................................................................................................................................................ 72 Figure 68 Impact on Household Expenditure ........................................................................................................................................................ 72 Figure 69 Drivers of Expenditure Change................................................................................................................................................................ 72 Figure 70 Impact on Prices....................................................................................................................................................................................... 72 Figure 71 Impact on Expenditure by Worker Type ............................................................................................................................................... 72 Figure 72 Impact on Poverty ................................................................................................................................................................................... 72 Figure 73 Trade Impacts of NDCs are Slightly Negative....................................................................................................................................... 74 Figure 74 Partly Driven by Declining Manufacturing Exports............................................................................................................................... 74 Figure 75 Building Blocks for the Transition........................................................................................................................................................... 77 Figure 76 Prioritization Approach for Recommendations.................................................................................................................................... 77 Figure 77 Timeframe and Expected Impact of Supply- (S) and Demand-side (D) Mitigation Measures....................................................... 86 Figure 78 Timeframe and Expected Impact of Adaptation Measures................................................................................................................ 90 Figure 79 Timeframe and Expected Impact of Enabling Condition Measures.................................................................................................. 97 I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T V ACKNOWLEDGMENTS This Country Climate and Development Report (CCDR) was a collaborative effort of the World Bank, International Finance Corporation (IFC), and Multi- lateral Insurance and Guarantee Agency (MIGA) under the overall guidance of Manuela V. Ferro (World Bank Regional Vice President), Alfonso Garcia Mora (IFC Regional Vice President), Ethiopis Tafara (MIGA Vice President and Chief Risk, Legal and Admin Officer), Satu Kristiina Kahkonen (World Bank Country Director for Indonesia and Timor-Leste), Hassan Zaman (World Bank Regional Director, Equitable Growth, Finance and Institutions), Benoit Bosquet (World Bank Regional Director, Sustainable Development), Kim-See Lim (IFC Director), Merli Margaret Baroudi (MIGA Director, Economics and Sustainability), Aaditya Mattoo (Chief Economist, EAP), Lars Christian Moller (World Bank Practice Manager, Macroeconomics Trade and Investment), Ann Jeannette Glauber (World Bank Practice Manager, Environment, Natural Resources, and the Blue Economy), John Nasir (IFC Practice Manager), and Bolormaa Amgaabazar (Operations Manager for Indonesia and Timor-Leste). The CCDR was prepared by a core team led by Habib Rab (Lead Economist) and David Kaczan (Sr. Economist) and including Abdoulaye Sy (Lead Econ- omist), Achim Schmillen (Program Leader, Human Development), Andhyta Firselly Utami (Environmental Economist), Andre de Aquino (Program Leader, Sustainable Development), Bryce Quillin (Sr. Economist), Bipul Singh (Sr. En- ergy Specialist), Claudia Vasquez (Program Leader, Infrastructure), Eugeniu Croitor (MIGA Risk Management Officer), Francesco Strobbe (Lead Financial Sector Specialist), Gaurav Trivedi (Financial Sector Consultant), Hasan Dudu (Sr. Economist), Hector Pollitt (Sr. Economist), Muthukumara S. Mani (Lead Environmental Economist), Ralph Van Doorn (Sr. Economist), Reidinar Wardoyo (Communications Specialist), Stephan Claude Frederic Garnier (Program Lead- er, Infrastructure), Tehmina Nawab (Strategy Officer), Utz Pape (Sr. Economist), Yulita Sari Soepardjo (Program Assistant), and Zahra Karim Didarali (Climate Change Consultant). The CCDR synthesizes findings contained in analytical work undertaken by an extended technical team (listed below). Detailed feedback, suggestions, and comments were received from peer review- ers: Richard Damania (World Bank Chief Economist, Sustainable Development), Vivek Pathak (IFC Director, Climate Business), Somik V. Lall (Lead Economist), Apurva Sanghi (Lead Economist), Giovanni Ruta (Lead Environmental Econo- mist), and Fernando Blanco (IFC Principal Economist). Comments were also gratefully received from Ahmad Baihaki (Sr. Fisheries Consultant), Ahmadou Moustapha Ndiaye (Director, Equitable Growth, Finance, and Institutions), Al- exander Lotsch (Senior Climate Change Specialist), Andy Mason (Lead Econo- mist), Anna Fruttero (Sr. Economist), Christian Schoder (Jr. Professional Officer), Claudio Rojas (Operations Officer), Craig Meisner (Sr. Economist), Daniel Halim (Economist), Dina Umali-Deininger (Practice Manager), Duong Le (Economist), Ethel Sennhauser (Director, Strategy and Operations), Florent McIsaac (Econ- VI omist), Francesca de Nicola (Sr. Economist), Georges Bianco Darido (Lead Urban Transport Specialist), Guillermo Diaz-Fanas (Public Private Partnerships Specialist), Helen Gall (Public Private Partnerships Consultant), Ira Dorband (Jr. Professional Officer), James P. Walsh (IMF), Jason Russ (Sr. Economist), Jenny Chao (Sr. Public Private Partnerships Specialist), Jonathan Lindsay (Lead Counsel), Jukka Strand (Sr. Infrastructure Finance Specialist), Julie Rieger (Chief Counsel), Khafi Weekes (Public Private Partnerships Consultant), Lestari Boedi- ono (Sr. External Affairs Officer), Masud Mozammel (Sr. External Affairs Officer), Mustafa Zakir Hussain (Manager), Nick Keyes (Sr. External Affairs Officer), Olivier Mahul (Practice Manager), Pablo Fajnzylber (Global Director, Infrastructure), Paolo Miguel Lazaro Tabuena (Investment Analyst), Penny Williams (Program Manager), Roumeen Islam (Economic Advisor), Samuel Freije-Rodriguez (Lead Economist), Stephane Hallegatte (Sr. Climate Change Advisor), Sumati Rajput (Financial Sector Specialist), Victor Bundi Mosoti (Lead Counsel), and Yoomin Lee (Jr. Professional Officer). Layout design by Kamal Muhammed. Support for the CCDR from the Australian Department of Foreign Affairs and Trade through the Australia-World Bank Indonesia Partnership (ABIP) is grate- fully acknowledged. This support contributed to research into specialized topics (see background analyses, below) as well as synthesis and dissemination. The land-related analysis was supported by the Sustainable Land Management Multi-Donor Trust Fund (SLM-MDTF), supported by the Governments of Norway and Australia. Land-related analysis builds on a model developed as part of the World Bank’s Global Program on Sustainability (GPS). Financial support of the donors to GPS is gratefully acknowledged, including the UK’s Department for Environment, Food & Rural Affairs (DEFRA); Germany’s Federal Ministry for Economic Cooperation and Development (BMZ); and Switzerland’s State Secretariat for Economic Affairs (SECO). Financial and technical support by the Energy Sector Management Assistance Program (ESMAP) for the power sector analysis is also gratefully acknowledged. BACKGROUND ANALYSIS The following analysis supported the CCDR: Adaptive Social Protection, Human Capital, and Climate Change: Identifying Policy Priorities for Indonesia. By Asha Williams (Sr. Social Protection Specialist) Gracia Hadiwidjaja (Social Protection Specialist), Rabia Ali (Sr. Economist), and Imam Setiawan (Economist). Carbon use, wealth accumulation, and environmental quality in the growth process in Indonesia. By Ahya Ihsan (Sr. Economist), Dwi Endah Abriningrum (Research Analyst), Khudadad Chattha (Young Professional), and Indira Maulani Hapsari (Economist). Cities and Climate Change: Indonesian cities at the forefront of climate smart development. By Gayatri Singh (Sr. Urban Development Specialist), Tiffany Minh Tran (Urban Development Consultant), Apoorva Narayan Shenvi (Climate Change Specialist), Alexandrina Platonova-Oquab (Senior Climate Change Specialist), Dao H Harrison (Sr. Housing Specialist), and Denada Stottele Ishmi (Urban Development Consultant). Climate Change Vulnerability Profiles and Local Adaptation Strategies in Indonesia. By James T. Erbaugh (Research Associate, Dartmouth College), Arun Agrawal (Professor, University of Michigan), Emcet O. Tas (Sr. Social Development Specialist), and Hannah J. Duncan (Social Development Consultant). Climate Change: Risks and Opportunities for the Financial Sector in Indonesia. By Francesco Strobbe (Lead Financial Sector Economist), Martijn Regelink (Sr. Financial Specialist), Owen Nie (Financial Sector Economist), Nepomuk Dunz (Jr. Professional Officer), Rachel Mok (Climate Change Specialist), Nepomuk Dunz (Jr. Professional Officer), Dorra Berraies (Climate Change Consultant), Gaurav Trivedi (Financial Sector Consultant), and Tehmina Nawab (Strategy Officer). I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T VII Climate Smart Livestock Technical Note; and Climate Smart Rice Technical Note. By Vikas Choudhary (Sr. Agriculture Specialist) and Alika Tuwo (Agriculture Specialist). Decarbonization and the Private Sector. By Alexandre Hugo Laure (Sr Private Sector Specialist), Aufa Doarest (Private Sector Specialist), Trang Thu Tran (Sr Economist), Mariem Malouche (Sr Economist), and Alvaro Gonzalez (Lead Economist). Decarbonizing Urban Mobility in Indonesia. By Nupur Gupta (Sr. Urban Transport Specialist), Elena Y. Chesheva (Sr. Transport Specialist); Amilia Aldian (Transport Engineer), and Tomás Herrero (Transport Consultant). Distributional Impacts of Climate Change in Indonesia. By Utz Pape (Sr. Economist), England Rhys Can (Consultant), Anissa Rahmawati (Consultant), Citra Kumala (Consultant), and Virgi Agita Sari (Economist). Fiscal Risks from climate shocks. By Richard Poulter (Disaster Risk Management Consultant) and Benedikt Signer (Program Coordinator). Gender Dimensions in Climate Change in Indonesia. By Dewi Novirianti (Social Development Consultant), Kate Anna Shanahan (Sr. Social Development Specialist), and Emcet Oktay Tas (Sr. Social Development Specialist). Indonesia Climate Change Institutional Assessment. By Arun Arya (Sr. Public Sector Management Specialist), Erwin Ariadharma (Sr. Public Sector Management Specialist), Khudadad Chattha (Young Professional), Hari Purnomo (Sr. Public Sector Specialist), Ahmed Zaki Fahmi (Economist), Unggul Suprayitno (Sr. Financial Management Specialist), and Andhyta Utami (Environmental Economist). Indonesia’s Green International Competitiveness and Green Trade; Green Goods Trade - A Firm Level Perspective; and The Role of Trade Policies in Indonesia’s Green Transition. By Csilla Lakatos (Sr. Economist), Angella Faith Montfaucon (Economist), Vicky Chemutai (Young Professional), and Bayu Agnimaruto (Trade Consultant). Just Transition in the Transition Away from Coal. By Michael Stanley (Lead Oil and Gas Specialist), Balada Amor (Sr. Mining Specialist), and Jasminah Woodhouse (Energy and Extractives Consultant). Low-carbon Transition in the Power Sector (published in Indonesia Economic Prospects, December 2021). By Stephane Garnier (Lead Energy Specialist), Sabine Cornieti (Energy Specialist), Claire Nicolas (Sr. Energy Economist), Hasan Dudu (Sr. Economist), and Abdoulaye Sy (Lead Economist). Managing Indonesia’s Forests and Lands for Climate, Health and Wealth. By David Brown (Forestry Consultant), Tim Brown (Sr. Natural Resources Management Specialist), Pasquale Lucio Scandizzo (University of Rome Tor Vergata), Daniele Cufari (University of Rome Tor Vergata), David Kaczan (Sr. Economist), Anna Leena Emilia Henttinen (Natural Resources Consultant), Andhyta Utami (Environmental Economist), Iwan Gunawan (Sr. Natural Resources Management Specialist), and Andre de Aquino (Sr. Natural Resources Management Specialist). Preparing Indonesia’s Workforce for Green Jobs. By Josefina Posadas (Sr. Economist), Julia Granata (Social Protection Consultant), Grace Hadiwidjaja (Social Protection Specialist), and Harsa Satrio (Social Protection Consultant). Role of Carbon Pricing in Achieving Indonesia’s Climate Commitments. By Andhyta Utami (Environmental Economist). The Climate-Water Nexus in Indonesia: Water Resource Vulnerabilities, Coastal Hazards, and Greenhouse Gas Emissions. By Micah Fisher (Water Consultant), Adilah Khalis (Water Consultant), and Irma Setiono (Sr. Water Supply and Sanitation Specialist). Green Fiscal Policy Instruments. By Ralph Van Doorn (Sr Economist), Anthony Obeyesekere (Economist), and Dwi Endah Abriningrum (Re- search Analyst). Aligning the State Budget to Climate Priorities in Indonesia. By Arun Arya (Sr. Public Sector Specialist), Dr. Muhamad Chatib Basri (NDC Economic Adviser for the Government of Indonesia), Melisa Sudirman (Sr Carbon Finance Consultant), Andhyta Firselly Utami (Environ- mental Economist), Ralph van Doorn (Sr Economist), Cut Dian Agustina (Economist), Hari Purnomo (Senior Public Sector Specialist), Muhammad Khudadad Chattha (Young Professional), Bambang Suharnoko (Sr Economist), and Retno Handini (PFM Consultant). VIII ABBREVIATIONS AND ACRONYMS ADS Accelerated Decarbonization Scenario KUR Kredit Usaha Rakyat (A Business Credit Scheme for Micro, Small, and Medium Enterprises) AMDAL Analisis Mengenai Dampak Lingkungan (Environmental Impact Assessment) LCDI Low Carbon Development Initiative ASI Avoid-Shift-Improve LCR Local Content Requirement ASP Adaptive Social Protection LGST Luxury Goods and Services Tax BAU Business-as-usual LTS-LCCR Long-Term Strategy for Low Carbon and Climate Resilience BMKG Badan Meteorologi, Klimatologi, dan Geofisika (Meteorology, LTV Loan-to-valuation Climatology, and Geophysics Agency) LUCF Land Use Change and Forestry BNPB Badan Nasional Penanggulangan Bencana (National Disaster Management Authority) MoA Ministry of Agriculture BPDLH Badan Pengelola Dana Lingkungan Hidup (Environment MoEF Ministry of Environment and Forestry Fund Management Agency) MoEMR Ministry of Energy and Mineral Resources BPS Badan Pusat Statistik (Statistics Indonesia) MoF Ministry of Finance BRGM Badan Restorasi Gambut dan Mangrove (Peat and Mangrove MoH Ministry of Health Restoration Agency) MoI Ministry of Industry BSP Benefit-sharing Plan MRV Monitoring, Reporting, and Verification CBAM Carbon Border Adjustment Mechanism MSoE Ministry of State-owned Enterprises CCDR Country Climate and Development Report ND-GAIN Notre Dame-Global Adaptation Index CDP Carbon Disclosure Project NDC Nationally Determined Contribution CGE Computable General Equilibrium NPL Non-performing Loan CNG Compressed Natural Gas NTM Non-tariff Measure CSA Climate Smart Agriculture NUMP National Urban Mobility Policy DMO Domestic Market Obligation OJK Otoritas Jasa Keuangan (Financial Services Authority) DRIP Disaster Resilience Improvement Program PFB Pooling Fund Bencana (Pooling Fund for Disasters) DTKS Data Terpadu Kesejahteraan Sosial (Integrated Social Welfare Database) PKH Program Keluarga Harapan (Family Hope Program) E&S Environmental and Social PLN Perusahaan Listrik Negara (State-owned electricity company) EGA Environmental Goods Agreement PPA Power Purchase Agreement EIP Eco-Industrial Park PPP Public Private Partnership EM-DAT Emergency Events Database PROKLIM Program Kampung Iklim (Climate Village Program) EPC Engineering, Procurement, and Construction PSO Public Service Obligation ESG Environmental, Social, and Governance PV Present Value ETS Emissions Trading Scheme RIL Reduced Impact Logging EU European Union RKP Rencana Kerja Pemerintah (Government Work Plan) EV Electric Vehicle RPJMN Rencana Pembangunan Jangka Menengah Nasional (National Medium-Term Development Plan) FAO Food and Agriculture Organization RPJPN Rencana Pembangunan Jangka Panjang Nasional (National FCPF Forest Carbon Partnership Facility Long-Term Development Plan) FDI Foreign Direct Investment RTRW Rencana Tata Ruang Wilayah (District Spatial Plan) FOLU Forestry and Other Land Uses RUEN Rencana Umum Energi Nasional (National Energy Plan) GDP Gross Domestic Product RUPTL Rencana Usaha Penyediaan Tenaga Listrik (Business Plan GGP Green Growth Plan for Electricity Provision) GHG Greenhouse Gas SEZ Special Economic Zone HCV High Conservation Value SNI Standar Nasional Indonesia (Indonesia National Standard) IDM Indeks Desa Membangun (Developing Village Index) SoE State-owned Enterprise IDS Intermediate Decarbonization Scenario SSE Sustainable Stock Exchange IEA International Energy Agency TORA Tanah Obyek Reforma Agraria (National Land Reform Program) IFC International Finance Corporation UNDP United Nations Development Programme ILO International Labour Organization UNFCCC United Nations Framework Convention on Climate Change IPP Independent Power Producer JKN Jaminan Kesehatan Nasional (National Health Insurance) I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T IX 1 CLIMATE & PAG E 1 —2 0 DEVELOPMENT IN INDONESIA B O RO B U D U R • YO GYA K A R TA 1 C limate challenges in Indonesia are intertwined with the country’s growth and development trajectories. Chapter 1 of Indonesia’s Country Climate and Development Report (CCDR) takes a historical look at climate and development challenges in Indonesia to: (i) present a baseline for the future low-carbon and climate-resilient journey; and (ii) develop a framework to illustrate climate-growth dynamics. The framework is centered around Indonesia’s abundant supply of carbon-intensive natural resources–land and energy–matched by high demand for those resourc- es in parts of the economy that drive growth–agriculture, urban expansion, industry, transportation, and trade. The resulting emissions have direct and indirect costs. They erode climate resilience and increase costs from climate shocks. Rising carbon content in the economy also imposes sunk costs for the low-carbon transition. Although these challenges are known, and efforts are being made to tackle them, the framework aims to link these economy-wide issues to the ongoing and future reforms that are discussed later in the CCDR. Indonesia has made important commitments to meet its climate and de- velopment targets. Ongoing efforts are starting to pay dividends in slowing greenhouse gas (GHG) emissions, maintaining growth, and strengthening eco- nomic and social resilience. The transition involves trade-offs between climate actions and near-term development priorities‒especially as Indonesia’s strong track record of growth and poverty reduction was thanks in part to its natural resource endowments‒including coal, oil, forests, and peatlands. Indonesia has set out a new path in its Long-Term Strategy for Low Carbon and Climate Resilience (LTS-LCCR) 2050 to sustain and potentially accelerate its economic transformation from a middle- to high-income country. As stated in the Low Carbon Development Initiative (LCDI), Indonesia is looking for ways to “maintain economic and social growth through development activities with low GHG emis- sions and minimizing the exploitation of natural resources” (Bappenas 2021). The CCDR does not take a position on Indonesia’s climate commitments. Indonesia has been clear in its Enhanced Nationally Determined Contribution (NDC) (Republic of Indonesia 2022) and its LTS-LCCR (Republic of Indonesia 2021) on the emissions reductions it intends to achieve with and without in- ternational support.1 Similarly, Indonesia has set out clear development goals, 1 As discussed in Chapter 2, Indonesia as per its national medium-term and long-term development plans (Rencana has committed in its Pembangunan Jangka Menengah Nasional: RPJMN and Rencana Pembangu- Enhanced NDC to a 31.9 percent reduction (below nan Jangka Panjang Nasional: RPJPN), toward achieving high-income status business-as-usual or BAU emissions) by 2030, and by 2045. New medium- and long-term plans are now under development‒with up to 43.2 percent with international financial the mainstreaming of climate measures a priority. In line with this policy focus, support. The Enhanced the intent of the CCDR is to assess how Indonesia can achieve its climate goals NDC was released in September 2022. while maximizing its development outcomes. “ Indonesia has made important commitments to meet its climate and development targets” I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 2 1.1 DEVELOPMENT TRANSITIONS & CARBON EMISSIONS I ndonesia has experienced important development transitions in the 25 years to 2022 that have involved rapid and positive change in a short period of time. Since 1997, Indonesia has seen rapid change (Figure 1) in its physical capital stock; access to electricity (67 percent of the population in 1995 to 99 percent in 2020); urbanization (36 percent of the population in 1995 to 56 percent in 2020); non-agricultural employment (57 percent of employment in 2006 to 71 percent in 2020); and fertility rates (declining to slightly above the population replacement rate in 2020). There are many other examples, including internet and mobile phone access, and the major political and governance changes of reformasi and decentralization. Economic growth over this period averaged five percent per year‒contributing to income convergence that accelerated rapidly relative to peer countries2 since 2009 (Figure 2). The poverty rate concurrently fell from 19 percent in 2000 to 9.4 percent by 2019. Indonesia’s transition to a low-carbon and climate-resil- ient economy is a transformation that could define the next phase of economic growth and poverty reduction. 2 This report uses a standard basket of peers where data allows. Peers are Nigeria, China, India, Ukraine, Thailand, the Philippines, Mexico, the Arab Repub- lic of Egypt, the Russian Federation, and Brazil, selected based on their statistical similarity in terms of population, GDP per capita, and total GDP. An additional set of aspirational peers is also used when relevant: Republic of Korea, Chile, Poland, and the Czech Republic. In some instances, developed countries are also used as comparisons when discussing emissions levels and targets. F I G U RE 1 F IG U RE 2 Important Development Transitions Acceleration in Income Convergence Indicators of development transitions (Index 1995=1) Indonesia and structural peers vs. US (GDP per capita, PPP 2017) Source: World Development Indicators (World Bank databank), Note: Figure 2 shows rate of income convergence of Indonesia versus rate of income figures compiled by World Bank Group (WBG) staff. convergence of structural peers (relative to the US). See Footnote 2. C limate & D evelopment in I ndonesia 3 Historically, those economic transitions meant rising carbon emissions, in line with Indonesia’s stage of development. Indonesia accounts for about 3.5 percent of global GHG emissions.3 Indonesia has the 4th largest popula- tion, the 16th largest economy, and accounts for 1.25 percent of the world’s Gross Domestic Product (GDP). Indonesia’s emissions–1,495 million tonnes of carbon dioxide (CO2) equivalent (MtCO2eq) annual average in 2018-2020–are high compared to structural peers in absolute terms (Figure 3) but encour- agingly show signs of slowing‒including in per capita terms (Figure 4). Per capita emissions in Indonesia in recent years have been in line with those of other large developing economies, and lower than those of large developed economies (Figure 5). The high emissions base has meant that GHG emissions overall increased only moderately between 1990 and 2018 (by 35 percent). China and India, which had higher base emissions in 1990, saw much larger overall increases in GHG emissions (above 400 percent and 300 percent re- spectively) but also have larger populations and economies, and experienced faster growth. 3 Climate Watch. “Data Explorer.” Emis- The challenge for Indonesia and other large developing economies is how to sions for 2018 include forestry and land use, decouple growth and GHG emissions. No country has transitioned to high-in- and all major green- house gases (link). come status while also reducing emissions, yet this is the challenge implicit 4 Relative decoupling in the low-carbon transition. GHG emissions in Indonesia have translated to is when emissions growth is positive but high but declining GHGs emitted per unit of GDP (Figure 6); GHG emissions less than GDP per capita from energy per unit of GDP has not increased as dramatically as in peer growth; absolute decou- pling is when emissions countries despite the increased dependence on coal. Indonesia has seen some are stable or decreasing while the GDP per capita decoupling between growth in per capita GDP and growth in GHG emissions is growing. (Figure 7),4 but the extent of decoupling narrows when adjusted for the carbon 5 Production-based emissions are from content in Indonesia’s traded goods. Higher growth countries like China and domestic output; de- mand-based emissions India show stronger relative decoupling but also higher emissions. Only 14 adjust for carbon content countries (mostly developed ones) have achieved absolute decoupling from in trade. See Hubacek et al. 2021. both production and consumption-based emissions.5 F I G U RE 3 F IG U RE 4 Absolute GHG Emissions Per Capita GHG Emissions Starting to Decline Annual GHG emissions (All GHG, 3-year moving average) Annual GHG emissions per capita (All GHG, 3-year moving average) I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 4 “ The challenge for Indonesia and other large developing economies is how to decouple growth and GHG emissions.“ F I G U RE 5 Per Capita Emissions Remain Below Those of Major Developed Economies and in Line With Developing Country Peers Per capita GDP (PPP constant 2017) vs. Per capita emissions (1990-2019) F I G U RE 6 F IG U RE 7 Growth Becoming Less Carbon Intensive Some Signs of Relative Decoupling Carbon intensity of growth (All GHG, 3-year moving average) Decoupling GHG emissions and GDP per capita (Index 1990=1, 5-year moving average, data up until 2019) Note: Interquartile range refers to performance of structural peers (see Footnote 2). Sources: World Development Indicators (World Bank databank); Cli- Notes: Lines show polynomial trends for 1990-2019 in per capita emissions. mate Watch Data Explorer; Ministry of Environment and Forestry (MoEF) LUCF = land use change and forestry. data; figures compiled by WBG staff. C limate & D evelopment in I ndonesia 5 1.2 SOURCES OF CARBON EMISSIONS T he carbon content of growth in Indonesia derives from a combined high supply of, and demand for, resources with a high carbon con- centration. The abundant supply of land (from carbon-rich forests and peatlands) and energy resources (from fossil fuels, particularly coal), have driven Indonesia’s emissions profile. On the demand side, large parts of the economy have made use of these resources to drive development (for electricity, industry, transportation, urban expansion, agricul- 6 Total of forest, land use, and peat fire emis- ture, and forestry). These trends are reinforced by the underpricing of carbon sions between 2000-20 in land and energy resources (explored in Chapter 2). as a proportion of total emissions (MoEF 2021 data). On the supply side, much of Indonesia’s GHG emissions come from land- 7 Carbon stored in Indonesia’s peatlands based sources. Deforestation and fires have historically accounted for about is estimated at 13.6 42 percent of Indonesia’s GHG emissions (Figure 8).6 Agriculture and forestry to 40.5 billion tonnes of carbon, one of the activities were the primary drivers of land cover change, notably export-orient- largest biological carbon stores on Earth. ed timber extraction, and pulp and paper plantations which expanded rapidly 8 At 3.31 million from the 1980s-90s, and oil palm, which followed in the 1990s-2000s (Tsu- hectares, Indonesia has the largest global stock jino, et al. 2016). These activities impacted carbon-rich ecosystems such as of mangroves (about 20 percent). Loss rates have peatlands–partially flooded lowland areas of Kalimantan, Sumatra, and Papua been high in past years with carbon-rich soils.7 Mangrove conversion for agriculture and aquaculture in but have slowed more recently. coastal areas similarly contributed to high emissions (Goldberg et al. 2020).8 I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 6 F I G U RE 8 Sources of Indonesia's Emissions over Time Indonesia GHG emissions by sector, 2000-2020 (MtCO2eq) Source: MoEF 2021 emissions data. Note: FOLU = Forestry and Other Land Uses; IPPU = Industrial processes and product use. 93% Considering these trends, the authorities significantly tightened forest and peat protection which has contributed to a slowdown in land-related emis- sions. About 8.49 million hectares of forest cover was lost between 2000 and 2020 (MoEF 2021), but the loss rate has slowed considerably in recent years of the energy supply comes from (Figure 9). Deforestation slowed from an average of 1.08 million hectares (ha) fossil fuels per year between 2000-07, to 0.61 million ha per year between 2007-14 and to an average of 0.48 million ha per year between 2014-21.9 Deforestation in 2019-21 was less than 0.12 million ha (MoEF 2021) per year, the lowest rates since 1990 (explored in Chapter 2). Fires also contributing to land-based emis- sions–some of which arise due to burning for clearing purposes (World Bank 2021). These also have decreased due to reduced clearing, zero-fire policies 80% (that ban the use of fires for clearing), peat rewetting, and fire suppression efforts in recent years.10 of Indonesia’s coal is Primary energy supply is heavily dominated by fossil fuels and it is the sec- exported, accounting ond largest source of carbon emissions. Energy accounts for approximately for about 10 percent of 39 percent of GHG emissions in Indonesia between 2000 and 2020. About 93 merchandize exports percent of the energy supply comes from fossil fuels, namely coal (43 percent), oil (31 percent), and gas (19 percent). Abundantly available domestically, the 9 Measured from mid-year, in line with share of coal in Indonesia’s energy mix increased over the two decades to 2019 MoEF data. (Figure 10). The coal industry’s share of the economy is less than 2 percent 10 Fire incidence was much lower in 2020 and it employs 0.2 percent of the workforce, but Indonesia is now the world’s and 2021 than in 2018 second largest coal exporter. About 80 percent of Indonesia’s coal is exported, and 2019 (MoEF data, Forest and Land Fire accounting for about 10 percent of merchandize exports. The use of coal is Early Warning and De- tection System). Longer most intensive in the power sector; 90 percent of what is not exported fuels timeseries (MODIS Burned Area satellite more than 50 percent of electricity generation. The share of renewables was data product) also shows low (10-15 percent) over most of the past two decades but has been increasing a declining trend in fire extent (2001-2021). slightly in the past six years (Figure 10). C limate & D evelopment in I ndonesia 7 F I G U RE 9 F IG U RE 10 The Rate of Deforestation Has Fallen Coal in the Energy Mix has Increased in Recent Years Indonesia primary energy consumption by source Deforestation extent per year (mil. ha) (% of total) Source: MoEF 2022 data, figure compiled by WBG staff, based on years for which annual data is available. Source: BP Statistical Review of World Energy; figure compiled by WBG staff. 14.7 Mil . Ha land used for oil palm On the demand side, there is potential to further slow emissions through efficiency gains in land use. The most economically important commodity, oil palm,11 extends over 14.7 million hectares. While estimates vary, an expected 20-30 percent of land-use conversion in the past two decades is thought to be due to plantation establishment. Conversion for oil palm peaked in 2009 and has declined since. Oil palm smallholder production in particular has con- 11 Oil palm is the plant. Palm oil is the refined siderable scope for increasing yields within the existing production area (Sari product. et al. 2021).12 Urban land use, while on a much smaller scale, also has scope 12 Recent estimates suggest the potential for for efficiency gains. Population growth has rapidly expanded the footprint of 50 percent land sparing with optimal technical Indonesian cities, with spatial patterns of growth hampering connectivity of efficiency (among small- residents to services and jobs in some locations. Urbanization in Indonesia’s holders, representing 34 percent of production). peer countries was associated with slightly higher growth outcomes. For Due to the rebound effect, about one-half of example, between 1996 and 2016, every percentage point increase in the this gain would be offset. Demand and supply-side share of Indonesia’s population living in urban areas was associated with a measures for land man- 1.4 percent increase in GDP per capita‒this compares to an average of 2.7 agement are, therefore, important complements. percent in other low- and middle-income East Asian countries, and 3 percent See Dalheimer et al. 2021. in China (World Bank 2016). I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 8 The demand for primary energy has been driven by the electricity sector (representing final energy)13 which has been the largest contributor to emis- sions from energy use (Figure 11). Those emissions are linked to the rising dominance of domestic coal in electricity generation (Figure 12). Of 70 GW of installed generation capacity in 2020, 52 percent was made up of coal-fired power plants, with approximately 16 GW of the 20 GW of capacity that was added in 2011-20 coming from coal. The grid connected capacity of 70 GW compares to a peak demand of approximately 40 GW; given current rates of demand growth, this represents several years of overcapacity, constraining the development of lower-carbon technologies. Expansion of the grid has supported electrification and the development of Indonesia’s manufacturing sector which accounts for about 40 percent of Indonesia’s total energy demand (Setyawan 2020). Growth in manufacturing and the grid’s increasing emissions factor contributed to increase the sector’s emissions. However, there are also clear trends toward greater energy efficiency in manufacturing which helped mitigate larger potential increases in emissions (Figure 13). F I G U RE 1 1 F IG U RE 12 Energy Supply Driven by Electricity Coal Dominates Power Generation Growth of GHG emissions from energy use (1990=100) Installed capacity (GW) and electricity generation by fuel type (share of total) Source: Climate Watch Data; figure compiled by WBG staff. Source: Ministry of Energy and Mineral Resources data (MEMR, 2020); figure compiled by WBG staff. F I G U RE 1 3 13 Primary energy refers to unpro- cessed energy sources, whereas final Manufacturing Emissions Increased along with Efficiency14 energy (such as electricity or refined Decomposition analysis of emissions growth 1991-2017 transportation fuels) is processed for end users. 14 Aggregate emissions are driven by the mixed impact from an increase in industrial output and reduced emission intensity within sectors. Figure 13 pres- ents the trends in aggregate emissions (log scale) and the contribution from changing output level (scale effect), technical effect (changing emission intensity within 2-digit sectors), and composition effect (changing sectoral composition). It shows that output has grown steadily but decreasing emission intensity within 2-digit sectors has lim- ited the increase in total emissions to a significantly lower rate. The contribution of changing sectoral composition to ag- gregate emissions has been negligible. Source: WBG staff decomposition analysis using BPS data. C limate & D evelopment in I ndonesia 9 Efficiency gains in transport systems and urbanization patterns could help to reduce energy demand. Improved spatial growth patterns of Indonesia’s cities, along with additional investment, could accelerate the development of low-carbon mobility options such as public transit, walking, and cycling. Public transit mode shares range between 2-15 percent in most Indonesian cities compared to 50 percent or more in other Asian cities.15 Road transport is responsible for over 85 and 90 percent of passenger and freight movement respectively (Leung 2016), and a similar proportion of overall fuel consumption (Sukarno et al. 2016). The vehicle fleet has grown at over 10 percent per year over the two decades to 2021, a trend likely to continue given motorization rates are still comparatively low. The transport sector, which is responsible for about 25 percent of Indonesia’s energy emissions and approximately 10 percent of total emissions, is an important element of Indonesia’s decarbonization efforts (see, for example, MoEF 2021a and Bappenas 2021). Recent investments and policies are promoting this shift, including Jakarta’s Mass Rapid Transit system, and investment in busways and feeder systems. Efficiency gains in natural resource use could further improve outcomes for Indonesia’s natural asset base and human capital. Historical patterns of 15 WBG staff analysis agricultural development in peatlands, for example, drove economic growth using 2019 Sakernas data. Jakarta and Band- but also caused costs. The value of total agricultural production in these areas ung achieve a public transport modal share of was estimated by the World Bank at US$48 billion between 2008 and 2017 about 10 percent, with other major Indonesian (5.7 percent of GDP), but with forest clearing contributing to health damages cities at 2-5 percent. By contrast, large and rapid- from smoke (estimated to cost US$23.5 billion over the same period), and ly growing cities in China fire damages to timber and crops (US$6.7 billion) (Figure 14). The fires that generally attract 20-30 percent public transport occurred in 2019 were estimated to have cost Indonesia US$5.2 billion (0.5 modal share while cities with well-developed percent of GDP) through their impact on agriculture, forestry, tourism, transpor- networks, such as Seoul; Singapore; Tokyo; Hong tation, health, and school closures (World Bank 2019). Indonesia’s program of Kong SAR, China; Mum- large-scale peatland rewetting and restoration (discussed in Chapter 2) has, bai; and Kolkata achieve more than 50 percent. however, reduced such fires and their costs in recent years (Kiely et al. 2021). F I G U RE 14 F IG U RE 15 Peatland Agriculture: Costs and Benefits Income Loss from Premature Deaths Socio-economic benefits and costs of Labor income due to premature deaths attributable peatlands agriculture (US$ billion) 2008-17 to air pollution, % of GDP equivalent 48 -6.7 -23 Source: WBG staff using a computable general equlibrium (CGE) Source: Changing Wealth of Nations database, figure compiled by WBG staff. model of Indonesia’s agriculture and forestry sector. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 10 Existing evidence points to the potential for significant human capital gains from reduced emissions. Air pollution levels in Indonesia are estimated to lower life expectancy by 1.2 years on average, with losses of over 4 years in some pollution hotspots (at sustained 2016 levels of pollution) (Greenstone and Fan 2019). The associated loss of labor income is estimated at 0.6 percent of GDP equivalent (2019) (Figure 15). Efficiency gains in transport and urbanization noted above could also contribute to significant gains. Congestion leads to significantly higher average commuting time in Indonesian cities and dispro- portionately affects the poor who tend to live far from the city center. Wasted time due to congestion is estimated to cost about US$5.1 billion nationally per year (equivalent to 0.5 percent of national GDP).16 1.3 VULNERABILITIES TO CLIMATE SHOCKS E missions are only one-half of the story: continuing to adapt to climate shocks will be central to avoiding large drops in econom- ic output and household welfare. Between 1990-2021, Indonesia 16 World Bank staff experienced more than 300 natural disasters‒including 200 flooding estimates based on anal- events affecting more than 11 million people. The frequency of these ysis of weekday traffic data in 28 metropolitan disasters is increasing (Figure 16)‒with climate-related disasters accounting areas in Indonesia. In addition to time costs, for approximately 70 percent of the total. These trends are expected to con- congestion contributed to excess fuel consumption tinue. Rising sea surface temperature is associated with greater severity of is approximately US$500 tropical cyclones, while heavier rainfall will exacerbate floods and landslides. million. More frequent El Niño events are likely to increase drought and fire risks for 17 By the end of the 21st century (2080-99) Indonesia’s agriculture and forestry sectors. Warmer temperatures also impact relative to a benchmark period of 1986-2005. labor productivity. The International Labour Organization (ILO) estimates that See World Bank Group and Asian Development Indonesia will lose 2.97 percent of its total worker hours (or approximately Bank. 2021. 4.0 million full-time equivalent positions) by 2030 due to heat stress. It is 18 ILO estimates based on a RCP2.6 path- estimated that the total cost of these and other climate-related impacts will way. See International reach 1.24 percent of GDP by 2030, increasing to 6.97 percent in the 2060s Labour Organization. 2021. under 3°C warming (Kompas et al. 2018). F I G U RE 1 6 Rising Incidence of Climate- Meteorological, hydrological and climatological related Disasters disaster incidence in Indonesia, 1990-2020. Source: Data from the international Emergency Events Database (EM-DAT), figure compiled by WBG staff. C limate & D evelopment in I ndonesia 11 300 Weather-related disasters C IL ACA P • C EN T R AL JAVA happened in Indonesia between 1990-2021 I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 12 Continuing efforts to adapt could accelerate poverty reduction as climate shocks are disproportionately felt by the poor and vulnerable. Areas of Java are better positioned in terms of both disaster incidence and development, while Kalimantan, Sulawesi, East Nusa Tenggara, and West Nusa Tenggara face greater disaster incidence and lagging development. Although climate change affects the whole population, the poor and vulnerable–one-third of the population–are likely to carry a disproportionate burden. Their livelihoods are more often reliant on agriculture and they often live in areas prone to natural hazards‒but without the necessary resilience to cope with shocks and the ability to protect their assets. Impacts are also differentiated by gender‒with women and girls at greater risk due to relatively poorer access to assets, services, and financial resources.19 Previous disasters in Indonesia (including the 2004 tsunami) led to a disproprtionate number of deaths among women (Frankenberg et al. 2011). Key impacts include water scarcity‒which could be partially alleviated through higher water productivity and plugging of infrastructure gaps. Inten- sification of both rainfall and drought are expected‒with parts of Sumatra and Kalimantan 10-30 percent wetter by 2080 from December to February, and islands below the equator anticipating a 15 percent decline in precipitation.20 In a context of increasing water demand21 the net effect will be one of scarcity: by 2050, 31 percent of Indonesia’s districts will no longer record months of surplus water,22 more than double the number in 2010. More erratic rainfall patterns are compounded by a lagging national water storage capacity, a level of water productivity (US$3.20 per cubic meter) that is one of the lowest in Asia, and high dependence on already strained resources. Approximately one-half of Indonesia’s GDP is currently produced in river basins experiencing “severe” or “high” stress in the dry season. Overall, a lack of water availability is project- 19 Women are more ed to result in 2.5 percent lower GDP by 2045 in the absence of adaptation likely to live in poverty than men, have less measures (World Bank 2021a). ability to move freely and own land, and may face violence and harassment that escalates during periods of financial or household instability caused by natural disas- ters. These inequalities may be worsened by climate-related hazards, resulting in heavier workloads, occupational hazards, and psychologi- cal or physical harm. Di- saster-response planning is often male dominated. These disparities are not unique to Indonesia. See Thurston, et al. 2021. 20 World Bank Climate Change Knowledge Portal: Mean Climate Projections (link). 21 Water demand is projected to increase by 31 percent between 2015 and 2045. See World Bank 2021a. 22 Months of surplus water is a key indicator of water scarcity and refers to excess water available in a system. See WBG and ADB 2021. C limate & D evelopment in I ndonesia 13 Agriculture is vulnerable to climate change impacts, with implications for food and nutrient security. At the national level, rising temperatures and shifting rainfall are projected to reduce yields of several production systems key to poverty reduction and food security‒including rice (-0.72 percent by 2030), maize (-7.1 percent) and palm oil (-1.21 percent) (Figure 17). Yield-en- hancing measures and investments in climate-resilient agriculture could more than offset these declines (discussed further in Chapter 2). Pest and disease outbreaks‒often induced by higher temperatures‒are expected to intensify along with the impact of floods, droughts, and saltwater intrusion. These fac- tors contribute to a higher risk of crop failure, loss of income for farmers, and price volatility for consumers. Indonesian consumers already pay among the highest prices in the region for staples and nutritious food with price volatility likely to further affect nutrition outcomes. While stunting levels have fallen considerably in recent years, 24.4 percent of Indonesia’s children under five years of age suffered from stunting in 2021 (Ministry of Health: MoH 2021).23 Adaptation efforts aside, Indonesia’s efforts to decarbonize could also help build resilience as acknowledged in the authorities’ climate strategies. 23 The rate of stunting While underlying climate changes‒as a function of global emissions–are largely is down from 30.8 percent in 2018. beyond Indonesia’s control, resilience is a function of Indonesia’s infrastructure, I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 14 human capital, and natural assets. For example, the vulnerability of Indone- sia’s cities could decrease through improved patterns of land use and reduced groundwater extraction. Between 2000 and 2014, Indonesian cities expanded by 6,904 km2 (3.9 percent). Nearly three-quarters of this expansion was on cultivated land or natural ecosystems (Coalition for Urban Transitions 2021) (in DKI Jakarta, for example, the vegetated area decreased from 60 to 29 percent between 1990 and 2018), increasing runoff rates and vulnerability to floods.24 At the same time, urbanization trends were driving groundwater extraction and consequent land subsidence‒thereby compounding the flood risks by lowering the height of land in critical areas. Jakarta, for example, continues to subside at 24 Projected peak runoff rates have been 1-15 cm per year (amounting to about 3.5 meters subsidence since the 1980s estimated to increase by 20 percent from in the most affected northern coastal areas). The vulnerability of Indonesia’s 2007 levels under 2030 projected land cover urban population to heat stress has similarly been driven by urban development changes in the Ciliwung patterns (Figure 18). The conflation of land use, water use, and rising sea levels River Basin, Jakarta. See Emam et al. 2016. has created some of the most climate-vulnerable urban centers in the world. F I G U RE 17 Climate Change will Reduce Agricultural Yields Without Adaptive Measures Projected Impact of Climate Change on Crop Yield in Indonesia (%) 2030 Source: WBG staff compilation of IMPACT model results (see IFPRI, Bappenas, and ADB 2019). Results are in the absence of yield-en- hancing research and development which can be expected to counteract some losses. F I G U RE 18 Elevated Temperatures in Cities and Share of Vegetated Land Cover Population exposed to specified average surface temperatures in ten cities (%), and vegetated land cover (%) (2021) Temp. (°C) ► 20 – 21 22 – 23 24 – 25 26 – 27 28 – 29 30 – 31 32 – 33 % of vegetated area Balikpapan 19 41 30 7 73.5 Sorong 24 36 31 9 1 62.9 Medan 1 16 34 43 8 1 44.2 Manado 1 25 38 31 5 36.7 Palembang 1 26 42 31 1 32.4 Semarang 1 17 34 46 3 30.8 Banajarmasin 10 28 55 8 27.2 Denpasar 2 18 70 11 26.4 Makassar 11 36 38 16 1 9.0 Bandung 1 3 8 31 50 8 1 6.3 Source: WBG staff analysis. Note: Darker colors indicate a larger share of population exposed. C limate & D evelopment in I ndonesia 15 Changes to land and water management planned or underway will improve resilience in rural areas. Restoration and rewetting of drainage-based agri- cultural cultivation in low-lying areas of Sumatra and Kalimantan, which cause emissions and land subsidence, will help reduce flood risks that are further com- pounded by sea-level rise. Halting mangrove loss for aquaculture development (concentrated in Kalimantan and Sulawesi) and for oil palm (concentrated in Sumatra) will strengthen the protective benefits that intact mangroves provide for communities and infrastructure along coastlines. The protective benefit of mangroves is recognized by the government in its recent commitment to restore 600,000 hectares of mangroves by 2024‒the largest such effort in the world. 1.4 TRANSITION RISKS W hile the low-carbon and climate-resilient transition can bring benefits, there are also substantial transition costs. Tight- ening global monetary policy impacts the cost of financing the low-carbon energy transition while subsidies increased due to soaring energy prices and below-cost pricing domestically. The supply of cheap land, and the expansive agricultural model that depends on it, will be constrained by land-emissions mitigation policies. Shifts within these supply chains will have spillover effects on workers and the financial sector, while global capital and trade preferences for greener goods will intro- duce further pressures. There is the challenge of dealing with stranded assets resulting from decarbonization efforts, with spillover effects to the real sector and the financial system. Renewed global turbulence since the start of Russia’s invasion of Ukraine has added new dynamics to the transition out of coal. Indonesia was the world’s largest thermal coal exporter in 2020. Coal prices have increased sharply and are projected to remain higher than historical averages over the next 5-10 years.25 This is driven in part by rising demand, including from Europe due to cuts to gas supplies from Russia, that could slow the planned exit from coal. At the same time, the rising cost of coal and other fossil fuels should encourage a shift 25 Consensus Economics Inc., Energy toward renewables, however, there are countervailing forces. First, progress on and Metals Forecasts eliminating energy subsidies (and replacing them with targeted transfers to the (September 2022). 26 East, South, and poor) has become more difficult in the very near-term. Second, the increased North Kalimantan, and cost of financing and higher investment costs due to tightening of global supply South Sumatra, with the East and South chains creates financial challenges for new investment in renewables. Third, high Kalimantan local econ- omies being relatively energy prices make it difficult to implement carbon pricing to shift incentives more dependent. In East Kalimantan, for instance, toward renewables. In addition, coal makes a large economic contribution in coal contributed 35 geographically concentrated areas with few economic alternatives‒making those percent of provincial GDP in 2017. areas vulnerable to severe and multiplicative impacts from mine closures.26 “ Tightening global monetary policy impacts the cost of financing the low-carbon energy transition while subsidies increased due to soaring energy prices and below-cost pricing domestically.” I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 16 Indonesia’s other major resource export–palm oil–faces its own risks. In 2019, Indonesia produced 52 million tons of palm oil product‒mainly from plantations in the lowlands of Kalimantan and Sumatra (Figure 19)‒contrib- uting 72 percent of global supply and 4.5 percent of Indonesia’s GDP (BPS 2020). Palm oil faces growing global demand, but the low-carbon transition implies restrictions on the supply of new land and rising costs of fuel and fertilizer. Land availability may decrease as forested areas are more strongly protected (Orbitas 2021). Several such protections have been implemented in recent years, including protection of high conservation value (HCV) forests within concessions (described in Chapter 2). Producers will need to use existing land, fuel, and fertilizer more efficiently. Smallholder operations (representing 60 percent of total production) have yields up to 40 percent below those of the larger producers; closing this gap presents a productivity opportunity but will require finance and technical support to replace older plantations with new high-yielding varieties. F I G U RE 19 Oil Palm Livelihoods are Concentrated in Kalimantan and Sumatra Lowlands Villages in which oil palm provides the primary income source for a majority. Source: WBG staff analysis based on PODES (2018) data. Climate actions by the international community could also impact Indo- nesia’s economy and international trade. These actions include individual countries’ actions under their NDCs and the European Union’s (EU) Carbon Border Adjustment Mechanism (CBAM). World Bank modelling results indicate that when both NDCs and the EU CBAM are implemented, Indonesia faces a real income decrease of 0.5 percent in 2030, relative to a 2030 counterfactual. The decrease of real income for Indonesia is a consequence of a fall in output of 1.1 percent, including due to a decrease in coal output of 20.3 percent or US$47 billion.27 The effect of the EU CBAM is negligible; the reduction is mainly due to NDC implementation by countries globally. The impact on Indonesia is lower compared to the rest of East Asia and Pacific (0.6 percent), but higher than for high-income countries in Asia (0.4 percent). These transition risks in the real economy could affect Indonesia’s financial sector. Almost three-quarters of the Indonesian banking system’s lending portfolio comprises sectors that are potentially exposed to climate transition 27 All figures are in risks (Figure 20).28 The processing industry comprises 24 percent of Indone- 2014 US dollars. sian banks’ loan portfolio, while agriculture (including palm oil) comprises 11 28 Measured as the carbon footprint adjusted percent, followed by construction (10 percent), transportation (8 percent), loans to total loans for deposits. and real estate (7 percent). Shocks to these sectors and thus to the financial C limate & D evelopment in I ndonesia 17 sector, could result from rapid and unanticipated decarbonization coupled with lack of industry preparedness. Stock markets in Indonesia are also exposed to climate transition risk with 75 percent of stocks belonging to transition-sensitive sectors (Figure 21). F I G U RE 2 0 F IG U RE 21 Lending Exposure of Indonesian Banks Indonesia’s Stock Markets are Weighed Toward to Transition-sensitive Sectors is High Emissions-exposed Sectors Distribution of non-transition and transition sensitive loans Distribution of transition sensitive equities Source: IMF Climate Change Dashboard (2021). Source: IMF Climate Change Dashboard (2021). Notes: Some sectors may be incorrectly classified due to aggregation. Indirect impacts Notes: Transition-sensitive sectors are those with either high absolute emissions, high such as supply chains are not captured. emission intensities, high exposure to emission-intensive sectors, or are expected to be directly affected by climate policies. 1.5 A VIRTUOUS CYCLE OF DECARBONIZATION, RESILIENCE, & GROWTH T he CCDR proposes a framework to illustrate how Indonesia’s ongoing and future reforms could support a just and affordable transition through positive climate and development dynamics (Figure 22). A reduction in the supply of carbon-intensive resources (land and non-renewable energy) (1) can be supported through policy and institutional reforms, some of which are already in place or underway (2). This will, however, also require a reduction in demand for those resources (for electricity, agriculture, urban expansion, transport, industry, and trade) (3) that require reforms to incentivize more efficient use of resources (for example, through carbon price, spatial planning) or alternative resources (for example, renewable energy) (4). Complementing these measures with enabling economic policies can help allocate resources to greener and more productive parts of the economy (5). A combination of these measures could help decouple growth I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 18 from carbon emissions (6) which could strengthen the economy’s resilience to a rising incidence of climate impacts (that is, higher temperatures, sea level rises, and flooding) (7). This could help reduce the development costs of cli- mate-related shocks (for example, physical damage, human capital loss) (8). This cycle could help accelerate growth in Indonesia’s national asset base (9). Indonesia’s total wealth increased between 1995 and 2018. Indonesia has diversified its stock of wealth through a buildup of human and physical capital. There is, however, scope to accelerate overall wealth accumulation and wealth convergence relative to structural peers (Figure 23). The natural capital stock has increased over this time but has involved a reduction in the stock of renewable resources on the one hand (like forests) and increased depen- dence on non-renewable resources on the other (like coal). The accumulation of human capital stock also has scope to accelerate (Figure 24). Given the role of wealth accumulation as the basis for future growth, this trajectory could support Indonesia’s effort to transition from a middle- to high-income country. F I G U RE 22 Reducing Supply of, and Demand for, Carbon-intensive Resources Through Sector and Enabling Policy and Institutional Reforms SUPPLY D EM A N D 5 ENABLING 4 DEMAND PRIM A RY RE SOU RC E S F IN A L RE SOU RC E S GROW T H D RI V ER S ECONOMIC POLICIES POLICIES 3 RESOURCE DEMAND AGRIC U LT U RE 6 ECONOMIC 7 CLIMATE A N D FORE S T RY GROWTH IMPACTS 1 RESOURCE SUPPLY URBAN E XPA N SION 9 WEALTH AC- 2 SUPPLY 8 DEVELOP- LAND CUMULATION POLICIES MENT COSTS EL EC T RIC T Y IN D U S T RY Source: Figure compiled by WBG staff. C OA L Note: The left-hand side of the figure illustrates the interactions between resource supply and demand and how these influence climate and development outcomes. FO S SIL F U EL S , The right-hand side presents key economic sectors that supply and demand natural B IOF U EL S resources and are discussed in the CCDR. T R A N SP OR TA - OIL T ION “ The CCDR proposes a framework to illustrate how Indonesia’s ongoing and IN T ERN AT ION AL TRADE future reforms could support a just and affordable transition through positive climate and development dynamics“ C limate & D evelopment in I ndonesia 19 F I G U RE 2 3 F IG U RE 24 Potential to Accelerate Convergence Including Through Faster Growth in in Per Capita Wealth Human Capital Stock Per Capita Wealth ex.nonrenewable source, convergence Indonesia change in national wealth (Index 1995=100) to US, Indonesia and interquartile range Note: The figure above presents the rate of per capita wealth convergence of Indonesia Source: Changing Wealth of Nations Database, figure compiled by WBG staff. against the per capital wealth convergence of structural peers, relative to the US. See footnote 2 on structural peers. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 20 2 COMMITMENTS PAG E 2 1 —3 7 & CAPACITIES T E G A L L A L A N G • BALI C ommitments & C apacities 21 I ndonesia has embarked on a path of policy and institutional reforms to address the climate and development dynamics discussed in Chapter 1. Low-carbon and resilient development policies are a national priority under the RPJMN 2020–24, the NDCs, and the LTS-LCCR. Chapter 2 of the CCDR considers the policies, tools, and resources that Indonesia is using to deliver on these ambitions, and opportunities for further strengthening. This chapter covers three issues: (i) climate mitigation through supply-side emission cuts (that is, land and energy); (ii) climate mitigation through demand-side emission cuts (that is, electricity, industry, transportation, urban expansion, and agriculture); and (iii) climate adaptation, including the management of disaster-related con- tingent liabilities. It focuses on sector-specific policies, rather than cross-cutting economic policies that impact those sectors (for example, fiscal, financial sector, investment, and trade policies) as these are discussed in Chapter 3. 2.1 POLICIES & INSTITUTIONS FOR THE SUPPLY-SIDE I ndonesia has committed to cutting emissions as part of its NDCs under the 2015 Paris Agreement. Indonesia’s Enhanced NDC, released in September 2022, sets out an unconditional 31.9 percent reduction in emissions against BAU projections by 2030, and up to a 43.2 per- 29 The Ministry of Finance (MoF) esti- cent reduction conditional on international support.29 It proposes actions mates the required international support across the economy, including for energy, agriculture, industrial, waste, and at about US$114 billion. See Ministry of Finance (MoF) 2021. FOLU sectors.30 Estimated per capita emissions under the Enhanced NDC’s 30 While the CCDR covers a wide range unconditional target are projected to be 6.5 tCO2eq per year in 2030, lower of sectors in line with its demand and supply-side framework (see Chapter than most other large economies including Brazil, China, Japan, and the United 1), relatively more attention is devoted in Chapter 2 to FOLU and Energy, States (Figure 25 and 26). Total emissions in 2030, of an expected 1,953 Mt- given their relatively larger fraction of emissions. Chapter 3 includes discus- CO2eq, will be on par with those of the EU and Russia, and below those of the sion of industry in the context of the US, China, and India (Figure 27). This CCDR does not take a position on what private sector and the overall enabling environment. Indonesia’s NDC targets should be. It acknowledges the principle of common 31 The common but differentiated but differentiated responsibility31 and assesses options for Indonesia to meet responsibilities principle is formalized within the United Nations Framework its commitments while also achieving its development goals. Convention on Climate Change (UNF- CCC). It recognizes that all countries have a shared obligation to address Indonesia has also mapped out longer-term emissions trajectories toward climate change but that responsibility for addressing the issue differs between a net-zero target by 2060 or earlier. The LTS-LCCR32 is a detailed roadmap countries, given different capabilities and historical contributions. that demonstrates the technical feasibility of a low-carbon trajectory, reach- 32 LTS-LCCR extends the uncondi- ing 1.61 tCO2eq per capita emissions by 2050 under its low-carbon strategy tional 2030 commitment through three scenarios: (i) current policies, where scenario (aligned with the Paris Agreement). While the NDC is a quantitative emissions will continue to increase after commitment, the LTS is a longer-term vision that demonstrates possibilities and 2030; (ii) transition, where emissions will decrease but are insufficient to pathways (Figure 28). The net-zero vision–and pathways toward it–are further reach the 2050 target; and (iii) low-car- bon, where emissions will decrease mapped out by the government’s LCDI (Bappenas 2021a). Recently, Indonesia rapidly after 2030. See Republic of Indonesia 2021. signaled a more ambitious target of peaking power sector emissions by 2030 33 Joint Statement by the Government and achieving net-zero emissions in the power sector by 2050 in the context of Indonesia, and the Governments of Japan, the United States of America, of the Joint Statement by the Government of Indonesia and the International Canada, Denmark, the European Partners Group (IPG) under the Just Energy Transition Partnership (JETP). The Union, Germany, France, Norway, Italy, and the United Kingdom (together the JETP is expected to mobilize US$20 billion over the next three to five years “International Partners Group” or IPG) (link). The GFANZ is a group of financial of which, of which $10 billion are expected to be mobilized by IPG members institutions including Bank of America, Citi, Deutsche Bank, HSBC, Macquarie, and the remaining will consist of private financing mobilized by the Glasgow MUFG, and Standard Chartered. Financial Alliance for Net Zero (GFANZ) Working Group.33 I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 22 F I G U RE 2 5 Per Capita Emissions of Major Economies under Stated Targets Projected per capita emissions (tCO2eq per year) in line with stated commitments F I G U RE 2 6 Absolute Emissions of Major Economies under Stated Targets Projected absolute emissions (GtCO2eq per year) in line with stated commitments Source: Countries’ NDCs, Climate Watch data, and UN population projections. Figures compiled by WBG staff. C ommitments & C apacities 23 F I G U RE 2 7 2030 Commitments Per Capita: Top-10 Emitters 2018 and projected 2030 per capita emissions (tCO2eq per year) based on NDC commitments Source: Countries’ NDCs, Climate Watch data, and UN population projections. Figure compiled by WBG staff. F I G U RE 2 8 Possible Post-2030 Pathways for Indonesia Emissions trends modelled in Indonesia’s Long-Term Strategy (2021) C U RRE N T P O L IC IE S T R A NSI T I O N S T R AT EGY LOW - CA RB O N SC EN A RI O C O MPAT I BLE WI T H T HE PA RI S AGREEMEN T Source: Republic of Indonesia (2021). Note: FOLU = Forestry and Other Land Uses; trial processes and product use. IPPU = Indus­ I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 24 The low carbon and resilient transitions are also reflected in Indonesia’s development plans. “Strengthening the environment and improving resilience against natural disasters and climate change” is one of six major development themes under the RPJMN 2020-24 which guides the government’s annual plans (Rencana Kerja Pemerintah: RKP). In the most recent annual plan, 26 out of 39 priority projects make a direct or indirect contribution toward NDC mitigation and adaptation targets. New medium- and long-term plans are now under development‒with the mainstreaming of climate measures a key priority. This is being supported by the inclusion of climate change indicators in the formulation of development targets. 34 Ministerial Decree No. 168/Menlhk/PKTL/ PLA.1/2/2022, the More than 60 percent of the emission reduction target in Indonesia’s En- Operational Plan for Indonesia’s FOLU Net hanced NDC is intended to be met through actions in the FOLU sector. Sink 2030. FOLU emissions are projected to fall from a BAU projection of 714 MtCO2eq to 35 Indonesia is home to 10 percent of the 214 MtCO2eq in 2030 under the NDC’s unconditional target (Figure 29 and world’s flowering species and is a major center for 30). While already ambitious, the government further aims to make FOLU a agrobiodiversity of plant carbon sink by 2030 (that is, negative net emissions) under its FOLU Net Sink cultivars and livestock. About 12 percent of the 2030 plan.34 Stipulated actions to achieve these goals include restoring 2.7 world’s mammal species live in Indonesia, ranking million hectares of peatlands, rehabilitating 5.3 million hectares of degraded second (after Brazil), 17 percent of bird species forestlands, and continuing recent progress in reducing deforestation and (ranking fifth) and 16 forest degradation rates (Table 1). Reforestation, peatland restoration, and percent of reptiles (fourth). mangrove restoration targets are also included in the RPJMN 2020-24. FOLU Net Sink 2030 activities are also expected to have important co-benefits for biodiversity and soil and water management35 F I G U RE 2 9 F IG U RE 30 Conditional and Unconditional Planned Sectoral Contributions 2030 NDC Targets to 2030 NDC Targets Emissions (MtCO2eq) by major emitting sector, 2019, Emissions reduction (MtCO2eq) from and 2030 (NDC targets) projected BAU under NDC targets Source: Indonesia Enhanced NDC and MoEF data (2022). Figures compiled by WBG staff. 60% C ommitments & C apacities More than 60 percent of the emission reduction target in Indonesia’s Enhanced NDC is intended to be met through actions in the FOLU sector 25 TAB L E 1 Actions (and Targets) to Reach Negative FOLU Emissions by 2030 AC T I O N TARG E T 1 Reduce deforestation on mineral soils Average rate of deforestation not to exceed 241,000 hectares/year 2 Reduce deforestation on peat soils 3 Reduce forest degradation on mineral Average rate of degradation not to exceed soils 131,000 hectares/year 4 Reduce forest degradation on peat soils 5 Develop industrial timber plantations 12.8 million hectares by 2050 6 Sustainable Forest Management and 1.7 million hectares of forest concessions prac- Reduced Impact Logging (RIL) tice RIL by 2030 and 8.8 million by 2050; all concessions gov. certified by 2050 7 Forest rehabilitation using non-native 5.3 million hectares rehabilitated by 2030, and species 10.6 million hectares by 2050 8 Forest rehabilitation using native spe- cies 9 Peatland restoration 2.7 million hectares by 2030 10 Improved peatland water management 950,000 hectares by 2030 Source: MoEF 2021. Note: An eleventh action calls for conserving biodiversity (a non-quantified target). Commitments are built on a foundation of strengthened policies and in- stitutions. In 2011 the government placed a moratorium on new licenses for forest conversion in primary forests and peat (a measure made permanent in 2019) and in 2016 strengthened the moratorium for areas of deep peat. These moratoriums protect a combined 66 million hectares. In 2015, the government merged the Ministry of Environment and Ministry of Forestry and mandated the new body to lead the country’s climate commitment. Two further agencies were established: (i) the Peat Restoration Agency in 2016 responsible for delivering peatland restoration targets (later expanded to include mangrove in 2021 as the Peat and Mangrove Restoration Agency (Badan Restorasi Gambut dan Man- grove: BRGM); and (ii) the Indonesian Environment Fund Management Agency (Badan Pengelola Dana Lingkungan Hidup: BPDLH) in 2019, a unit under MoF that is responsible for channeling financing for climate and environmental projects (in FOLU activities, energy investments, and beyond). More recently, Presidential Regulation No. 98/2021 on the Economic Valuation of Carbon was introduced to support result-based payments and other market-based instruments that incentivize climate mitigation activities. These and other actions are showing progress‒MoEF data indicates that deforestation slowed from an average of 1.13 million hectares (ha) per year between 2000-06, to 0.12 million ha and 0.11 million ha in 2019-20 and 2020-21 respectively (see Figure 9 in Chapter 1). This represents a downward trend that stands in contrast to other major tropical forest countries. Further I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 26 “ deforestation slowed from an average of 1.13 million hectares (ha) per year between 2000-06, to 0.12 million ha and 0.11 million ha in 2019-20 and 2020-21 respectively” measures are expected to support this trajectory going forward (Figure 34). MoEF revoked 3.1 million ha of forest concession licenses in 2022 and required concessionaires to protect HCV forest areas. Restoration of 1.3 million hectares of peatlands has been undertaken by BRGM to date, with a further 3.6 million ha restored by the private sector within concessions under the government’s peatland management regulations (MoEF 2022). In contrast to earlier years (2001-15), the rise in oil palm prices since 2016 does not appear to have led to an upswing in forest clearing (Kiely et al. 2022). This may suggest a decou- pling of commodity market prices and deforestation. Many policy measures have long lead times to impact, with further results expected in future years. The government’s commitment to land rights reform is another important step toward reducing land-based emissions. Many smallholder activities within forest areas are informal, encouraging land conversion and preventing access to social support and markets. Indonesia has embarked on major land tenure reforms, including a commitment to award 12.7 million hectares of social forestry licenses. These are a form of land use right held at the community level that aim to reverse incentives for forest clearing and encourage investment in lower-impact land uses such as tourism, selective logging, and agroforestry. Approximately 4.1 million hectares of social forestry access had been grant- ed by May 2020. Similarly, the National Land Reform Program (Tanah Obyek Reforma Agraria: TORA) aims to formalize land ownership of an additional 9 million hectares outside the forest estate. These are some of the largest land reform programs in the world (MoEF 2021). Over time, these programs could be further targeted toward high deforestation-risk areas to maximize impact and combined with livelihood programs to improve communities’ access to capital and technical resources for low-impact livelihoods (Resosudarmo et al. 2019; Kraus et al. 2021). After FOLU, the energy sector would need to deliver the largest tranche of emission cuts. About 39 percent of the emission reduction target in Indonesia’s Enhanced NDC would be met through actions in the energy sector. Absolute emissions from the energy sector are projected to increase from approximately 600 MtCO2eq in 2020 to 1,311 MtCO2eq under the unconditional target in the Enhanced NDC (Figure 32)‒an increase in absolute terms but a 21 percent reduction relative to the estimated 1,669 MtCO2eq of energy sector emissions by 2030 under a BAU scenario (Figure 33). By 2030, the energy sector would have overtaken land as the biggest source of carbon emissions in Indonesia. C ommitments & C apacities 27 F I G U RE 3 4 The Land Use Policy Framework: A Chronology Decentralization of many land use 1998 decisions to districts Law 41 on Forestry: Established Indonesia’s Elimination of restrictions on plywood exports 1999 system for managing forests in terms of conservation, protection, and production Tariff reductions on roundwood and sawn timber exports 2005 InPres 4: Accelerating Action against Illegal PP 6: on Forest Administration, Management, Planning, and Utilization 2007 Logging Permentan 14: Peat for Oil Palm Plantation 2008 PermenLHK 2: Non-tax state revenue from forest utilization PermenLHK 36: Licensing procedures for carbon sequestration projects in production 2009 PermenLHK 68: on REDD Demonstration Activities and protection forests E S TABL I S H M EN T OF I C C T F 201 0 E S TAB L ISH MEN T OF RED D + TA SK FORC E Law 18: Law 18 Strengthening Forest 201 1 InPres 10: Moratorium on license issuance for log- Law Enforcement ging and agriculture concessions in primary forests 201 3 and peatlands (renewed in 2013, 2015, 2017) Peat Restoration Agency (BRG) established 201 4 PP 71: Protection and management of peat PP 57: New moratorium for land clearing on ecosystems peatlands Ratification of ASEAN Agreement on Law 16: Paris Agreement Ratification Transboundary Haze PermenLHK 83: Social Forestry target (4.1 million MERGER OF MIN IS T RIE S OF FORE S T RY A N D ha) EN V IRON MEN T TO B EC OME MOE F, E S TAB L ISH MEN T O F D G C L IM AT E C H A N GE PP 9: One Map Policy E S TABL I S H M EN T OF PE AT 201 5 InPres 15: Improved Land and Forest Fire Control RE S TO R AT I O N AG E N CY ( B RG ) 201 6 201 7 PP 46: Economic Instruments for the Environment InPres 5: Permanent moratorium of license issuance, protecting over 66 million ha. Four Ministerial Regulations on peatland restoration PermenLHK 10: Management of peat-based hydrological units (peat domes) 201 8 InPres 8: Moratorium on oil palm plantation SIMATAG, SIPALAGA, and PRIMS initiatives by BRG license issuance and review E S TABL I S H M EN T OF I N DON E S I A E N V I RON ME N T F UN D 201 9 ( BPD L H ) PP 120: Establishment of Peat and Mangrove 2020 Restoration Agency (BRGM), with mandate to restore 1.2 million ha. in 7 provinces and 600,000 PP 22: Environmental protection ha. in 9 provinces by 2024 PP 23 & 24: non-tax revenue from the forestry 2021 InPres 3: Management of Forest and Land Fires sector Permentan 38: Indonesia Sustainable Oil Palm PP 26: Environmental considerations and Certification coordination in the agriculture sector T R A N SFORM AT ION F ROM B RG TO B RGM PP 43: Resolution of Inconsistency in Spatial Planning, Forest Area, Licensing, and Land Tenure 2022 3.1 mil. ha forest licenses revoked PermenLHK 9: Social Forestry Management 4.1 mil. ha high conservation value forest (HCVF) PermenLHK 8: Reduced Impact Logging within protected in concessions Concessions 3.6 mil. ha peatland restoration in concessions PerPres 98: Economic Value of Carbon  Source: Figure compiled by WBG staff. Notes: PP = Peraturan Pemerintah (Government Regulation); PerPres = Peraturan Presiden (Presidential Decree); InPres = Instruksi Presiden (Presidential Instruction); UU = Undang Undang (law), Permen LMK = Ministerial Regulation (MoEF); BRG = Badan Restorasi Gambut (Peat Restoration Agency); ICCTF = Indonesia Climate Change Trust Fund. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 28 To implement cuts in energy emissions, Indonesia aims to change its pri- mary energy mix. Given Indonesia’s intensive use of fossil fuels as covered in chapter 1 above, the scale of the effort required is substantial. This includes targeted cuts to the share of coal (43 to 30 percent between 2020 and 2030) and oil (31 to 25 percent) and targeted increases in the share of renewables (6.1 to 25 percent)36 (Figure 31). There has been some increase in renewable energy consumption to date, driven mainly by biofuels (Figure 32). Biofuels have increased since 2016 on the back of subsidies and mandates, with a government rule requiring diesel fuels to have 30 percent biodiesel content by 2020 (and 40 percent by 2025). However, the use of other renewable energy resources has not progressed substantially, and not at the scale needed to implement the NDC’s energy commitments. Most sources of primary energy (including coal but excluding oil) will continue to increase in absolute terms until 2050. F I G U RE 3 1 F IG U RE 32 Commitments to Changes Renewables as a Share of Total in the Energy Mix Energy Consumption Primary energy mix (% shares) Indonesia renewable energy consumption (% share of total energy consumption) Source: Our World in Data, Indonesia NDC 2022 (p.7), Source: Our World in Data, figure compiled by WBG staff. figure compiled by WBG staff. Against this backdrop, an important initial step in enabling increased re- newable energy penetration in the energy mix was the recent decision to establish a more favorable pricing scheme for these technologies. Presiden- tial Regulation No. 112/2022 overrides the existing regulation which caps such purchase prices at or below the average cost of grid electricity generation (which is mostly determined by coal-based generation). Instead, the regulation sets out new ceiling prices differentiated by renewable energy technologies, size, and location which, overall, are higher than the previous caps. It also estab- lished competitive principles for procurement of renewable energy technologies such as Solar PV and provides for direct fiscal support for the state-owned electricity company PLN (PT. Perusahaan Listrik Negara) to be compensated if 36 Under the Just Energy Transition Part- the development of new renewable capacity increases its average generation nership, the target share of renewables in 2030 cost. Facilitated by these regulatory reforms, the implementation of large-scale is now 34 percent of the competitive selection processes will be needed going forward to achieve the power mix (that is, not primary energy mix). deployment of renewable energy at the scale required for the transition. C ommitments & C apacities 29 Two other fundamental reforms will be needed to incentivize the move away from coal. As noted above, recent global developments create headwinds for the coal exit, including rising coal prices and higher costs of financing for the energy transition. Reforms that can help reduce the relative cost of renewables will be even more important in the current environment. Priority changes in this regard would remove: 1 The Domestic Market Obligation (DMO) for coal Indonesian coal producers are obliged to sell a minimum amount of their out- put to PLN for electricity generation‒at a rate capped at US$70/tonne, a rate well below recent market prices. This creates incentives for reliance on coal for electricity generation, and artificially reduces the cost of electricity, leading to less efficient use of final energy by end users on the demand side. 2 Local content requirements (LCRs) Existing regulations set a minimum threshold for local content both for materials and services used in renewable energy generation, including solar power, with the ambition of supporting development of domestic manufacturing capability.37 Local solar panel manufacturers have not yet reached sufficient scale and com- petitiveness, however, resulting in panels that are more expensive and of lower quality than those on the international market. Local content requirements there- fore increase the cost of renewable energy, making it less competitive vis-à-vis fossil fuel generation. 2.2 POLICIES & INSTITUTIONS FOR THE DEMAND SIDE A t COP26 in 2021, Indonesia committed to the ‘Global Coal to 37 Ministry of Industry Clean Power Transition Statement’ ensuring transition away (MoI) Regulation No. 54/2012 (updated from coal.37 Following this announcement, PLN removed in its through MoI Regulation 2021-2030 10-year investment plan 20 GW of new coal plants No. 5/2017, and further detailed in MoI Regula- compared to the previous 10-year plan (2019-2028). Some 13.8 tion No. 4/2017). GW of planned grid-connected coal capacity is, however, already under devel- 38 Like some other countries, Indonesia opment and expected to come online before 2030.39 Indonesia is considering excluded the third point of the statement, which options to reduce these increases. Of the planned 13.8 GW of coal plants, requires no further issuance of new permits 9 to 10 GW are at advanced stages of construction. These are expected to for the construction be commissioned in the next two years. As mentioned in Chapter 1 above, of unabated coal-fired power plants. Over 40 additional coal generation will result in stranded assets which will become a countries supported the statement in whole or constraint for the transition. in part. Indonesia has stated a willingness to consider accelerating the In an important recent step forward, Indonesia set out for the first time a coal phase-out into the 2040s, conditional on legally binding restriction on building coal-fired power plants connected to additional international financial and technical the country’s electricity grid in Presidential Regulation No. 112/2022. The assistance. regulation also provides, however, for significant exemptions to this coal plant 39 These are part of the government’s plan moratorium. These exemptions include coal plants that were already approved that was approved in and those integrated with industries aimed at the transformation of raw natural 2015 for an additional 35 GW of capacity. resources or that support projects deemed of national strategic importance. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 30 Indonesia has banned the export of nickel and bauxite, and the government has plans to gradually stop exporting other raw materials too. Energy demand for the processing of minerals has the potential to increase substantially over the next few years. The exemption in the regulation poses a significant risk to Indonesia’s coal phase-down if new coal-fired plants materialize and could further lock industrial processes into a high-carbon content development path. To enable the phase out of coal, Indonesia is establishing an Energy Tran- sition Mechanism Country Platform. This Platform creates the institutional set-up to organize, achieve scale, and coordinate funding and financing for the energy transition. The Country Platform, to be managed by PT. Sarana Multi Infrastruktur (PT. SMI), will channel state budget, donor funding, and proceeds from carbon trading for energy transition projects. Financial solutions have the potential to reduce the costs of the energy transition by harnessing multilateral, donor, and philanthropic funding and financing to blend it with state budget and private sector capital to maximize resources. Investments and activities expected to benefit from these mechanisms include, among others, renewable energy projects and early retirement of coal-fired power plants. The contribution of solar and wind to the energy mix will need to accelerate rapidly but is challenged by over-capacity in coal. From 2010 to 2019, the share of renewable electricity output increased from approximately 14.1 per- cent to 15.3 percent overall,40 leaving a considerable gap to the 2025 National Energy Plan (Rencana Umum Energi Nasional: RUEN) target of 23 percent, and the 2030 targets above. The over-supply of capacity in the system, mainly from coal, has reduced the ‘space’ for adding renewable energy without creating stranded coal power assets, most notably in the Java-Bali grid. Reforming PLN’s current revenue model and retargeting of end-user sub- sidies is needed to put the electricity sector in a solid financial footing to implement the transition. Scaling and integrating variable renewable ener- gy (solar and wind) will require both PLN and the private sector to invest in grid and transmission capacity, energy storage such as pumped hydro and battery storage, digitizing the grid, and improving system dispatch, among others. Since 2017, however, tariff adjustments that would allow costs to be passed on to consumers have been restricted, limiting PLN’s ability to make necessary investments, and resulting in losses that are covered by the state budget. This requisite payment (or top-up) from the budget to PLN is typically delayed‒sometimes by up to two years‒resulting in cash flow challenges. PLN also sets tariffs below cost recovery to provide low-cost electricity to poor and vulnerable customers but, as they are based on weak targeting, they further exacerbate inefficient subsidies. PLN’s current revenue structure, set as a cost- plus seven percent margin, is not sufficient to cover operating costs and debt 40 The proportion of renewables in the service. The incremental cost of the transition will be substantial as discussed generation mix moves considerably from year in chapter 3 below and therefore, improving PLN’s financial sustainability will to year given fluctuations in local conditions (for ex- be key to enable its implementation. ample, hydropower dam storage). The average of the three years up Addressing PLN’s debt burden will also be important to enable it to in- to 2010 and 2019 is reported to account for vest in the energy transition. The rapid growth in outstanding debt has fed these fluctuations (Inter- national Energy Agency: through into increasing challenges in meeting debt service commitments. IEA data). This dependence on subsidies has posed several challenges. It has heavily C ommitments & C apacities 31 politicized the process of setting tariffs and led to an emphasis on short-term cost minimization at the expense of investing now to reduce costs and risks in the longer-term. Commitments to reduce the carbon intensity of the electricity system are being complemented by the government’s electric mobility targets. The National Electric Vehicle (EV) Program for Road Transportation,41 initiated in 2019, establishes a target for domestic EV production to represent 20 percent of total domestic sales by 2025 (Maghfiroh and Pandyaswargo 2021). By 2030, the Ministry of Energy and Mineral Resources (MoEMR) aims for 0.6 million electric cars, and 2.45 million electric two-wheelers on Indonesia’s roads. These targets aim to reduce fossil fuel use, improve air quality, and develop the country’s nickel reserves (the largest in the world) for lithium-ion batteries. Ambitious targets for the electrification of public transit fleets (90 percent by 41 Presidential Decree No. 55/2019 on the Pro- 2030) are also in place. Market uptake has been limited to date, owing to higher motion of Battery Electric up-front EV costs (which are exacerbated by LCRs). Higher uptake, provided it Vehicles (EVs) for Ground Transportation. occurs in concert with grid decarbonization, will help lower emissions (Box 1). “ Commitments to reduce the carbon intensity of the electricity system are being complemented by the government’s electric mobility targets.“ I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 32 B OX 1 Modelling urban transport GHG emissions reductions W orld Bank modelling assessed potential emissions re- ductions from the deployment of mode shift strategies (public transport and walking and cycling, demand man- agement) along with electrification. Estimates are based on data for urban cores of 29 large urban agglomerations in Indonesia, combined with typical trip rates and mode splits between public and private transport. These were projected year-by-year for 20 years, considering potential changes in vehicle ownership, vehicle elec- trification and electricity carbon emissions. Mode shares of 25 percent public transit by 2034 would lead to reductions of 14 percent in urban transport GHG emissions by 2040 (Figure B.1.1). Reductions could be scaled up to 21 percent by implementing more sophisticated and high-per- formance mass rapid transit systems in densely trafficked corridors. These strategies further contribute to reduced congestion and the livability of Indonesia’s cities. A strategy for vehicle fleet electrification in isolation shows limited results by 2035 owing to the proportion of coal in the energy mix. Combining an electric mobility strategy with the urban mobility strategy leads to bigger climate impacts and reduced congestion. A high electrification scenario alone results in lower emission reductions of 2 percent by 2030 and 19 percent by 2040 (as the grid begins to decarbonize). Combining with improved public transport mode share (25 percent) and implementation of mass rapid transit systems leads to emission reductions of 31 percent and 38 percent respectively. F I G U RE B .1 .1 . Commitments to Changes in the Energy Mix Reduction in urban transport GHG emissions through sustainable transport strategies Notes and source: High vehicle electrification of 25 percent car, 50 percent motorcycle, and 100 percent bus electrification by 2034. Estimates assume BAU electricity emission factors as described in the energy model. WBG staff estimates. C ommitments & C apacities 33 Building on recent investments in urban transport infrastructure, there are opportunities to include broader transport strategies in national plans and commitments. “Avoid-Shift-Improve” (ASI) strategies for decarbonizing the transportation sector would complement existing NDC plans for the transport sector. “Avoid strategies for decarbonizing urban mobility reduce the number and length of trips via integrated land use and transport planning. They require several decades to show results. ‘Shift’ strategies promote a move toward less GHG-intensive modes of transit via investment in reliable and integrated public transit, improvements to the pedestrian and cycling environment, and demand management tools (parking policies, personal vehicle taxes, and gradual re- moval of fuel subsidies). ‘Improve’ strategies include adoption of cleaner fuel technologies‒such as from diesel to compressed natural gas (CNG) or electric, improved fuel, or efficiency standards. Including ASI strategies can guide efforts to reduce transport-related emissions while supporting competitiveness and urban livability. There are also further opportunities to harness city planning and construc- tion processes to reduce urban emissions. Urban footprints, and associated emissions from land use and service provision will expand dramatically over the next decade in Indonesia (Figures 33 and 34). Indonesia has mandated efficiency standards (green certification) for high-rises. Including landed hous- es under certification standards (Sertifikasi Bangunan Gedung Hijau) would help further energy efficiency gains. Regional Low-Carbon Development Plans (Rencana Pembangunan Rendah Karbon Daerah) are under development. The first such plan approved was for Jakarta in 2021, which targets GHG emis- sions reductions of 50 percent by 2030. Expansion of this process to other locations will strengthen the alignment of national climate goals with actions at the subnational level. F I G U RE 3 3 F IG U RE 34 Emissions from Land Cover Changes Emissions from Provision of Urban Services in Rapidly Developing Cities Expected increase in emissions due to Expected emissions due to land use change (MtCO2) urban services after urban expansion (%) Source: World Bank modelling of expected urban development for ten metropolitan areas between 2015 and 2030. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 34 2.2 COPING WITH CLIMATE CHANGE P olicies and institutions that are key to adaptation have improved in recent years. Indonesia’s high-level adaptation commitment is to minimize GDP loss to 2.87 percent by 2050.42 The LTS and NDC provide frameworks for adaptation actions that are intended to guide the RPJMN and budget allocations; regulations guide their incorpora- tion into regional and sectoral development plans along with vulnerability and climate risk assessments.43 Major adaptation and resilience initiatives include Indonesia’s Disaster Resilience Improvement Program (DRIP) which invests in resilient infrastructure and disaster preparedness and the recently established Pooling Fund for Disasters (Pooling Fund Bencana: PFB)‒a central mechanism for managing disaster-related contingent liabilities in a cost-effective manner. An Adaptive Social Protection (ASP) Roadmap has been developed to provide a guide for leveraging social protection to address risks to climate-related hazards and other shocks. These and other initiatives have contributed to improvements in Indonesia’s overall climate “readiness”. Empowered decision-making at a local level‒in collaboration with the pri- vate sector, academia, and civil society‒is also contributing to improved resilience. The success of Indonesia in achieving adaptation goals under the NDC will be strongly influenced by the actions of non-party stakeholders, and communities’ awareness and empowerment. The Climate Village Program (Pro- gram Kampung Iklim: PROKLIM) is a key contribution toward such participation. Launched in 2012 and expanded in 2016, the program helps communities understand climate risks, determine their adaptation needs and mitigation potential, and implement and monitor progress, while bringing local authorities together with civil society actors, the private sector, and academia. As of 2021, 3,270 villages had established PROKLIM activities, toward a targeted 20,000 villages by 2024 under the RPJMN 2020-24. Communities are also receiving support through related sector-specific programs, including Fire Care Com- munities, the Disaster-Resilient Villages Program under the National Disaster 42 Government Management Authority (Badan Nasional Penanggulangan Bencana: BNPB), modelled losses in the absence of adaptation. and the Climate-Healthy Villages Program under the MoH. Climate information See MoEF 2021a. at local level is being provided by the Vulnerability Index Data Information Sys- 43 Notably, MoEF Regu- tem (Sistem Informasi Data Indeks Kerentanan)‒a national data platform for lations No. 33/2016 and No. 7/2018. tracking village vulnerability. C ommitments & C apacities 35 Recent expansions to social systems–social protection and health pro- grams–will underpin climate resilience and the human capital accumulation needed for growth. A key social protection commitment under the RPJMN 2020-24 is to facilitate access to social protection for 98 percent of the popula- tion. Social protection programs have seen a significant expansion of coverage over the decade to 2021‒complemented by a suite of non-contributory transfer programs for emergency situations. A unified social welfare registry list (Data Terpadu Kesejahteraan Sosial: DTKS) of nearly 29 million poor and vulnerable households has been developed to identify potential beneficiaries for a range of programs. Health insurance coverage (Jaminan Kesehatan Nasional: JKN) has increased from 130 million people to over 220 million in the five years to 2021, with an RPJMN 2020-24 commitment to increase coverage to 98 per- cent of the population. In addition to financial protection against impoverishing health episodes, JKN helps promote climate resilience of health facilities and improve care for climate-sensitive health conditions. In 2021, social assistance spending was 1.5 percent of GDP‒close to the global average (1.54 percent), however, as is the case in countries globally, these systems will be stretched further by climate change. Disaster risk management (DRM) has improved significantly. The govern- ment’s 30-year disaster management master plan aims to reduce the number of cities with high disaster risk from 75 percent to 40-45 percent by 2045. Important steps toward this goal include the laws on Disaster Management and Spatial Planning passed in 2007 which clarified responsibilities for disaster preparedness and response and ensured identification and protection of evac- uation areas and high-risk areas. The BNPB which was established in 2008, improved coordination across government. A new regulatory framework has further incorporated disaster risk into spatial plans‒an important step with the potential to change the trajectory of community and infrastructure vulnerability long term.44 As a result, Indonesia has internationally recognized good practices in emergency response and community-based post-disaster recovery, however, financing for contingent liabilities remains below needs; the CCDR returns to this difficult issue in Chapter 3. Complementing these DRM reforms, there are opportunities for further detailed consideration of disaster risks in development spatial planning, and in infrastructure standards (see Chapter 5). Some structures–notably tariffs in the water sector–contribute to increased vulnerability (World Bank Forthcoming). Just as PLN’s revenue model con- strains its ability to expand renewable energy capacity, the revenue model for some water utilities may indirectly contribute to urban flooding. The rapid sinking of Jakarta and north coastal areas of Java is partially due to ground- water extraction which is itself a response by residential and commercial water users to the cities’ low coverage of piped networks. In Greater Jakarta, it is estimated that about 43 percent of piped water needs are currently covered. 44 Flood modelling for Water utilities face technical and financial constraints to expanding these net- Indonesian cities shows that rigorously enforced works as the water tariff does not fully cover the operation and maintenance spatial planning can reduce flood exposure by of existing systems, let alone the expansion of services. Mayors or heads of 50 to 84 percent and is particularly effective in districts have authority to approve tariff increases, however, they often ask cities with rapid urban for approval from the city/district council and rate increases are politically expansion. See Muis et al. 2015. challenging. While groundwater pumping is not the only cause of subsidence I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 36 and flooding, aligning incentives in the tariff structure could help to alleviate investment constraints and to improve water use efficiency. These measures would be well-complemented by disincentives to pumping groundwater directly, including increased charges for groundwater use and stronger limits on new or extended permit issuances. The agriculture sector has adopted reforms to adapt to climate change and build resilience. In February 2022, the Ministry of Agriculture (MoA) released the draft Grand Design on Climate-Resilient and Low-Carbon Agriculture which 45 CSA packages would outlines the ministry’s overarching strategy to improve the adaptive capacity of typically comprise a mix of advisory services (for the country’s agricultural sector to climate change while simultaneously achiev- example, agronomic, ing its NDC commitments. The framework, together with the establishment of climatic, and business development advisory the MoA Climate Change Working Group, provides an opportunity to improve the services), improved inputs (for example, linkages and coherence of Climate Smart Agriculture (CSA)-related initiatives higher yielding and/or drought-/flood-tolerant that currently reside under different technical units within the ministry. The varieties), climate-re- silient infrastructure MoA is in the process of developing roadmaps and action plans to operation- and technologies (for alize the Grand Design. A further useful step could be to establish monitoring, example, water-saving irrigation, improved reporting, and verification (MRV) systems to track and evaluate progress, along post-harvest infrastruc- ture to minimize losses, with coordination mechanisms with other line ministries, such as the Ministry of digital technologies), and other supporting services Public Works and Public Housing, MoEF, and the Meteorology, Climatology, and (for example, financial Geophysics Agency (Badan Meteorologi, Klimatologi, dan Geofisika: BMKG), services). Adaptation measures in agriculture to support MoA in achieving its climate objectives. typically also have miti- gation co-benefits. 46 For example, the Climate resilience in the agriculture sector would benefit from further promotion of the System of Rice Intensification, in- site-specific services to build adaptive capacity.45 Many countries face chal- tegrated crop calendars, lenges in scaling CSA practices.46 Such challenges include fragmented land climate field schools, rice and livestock insurance holdings (close to 90 percent of Indonesia’s farmers own less than 2 hectares schemes, and the devel- opment of flood- and/ of land) (BPS 2018), and gender barriers to farmer groups that limits women’s or drought-tolerant rice varieties. access to extension services and new technologies (Food and Agriculture Orga- 47 In 2020, Indonesia nization 2019). Fragmentation of programs across government departments is spent approximately 20 times more on fertilizer also common, and farmer demographics tend to be older and less educated. subsidies (US$16.4 These challenges are not easy to overcome. Gradually redirecting resources billion) than on its agricultural knowledge from input subsidies to more targeted forms of climate-sensitive support–in- and innovation systems (US$81.6 million; com- cluding extension services for new technologies and expansion of agriculture prising US$ 23.6 million for agricultural research credit (such as Kredit Usaha Rakyat: KUR)–could help.47 Improved smallholder and development and access to formal credit and insurance enables farmers to finance climate-smart US$ 58.0 million for extension services). investments and better manage risks (Saveli et al. 2021). “ Recent expansions to social systems–social protection and health programs–will underpin climate resilience and the human capital accumulation needed for growth” C ommitments & C apacities 37 3 ENABLING PAG E 3 8 —58 ECONOMIC POLICIES & INSTITUTIONS SCB D • JA K A R TA I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 38 3.1 BUILDING THE FOUNDATIONS FOR A LOW-CARBON & CLIMATE- RESILIENT FUTURE T he sector-specific policies and institutions for mitigation and adap- tation discussed in Chapter 2 are critical, but not the only building blocks toward Indonesia’s stated commitments. For a transition that also delivers on Indonesia’s development ambitions, a broad set of policy and institutional enablers can be used to complement the sector-specific measures. These enablers aim to raise and allocate financial, physical, and human resources for climate action. They are also important foundations for capital accumulation and efficient resource allocation that will underpin long-term economic growth: 1 2 3 4 The fiscal framework The financial system Investment climate Trade policies can be can be used to can be used to raise and regulations used to facilitate green address market and channel savings can be used to exports and imports, failures in mitigation to mitigation and engage private move Indonesia toward and adaptation, raise adaptation activities, sector participation the green technology revenues, and provide provided that structural in mitigation and frontier, and modify buffers during the low- constraints and adaptation. incentives for carbon- carbon and climate- exposure to climate intensive commodity resilient transitions. and stranded-assets production. risks can be alleviated. These enabling policies and institutions are interrelated and mutually rein- forcing. The fiscal framework helps set price signals and protect investments. In doing so it affects the cost and availability of financial capital for green in- vestments. Green investments are further influenced by the investment climate and business regulations. Meanwhile, trade policies support firms’ access to green inputs and markets‒further facilitating green investments. These interactions further determine the incentives and opportunities for firms and workers to participate in the green economy. Chapter 3 first considers these enabling conditions, before turning to Indonesia’s private sector directly to ask: to what extent is it ready and willing to step up to make the investments and operational changes that will move the transition forward? E nabling E conomic P olicies & I nstitutions 39 3.2 FISCAL POLICY FOR THE CLIMATE AND DEVELOPMENT CHALLENGE Indonesia’s fiscal framework has historically incentivized carbon consump- 45% tion, although ongoing reforms are trying to redress this. Incentives are driv- en by low taxation of, and subsidies for, fossil fuels. Support for fossil fuels as a share of tax revenue in Indonesia has declined, with a sharp drop in 2015 of the PSO is used to (Figure 35). This drop was driven by ambitious transport fuel subsidy reform in subsidize households that do not fall within the 2014-15. Transport fuels receive around one-half of total fossil fuel support. This database for poor and has declined over the 20 years to 2020 (Figure 36). Cuts in total support (from vulnerable households 3.9 percent of GDP in 2000 to 1.8 percent in 2020)47 created space for higher spending on health, infrastructure, and social assistance. Social assistance in- creased from 0.3 percent of GDP in 2004 to 1.5 percent of GDP in 2021. Total fuel subsidy expenditure rose because of the energy crisis in 2022, although the government has increased administered prices to contain these pressures. There are opportunities for further reduction in fossil fuel support that could enhance economic efficiencies and welfare. Most fossil fuel support is target- ed to consumers rather than producers (Figure 37). This results in low petrol end-user prices (Figure 38) designed to assist households; however, benefits accrue more to the better-off households as they are larger consumers of fuel than the poor. In the power sector, as discussed in Chapter 2, electricity tariffs are set below cost recovery under a PSO arrangement (Figure 39). Although 48 As per the 2020 national budget. This efforts have been made (especially between 2015 and 2017) to reassign includes reported direct subsidy spending and consumers to non- or less-subsidized tariff classes through means testing, estimated implicit subsi- dies accruing as payment many relatively better-off households still receive the benefit of the PSO tariff. obligations to Pertamina, Approximately 45 percent of the PSO is used to subsidize households that do the state-owned oil and gas enterprise. not fall within the database for poor and vulnerable households. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 40 F I G URE 35 F IG U RE 36 High but Decreasing Most Support Goes Fossil Fuel Support Toward Petroleum Total fossil fuel support Petroleum support F I G U RE 3 7 F I G URE 38 F IG U RE 39 Most Support is Resulting in Low Petrol And Low Residential Geared to Consumers End-user Prices Electricity Prices Fossil fuel consumer support Petrol end-user price Residential electricity price Sources: OECD Green Growth Data, figures Note: Interquartile range refers to equivalent data for the 25th and 75th compiled by WBG staff. percentile of structural peers (see Footnote 2). The current economic environment does create challenges for the reduc- tion of fossil fuel subsidies although there are steps that can be taken to help gradually move the process forward. Some governments choose fuel price subsidies over targeted transfers at times when energy prices are high because for example: (i) many poor households do not receive social transfers to compensate for higher fuel prices; (ii) price controls can shield producers from higher input costs; and (iii) price controls help keep inflation expectations in check. Reducing and redirecting fossil fuel subsidies will require sustained efforts to strengthen the delivery infrastructure for social protection and devis- ing transfers that are consistent with political imperatives‒such as timebound transfers to affected households. Fiscal instruments could be used to disincentivize emissions in other emis- sions-intensive sectors. Several fuels and sectors currently lack direct fiscal incentives to increase efficiency, including oil and gas, industrial processes 49 The emissions and product use, and residential electricity. Although the forestry sector and footprint of one tonne plantation agriculture are subject to licenses and export levies–forms of fiscal of crude palm oil varies spatially by a factor of 35 instruments–these are not differentiated between production on land associ- (0.7-26.0 tCo2eq-1). See Lam et al. 2019. ated with high emissions and that in more suitable areas.49 E nabling E conomic P olicies & I nstitutions 41 There are opportunities to promote greater consistency across fiscal in- struments for stronger overall incentives to decarbonize. In some instances, fiscal instruments within the same sector that have countervailing effects could be addressed over time: 1 2 Coal Agricultural S EC TOR S EC TOR Royalties and the upcoming carbon tax on Fertilizers account for over 10 percent of coal-fired power plants combine to discourage agriculture-related emissions, implicitly the use of coal. This is partially offset by a encouraged through fertilizer subsidies. A crude zero-royalty policy on coal used for domestic palm oil export levy aimed at boosting domestic value-added activities, including coal used for supply implicitly discourages emissions from the coal-fired power plants. palm oil sector (the second largest consumer of fertilizers in agriculture), yet expenditure of the levy’s proceeds on subsidizing biofuels may be increasing production and, therefore, emissions.50 3 4 Residential Transport S EC TOR S EC TOR Emissions are encouraged by electricity subsidies Provincial government taxes on transport fuels provided by below-cost retail prices and a discourage emissions but are counteracted by commitment to compensate PLN for losses. At the central government subsidies on diesel and same time, the carbon tax will raise PLN’s cost a popular brand of low-quality, high-emission for supplying electricity, but not the administered gasoline. The net effect of fiscal policy is to retail prices‒thereby creating a need for larger promote transport emissions (representing government subsidies. approximately 25 percent of energy-related emissions). “ Fiscal instruments could be used to disincentivize emissions in other emissions-intensive sectors” 50 There is a risk that incentives for biofuels production could promote land-associated emissions in the absence of forest protection measures and sustainable palm oil production standards. While biodiesel produced by oil palm is less emissions intensive than conventional diesel at point of use, it can be more emissions intensive if land conversion is required. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 42 Beyond emissions mitigation, fiscal policy is equally critical for climate resil- ience. Indonesia has made important advances in DRM institutions, including the new PFB. As fiscal space permits, increased contributions will be needed to match climate shock risks. Post-disaster spending was 0.11-0.38 percent of total government expenditure from 2014-18.51 World Bank analysis finds that, under current rates of disaster incidence, Indonesia can expect to face average direct disaster losses of US$1.3 billion per year (excluding post-disaster economic support). Greater costs are possible in more severe years, with a 2 percent probability of US$6.4 billion in losses in a given year.52 Climate-related risk represents 63 percent of these average direct disaster losses and can be expected to rise. The government’s new PFB is an important step toward covering these costs, adding to the allocations made to the existing disaster reserve fund (a total of US$560 million in 2022) (Figure 40). F I G U RE 4 0 Expected Contingent Liabilities from Natural Disasters Expected liabilities from disaster events, with comparison to 2004 and 2018 earthquakes (for scale), based on past (20-year) records 2022 C OMB INE S B U DGE T AL LO CAT ION FOR DISA S T E R RE SP ONSE ( E X IS T ING RE S E RVE FU ND AND PFB ; APPROX . U S$560 MIL . ) Source: WBG staff analysis based on the EM-DAT database. Note: Loss estimates are calculated based on past disaster incidence, not projected risks. Climate change is expected to increase some risks. 2004 and 2018 earthquakes refer to all earthquakes in those years, although the majority of damage occurred in the North Sumatra and Central Sulawesi events in those years respectively. Expected liabilities are estimated disaster damages at various percentiles of the distribution of damages fitted to historical data (all those recorded in EM-DAT). The CCDR recognizes that reforms to fiscal policy and energy subsidies are politically challenging, particularly at a time of rising global food and fuel prices. It is unlikely that the remaining fossil fuel subsidies can be addressed 51 This underestimates spending on on short timelines and the same applies to the introduction of carbon pricing. reconstruction which is often integrated in future capital investment projects or Nevertheless, in the context of Indonesia’s low tax revenue (8-10 percent of reallocated from budget items such as maintenance. Based on a World Bank GDP), these distortions become increasingly expensive as prices rise, and the review of disaster-related public expendi- revenue they absorb is needed for Indonesia’s expanding and improving social tures from 2016-20. infrastructure (see Chapter 2). Resilience investments and contingent liabilities 52 World Bank staff analysis based on the EM-DAT database. These figures esti- will also require further financing, consistent with trends globally. Despite the mate the total damages from a disaster, which does not necessarily represent the challenges, targeted, incremental reforms are currently being pursued by In- government’s contingent liability arising from a disaster. Governments also face donesia, such as those underway on electricity tariffs and fuel prices.53 These costs from longer-term support needs. will gradually reshape incentives for emissions and help create fiscal space. 53 The government increased electricity prices for selected households in July As outlined in Chapter 5 of the CCDR, further such adjustments, timed for 2022 and raised the administered price when circumstances allow, will be important for development of an efficient, of gasoline and diesel by 30 percent in September 2022. incentive-compatible fiscal system for the medium and long term. E nabling E conomic P olicies & I nstitutions 43 3.3 PUTTING A PRICE ON CARBON N otwithstanding the near-term challenges of high energy prices, the eventual expansion of carbon-pricing when the economic condi- tions allow will help complement the above fiscal reforms. In Oc- tober 2021, the government enacted legislation that provides a legal basis to introduce carbon-pricing instruments‒including an emissions trading system (ETS)54 and a carbon tax.55 Carbon-pricing instruments shift the costs associated with GHG emissions from society to emitters and help incen- tivize investments in low-carbon options. Carbon pricing also benefits countries with a large informal sector‒such as Indonesia (carbon prices may be imposed upstream where fuel enters the economy or downstream where commodities are exported or processed, indirectly incentivizing, and raising revenue from, informal actors). Once implemented, Indonesia will join about 40 countries and more than 20 cities, states, and provinces that use carbon pricing mechanisms (covering about 20 percent of annual GHG emissions globally). The authorities plan to introduce an ETS in the power sector. Building on the experience of a voluntary cap-and-trade system introduced in 2020 (covering 84 coal-fired power plants), the MoEMR is preparing the launch of a manda- tory emissions trading system to be fully implemented by 2024. An MoEMR regulation will introduce an ‘emissions cap’ for coal-fired power plants, tiered by their capacity at the unit level. At the end of the reporting year, units with emissions exceeding the cap will need to either purchase allowances from other units or through carbon offset credits (from energy efficiency or renew- able energy projects), although the former will be prioritized. Given high energy prices globally, the previous plan to complement the above mechanisms with a carbon tax (planned at approximately US$2.10 per tonne) has been delayed. Indonesia has a mechanism to ensure alignment across carbon-pricing instruments which could be strengthened with coordination with the broad- er emissions reductions policies‒as both are critical to avoid “waterbed effects.” In October 2022, MoEF issued an implementing regulation which mandates NDC-relevant sectoral ministries to issue a carbon-trading road- map based on emissions considerations prior to introducing an ETS. This will be harmonized with the carbon-tax roadmap to be issued by the MoF. This is important to ensure that each sector will be covered by one carbon-pricing in- strument.56 This will help avoid waterbed effects, which occur when emissions cuts in one sector are offset by higher emissions in another. For example, if 54 Presidential Regu- lation No. 98/2021 on policies to promote energy efficiency lower coal-fired power plants’ demand Economic Valuation of Carbon. for emissions allowances, the price of those allowances in the market will 55 Law No. 7/2021 on drop. This benefits other industries within the ETS that can purchase cheaper Tax Harmonization. allowances resulting in higher emissions (in the absence of adjustments to 56 The most recent the overall cap). Similarly, carbon tax implementation will interact with the draft of the roadmap spells out that the power cap-and-trade mechanism. sector will be covered by the ETS, transportation by carbon tax, buildings will use a carbon offset Further analysis on market design could support development of the sys- mechanism, and carbon tem’s operational plans and implementation. Regulations that formalize the trading for the industry sector. technical design and underlying infrastructure of carbon pricing will determine I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 44 the efficiency and impact of the system. These design elements include the level of pricing over time, revenue collection points (upstream or downstream), GHG and sectoral coverage, MRV mechanisms, and the carbon exchange market setup. Analytical work to better understand the impact of the carbon price at different levels, instrument design options, and interactions with other policies, can also help guide these operational plans. This could build on existing studies such as the LCDI which found revenue-generating potential of 2.6 percent of GDP by 2031 under moderate carbon tax and subsidy reforms57 (Bappenas 2021). The CCDR also considers a subset of these issues in Chapter 4, where it presents GDP, price, and poverty outcomes for carbon prices in combination with sectoral policies. Indonesia is harnessing other forms of carbon pricing, including results-based payments and carbon credits trading. There are options for international pay- ments for emission reductions that do not require corresponding adjustments to Indonesia’s NDC. For example, Indonesia is harnessing international emis- sions reduction payments to incentivize jurisdiction-wide actions in Jambi and East Kalimantan Provinces (Box 2). This could be scaled to other provinces. There are also emerging opportunities to utilize other international payment mechanisms to incentivize private sector actions without transfer of mitigation outcomes (corresponding adjustments)‒thereby ensuring that Indonesia’s NDC progress is not compromised. B OX 2 Realizing the Economic Value of Reduced Emissions T hrough the MoEF and provincial governments, Indonesia is implementing ambitious jurisdictional-level programs to reduce emissions from deforestation and forest degradation (REDD+). Jurisdictional programs provide payments for verified emissions reductions from a defined region overall‒helping to avoid the problem of leakage that can arise from project-level payments. The pay- ments help cover the investment costs needed for emissions reduction and provide a financial incentive to the jurisdiction for success. Unlike carbon credits, where prices are determined by market forces, negotiation between donors and recipient jurisdictions sets the payment rates. Indonesia has jurisdictional programs under formal development in East Kalimantan and Jambi. In East Kalimantan, The Forest Carbon Partner- ship Facility (FCPF), a global partnership to achieve REDD+, pledged to provide up to US$110 million in payments for reduced emissions within the province between 2020 and 2025, verified by external third parties. Actions to reduce emissions included the protection of HCV forest located within oil palm concessions and tighter regulations on mining. To date, the East Kalimantan REDD+ program has achieved significant results. While still under verification, it is expected that the province reached about 30 57 Under a carbon tax that starts at less million Emissions Reductions (equivalent to tons of CO2eq) from 2019 to than US$5.00 per tonne 2020, a rate three years ahead of schedule. A first payment of US$20.9 in 2022 and rises to US$40.00–60.00 by million was made in November 2022. 2040. See Bappenas (2021). E nabling E conomic P olicies & I nstitutions 45 In Jambi, the BioCarbon Fund Initiative for Sustainable Forest Landscape (BioCF-ISFL) has pledged to provide payments for an expected 14 million tonnes of emissions reductions. The payments will help support the prov- ince’s Green Growth Plan (GGP)‒a long-term vision for low-emission eco- nomic growth. The implementation of GGP aims to reduce the average rate of deforestation to 1,770 ha/year compared to the BAU of 4,730 ha/year. In both provinces, payments will be distributed to stakeholders according to a benefit-sharing plan (BSP), a crucial part of jurisdictional program design. The BSP defines the proportion of payments that will flow to pro- vincial and district governments, private sector actors, and communities, and in return for what actions. The programs thus bring together a wide range of stakeholders to contribute to Indonesia’s national targets for emission reductions. This is an example of how large-scale GHG emissions reductions can be incentivized across Indonesia’s complex governance structure, with opportunities for scale-up to other provinces across Indo- nesia. Additionally, the World Bank intends to provide further support for results-based payments for REDD+ through a new multi-donor trust fund, Scaling Climate Action through Lowering Emissions (SCALE). Source: World Bank staff based on East Kalimantan Emissions Measurement, Monitoring, and Reporting Portal (2022) (link) See also SCALE (link). I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 46 3.4 DEEPENING THE FINANCIAL SYSTEM FOR CLIMATE & DEVELOPMENT ACTION A ll countries’ financial systems must respond to two important climate-related challenges: (i) the management of climate and environmental risks to the financial sector; and (ii) mobilization of financial capital for mitigation and adaptation investments. The two are interrelated. Climate-related risks, if not well-managed, can cause shocks to the financial system that reduce the appetite for invest- ments, whether green or not. Fiscal policy, as discussed above, is constrained in its ability to protect against such shocks. On the positive side, measures to expand green finance also address factors that may otherwise impede the depth, efficiency, and reach of the financial sector more generally. These mea- sures are crucial for long-term efficient capital allocation. The financial sector is exposed to climate-related risks.58 Those risks are grouped in two main categories. The first are physical risks from climate shocks (for example, business disruption and property damage) that reduce borrowers’ ability to service their debt, thereby causing financial instability. The second are transition risks from financial sector exposure to high-emissions sectors that will shrink because of low-carbon policies at home and abroad. Indonesia has the fourth highest carbon intensity of its loan portfolio of any country.59 These challenges are magnified by the relatively small size of Indonesia’s financial sector in terms of its total assets and private credit relative to GDP 58 For example, private (World Bank 2022). credit to GDP accounts for only 38 percent, compared to a middle-in- As is the case in many countries, the financial sector’s capacity to monitor come-country average of over 120 percent of GDP. and manage climate-related risks is nascent, however, there has been re- 59 Measured as the cent progress. Indonesia participates in international and national networks carbon footprint adjusted loans to total loans for on managing climate risks to the financial sector.60 The Financial Services Au- deposits. Data from IMF Climate Dashboard thority (Otoritas Jasa Keuangan: OJK) released a Sustainable Finance Umbrella (2021). Policy in 2017, including regulations requiring banks to develop procedures for 60 For example: (i) OJK monitoring and managing Environmental, Social, and Governance (ESG) risks. is a member of the In- ternational Finance Cor- OJK has also launched two roadmaps on sustainable finance.61 These outline poration’s Sustainable Banking and Finance priorities including: (i) a green taxonomy; (ii) sustainability disclosure require- Network; (ii) Bank Indo- nesia is a member of the ments; (iii) a climate financial risk management framework and risk-based Network for Greening the Financial System; (iii) In- supervision; (iv) innovative green financing instruments; and (v) a National donesia is a member of Taskforce on Sustainable Finance. Over time, detailed guidance to financial the Coalition of Finance Ministers for Climate institutions will help them assess, manage, and price climate risks. This could Action; (iv) the Indonesia Sustainable Finance be complemented by capacity-building to conduct detailed climate-risk assess- Initiative was established as a market-led platform; ments, including on data and modelling. and (v) OJK implemented a pilot project on “first movers on sustainable Climate-risk management challenges aside, the government is working banking”. to catalyze a broader greening of the financial system. An important step 61 Indonesia Sustain- able Finance Roadmap forward was the issuance of the OJK Regulation on the Implementation of Phase I (2015-19) and II (2021–2025). Sustainable Finance in 2017, requiring financial institutions to incorporate E nabling E conomic P olicies & I nstitutions 47 sustainable practices in their business operations. OJK’s Sustainable Finance Roadmaps and the Green Finance Taxonomy are promoting the development 6.4 of financial instruments such as green bonds or Sukuk (Islamic bonds), along with the technology and information infrastructure to ensure the integrity of the green bond market and build capacity for industry’s participation. OJK has bil. mandated financial institutions to publish sustainability action plans to raise awareness of ESG issues among investors and issuers, and the Indonesian has been raised by Stock Exchange joined the Sustainable Stock Exchanges (SSE) initiative in Indonesia through green 2019 to strengthen its commitment to ESG issues. bonds and syndicated loans since their first issuance in 2018 Indonesia’s green financial markets can contribute to the country’s climate ambitions if sufficiently scaled. Approximately US$6.4 billion, or about 0.6 percent of GDP, has been raised by Indonesia through green bonds and syndi- cated loans since their first issuance in 2018. The country ranked 42nd in terms of amount raised (as a share of GDP) over the 2017-21 period and compares favorably to structural peers (Figure 41). Bonds accounted for 92 percent of the amount raised. Issuances by the government and government-backed entities accounted for a significant fraction (almost 70 percent)‒a contrast to structural peers where corporations were the dominant issuers (Figure 42).62 Indonesia has issued Sovereign and Retail Green Sukuk (Islamic finance) amounting to approximately US$3.9 billion between 2018 to 2021 (the largest issuance of any country). Nevertheless, private sector involvement is limited, and total corporate green bond issuance remains low at US$1.7 billion.63 The character- istics of green debt in Indonesia (tenor and currency of denomination) reflect the dominance of government-backed entities in the market. Green issuances were mostly in foreign currency, with 93 percent of the amount raised in US 62 Corporations issued dollars,64 and have some of the longest maturities among peer countries (over 80 percent or more of green bonds in Brazil, 11 years on average) (Figure 43). Mexico, Philippines, Thailand, and Ukraine, and about 70 percent Energy dominates the use of green bond proceeds (Figure 44). About 98 in China and India. Indonesia has one of percent of all green issuances from Indonesia stated that proceeds would be the lowest numbers of allocated (either totally or partly) to projects in the energy sector. Only two corporate issuers among peer countries. non-financial corporations issued bonds for other purposes, namely projects 63 Asian Development related to green buildings and sustainable land use. While energy uses also Bank Asia Bonds online database (link). dominate other green finance markets, funding use in peer countries is more 64 About one-half of diverse (for example, at least 30 percent of the proceeds of green issuances the green issuances from Brazil and Russia, in Thailand flowed to the transport sector). about two-thirds of the issuances from China, and almost all issuances Indonesia’s green finance system has both demand (that is, borrower) and from Thailand and Nigeria were in local supply-side (that is, investor) challenges. On the demand side there is a need currency. to: (i) increase market awareness and local knowledge of green and sustainable 65 Some 66 percent of 125 global companies projects and the applicable financing instruments; (ii) reduce the high cost of surveyed by the Carbon Disclosure Project (CDP) issuing green bonds–issuances of less than US$100 million have costs above cited reputational and those of a comparable-sized loan from conventional sources (Climate Bonds market-related risks as the greatest challenges Initiative 2019); and (iii) increase the availability of longer-term credits. Chal- within the palm oil supply chain. By contrast, lenges on the supply side include a lack of assets and projects to invest in, 16 percent of companies nominated regulatory and reputational risks (Orbitas 2021).,65 Greater transparency will be required risks. See Carbon within the financial sector and within sectors targeted for green investment to Disclosure Project (CDP) 2020. increase the size of the pipeline. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 48 F I G U RE 4 1 F IG U RE 42 Green Debt Market Size Types of Green Debt Green debt markets (amount raised as a Issuances by Corporates vs. Government share of GDP, 2017-2021) Backed Entities (Share of total raised) F I G U RE 4 3 F IG U RE 44 Maturity of Green Debt Use of Green Debt Proceeds Green debt maturity at issuance Sector allocation of green debt issuances (share of amount raised, 2017-2021) (use of proceeds, 2017-2021) Source: WBG staff analysis using Climate Bonds Initiative data. The CCDR’s survey of Indonesian financial institutions affirms the need for “ Three-quarters of respondents considered laws standards, information transparency, and capacity-building. Three-quarters of respondents considered laws and regulations requiring financial institutions and regulations to review ESG risks to be the most important drivers of sustainable investing. requiring financial institutions to For about one-half of the respondents, integration of ESG principles is driven by: review ESG risks (i) the perception that they are good for profits; (ii) mandates from the board or to be the most important drivers top management; and (iii) the potential for reputational gains from sustainable of sustainable investing. Nevertheless, only 35 percent of the respondents believed that ESG investing.” investments would drive effective change in recipient firms. Moving from ESG motivators to climate investment opportunities more broadly, asset managers and banks reported the range of opportunities to be limited (although insurance companies were more optimistic). Lack of information and insufficient expertise were considered the most binding constraints for sustainable investing. This highlights the need for clear, consistent, and globally accepted definitions, reporting and disclosure standards, and analytics, to reduce uncertainty and the risk of greenwashing. E nabling E conomic P olicies & I nstitutions 49 3.5 CLEARING THE WAY FOR THE PRIVATE SECTOR TO STEP UP F urther progress on investment climate and regulatory reforms in In- donesia could enable greater private sector participation in climate action. Sustained macroeconomic stability has been an essential ingredient in promoting private sector competitiveness. Indonesia’s key reform opportunities now lie at the micro level, including competition, infrastructure, human capital, and financing (Chang et al. 2019). Addressing financing gaps, as discussed above, is necessary to promote private green investments. Boosting human capital, including green skills, as discussed be- low, will also be important. Even more critical, however, will be competitiveness measures to encourage private firms’ market entry and expansion. These will support Indonesian firms’ ability to expand green investments while boosting private sector productivity more generally. Competitiveness measures can also help address Indonesia’s declining share of manufacturing in output, exports, and inward foreign direct investment (FDI). Some competition constraints were alleviated recently through the removal of sector-based and other restrictions on private domestic and foreign investment. Addressing remaining issues, including trade restrictions as discussed below, will help improve private in- vestment in climate mitigation and adaptation. Private sector investment could be encouraged by allowing more private participation in, for example, infrastructure projects currently dominated by State-Owned Enterprises (SoEs). The government has relied heavily on SoEs for infrastructure investment‒often accompanied by state equity injections, subsidies, guarantees, and preferential access to finance. This allows SoEs to accept risk allocations and rates of return that private investors cannot‒giving SoEs a competitive advantage when bidding on publicly tendered projects. Pri- vate investment in infrastructure has concurrently declined, while SoE leverage has increased (World Bank 2022a), part of which is also due to the pandemic. Private green investments could be supported by further strengthening the framework for Public Private Partnerships (PPP). The government has devel- oped PPP institutions, instruments, and processes overseen by the Ministry of I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 50 National Development Planning (Bappenas) and MoF (International Finance Corporation 2018). Various government support instruments (for example, viability gap funding, availability payments, and guarantees) are available to support PPP. Some PPP project structures and documentation do not meet in- ternational standards, however, thereby limiting their appeal to private investors. Among other areas, these constraints hold back progress on the deployment of renewable energy. Improvements to the PPP framework could help support SoEs in partnering with independent power producers (IPPs), unlocking private investments and access to the latest renewable energy technology. Measures to strengthen the legal framework for cooperation projects could also facilitate private investment. At present, different regulations govern different aspects of the project preparation and procurement life cycle, there- by causing uncertainties. For example, IPPs are required to obtain a business viability letter, a form of government guarantee, even though IPPs fall under Presidential Regulation No. 38/2015 on PPPs. To take another example, the 2017 Construction Law requires a project company to select and appoint its engineering, procurement, and construction (EPC) contractor using an indepen- dent tender process. This effectively means that project sponsors cannot bid on tenders in consortium with an EPC contractor, in contrast to international prac- tices as well as the principles set out in the regulation on cooperation projects. In some cases, complexity has been compounded by legal and regulatory regime changes. Given that cooperation projects tend to be based on long-term (often 20 to 40-year) contracts, stability will help ensure private investor confidence.66 Environmental and social (E&S) standards within the infrastructure sector are improving. E&S standards are essential to attract foreign and private sector financing‒helping to mitigate risks for investors in large-scale infrastructure and other investments. Awareness and implementation of E&S standards for sustainable infrastructure would further benefit from guidance regarding the methodologies and rules governing the environmental impact assessments that are required under the legal framework on cooperation projects (World Bank 2018). Recent progress includes OJK’s draft policy on sustainable financing and the deployment of an E&S that is broadly compliant with international standards by the government-backed financier PT. SMI. Improving the investment climate in addition to addressing the sector-spe- cific constraints discussed earlier (that is, energy, land, transport) could help unlock green investment potential. Preliminary due diligence suggests private sector interest and opportunities for mitigation investment in: (i) energy, includ- ing renewables (wind, solar, geothermal, distributed solar rooftop generation) and biofuel (sustainable palm-based biodiesel); (ii) transportation, including EVs and their supporting infrastructure; (iii) urban development, including green buildings, green retrofitting, waste-to-energy projects, and waste management; and (iv) manufacturing, including cement sector emissions reduction and battery 66 The energy sector, cell production. Carbon pricing will improve the attractiveness of mitigation in- for example, was subject to multiple changes af- vestments and efficiency measures, which will be further facilitated by expanded fecting Power Purchase Agreements (PPAs) green financing instruments. While the bulk of adaptation investments tend to and IPPs in 2016 and 2017, with multiple new come from the public sector, there are also opportunities for private investment regulations within a year in water storage, climate-smart irrigation, and others. of issuance. See World Bank 2018. E nabling E conomic P olicies & I nstitutions 51 3.5 TRADING IN GREEN T rade policies can also contribute to Indonesia’s decarbonization objectives. Despite low average tariffs on imports of green goods and technologies, non-tariff measures (NTMs) continue to pose costs to green goods in Indonesia. At an average of 1.1 percent, Indonesia’s tariffs on green goods are lower than aggregate average tariffs on all imports (Figure 45). CCDR estimates, however, find that NTMs on green goods have been growing in number (Figure 46) and impose costs equivalent to an average 20 percent tariff, higher than those on “non-green” goods (Figure 47). Among NTMs, import approvals, compliance with Indonesian national standards (Standar Nasional Indonesia: SNI), and pre-shipment inspections (PSIs), have impacts on products critical to climate-change adaptation (Figure 48). Their impact in Indonesia exceeds that seen in regional peers. While LCRs may provide incentives for local manufacturing, they impact short-term uptake of renewable energy technologies. LCR regulations set the level of domestic components for solar modules at a minimum of 40 per- cent. Domestically produced solar panels are still more expensive and their efficiency is lower than those available in foreign markets (Institute for Essential Services Reform 2021). These incremental costs also negatively weigh on the competitiveness of renewable energy generation vis-à-vis fossil fuels. LCRs may also act as barriers to international public procurement‒thereby reducing the attractiveness of major renewable energy sector public procurement projects. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 52 F I G U RE 45 F IG U RE 46 Tariffs on Green Goods are Low But NTMs can be Burdensome Indonesia’s average tariffs on green goods imports (%) Indonesia’s NTMs on green goods (number) AV E R AG E = 1 . 1 % F I G U RE 4 7 F IG U RE 48 Contributing to Higher Import Costs And Loss of Competitiveness Tariff equivalents of selected NTMs (%) Tariff equivalent of Most Problematic NTMs on Green Goods relative to EAP (average difference) (%) Source: WBG staff calculations based on the World Bank Jakarta NTM database and Green Transition Navigator list of green goods. Note: SPS: Sanitary or phytosanitary; TBT: Technical barriers to trade; EAP: East Asia and the Pacific; SNI: Standar Nasional Indonesia; PSI: pre-shipment inspections E nabling E conomic P olicies & I nstitutions 53 Indonesia could consider making further use of environmental provisions in trade agreements. At the global level, close to 90 percent of trade agree- ments currently in force include some form of commitments concerning the environment. Of Indonesia’s 11 trade agreements in force, four (the ASE- AN-Republic of Korea, ASEAN-Japan, Indonesia-Chile, and Indonesia-Japan agreements) include environmental provisions. Of these, the Indonesia-Chile and ASEAN-Japan agreements include environmental provisions that could be legally enforced. The inclusion of such provisions in trade agreements has been shown to mitigate potential adverse environmental effects. Indonesia ratified a trade agreement with countries of the European Free Trade Association (a small market) in May 2021 which strengthens certification and MRV systems for the trade of sustainable palm oil. Indonesia could also consider helping to shape the Environmental Goods Agreement (EGA) at the World Trade Organization in ways that support its economy. Indonesia is not currently engaged in negotiations to eliminate tariffs on green goods under the EGA. CCDR analysis finds that the implementation of the EGA without Indonesia’s participation would slightly reduce exports (0.3 percent) and imports (0.8 percent) due to trade diversion, while participating would boost green goods exports by 1.1 percent (US$99 million) and imports by 1.2 percent (US$214 million)‒valuable in direct terms and in unquantified benefits from technology transfer over time. Indonesia could also consider join- ing and influencing recently launched multilateral initiatives aimed at tackling climate trade issues: (i) the Trade and Environmental Sustainability Structured Discussions; (ii) the Informal Dialogue on Plastics Pollution and Sustainable Plastics Trade; and (iii) the Fossil Fuel Subsidy Reform. 3.5 ARE BUSINESSES & WORKERS READY TO GO GREEN? Fiscal, financial, investment, and trade reforms could incentivize firms and workers to participate in the green economy–but are they ready? Indonesia’s competitiveness has improved over time although there is scope for further 67 The CCDR survey of 750 firms gath- progress including through higher FDI and greater firm-level connections with ered evidence on firm-level emissions, the global market. This can help accelerate investment in new technologies environmental management practices, and drivers of, and constraints to, green including those required for the climate transition. The transition will be dis- practices. The sampled firms cover large and medium manufacturing firms based ruptive for some firms‒particularly those in carbon-intensive sectors‒requiring in Java (which accounts for more than 75 percent of all manufacturing firms a transformation in what and how they produce. Fiscal, financial, investment, in Indonesia). The survey was carried out for firms in six industries that have and trade enablers may help them in this transformation, but they are not a high share of electricity and fuel in sufficient. Knowledge, access to technology, access to finance, and skills at both output and the energy mix. These are the firms that will be most disrupted the firm level are needed to grasp new opportunities and adjust to a new nor- by the low-carbon transition and where environmental management practices mal of carbon prices and lower demand for carbon-intensive production. The will, therefore, be most relevant. The survey follows a similar structure to the CCDR assesses firm level readiness using a survey of manufacturing firms,67 green module in the most recent World and assesses labor market readiness using job-vacancy and employment data Bank Enterprise Surveys in the Europe and Central Asia Region. that indicates green skill needs across different occupations. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 54 An encouraging sign on firm readiness in Indonesia is the prevalence of green practices in manufacturing industries68 that have high carbon emis- sions (Figure 49). Indonesian firms perform relatively well compared to firms surveyed in Eastern Europe and Central Asia (where the World Bank has re- cently deployed an equivalent survey instrument, see footnote 67) (Figure 50). Approximately 40 percent of Indonesian firms reported having a green 68 Included firms are those that manufacture strategy, 58 percent of firms reported having dedicated energy teams or per- chemicals and chemical products, other non-me- sonnel, and, while about 37 percent of surveyed firms indicated that they tallic mineral products, rubber and plastic prod- monitor emissions from energy use, only 15 percent set energy and emissions ucts, paper and paper targets. Foreign-owned, and large firms tend to have higher green practice products, textiles, and other manufactures. scores (Figure 51). F I G U RE 4 9 F IG U RE 50 Good Signs on the Prevalence of Some Green Indonesian Firms Perform Well Relative Practices in Indonesia to Firms in Selected ECA Countries Tariff equivalents of selected NTMs (%) Green Practice (z score) Presence Presence Presence Presence of Green of Energy of Emission of Emission Strategy Team/Per- Monitoring Target sonnel Bulgaria 36% 19% 7% 13% Czech Republic 39% 38% 17% 7% Hungary 43% 30% 13% 10% Indonesia 39% 58% 37% 15% Kazakhstan 22% 17% 11% 7% Poland 25% 21% 8% 7% Romania 24% 21% 12% 9% Russian Federation 23% 13% 6% 4% ECA: Eastern Europe and Central Asia F I G U RE 5 1 F IG U RE 52 Foreign and Large Firms have Higher Electricity and Energy Use are Weakly Green Practice Scores in Indonesia Associated with Green Practices Relation between firm characteristics Electricity and energy use vs. green practice and z-score green practice Sources: CCDR firm survey and ECA Enterprise Survey, WBG staff estimates. E nabling E conomic P olicies & I nstitutions 55 Some industries that make up important shares of energy and electricity use in manufacturing have potential to improve green practices. Chemicals and chemical products firms, which account for a large share of manufac- turing electricity and energy use, score well on green practices (Figure 52). Non-metallic mineral products and textiles perform less well. Unsurprisingly, government regulations drive adoption of many green practices. Approximately 60 percent of surveyed firms are required to comply with Environmental Impact Assessment (Analisis Mengenai Dampak Lingkungan: AMDAL) environmental regulations. Controlling for industry and location, firms covered by AMDAL reg- ulatory requirements have higher environmental practice scores. About one-half of the respondents reported investing in energy efficiency measures–those that did not invest did not consider it a priority or were constrained by lack of information or financing. Approximately one-half of those that did invest reported increased use of energy-efficient manufacturing equipment and lighting and one-quarter reported investment in energy-efficient equipment. At the same time, however, about 58 percent of firms reported that energy efficiency is not their priority (Figure 53). Other important reasons for not adopting energy-efficiency practices include lack of information on ener- gy-efficient technologies and lack of access to finance. The access to finance challenge is consistent with the above discussion on finance as an enabler of the green transition–it is not just the availability of finance, but also its cost and its tenor. The estimated payback period for energy investments is three years for medium firms and five years for large firms, but most credit options available in the market have shorter maturity (Figure 54). “ Some industries that make up important shares of energy and electricity use in manufacturing have potential to improve green practices” F I G U RE 5 3 F IG U RE 54 Reasons for Firms (Lack of) Adoption Payback Periods for of Energy Efficiency Measures Energy Efficiency Reasons for not adopting energy efficiency measures Measures (share of respondents) Payback period 50% (in years) of respondents reported investments in energy efficiency measures Sources: CCDR firm survey and ECA Enterprise Survey, WBG staff estimates. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 56 Industrial estates and Special Economic Zones (SEZ) remain carbon inten- sive, however, Eco-Industrial Parks (EIPs) may improve the climate footprint of manufacturing firms. SEZs are geared to export firms, whereas industrial estates include domestic firms. Both are equipped with supporting facilities and infrastructure to encourage benefits from agglomeration. The number of industrial parks in Indonesia increased from 45 to 122 between 1999 and 2021. Industrial estates and SEZs are, however, carbon-intensive‒accounting for approximately 20 percent of Indonesia’s GHG emissions. Indonesia is devel- oping EIPs (GEIPP 2022) to improve the climate footprint of firms. Such zones focus on shared infrastructure and knowledge for low-carbon and resource-ef- ficient production.69 These approaches could be further supported through development of an EIP strategy with environmental performance indicators and targets, and a shift away from SoE utilities and operators with insufficient capital for investments in low-carbon energy supplies. 69 For example: solar photovoltaic plant, waste The supply and demand for green skills70 is small but likely to grow. Indone- heat recovery at the on-site power plant, solid sia’s economy has a small share‒six percent‒of firms producing green outputs. waste management in- cluding segregation and Five percent of online job advertisements surveyed for the CCDR required at recycling, smart water metering and distribu- least one green skill.71 Of those, the skills most in-demand are those related tion, and GHG emission to clean energy (9 percent), natural resource conservation (8 percent), GHG accounting systems. reductions and pollution reduction (6 percent), and recycling and reuse of waste 70 The CCDR considers green jobs and skills to materials (4 percent). Not all green-related jobs in Indonesia have high skill be those that reduce a firm’s impact or contrib- requirements, (Figure 55), yet trends in high-income countries suggest that the ute to environmentally friendly outputs. demand for advanced green skills will grow‒requiring a commensurate shift in 71 World Bank analy- training and education.72 Overall, Indonesia can expect to see both changes sis of 140,000 Indone- sian job advertisements in the number of new green jobs and changes to the nature of existing jobs. retrieved in 2020 from more than 200 online sources. As demand grows, benefits will accrue to those who can access green jobs. 72 In the U.S. 60 Jobs with high green task intensity pay 18 percent more than jobs without any percent of total green employment belonged green tasks. The difference gradually shrinks for jobs that are relatively less to highly skilled occupa- green, but even jobs with low levels of greenness in Indonesia still pay about tions in 2006-14. 73 World Bank staff three percent more than jobs with no green tasks.73 Access to green jobs is analysis using a wage not yet equal as women are less likely to hold a green job (Figure 60), poten- regression controlling for gender, education tially because green jobs tend to demand science, technology, engineering, level, broad occupational groups) (Indonesian and mathematics qualifications that women are less likely to pursue. This Standard Classification of Position (Klasifikasi compounds existing inequalities in Indonesia’s labor force which has a 28-per- Baku Jabatan Indone- centage point difference between labor force participation rates for men and sia)), and province of residence. women (a gap close to the global average of 25 percentage points) (ILO 2022). E nabling E conomic P olicies & I nstitutions 57 F I G U RE 55 Green Tasks by Occupation Category Intensity of green tasks (contributing to defined green outputs) by occupation category Note: GTI = Green Task Index. F IG U RE 56 Women are Under-represented in Green Jobs Share of women in non-agricultural green and non-green jobs Source: WBG staff analysis using Labor Force Survey (Sakernas) 2017 data. Note: High, medium, low, and “no” categories are defined as the 1st, 2nd, 3rd, and 4th quartiles respectively for the proportion of green tasks (that is, activities producing defined green outputs such as ensuring compliance with environmental regulations, fire prevention), and green skills. GTI = Green Task Index. “ Access to green jobs is not yet equal as women are less likely to hold a green job” I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 58 4 ECONOMIC PAG E 59—74 IMPACTS OF CLIMATE ACTIONS S U R A K A R TA CI T Y • SO LO E conomic I mpacts of C limate A ctions 59 4.1 THE IMPACTS & SIDE-EFFECTS OF CLIMATE ACTIONS T he CCDR explores the possible economic and social impacts of climate actions. It looks at how energy, land, and fiscal policies dis- cussed in Chapter 2 and 3 could impact emissions and the economy. The impacts of policy reforms are difficult to predict because they partially depend on factors like technological change and global cir- cumstances. The modeling results below do not, therefore, prioritize a particular outcome above all other possibilities. The intention is to help think through possible interactions between policies and economic outcomes. It focuses on the implications of mitigation given its challenge relative to adaptation. The estimated costs of climate change are discussed in Box 3 at the end of Chap- ter 4. Potential adaptation costs for the budget are analyzed in the discussion on contingent liabilities. To analyze broader costs to the economy will require development of damage functions that can be brought into the CGE modeling below; this could be done separately as a follow-up to the CCDR. The economic and social impacts of climate actions are modelled in an in- tegrated three-stage modelling exercise (Figure 57). In stage one, separate land and energy models are used to assess the impacts of sector-specific poli- cies. In stage two, the land and energy modelling results are brought into a CGE model and complemented with fiscal policies (elimination of fossil fuel subsidies, carbon taxes) to estimate economy-wide impacts. In stage three, the outputs of the integrated CGE model are further assessed using microeconomic and trade simulation models to assess household and trade impacts of climate actions. The modelling scenarios are based on incremental climate actions; they start with actions that enable Indonesia to internalize benefits through to more ambitious ones that could benefit other countries. Clarifying how much Indonesia can internalize the benefits of its climate actions is important to understanding what the country should do on its own and what it might do if international support is forthcoming. The macro-CGE modelling exercise, therefore, looks at three levels of climate actions for Indonesia: (i) actions to remedy domestic policy distortions that create deadweight loss (for example, untargeted fossil fuel subsidies) and, thereby, work against the national eco- nomic interest; (ii) actions that reduce emissions to address local (within Indo- nesia) externalities (for example, reduced pollution from fires associated with deforestation), which go against Indonesia’s national welfare; and (iii) actions 74 For example, mitigat- ing the negative impacts that reduce emissions to remedy global externalities and would, therefore, of air pollution would improve health outcomes require external financial and technological support.74 locally, so it is in Indo- nesia’s best interest to act on this, regardless In summary, the proposed climate actions could help reduce emissions while of external support. Conversely, increasing also generating growth and poverty reduction gains. The economic impact, (the scope and the speed of) emission cuts yield however, depends on whether savings are channeled to transfers (resulting benefits not only for Indo- nesia but also for the rest in slower growth but lower poverty than business as usual, BAU) or to invest- of the world, so external ments (higher growth but weaker welfare outcomes); the latter is illustrative, support in this area may be warranted. as Indonesia is required by law to provide subsidies to protect the poor from I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 60 F I G U RE 5 7 Overview of Modelled Scenarios 1 Energy Policies Land Policies Green RUPTL in 2020-30 (BAU) Current land policies and restoration extent (BAU) Intermediate decarbonization scenario (IDS) (Green RUPTL in Peatland restoration (3 million ha) 2020-30 and economic least-cost expansion in 2030-40) Extended forest and peatland moratoriums Accelerated decarbonization scenario (ADS) Land-based emissions tax with redistribution (a cap on emissions is used to drive an 80% ($US5/tCO2eq) power sector emissions reduction) Combination of above land interventions 2 Economy-wide Scenarios C U RRE N T P O L ICY S E T T IN G S Eliminate fuel and electricity subsidies NDC by 2030 scenario NDC+ No additional energy policies Carbon tax → $US40/tCO2eq by 2040 Carbon tax → $US200/tCO2eq by 2040 No additional land policies Energy Policies → decarbonization Energy Policies → decarbonization Land policies → Selection of above Land policies → all of above combined (NDC consistent) Foreign Investment 3 Further Implications DI S T RI BU T I ONAL I MPAC T S T R ADE IM PAC T S Note: RUPTL: Rencana Usaha Penyediaan Tenaga Listrik (Business Plan for Electricity Provision). rising energy prices. Actions that only remedy inefficient energy subsidies do not significantly reduce GHG emissions. Combining subsidy reforms with land and energy reforms, together with a carbon tax, phased in gradually (US$40 per tonne of CO2eq by 2040), could help achieve the NDC targets and add an average of 0.7 percentage points to GDP over the long term. A more ambitious carbon tax (US$200 per ton of CO2eq by 2040, also phased in gradually) would over the long term see a reduction in growth below the baseline unless there is external financing‒which could add 0.8 percentage points to GDP on average over the long term. These carbon tax scenarios are illustrative–they are not recommendations. Incremental investment costs could range from 0.4 percent to 1.6 percent of GDP per year. Poverty is expected to decline in the modelled scenarios. The modeling analysis is based on specific assumptions‒which suggests caution in interpreting the results. The analysis in the power sector focuses on generation connected to the electricity grid managed by PLN. In 2020, E conomic I mpacts of C limate A ctions 61 this represented 64 GW of a total installed capacity of 70 GW. As a result, the modelling does not cover, for example, coal-generation in captive power plants or in off-grid systems. Secondly, the CGE model assumes that markets work efficiently75 and that the economy always operates at full capacity. In reality, there are many frictions that prevent markets from clearing. Thirdly, the model assumes that agents know of all technological options and that there is an instant adjustment, however, it takes time to adopt new technologies, so outcomes may take longer than predicted. Fourthly, the model assumes fixed money supply, so additional investment in low-carbon equipment will either crowd out other investment or require higher savings and reduced consump- tion. Fifthly, the carbon tax assumptions are only used to illustrate the range of possible economic outcomes, they are not recommendations for the carbon tax rate in Indonesia. Finally, there are political economy factors that may impede progress on reforms. These are not possible to model. 4.2 MITIGATION PATHWAYS FOR FOREST- & LAND-BASED EMISSIONS R eductions in forest- and land-based emissions are key to achiev- ing Indonesia’s NDC. Policy levers that are or could be pursued by government include: (i) strengthened limits on forest conversion; (ii) restoration of peatlands and forests; and (iii) a carbon tax applied to land-based emissions. The first two levers are extensions of existing 1.3 MIL policies and are aligned with the government’s approach, notably the FOLU Net Sink 2030 plan (MoEF 2022a). The restoration scenario assumes restoration of 3 million hectares of degraded peatlands‒slightly higher than the government’s hectares of peatland target of 2.7 million hectares (by 2030). Restoration of 1.3 million hectares restoration has already of peatlands has already been undertaken. Second, a strengthened peat and been undertaken mangrove forest moratorium scenario assumes increased protections on 1.4 million hectares of at-risk peatlands and 0.5 million hectares of at-risk man- groves inside the existing moratorium area and geographic extension of the moratorium to 1.0 million hectares of at-risk peatlands outside the moratorium area. In the third scenario, a land-based emissions tax is modelled, although 75 Although the CGE does assume it is important to note that Indonesia has not implemented such a tax and the labor market frictions. CCDR does not take a position on such an instrument. This hypothetical scenar- 76 Such an instrument would be io would entail a US$5 per tonne charge on high-emissions agricultural activity relatively novel. One approach would be to apply a downstream tax on select (including forest conversion) to provide a disincentive on the development of commodities produced on designated high-carbon landscapes via adjustments the most carbon-rich forest or plantation concessions.76 While not based on an to the existing fiscal instruments used in the agricultural sector (such as the existing policy, it is included to explore potential complementarities between palm oil levy). While some implemen- fiscal- and moratorium-based options. tation challenges remain, Indonesia’s agricultural traceability systems can increasingly distinguish commodity units by production location or method. Land-based measures drive substantial emissions reductions and have rela- More broadly, fiscal policies on land use could include payments for ecosystems tively small impacts on GDP. By 2030, emissions reductions of 521, 453, and services (an incentive rather than a disin- 69 MtCO2eq per year are expected to be realized from restoration, strengthened centive) and results-based payments at the landholder level. moratoriums, and the land-based emissions tax respectively. The combined I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 62 scenario (all three policies) is estimated to reduce emissions by 987 MtCO2eq by 203077 which is sufficient to meet the government’s FOLU Net Sink 2030 objective and exceed its NDC commitments regarding land-based emissions. In aggregate, this package of complementary forestry and land use policies is positive in terms of GDP. Between 2018-30, GDP is projected to increase under the restoration scenario because of the investment required.78 GDP is reduced under the strengthened moratoriums and under the hypothetical land emissions tax. This results in a net gain of US$16.19 billion over the 12-year period. The distributional impact of the package of activities is projected to favor low-income households (the bottom quintile)‒with an income rise of 4.6 percent (relative to BAU), due to assumed redistribution of the land emissions tax proceeds and positive economic impacts of restoration activities. Strength- ened moratoriums alone are projected to have limited impacts on household incomes of this group (0 to -0.8 percent). 77 Model outcomes Forestry and Land Use-based measures have considerable additional benefits are not purely cumulative due to general equilib- in terms of reduced health impacts and losses due to fires. Fires started during rium effects within the model. Changes to factor clearing processes risk causing damage to crops and timber, while harmful par- prices and quantities ticulate matter emissions from fires reduce labor productivity and cause illness from one policy influence the effects of other and fatalities. Avoided losses from these impacts is estimated at US$65.04 policies. billion between 2018-30 for the combined policy scenario, including US$34.90 78 All cumulative values are calculated at billion in avoided health impacts and US$5.47 billion in avoided fire damages to a five percent discount rate. Estimates are crops and timber. The strengthened moratoriums alone reduce health impacts based on World Bank staff analysis using an by US$22.38 billion, along with a further US$3.02 billion in avoided physical integrated economic and fire damages over 12 years. These contribute to significant net benefits from biophysical CGE model (see Figure 58 notes). land interventions independent of carbon emissions reductions (Figure 58). E conomic I mpacts of C limate A ctions 63 F I G U RE 5 8 Policies to Reduce Land-based Emissions have Significant Economic Co-benefits Source: World Bank staff analysis Notes: Economic values are cumulative (2018-30), discounted at 5 percent. Costs of health impacts (premature using an integrated economic and mortality, lost working days) arise from estimated particulate matter emissions. Forest losses are the present value biophysical CGE model. (post 2030) of losses in timber. GHG emissions include peat oxidation, peat fires, and emissions from mineral soils. Impacts on biodiversity and watershed protection are not modelled. A US$5.00/tonne carbon price is a conservative assumption; international carbon markets may offer higher prices in future. 4.3 MITIGATION PATHWAYS FOR THE ENERGY SECTOR T ransition pathways for Indonesia’s coal-dominated electricity grid will be crucial for decarbonization. To inform the discussion on clean energy transition pathways, an exploratory decarbonization analy- sis was performed for the CCDR. As mentioned above, the analysis focused on PLN’s system which covers 64GW out of an installed generation capacity of 70 GW in 2020. The analysis reviewed the costs of different decarbonization scenarios in economic terms.77 Three scenarios are considered (Figure 59 and 60). First, a BAU scenario that: (i) follows the capacity expansion plan in the Green RUPTL in the 2020-30 period; and (ii) 79 The analysis does maintains the level of peak coal reached in 2030 in the 2030-40 period while not consider financial costs to PLN and MoF allowing renewable energy and gas to meet the increase in demand. Second, from early retirement of coal plants. an intermediate decarbonization scenario (IDS) that: (i) follows the capacity 80 The model- expansion plan in the Green RUPTL in the 2020-30 period; and (ii) adopts an ing did not include carbon capture and economic least-cost expansion plan in the 2030-40 period. Third, an advanced other emission-removal decarbonization scenario (ADS) that adopts an expansion plan to achieve a technologies that would be expected to have a nearly 80 percent emission reduction compared to the BAU scenario by 2040. role in achieving net zero emissions in the The ADS is consistent with Indonesia’s ambitions to achieve net zero emissions power sector. In its place, a generic backstop before 2060, with coal generation and capacity falling well before 2030 and technology was modelled renewable generation capacity increasing strongly in the following decade by considering a value of US$300.00/tonCO2eq. (Figure 61 and Figure 62).80 I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 64 F I G U RE 5 9 F IG U RE 60 Accelerated Decarbonization is Consistent with This Would Require 50 percent Higher Net Zero Emissions Before 2060 Investment Compared to BAU 2 0 2 2 E MIS SIO N S = 1 9 0Mt C O 2 eq Note: BAU: Business as usual; IDS: Intermediate decarbon- ization scenario; ADS: advanced decarbonization scenario F I G U RE 6 1 F IG U RE 62 Renewable Generation Capacity Fossil Fuels Remain in the Generation Mix Increases Strongly after 2030 but at Greatly Reduced Levels through 2040 Historical and Forecast Electricity Generation Historical and Forecast Electricity Generation (TwH) Capacity (GW) 1990 -2040 (ADS Scenario) 1990 -2040 (ADS Scenario) Source: WBG staff analysis based on power sector modeling. Historical electricity generation and capacity data based on EIA Statistics. TAB L E 2 Present Value (PV) of Total System Costs under Different Scenarios (2022-40) ITEM BUSINESS AS USUAL (BAU) INTERMEDIATE DECARBONIZATION (IDS) ADVANCED DECARBONIZATION (ADS) Capital costs (generation) (US$ bil.) 80 91 121 Fuel costs (US$ bil.) 120 107 106 Variable Operating and Maintenance 16 10 9 (O&M) costs (US$ bil.) Fixed O&M costs (US$ bil.) 36 32 39 Capital costs (network) (US$ bil.) 24 27 36 Total system costs (US$ bil.) 276 267 311 Levelized cost of electricity 5.7 5.6 6.3 (average 2022-40) (US$/MWh) Cumulative GHG emissions 4,559 3,037 2,351 (millions of tonnes) Local environment damage costs (US$ bil.) 41 29 20 Global environment (GHG) damage costs 124 90 71 (US$ bil.) Source: WBG staff analysis based on Notes: Present values calculated at 6 percent discount rate. Values in columns are totals, not incremental above BAU. power sector modeling. Global and local environmental costs calculated using World Bank standard values for GHG emissions (lower bound) and local pollutants (SOx, NOx and PM2.5). E conomic I mpacts of C limate A ctions 65 The modelling analysis suggests that it will be economically advantageous for Indonesia to exit from 4 GW out of 13.8 GW of pipeline coal plants that have not started construction or are at early stages of development. Given the excess capacity in the system, these plants will not be needed to meet electricity demand. Their PPAs will be financially onerous on PLN and deter the development of renewable energy. In addition, it will also be important for Indonesia to pursue its plans for early retirement of coal plants to benefit from low-cost renewable energy generation. Accelerating the decarbonization of the power sector is likely to require significant investment for Indonesia. The investment requirements of the power sector are expected to be at least 50 percent higher under ADS (US$157 billion in discounted terms) than BAU (US$104 billion in discounted terms) (Figure 60). At the same time, the levelized cost of electricity in ADS will be 11 percent higher than under BAU (Table 2). The domestic and international private sector can play a leading role in investments. An estimated two-thirds of capital investments, about US$200- 220 billion (undiscounted terms) between 2022 and 2040, can be mobilized from the private sector, driven substantially by renewable energy projects (214 GW by 2040 under ADS). This estimate is based on the mix of energy types predicted by the model. Additional opportunities exist for the private sector to participate in the clean energy transition in the medium term, including: (i) green bonds issued by sector utilities (SoEs); (ii) equitization and recycling of existing sector assets; (iii) selected transmission and distribution investments (for instance, lines connecting private power plants to the grid network); and (iv) the energy-efficiency market. Indonesia can also develop its expertise in the clean energy supply chain (solar panels, wind turbines, batteries) to enhance prospects for exporting such equipment and services. US$ Public sector support can create an enabling environment to leverage pri- 200 vate investments in low-carbon power infrastructure. Continued public invest- ment support, estimated to be about US$100-120 billion (undiscounted terms) between 2022 and 2040, can de-risk power sector projects (for example, by BIL. alleviating grid bottlenecks and building inter-island connections, enhancing system flexibility), support early retirement of coal plants, help manage the between 2022 and poverty and social impacts of the energy transition and provide market-based 2040, can be mobilized guarantees to unlock green finance. A significant share of these public re- from the private sector, driven substantially by sources will have to be on concessional terms to support the early retirement renewable energy projects of coal plants, improve the financial viability of PLN, and ensure affordability of electricity for consumers. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 66 4.4 ECONOMY-WIDE IMPLICATIONS OF MITIGATION PATHWAYS T he combined effects of land, energy, and fiscal policies are analyzed in three scenarios with incremental levels of ambition to assess costs and benefits of decarbonization over time. This is done using a CGE model that provides an economy-wide analysis of long-term emissions and economic growth. The baseline projection is a BAU case in which current climate policies are maintained with no new additional policies; the impacts of the three scenarios are presented as percentage points of GDP differ- ence compared to BAU (at the equivalent point in time). The three scenarios are: 1 Redirection As discussed in Chapter 2 and 3, the retargeting of remaining scenarios is expected to be a net gain for Indonesia. No additional land or energy policies of electricity & are assumed in this scenario. Two sensitivity analyses are conducted on use fuel subsidies of savings from the elimination of subsidies: first, transfers to compensate the bottom 40 percent of the population; and, second, no transfers but investment instead. The latter is only illustrative as Indonesia is required by law to provide subsidies to protect the poor from rising energy prices. 2 Nationally This includes redirection of subsidies, new land and energy policies (as per above sector-based modelling), and a carbon tax that reaches US$40.00/ Determined tCO2eq by 2040. The carbon tax is applied to all sectors and greenhouse gas Contribution emissions except for agriculture. The reduction of emissions under this sce- (NDC) nario should enable Indonesia to internalize benefits by lowering fire and flood hazards that impose economic costs. Revenues from the carbon tax are used for investment‒including in low-carbon equipment. It is assumed that replacing stranded fossil fuel assets accounts for 25 percent of the new investment. 3 Nationally This includes all the actions from the NDC scenario, but also includes a much higher carbon tax rate, reaching US$200/tCO2 by 2040. This could reduce Determined emissions twice as quickly as in the NDC scenario. This is a more ambitious Contribution scenario that would involve higher net costs for Indonesia while also reducing Plus (NDC+) global externalities. To help compensate for the costs and positive externali- ties, a sensitivity analysis is added to this scenario with an increase in foreign investment that is equivalent to 1 percent of GDP in Indonesia throughout the projection period.81 81 The LCCR target is to reach 540 MtCO2eq total emissions by 2050 (LTS-LCCR 2050). The CCDR’s NDC+ scenario is less ambitious. Under the NDC+ scenario trends, Indonesia could reach 540 MtCO2eq by 2060. This is, however, just an illustrative scenario, not a prediction. Much will depend on technological progress, reforms, and investments. E conomic I mpacts of C limate A ctions 67 The modeling results show that the impact of climate actions on GHG emis- sions reduction will be driven in large part by land-related policies. SCENARIO 1 (redirection of energy subsidies) is expected to reduce emissions by 3-4 per- cent, but the effects are limited once redirection is completed (Figure 63). The land use policies and carbon prices are projected to have a more substantial impact, with continued emissions reduction as the carbon prices are increased. By 2030, GHG emissions under SCENARIO 2 (NDC) could be lower by 27 percent compared to BAU; this reduction would help meet Indonesia’s conditional NDC target. Under SCENARIO 3 (NDC+), GHG emissions are 47 percent below BAU by 2030 and 63 percent below BAU by 2040. Beyond land, the power sector, which has the technologies available to reduce emissions to near-zero levels, shows the biggest reductions in all scenarios. There are also substantial emis- sion reductions from manufacturing and transport. The net impact of climate actions on long-term GDP depends, in part, on how increased carbon tax receipts and reduced subsidies are recycled. In all scenarios, if savings from lower subsidies are recycled through transfers, then GDP could be slightly lower than in the BAU during initial years. On the other hand, if they are channeled to investment, there could be a small initial reduction followed by an increase in GDP that is sustained throughout the pro- jection period. In SCENARIO 1 (redirection of energy subsidies), the difference in output compared to BAU is projected to be positive (Figure 64). This reflects the removal of the distortionary effects of the subsidies, and possibly additional indirect air quality effects. SCENARIO 2 (NDC) has a stronger positive impact on GDP (assuming carbon tax receipts are channeled to investment rather than transfers), peaking at 1.5 percentage points of GDP above BAU in the early 2030s. This result is driven by the removal of economic distortions from energy subsidies, higher investments financed out of carbon tax receipts, an increase in agricultural productivity, and enhanced labor productivity through improved air quality. The air quality effect grows in line with the phase-out of coal. In the more ambitious Scenario 3 (NDC+), the availability of external financ- ing could play an important role in determining the long-term economic growth path. SCENARIO 3 is projected to have a positive impact on GDP up to 2035 which is higher than the NDC benefits in the mid-2020s. Beyond 2035, the distortionary effects of the carbon tax, which is much larger than in SCE- NARIO 2 , outweighs these positive effects. A higher carbon tax could reduce the use of fossil fuels more quickly (thereby reducing growth) than the economy can offset through adoption of new technologies (which would otherwise accelerate growth). It could also disincentivize investment due to higher cost from carbon tax on the one hand and domestic financing constraints on the other. These constraints could be alleviated through external financing. An additional 1 percent of GDP financing could lead to a positive impact on GDP (Figure 65). The primary energy sector will be negatively impacted by domestic de- carbonization and global reduction in demand over the long term, despite short-term windfalls due to Russia's invasion of Ukraine. Model results show a reduction in output for fossil fuel producers across all scenarios. Overall out- put would decline as would employment (by potentially up to 115,000 workers by 2040 out of 240,000 currently employed). Global demand and coal prices I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 68 are projected to decline sharply. Although coal production and prices have received a short-term boost from the effects of the war, it has also triggered energy security concerns and commitments to accelerate the transition to renewable energy. The long-term (post 2030) outlook is for significant losses of coal export market opportunities, combined with depressed prices. There will be gains and losses across sectors. Sectors that are likely to be most directly affected by carbon pricing and other emissions reduction measures (e.g., energy, power, transport, waste) are likely to experience the sharpest drops in output (Figure 66). The coal sector accounts for significant export earnings that have financed important developments in the real sector. Other sectors, which make up large shares of GDP (e.g., construction, finan- cial services, hospitality, wholesale and retail trade) and where the impact of transition policies is not as direct, are projected to expand and offset losses in the long term. Any transition will be disruptive in the short term‒even if beneficial over the long term; strong political support for a comprehensive decarbonization strategy will be essential to promote a smooth transition. All three scenarios, however, are within Indonesia’s reach. Although the redirection of fossil fuel subsidies is challenged by current energy prices, it is consistent with the lon- ger-term trend in Indonesia, will generate fiscal savings for development, and incentivize more efficient resource use. The NDC scenario is already consistent with the authorities’ land and energy sector commitments. The estimated investment above BAU that is assumed across the above scenarios range from an average of 0.4 to 1.6 percent of GDP per year. The model assumes a fixed money supply which means that additional investment in low-carbon equipment must be financed either by displacing (‘crowding out’) other investment or through increased savings and reduced consumption. There is, therefore, no possibility for the financial sector to play a positive role in the transition under this assumption. Conversely, potential issues relating to a lack of access to finance are also not covered by the model. In all three scenarios (removal of energy subsidies, NDC, and NDC+), therefore, it is as- sumed that investments will be financed out of domestic sources, whether through crowding out or increased savings. Only in SCENARIO 3, where sensitivity analysis assumes external financing, do additional investments peak at just below 2 percent of GDP in the late 2020s. Table 3 presents a summary of all macroeconomic results. E conomic I mpacts of C limate A ctions 69 F I G U RE 6 3 F IG U RE 64 Achieving Decarbonization Objectives With Potential Positive Growth Payoffs Total GHG Emissions, difference from BAU (MtCO2eq) GDP percentage difference from BAU F I G U RE 6 5 F IG U RE 66 Foreign Investments can Alleviate Trade-offs There Will Be Gains in More Ambitious Scenarios and Losses Across Sectors Investments (difference from BAU, % of GDP) Sector Output % difference from BAU in 2040 Source: WBG staff analysis using the MANAGE CGE model. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 70 4.5 IMPACT OF CLIMATE ACTIONS ON HOUSEHOLDS T he economy-wide impacts of climate mitigation will affect house- holds through employment and wages.82 By redirecting energy sub- sidies, the first scenario has only minuscule impacts on employment growth, while the second and third scenarios (NDC and NDC+) lead to marginal impacts‒not exceeding 0.7 percentage points annually over the 2020 to 2040 period. Most negative impacts are felt in energy-inten- sive sectors (Figure 67) given the increase of costs due to the carbon tax, but overall employment in these sectors is relatively low (below 10 percent of total employment). Wage growth in most sectors is not substantially affected by the scenarios, except for large increases in electricity, gas, and water supply sec- tors, by about 25 percent in the NDC and 215 percent in the NDC+ scenarios relative to the BAU scenario (by 2040). Labor demand for renewables and gas increase, leading to higher wages given labor frictions (that is, a function of the skill transferability of workers). The implementation of land policies together with the introduction of a carbon tax (NDC and NDC+) progressively affect household expenditures‒ driven by recycling of revenues into social assistance. While the effective tax on energy increases energy prices across scenarios, improved agricultural productivity due to land policies in the NDC and NDC+ scenarios more than mitigates the aggregate price impact through lower food and non-food prices (which are much larger components of the overall consumption basket than energy) (Figure 68). Household expenditures increase progressively in absolute terms for the NDC and NDC+ scenarios (Figure 69). The progressive growth of household expenditures is mostly driven by increased social assistance which is generated by revenue from the carbon tax. Except in the SCENARIO 1 , household expenditures in rural areas increase more than in urban areas given the higher agricultural productivity of land due to the land policies and an increase of investment in the agriculture sector due to its lower energy intensity (Figure 71). While revenue recycling can mitigate adverse impacts on poverty, specific 82 Distributional impacts are assessed groups might still require targeting with tailored support. The poverty rate using micro-economic simulations of the results from the CGE macro model. An is hardly affected in the subsidy removal scenario. Poverty is set to decline in occupational choice model re-allocates the NDC and NDC+ scenarios (Figure 72)‒driven by social assistance. Although workers based on the outputs of the CGE model. Income is transformed into poverty is not worsening in any geographic area, specific groups can lose from expenditure based on the marginal propensity to consume. Consumption the reforms and will need targeted asistance. In the short term, however, poverty shares are kept constant assuming that households do not adapt their behavior might be more strongly affected by price volatility undermining households’ in response to changes in prices. popula- purchasing power. A food price shock of 30 percent can increase poverty by tion parameters are adjusted based on UN population growth projections, with seven percentage points while a similar energy price shock increases poverty education levels adjusted based on the aging of the youngest cohorts. by only 1.4 percentage points. E conomic I mpacts of C limate A ctions 71 F I G U RE 6 7 F IG U RE 68 Impacts on Employment Impact on Prices Employment Relative to BAU by 2040 (percentage points) Price Change vs. BaU by 2040 (percentage points) F I G U RE 6 9 F IG U RE 70 Impact on Household Expenditure Impact on Expenditure by Worker Type Percent Change in Expenditure vs BaU by 2040 Percent Change in Expenditure vs. BaU by 2040 F I G U RE 7 1 F IG U RE 72 Drivers of Expenditure Change Impact on Poverty Contributions to Expenditure Growth, by urban/rural Change in Poverty Rates vs. BaU by 2040 (percentage points) Macroeconomic projections are derived from CGE results above. forward to 2020 (to avoid perturbations by COVID-19 impacts). tion Model. Model is based on SUSENAS 2019 data projected Source: World Bank staff estimates based on a Microsimula- I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 72 TAB L E 3 Summary of Macroeconomic Modelling Results 2022 2030 2040 2022 2030 2040 2022 2030 2040 2022 2030 2040 2022 2030 2040 BAU Minus Energy Subsidies NDC NDC+ NDC+ with Foreign Funds Deviation from BAU Deviation from BAU Deviation from BAU Deviation from BAU (Percent)* (Percent)* (Percent)* (Percent)* Average Growth, % Real GDP 5.21 5.02 4.66 -0.08 0.03 0.03 0.13 0.05 -0.06 0.22 -0.12 -0.11 0.16 -0.04 -0.12 Real GDP per 4.13 4.19 4.06 -0.08 0.03 0.03 0.13 0.05 -0.06 0.22 -0.12 -0.11 0.16 -0.04 -0.12 capita Per Capita Income and Consumption Real GDP Per 639 893 1,329 -0.08 0.26 0.62 -0.09 0.39 1.04 -0.01 0.12 -0.58 -0.06 1.01 0.47 Capita (Constant 2020 US$) Real Household 345 511 810 -0.63 -0.20 0.21 -0.41 -0.34 0.04 -0.58 -1.56 -2.58 -0.58 -0.17 -0.74 Consumption Per Capita (Constant 2020 USS) Real Expenditure Shares in Real GDP Private Consump- 54.02 57.18 60.91 -0.30 -0.26 -0.25 -0.17 -0.41 -0.61 -0.31 -0.96 -1.22 -0.28 -0.67 -0.73 tion (% of GDP) Government 8.75 8.75 8.75 0.00 -0.07 -0.13 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Consumption (% of GDP) Private Investment 27.96 25.95 23.06 0.30 0.35 0.43 0.11 0.28 0.42 0.20 0.56 0.59 1.16 1.31 1.15 (% of GDP) Government 1.09 1.02 0.95 0.00 0.00 -0.01 0.00 0.00 -0.01 0.00 0.00 0.01 0.00 -0.01 0.00 Investment (% of GDP) Net exports (% of 4.96 4.96 4.98 0.00 -0.01 -0.03 0.06 0.14 0.21 0.11 0.40 0.61 -0.88 -0.61 -0.41 GDP) Sectoral Shares in GDP Agriculture 6.49 5.97 5.23 0.02 0.00 -0.02 0.02 0.07 0.10 0.03 0.17 0.34 0.02 0.13 0.28 Industry 54.11 54.67 57.52 -0.04 -0.03 0.11 -0.10 -0.27 -0.38 -0.12 -0.76 -2.05 -0.01 -0.65 -1.90 Services 39.40 39.37 37.24 0.02 0.03 -0.09 0.08 0.20 0.28 0.09 0.59 1.71 -0.01 0.52 1.61 External Balance Current Account -5.11 -4.77 -4.46 0.00 0.01 0.03 0.00 0.02 0.05 0.00 0.01 -0.03 1.00 1.04 1.02 Balance (% of GDP) Fiscal Aggregates Fiscal revenue (% 8.77 9.14 9.95 0.75 0.74 0.82 0.59 1.60 2.52 1.14 4.04 5.89 1.21 4.16 6.05 of GDP) Fiscal expenditure 13.27 15.62 19.30 0.01 -0.04 -0.12 0.23 0.65 1.05 0.45 1.49 1.83 0.58 1.80 2.26 (% of GDP) Budget deficit (% -5.59 -7.52 -10.39 0.74 0.78 0.94 0.36 0.94 1.48 0.68 2.53 4.05 0.62 2.35 3.80 of GDP) Public debt (% of 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 GDP) Emissions Emissions (mil- 1,895 2,487 3,538 -3.27 -3.67 -3.47 -12.87 -30.90 -44.63 -25.40 -65.50 -68.86 -25.28 -64.98 -68.28 lions of tons C02) Emissions per unit 1608.0 1410.2 1260.2 -3.20 -3.92 -4.06 -12.79 -31.16 -45.20 -25.40 -65.54 -68.68 -25.24 -65.33 -68.43 of output (tons C02) 4.6 IMPACT OF CLIMATE ACTIONS ON TRADE T he redirection of distortive electricity and fuel subsidies will result in efficiency gains for Indonesia and benefit not only the domes- tic economy but also international trade. Exports and imports are found to expand by 1.2 percent and 1.1 percent by 2040, respectively (Figure 73). Gains materialize over the long run (that is, after 2033), E conomic I mpacts of C limate A ctions 73 following muted initial adjustment losses in earlier years. Export gains are mostly explained by the expansion of sectoral exports such as manufacturing and extractives, while on the imports side the increase in imports of manu- factures and services is outweighed by the decline in imports of mining and energy products. NDCs are found to have a muted but negative impact on Indonesia’s trade flows‒with an estimated decline of 1 percent and 1.4 percent by 2040 in exports and imports, respectively. The contraction of exports is driven by the decline of extractives exports, while other sectors are found to expand (Figure 74). Results show that, over time, the negative impact on trade is outweighed by benefits for the economy as a whole‒with a slight U-shaped recovery of trade flows over the longer term. When worldwide climate action is considered, the impact on Indonesia’s economy and trade is marginal, and exports mainly decline in carbon-intensive sectors while other sectors benefit. Achieving a much more ambitious net zero emissions goal is found to have a more pronounced impact on trade‒with a decline of 15.5 percent in ex- ports and 13.9 percent in imports by 2040, respectively (Figure 73). In this scenario, exports of energy and extractives decline significantly and are also associated with a decline of manufacturing exports. As the adjustment of the economy to the net zero goal continues to 2050, the decline of trade over the years is cumulative and more pronounced. With the right policies, however, Indonesia may mitigate some of this negative impact‒for example, through policies that would enable access to green technologies from the global mar- ket‒including through addressing specific NTMs and multilateral agreements on green goods with other countries (through the World Trade Organization). F I G U RE 7 3 F IG U RE 74 Trade Impacts of NDCs are Slightly Negative Partly Driven by Declining Manufacturing Exports Trade impacts relative to BAU in 2040 (%) Sectoral drivers of trade growth relative to BAU in 2040 (%) Source: WBG staff estimates using the World Bank’s Environmental Impact and Sustainability Applied General Equilibrium (ENVISAGE) CGE model. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 74 B OX 3 Potential Impacts of Climate Change & Adaptation Capabilities I ndonesia is ranked in the top-third of countries in terms of climate risk, with high exposure to flooding and extreme heat. Without effective ad- aptation, population exposed to these hazards will rise. For example, modelling suggests that the population exposed to an extreme river flood can be expected to grow by 1.4 million by 2035–2044 in the absence of adaptation measures and under moderate climate change. Indonesia is also vulnerable to sea-level rise, with the country ranked fifth highest in the world terms of the size of the population inhabiting lower elevation coastal zones. Without adaptation, the total population likely to be exposed to permanent flooding by the period 2070–2100 could reach over 4.2 million people (WB and ADB 2021). The impacts of climate-related shocks can be highly disruptive to the econ- omy through their effects on firms and households. For example, World Bank modelling suggests that the costs to firms in Indonesia from various infrastructure disruptions in 2019 could have been in the order of 2.4 per- cent of GDP (Hallegatte, et al. 2019). Most of those costs are estimated to have been driven by loss of sales followed by reduced utilization rates (that is, output capacity that goes unused due to transport and services interruptions) (Figure B.3.1). Projecting forward, the approximate loss in GDP under midrange climate assumptions is expected be around 1.4 per- cent of GDP by 2030 relative to a scenario with no climate change (Figure B.3.2). Concurrently, the income of the bottom 40 could fall by 2.2 percent by 2030 relative to a scenario with no climate change (Figure B.3.3). F I G U RE B .3 .1 F IG U RE B . 3 . 2 Climate shocks pose risks through Which contribute to long-term infrastructure disruptions loss in income Cost of climate shocks on infrastructure Change in GDP with climate change relative disruptions (% of GDP, 2019) to a scenario with no climate change E conomic I mpacts of C limate A ctions 75 F I G U RE B .3 .3 F IG U RE B . 3 . 4 Including through impacts on the Gradual improvement in readiness to income of the bottom 40 deal with climate shocks Change in income by 2030 of the bottom Readiness versus peer countries 40% with climate change (%) Sources: Data from Notre Dame Global Adaptation Initiative (2022). Structural peers are Nigeria, China, India, Ukraine, Thailand, Philippines, Mexico, Egypt, Russia, Sources: Figures B.3.1-B.3.3 are WBG estimates Brazil with benchmarking choices based on population, GDP per capita, and total (Hallegatte, et al. 2016; 2019) GDP. Indonesia’s capacity to adapt to these climate shocks has gradually strengthened as discussed in part B, and further measures will help better absorb the above costs. According to the Notre Dame-Global Adaptation In- dex (ND-GAIN), Indonesia is the 87th least ready country to the impacts of climate change (i.e., around the global median). Readiness (i.e., country’s ability to leverage investments and convert them to adaptation actions) is assessed by considering indices of economic performance, governance, and social systems. Indonesia’s performance on readiness is improving, including gradual catch up with the performance of peers (Figure B.3.4). An example of where Indonesia is improving readiness is in the capacity of the Social Protection (SP) system. The CCDR undertook a ‘Stress Test’ (Sen et al, 2022) to assess the capacity of Indonesia’s SP System to respond to climate shocks and found the country to be operating at a midrange Level. Indonesia scored 3.26 on a scale of 1 (Nascent) to 5 (Advanced) in four areas, including the effectiveness of its Programs and Delivery Systems (score: 3.47); Data and Information (score: 3.08); Financing (score: 3.25); and Institutions and Partnerships (score: 3.25). These scores are in line with countries of comparable income. While opportunities remain for fur- ther improvement, recent progress has included expansion of conditional cash transfers and establishment of a social registry of the poorest 40 percent (see Chapter 2). Other areas of adaptation have also improved, such as early warning systems (EWS) for natural hazards. Source: Hallegatte, et al. 2016; 2019; Notre Dame Global Adaptation Initiative (2022); WB and ADB 2021, “Indonesia Climate Risk Profile” I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 76 5 CLIMATE & PAG E 7 7 —99 DEVELOPMENT POLICY FRAMEWORK KERENG BANGKIRAI • CE N T R A L K A L I M A N TA N C limate & D evelopment P olicy F ramework 77 5.1 THE CLIMATE & DEVELOPMENT TO–DO LIST What are the implications of all the above for priorities going forward? To recap, Indonesia has drawn on its abundant supply of natural resources while achieving impressive development transitions in income, social services, infrastructure, economic growth, and poverty reduction‒particularly over the quarter-century to 2022. Yet climate change poses physical and economic risks for Indonesia, and some aspects of the earlier growth model have imposed costs on development. In response, Indonesia has embarked on a transition toward low-carbon and climate-resilient growth that “balances between emis- sion reductions and economic development” (Republic of Indonesia 2021). Addressing mitigation and resilience needs will entail not just sector policies but also enablers that are important for long-term growth. Reforms for a cli- mate transition will, therefore, involve four types of measures: (i) supply-side; (ii) demand-side; (iii) adaptation; and (iv) enabling policies and institutions. All four work together, with the transition expected to be more efficient when simultaneous progress is made in each area. The CCDR draws on the government’s strategic documents as well as its own analysis to propose a policy framework that balances climate and development (Figure 75). Policies aim to balance changes in the supply of carbon-intensive inputs with adjustments to demand for those inputs. They further aim to create the enabling conditions that will facilitate a reallocation of resources from carbon-intensive to greener parts of the economy, and from low-productivity to high-productivity areas of the economy, while raising new financing. Policies also aim to provide certainty and insurance for Indonesia’s economy and people via adaptation measures that protect against shocks, reduce risks, and ensure inclusion. While many actions could contribute to these needs, not all are urgent and not all contribute to both climate and development goals to the same extent. The CCDR policy framework is built around considerations of urgency and synergy. While many measures are important, some are relatively more urgent because inaction will lock in carbon-intensive development patterns or vulnerabilities that increase subsequent costs and financial risks. Other measures can be delayed in recognition of short-term financing limits or po- tential benefits from the expected decline in the cost of green technologies. The CCDR indicates urgency by suggesting each action as either a short-term priority (by 2025), a medium-term priority (by 2030), or a long-term priority (beyond 2030). Regarding synergy, some measures are expected to contribute to both climate and development goals by improving the business environment, helping to balance the budget, or by reducing development costs such as local air pollution. The CCDR indicates those measures with high potential toward both goals (Figure 76). Urgency and synergy inform selection of the measures and their relative prioritization presented later in this Chapter. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 78 F I G U RE 7 5 Building Blocks for the Transition Reduced transition Supply-side Demand-side costs Measures Measures TO G E T H ER Efficient resource PROMOT E allocation Adaptation Enabling Conditions Certainty and insurance F I G U RE 7 6 Prioritization Approach for Recommendations U RG E N CY SY NERGY When to act Expected climate and development outcomes S H O R T T E RM PRI O RI T Y S 3 3 V ERY H IG H M E D I UM T E RM PRI O RI T Y M 2 2 HIGH LO N G T E RM PRI O RI T Y L 1 1 LOW - MOD ER AT E Source: WBG staff. Note: Extent of synergy is indicated by C LIM AT E D E V ELO PMEN T a qualitative (1-3) scoring of expected climate and development benefits: mea- sures with high potential (that is, higher scores) toward both goals are considered more synergistic. Urgency is defined by short (by 2025) medium (by 2030), and long-term (after 2030) categories. “ The CCDR policy framework is built around considerations of urgency and synergy ” The CCDR recognizes that the feasibility and ultimate success of reforms do not depend only on their technical merits but also on political support for those reforms. Political support will depend on, among other things: (i) the dis- tributional impacts of reforms; (ii) the tradeoffs between the short-term costs of reforms and their long-term gains; and (iii) institutional capacities to implement reforms. The CCDR does not claim that these reforms are straightforward, nor that they can be all be achieved within the timeframes presented. It is likely that political considerations will necessitate tradeoffs and choices between competing priorities. Nevertheless, the CCDR presents a policy framework and timeline from a technical perspective, informed by Indonesia’s stated ambition, while recognizing that it is for Indonesia to decide collectively how, when, and what reforms to move forward. C limate & D evelopment P olicy F ramework 79 1 GETTING STARTED Before presenting the full policy framework (below), the CCDR offers a se- lection of short-term priorities (by 2025) based on urgency and synergy con- siderations. These are short-term priorities that aim to place Indonesia on a smooth transition trajectory. They are starting points‒with longer-term reforms and investment options to follow the planning and initial steps they establish. In some cases, these short-term priority areas refer to actions that the CCDR designates as medium- and long-term actions. This is because longer-term implementation does not mean delayed action: planning, piloting, institutional strengthening, and initial steps toward longer-term outcomes may need to start now for realization of future results. CHALLENGES ADDRESSED SELECTED SHORT-TERM PRIORITIES (BY 2025) 1 Some remain- Continue to strengthen the policy framework for net zero emissions from ing gaps in forests and land use and develop a financing roadmap for the FOLU Net Sink forest and land use 2030 plan. Build on recent regulatory reforms to further expand forest protec- policies and tions over areas of peat not already covered. Integrate mangrove protection into finance subnational (provincial and district) spatial plans (focused on nonforest areas) and help ensure AMDAL assessors correctly designate mangroves as HCV eco- systems. Finalize OneMap and continue to clarify tenurial status of different land functions as a stronger basis for enforcement. Use fiscal incentives plus increased enforcement to ensure district governments complete their spatial plans to direct new agriculture away from high-carbon and sensitive ecosystems. Develop a financing roadmap to support restoration investments and other planned FOLU Net Sink 2030 activities. Support (longer-term) expansion of farmer extension and financing to improve agricultural yields, focused on smallholders. 2 Structural Implement an energy transition strategy founded on five pillars: (i) adopt a barriers comprehensive approach to decarbonization planning and energy transition; impede the energy (ii) accelerate carbon pricing and subsidy reform when circumstances allow transition (including removal of the DMO and the price cap for coal)‒to increase the incen- tives for investment in renewable energy and energy efficiency; (iii) improve the investment climate for renewable energy through institutional and regulatory reforms; (iv) strengthen the capacity and flexibility of electricity networks to absorb additional renewable energy; and (v) manage the poverty and social impacts of the energy transition. 3 Inefficiencies Further catalyze investments in low-carbon transport through the develop- in energy ment of a national urban mobility policy (NUMP) framework and increase use in transportation energy efficiency of commercial and residential buildings through green and buildings certification. Unplanned urbanization risks locking in suboptimal energy use patterns in the building sector and in transportation networks. A NUMP will set goals for achievement of green mode share targets, and develop planning, institutional, and funding frameworks for prioritizing investments in efficient modes (public transport, walking, and cycling) and efficiency improvements (electrification of vehicles) in the longer term. Meanwhile, cost-effective green standards already exist but are not yet applied to all building types. These could be considered for extension. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 80 CHALLENGES ADDRESSED SELECTED SHORT-TERM PRIORITIES (BY 2025) 4 City planning Improve flood resilience through spatial planning and early-warning systems. undermines Re-map flood-prone zones with climate-sensitive hydrological predictions and climate and development update spatial plans. Prioritize enforcement of mandated groundwater abstrac- efforts tion limits or prohibitions at subsidence hot spots to reduce coastal flooding risks. Continue investing in an integrated and people-oriented multi-hazard early warning system based on a user needs study for improving weather warning services and develop a roadmap for shifting from weather-prediction to “impact-prediction” services. 5 Fiscal policy Continue to shift fiscal policy to disincentivize emissions. Develop a roadmap distorts price for subsidy reform covering: (i) resumption of transport fuel subsidy reductions signals for decarboniza- building on recent progress; (ii) replacement of the electricity price subsidy tion (PLN’s PSO) with targeted cash transfers; and (iii) consistent with the subsidy reform plan, develop a medium-term plan for carbon pricing. This could include fossil fuel excises and extension of the existing pilot ETS and carbon tax across additional sectors. 6 Underinvest- Strengthen the financial and private sector enabling environment for green ment in green investments: (i) develop a comprehensive strategy for financial sector cli- projects by financial mate-risk assessment with detailed guidance for banks; (ii) develop further and private specific national climate finance strategies to diagnose Indonesia’s climate sectors finance gap; (iii) incentivize the use of green bonds; (iv) reform SoEs to create new opportunities for private investment in green infrastructure; and (v) reform PPP project selection, preparation, agreement, and concession procedures. E A S T KE L A PA G A DI N G • JA K A R TA C limate & D evelopment P olicy F ramework 81 2 THE CLIMATE & DEVELOPMENT FRAMEWORK S U PPLY Supply-Side Policies & Institutions A PRIMARY ENERGY SUPPLY Achieving Indonesia’s target of rebalancing the primary energy mix from coal to renewables requires short-term regulatory reforms and a just transition for the coal sector. There are opportunities to make the regulatory framework more supportive of Indonesia’s energy mix objectives, including reforms to PLN (discussed in the next section) which could help reduce demand for car- bon-intensive energy sources. Specific measures include: S.1. Fragmented Adopt a comprehensive approach to decarbonization planning and the energy approach to decarbon- transition. This includes: (i) incorporation of government climate commitments ization planning and energy transition and targets in sectoral plans such as the RUPTL and corporate plans of SoEs such as PLN; (ii) further assessment of cost-effective decarbonization path- U RG E N CY ways, building on the LTS-LCCR and LCDI; (iii) development of a decommis- C L I M AT E sioning timetable for coal-fired power plants, a financing plan, and least-cost replacement of coal generation with renewable energy sources consistent D E V E LO PM EN T with Presidential Regulation No. 112/2022 on Renewable Energy issued in September 2022; and (iv) a stakeholder consultation and dissemination plan. A coordinating inter-ministerial commission with the participation of MoEMR, the Ministry of State-owned Enterprises (MSoE), and MoF could be established to ensure alignment of sector, climate, and financial targets. S.2. Coal pricing Continue energy pricing and subsidy reform by phasing out coal DMO subsi- disincentivizes dies and phasing in carbon pricing. This includes: (i) progressively removing renewables the DMO for coal to help level the playing field for renewables; and (ii) preparing U RG E N CY a roadmap for carbon pricing (extension across sectors and a price trajectory through time). See also recommendation E.1 - E.5. C L I M AT E D E V E LO PM EN T S.3. Distorted Lower regulatory barriers to renewable energy development by the private investment climate sector. LCRs which set a minimum threshold for local content both for materials for renewables and services used in solar power generation raise costs for solar IPP devel- U RG E N CY opers and reduce PLN’s willingness to enter new PPAs with them. Local solar panel manufacturers have been unable to produce at scale, resulting in solar C L I M AT E PV panels which are more expensive and often of a lesser quality than what D E V E LO PM EN T the developers could procure on the international markets. To address this, the government could issue a waiver on these protections for several years. This will give time for the domestic solar generation sector to develop, thereby creating a base for demand for equipment. The government could keep the waiver under review, returning to the domestic production protections when that no longer undermines demand. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 82 S.4. Lack of capacity Further invest in the capacity and flexibility of transmission and distribution and flexibility of networks, including interconnections between island systems. These invest- electricity networks ments would be supported by pricing mechanisms and associated regulations U RG E N CY for energy storage systems and ancillary services that support renewable energy integration. Planning by MoEMR is underway toward island intercon- C L I M AT E nections‒with major islands intended to be connected by 2024 and smaller D E V E LO PM E N T islands subsequently. S.5. The coal phaseout Pursue a “Just Transition for All” for the coal phaseout. A just transition can be will have negative underpinned by: (i) continuous dialogue and consultation with a wide variety of economic impacts stakeholders to determine scope, scale, and timing of coal facilities’ closures; U RG E N CY (ii) upfront planning, sustained through dialogue and participatory monitoring during the stages of closure and transition; (iii) provision of temporary income C L I M AT E support to coal workers and their families that is complementary to other ex- D E V E LO PM EN T isting social protection programs; and (iv) deployment of active labor market policies that offer services, programs, and incentives to encourage and enable re-employment among laid-off workers. B SUPPLY OF LAND RESOURCES Indonesia has a clear pathway toward negative emissions from the land sector by 2030. The most cost-effective first step is further strengthening conserva- tion of primary forests and peatlands, building on recent regulatory tightening that is protecting HCV forests and peat. Land management in Indonesia will require an integrated landscapes approach with coordination across sectors and levels of government. Specific measures include: S.6. Gaps in forest Continue strengthening regulations on forest clearing. Indonesia has imposed conservation regulations that have been effective in slowing deforestation (see Chapter 1). measures Continued strengthening of measures to protect high-value, carbon-dense U RG E N CY peatland and primary forest will support the Net Sink 2030 objective. For mangroves, this could be supported by integrating mangrove protection into C L I M AT E subnational (provincial and district) spatial plans (focused on non-forest areas) D E V E LO PM EN T and by helping to ensure that AMDAL assessors correctly designate mangroves as HCV ecosystems. For forests outside of the Forest Estate, technical support and fiscal incentives could be provided to districts willing to designate high-val- ue forests as Essential Ecosystem Areas (conservation zoning). S.7. Fragmentation in Expand the integrated landscape management approach. BRGM has suc- management of key cessfully demonstrated how an agency with the mandate to achieve specific natural resources ecosystem outcomes can operate effectively in a complex administrative envi- U RG E N CY ronment. This landscapes approach could be broadened for the management of critical ecosystems such as primary forests and mangroves, in addition to C L I M AT E peatlands. This approach would entail the adoption of high-resolution maps for D E V E LO PM EN T planning, cumulative impact assessment, and common performance metrics across ministries and subnational governments. C limate & D evelopment P olicy F ramework 83 S.8. Misalignment Increase fiscal incentives for sustainable land use practices at the local between local level. Indonesia’s decentralized system of governance requires vertical fiscal land incentives and national land transfers that incentivize local actions aligned with national priorities. Add incentives payment metrics to the Regional Incentive Fund (Dana Insentif Daerah) for the completion and enforcement of district spatial plans (Rencana Tata Ruang U RG E N CY Wilayah: RTRW), and/or incentivize with international results-based-payments C L I M AT E channeled through BPDLH, potentially through a streamlined BPDLH funding D E V E LO PM EN T window that aggregates donor contributions and provides ongoing and simpli- fied results-based support to provinces. Increase the knowledge and capacity of the most vulnerable villages regarding climate resilience and mitigation activities with livelihood co-benefits, and provide implementation support (for example, technical training and multi-year budgeting flexibility). Provide top- up funds rather than diverting already stretched revenues under the Village Fund (Dana Desa) and Village Fund Budget (Alokasi Dana Desa). Village-level services could be established to provide subsidized land preparation services as an alternative to burning, although priorities should be determined at the local level in line with village funding principles. DEMAND Demand-Side Policies & Institutions A THE DEMAND FOR ENERGY Efforts to rebalance the supply of primary energy will be most effective if com- plemented with reforms that support a reduction in the demand for coal in the electricity sector. PLN’s impaired balance sheet further prevents a move away from coal. This is driven by PLN’s current revenue structure that is not sufficient to cover operating costs and service its debt. It is also driven by tariffs set well below cost-recovery. In addition, high external leverage of PLN creates debt overhang which is aggravated by low viability of renewable energy created by regulatory pricing distortions. These make it difficult for PLN to scale up the investment and attract the private investment needed for renewable energy. Specific issues and measures include: D.1. PLN’s tariff Increase the share of revenue received from electricity tariffs. PLN’s tariff ad- arrangements and justment arrangements weigh on the balance sheet. Reforms could include: (i) untargeted subsidies weigh on balance improving the automatic adjustment formula to account for future investments, sheet including renewables; (ii) revising the tariff structure to make it more trans- parent and provide greater pricing signals to customers, shifting demand from U RG E N CY peak periods and greater energy efficiency, and potential progressive tariffs for C L I M AT E certain categories of customers. These measures would be well complemented by electricity subsidy reform (see recommendation E.2.). Some tariff reforms D E V E LO PM EN T are underway, along with subsidy targeting efforts. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 84 D.2. Traditional Review alternative financing options for PLN to use to finance expansion of financing is insufficient renewable energy. Traditional financing is unlikely to be sufficient for PLN’s for PLN to expand renewable energy expansion plans for renewable energy. Alternative financing could include: (i) further developing the use of asset-based securities and asset recycling and U RG E N CY monetization models; (ii) expanding the use of green bonds and green financing through full implementation of the ESG and sustainable financing framework; C L I M AT E and (iii) introducing independent transmission providers. D E V E LO PM EN T Further downstream in the energy value chain are opportunities to improve efficiency in use. Regulations for efficiency have been applied in some types of buildings and could be extended to others. Transportation has scope for reductions through further spatially informed infrastructure planning and com- pact urban design, shifting to low-emissions transport modes, and improving efficiencies and electrification of existing technologies. Substantial efforts are also needed to encourage the development of clean energy supplies for indus- trial processes such as those transforming raw minerals. Energy efficiency and electrification measures would be well complemented by measures to reduce the carbon-intensification of the electricity grid. Specific measures include: D.3. Lack of green Increase energy efficiency in commercial and residential buildings through design standards in green certification. Investing in green buildings will significantly reduce GHG construction leads to energy inefficient emissions and result in lower housing costs for households and developers. houses Integrate cost-effective climate-smart components and green standards into government programs such as One Million Homes and Credit for Home Own- U RG E N CY ership (Kredit Pemilikan Rumah: KPR Subsidi). In the short term, conduct a C L I M AT E study on green building feasibility for the Bantuan Stimulan Perumahan Swa- daya (Stimulus Assistance for Private Housing) retrofit program, and consider D E V E LO PM E N T expanding green standards (Sertifikasi Bangunan Gedung Hijau) for a wider range of building types. D.4. High dependence Develop a NUMP to catalyze investments into public transport, walking, and on energy-inefficient cycling. This would include: (i) national goal setting for green mode shares; (ii) private transport modes in urban areas sustainable urban mobility strategies and action plans for urban areas above a certain size that prioritize transit, walking, and cycling, demand management U RG E N CY and integrated spatial planning; and (iii) integrated institutions to plan, fund, and manage urban transport across metropolitan areas and across modes C L I M AT E (for example, Metropolitan Transit Authorities with statutory authority). These D E V E LO PM E N T could be supported by dedicated sources of funding (for example, transport tax revenues) and a national assistance scheme for mass transit that would rein- force the NUMP framework. This would be the primary decarbonization strategy for transport which yields robust impacts irrespective of energy source‒with electrification as a complement (see recommendation D.5). C limate & D evelopment P olicy F ramework 85 D.5. Low uptake of Accelerate the adoption of electrified mobility (e-mobility) in concert with electrified mobility decarbonization of the electricity grid. This could involve: (i) mandates for the options procurement of electrified public fleets on a timed schedule that provides a sig- U RG E N CY nal to EV manufacturers; (ii) direct monetary incentives for EVs, as is being pur- sued through the Low-Carbon Emission Vehicle Program that increases vehicle C L I M AT E taxes proportionally to vehicle CO2 emissions; and (iii) revised business models D E V E LO PM E N T for public bus services to: (a) address the short contract duration (of up to three years) that currently makes it difficult to recoup large e-bus capital expenses; and (b) explore possibilities for fleet aggregation and leasing, and charging-as- a-service models, which provides flexibility for private sector innovation. D.6. National climate Integrate cities into medium- and long-term climate change strategies at targets are not yet fully the national level with dedicated city-level targets. Engaging cities in the translated into city- level policy making low-carbon transition could have a substantial impact on the distribution of mitigation efforts and their costs. Dedicated climate targets at the city level will U RG E N CY incentivize local authorities to mainstream climate change into planning, develop implementation strategies, and prioritize low-carbon investments. This is under- C L I M AT E way in some cities (for example, Jakarta) with opportunities to expand further. D E V E LO PM E N T B THE DEMAND FOR LAND Mitigation actions based on influencing the supply of land would be best com- plemented by measures that simultaneously improve efficiency of land use. Supply-side restrictions on land conversion, for example, restrict plantation expansion. These impacts can be offset by increased intensification of existing plantations. Better use of land could also be achieved through fiscal incen- tives aligned with climate objectives, some of which are underway. Specific measures include: D.7. Inefficiencies Bridge yield gaps through sustainable intensification. Smallholder operations remain in plantation in palm oil have yields on average 25 percent lower than large plantations. Im- agriculture, particularly among smallholders proved access to technologies and inputs (for example, high-yielding varieties, balanced mix of fertilizer, digital and precision farming technologies); technical U RG E N CY advisory and supporting services (for example, veterinary, climate advisory, equipment rental and maintenance services); and finance could help improve C L I M AT E yields. The private sector will play an important role in incentivizing the adoption D E V E LO PM E N T of climate-smart practices and in co-financing necessary investments. Further enhancements to traceability systems could be used to enable the rewarding of sustainable practices at farm level‒for instance, through concession license renewals and price premiums for sustainably produced goods. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 86 D.8. Public Repurpose public spending in agriculture to incentivize resilient and low-car- expenditure for bon agriculture. Public support to agriculture in Indonesia is among the high- agriculture is misaligned with est in emerging and OECD economies‒but has been largely directed toward climate goals fertilizer subsidies and irrigation that is predominantly focused on rice‒without commensurate gains in growth and productivity. There are opportunities to U RG E N CY gradually re-orient agricultural spending to support increased productivity and C L I M AT E farmer incomes and achieve climate objectives. This requires: (i) shifting input subsidies toward direct payments that are conditional on environmentally sus- D E V E LO PM E N T tainable practices; (ii) promoting diversification to high-value, locally suitable, less emissions-intensive crops; (iii) incentivizing adoption of climate-smart practices (for example, use of improved crop varieties and livestock breeds); (iv) conservation agriculture; (v) water-use efficiency; and (vi) integrated pest management. These would need to be enabled by business development training for small-scale producers, the development of producer groups, and financing mechanisms. D.9. Lack of clarity Clarify peat and forest land designations and tenure rights, within and be- on land tenure and yond the forest estate, with a focus on high-risk areas. Land rights issues spatial planning leads to under-investment are being addressed through major land rights reform programs underway and deforestation (TORA and social forestry) that are helping to incentivize improved local land management. These programs could be spatially targeted based on ‘prioritiza- U RG E N CY tion maps’ (combining environmental value, socioeconomic disadvantage, and C L I M AT E high deforestation risk). A ‘high-priority’ area target for tenure reform could be used alongside existing targets to incentivize and measure progress in areas D E V E LO PM E N T where land rights issues are most pressing. Land administration would be further strengthened by publication of timber and plantation concession maps under the One Map Policy, and through completion of high-resolution maps of peatlands and lowlands. Increased technical guidance and funding could help district governments to complete their RTRWs and incorporate climate consid- erations (risks and land-based emissions). Similar land use dynamics play out in the urban space. Spatial planning that protects natural land–including forests at the urban periphery and high-risk flood zones–would be well complemented by efficient urban design measures and transportation systems that make higher density livable. The measure proposed below aims to improve synergies between measures influencing the demand and supply of land in urban areas: D.10. Inefficient Integrate spatial planning with capital investment planning and prioritiza- spatial growth patterns tion‒especially in new, secondary, and small cities. Promoting a compact in cities urban form will be crucial in Indonesia’s secondary and smaller cities (with U RG E N CY populations under 1 million), where most of the infrastructure needs to be built and carbon-intensive spatial patterns are yet to be locked in. Integrating C L I M AT E spatial and capital investment planning may help reduce emissions arising D E V E LO PM E N T from urban expansion and tree cover loss, and improve livability, while creating conditions for low-carbon transport modes. C limate & D evelopment P olicy F ramework 87 Mitigation measures can be prioritized based on urgency and development synergies (Figure 77). Recommendations assessed as being relatively more urgent are those needed to avoid locked-in carbon-intensive development (such as avoiding loss of peatland and primary forest), start or strengthen crucial planning processes (for example, the coal transition framework), and put in place settings needed for longer-term investments (for example, renewable energy regulatory reforms). Short- and medium-term actions with the greatest expected mitigation impacts, combined with large, expected development co-benefits, include reform of energy subsidies, reform of agricultural subsidies, and the coal transition framework. F I G U RE 7 7 Timeframe and Expected Impact of Supply- (S) and Demand-side (D) Mitigation Measures Integrated Decarbonization landscape management Lower RE planning barriers Coal and VERY HIGH subsidy S.2 S.1 S.7 S.3 phaseout plan Coal DEVELOPMENT Invest in power S.5 transition interconnections S.4 S.6 D.1 SYNERGIES framework Ag. subsidy reform Further forest National urban MITIGATION & ADAPTATION IMPACT protections mobility policy Electricity tariff reform Very High Forest boudaries and D.8 S.8 D.3 D.4 D.10 D.9 HIGH land rights reform Green building Urban planning Land use fiscal standards and investment incentives High alignment LOW-MODERATE D.6 D.2 D.5 D.8 Low- mod. City-level Non-debt RE targets investments E-mobility by PLN Improve plantation yields LONG-TERM PRIORIT Y MEDIUM-TERM PRIORIT Y SHORT-TERM PRIORIT Y URGENCY Source: WBG staff assessment. Note: Actions assessed as being more urgent, with the greatest climate impacts, are to the top right; those with greatest development co-benefits are represented by larger/darker circles. Short-term priorities are those envisaged prior to 2025, medium term prior to 2030, and long term after 2030. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 88 Adaptation ADAP TAT I ON & Resilience Indonesia’s physical and human capital stock underpin long-term growth prospects but are threatened by climate change. Reforms in social protection and DRM are already underway, building on important institutional and policy foundations such as the DTKS, the BNPB, and the 2007 laws on Disaster Man- agement and Spatial Planning. Complementary recommendations are made below with the aim of strengthening synergies between disaster response and ex ante risk reduction, ensuring comprehensiveness of social protection systems, and strengthening spatial planning. Specific measures include: A.1. Damage to Continue to improve standards and practices for more resilient infrastruc- infrastructure from ture. Intensify post-disaster investigation to better understand climate-related climate-related disasters disaster impacts on infrastructure, revise technical guidelines, strengthen con- struction supervision practices, and enhance Balai level budget planning and U RG E N CY funding flexibility for disaster needs (for example, high-priority maintenance and C L I M AT E monitoring). Include climate resilience considerations in public infrastructure implementation processes via: (i) specific guidelines for conducting climate D E V E LO PM EN T and environmental assessments; (ii) explicit inclusion in contracts of climate risks (and contingent liabilities); and (iii) inclusion of climate risks in State Asset Condition reports. A.2. Flood Improve flood resilience through spatial planning and groundwater pumping management remains control. Map flood-prone zones and delineate in spatial plans. Ensure develop- challenged by limits to data, planning, and ment is controlled accordingly via zoning. Link spatial plans to investment plans enforcement and annual budgets at city levels (see also D.9. on spatial planning for efficient urban spaces). A Water Information Management System could be used for U RG E N CY improved data sharing on flood risks. Further enforce mandated groundwater C L I M AT E abstraction limits at high subsidence areas to reduce coastal flooding risks. Consider opportunities to adjust tariffs for cost-recovery and long-term invest- D E V E LO PM EN T ment in piped water infrastructure (to offset groundwater abstraction). A.3. Gaps in Complete the ongoing reforms to strengthen the social protection system’s social assistance adaptability to climate risk, including finalizing links to the PFB and com- programming pletion of the ASP roadmap. Continue to close remaining social protection coverage gaps to poor and at-risk populations and improve ex ante quantifi- U RG E N CY cation of post-shock social protection financing needs to facilitate improved C L I M AT E pre-positioning of resources. Improve the use of social registry systems for D E V E LO PM EN T faster provision of post-shock support by increasing coverage and updates to the DTKS with links to early warning systems, necessary data for post-shock delivery, and providing improved registry access to humanitarian agencies during shocks. C limate & D evelopment P olicy F ramework 89 A.4. Social assistance Build resilience among households through social programs. Existing social programs are not yet programs provide support but do less to improve preparedness for climate fully harnessed to build resilience shocks and adaptive capacity of households. This can be addressed by: (i) providing education and information about climate-related disaster prepared- U RG E N CY ness; (ii) ensuring programs have climate-informed designs (for example, disas- C L I M AT E ter-resilient and energy-efficient housing social assistance); and (iii) improving cross-sectoral cross-links to other social programs that build complementary D E V E LO PM E N T aspects of resilience (for example, livelihood diversification programs and green jobs; support for climate-smart agriculture; and climate-resilient housing for social protection beneficiaries). A.5. Disaster response Improve DRM processes to address the needs of diverse and vulnerable is not yet fully groups. Develop targeted mitigation and preparedness initiatives for people of sensitized to gender and inclusion of all ages, abilities, and genders; and ensure inclusive response and recovery pro- vulnerable groups grams. This could be achieved by: (i) improving information sharing on affected households with vulnerable categories; (ii) direct targeting of DRM programs U RG E N CY to women and people with disability; (iii) ensuring that temporary shelters and C L I M AT E reconstructed infrastructure and buildings include universal accessibility and safety measures to prevent gender-based violence; (iv) increasing the repre- D E V E LO PM E N T sentation of women, people with disability, and other vulnerable groups to make decisions on DRM programs; and (v) increasing gender-specific research (including sex-disaggregated data collection) in sectors prone to climate change. A.6. Cities are Invest in city-level infrastructure for urban flood resilience and livability. Inte- increasingly vulnerable grated green infrastructure and water-sensitive urban designs can reduce flood to water- and heat- related threats risks and produce co-benefits for urban livability. Investments could include integrated water storage infrastructure for rainwater capture and flood control U RG E N CY at strategic locations and ‘blue-green’ urban infrastructure such as street C L I M AT E trees, parks, and urban water bodies to reduce heat stress. Some steps to implement this vision include: (i) establish the foundations for the proposed D E V E LO PM E N T National Urban Flood Resilience Program with a set of pilot cities; (ii) generate a knowledge exchange platform for capacity building on urban flood resilience for cities; and (iii) identify risk-financing mechanisms for local government for implementing multi-year flood-resilient city plans. A.7. Early warning Further invest in an integrated and people-oriented multi-hazard early warning services are system. Indonesia’s early warning services remain fragmented with multiple fragmented and need a coordinated agencies responsible for upstream hazard monitoring and downstream warning and impact-based dissemination to stakeholders. Further coordinated investments in integrating approach early warning monitoring and dissemination platforms; instrumentation, equip- ment, and decision support systems; and capacity building for impact-based U RG E N CY warnings (that provide clear advice on early actions) is needed. Short-term C L I M AT E actions toward this goal include: (i) conducting a user needs study to inform D E V E LO PM E N T weather warning services improvements; and (ii) developing a roadmap for impact-based hydrometeorological warning services. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 90 A.8. Climate impacts Deliver site-specific CSA intervention packages based on local vulnerabil- on agriculture vary ities. Climate impacts on agriculture vary greatly by location. Tailored pack- greatly by location ages could comprise: (i) advisory services (for example, expanded coverage U RG E N CY of KATAM Integrated Crop Calendar, climate information and early-warning services developed by BMKG, closer linkages between agriculture extension C L I M AT E and Climate Field Schools run by BMKG); (ii) advice on improved use of inputs D E V E LO PM EN T (for example, site-specific nutrient management, balanced fertilization, and use of locally adapted drought-/flood-tolerant crop varieties); (iii) climate-resilient infrastructure (for example, investments in dams to complement water-saving tertiary irrigation, post-harvest infrastructure to minimize food losses); and (iv) enabling environment measures (for example, strengthened capacities of subnational governments and agricultural extension workers to formulate local CSA intervention packages, and expanded use of KUR to finance smallholder investments). Measures can leverage the private sector in developing and disseminating CSA technologies, training farmers and extension workers, and co-financing CSA infrastructure). A.9. Climate Leverage technology including telemedicine to strengthen the health system challenges will in the face of climate challenges. Better leveraging of technology including necessitate strengthening of the telemedicine can improve the availability, accessibility, and quality of health health system services and help people adapt to climate-sensitive diseases and shocks such as heat stroke, heat exhaustion, and typhoid or cholera (from increased U RG E N CY flooding). It can also help maintain access to support in case of more extreme C L I M AT E disasters and events disrupting the availability of physical health centers and in rural and remote areas that face personnel shortages. Several actions will D E V E LO PM EN T enable increased use of telemedicine: (i) a standardized regulatory framework for the public and private sector; (ii) a focus on data privacy and clear flows of data; (iii) clear communication for improved public trust and knowledge; and (iv) continued efforts to increase households’ internet penetration rate. Adaptation measures could focus on completion of disaster financing and social protection measures as short-term priorities, while commencing plan- ning for longer-term urban infrastructure investments (Figure 78). While steps toward resilience investments are needed in the short term, such as fur- ther investments in the disaster pooling fund and social protection systems, and strengthened spatial planning to avoid locking in vulnerabilities, a lon- ger-term horizon is expected for physical urban investments given their capital requirements. Medium-term priorities could focus on supporting farmers with site-specific extension programs, financing, and technology for higher and more drought-resistant yields; development of improved warning systems (impact-based forecasting); while strengthening the built infrastructure that will be required to support growth over future decades. C limate & D evelopment P olicy F ramework 91 F I G U RE 7 8 Timeframe and Expected Impact of Adaptation Measures Urban green-blue infrastructure for Flood resilience through flood resilience spatial planning and VERY HIGH updated mapping A.2 A.5 DEVELOPMENT SYNERGIES Complete disaster Resilient farming Resilient A.3 pooling fund and social MITIGATION & ADAPTATION IMPACT systems infrastructure protection roadmap standards Very High HIGH A.4 A.8 A.1 A.7 Multi-hazard-impact based early warning Build household system resilience through High social programs LOW-MODERATE A.9 A.5 DRM Process for Low- vulnerable group mod. Telemedicine LONG-TERM MEDIUM-TERM SHORT-TERM URGENCY Source: WBG staff assessment. Note: Actions assessed as most urgent, with the greatest climate impacts, are to the top right; those with greatest development co-benefits are represented by larger/darker circles. Short-term priorities are those envisaged prior to 2025, medium term prior to 2030, and long term after 2030. Enabling Policies E N AB L E R S & Institutions A FISCAL MEASURES Fiscal policy reforms can help create price signals that promote a low-car- bon transition and raise revenues for mitigation and adaptation investments. Although subsidy spending on energy consumption has declined in recent decades, it continues to provide significant support for the use of fossil fuels in the economy. These inefficient and poorly targeted electricity and transport fuel subsidies are inconsistent with the low-carbon transition. In addition, the coverage of fossil fuel taxes is limited, while in some instances fiscal instru- ments within the same sector have countervailing effects on the incentives for emissions. Fossil fuel taxes can raise revenue for climate expenditures, which are below mitigation and adaptation needs, and not yet fully aligned with NDC objectives. Specific issues and measures include: E.1. Fuel subsidies Develop a roadmap to complete transport fuel subsidy reforms. Fuel sub- are regressive, distort sidies are regressive, distort carbon price signals, and weigh on the budget. carbon price signals, and weigh on the Rising global oil prices make it politically difficult to eliminate fuel subsidies in budget the short-term, however, planning for reform could begin now in anticipation of more favorable medium-term conditions. Reform planning would include redis- U RG E N CY tribution mechanisms to offset impacts on the poorest. World Bank analysis C L I M AT E suggests that removing subsidies in isolation could increase the poverty rate by 0.4 percentage points, but fiscal savings (from reduced fuel and electricity D E V E LO PM E N T subsidies) can be used to offset impacts on households with net fiscal savings of 0.3 percent of GDP. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 92 E.2. Some households Convert the electricity price subsidy (PLN’s PSO) into targeted cash transfers receiving electricity for eligible households. This would allow the charging of tariffs that cover gen- subsidies are not poor eration costs while using cash transfers to compensate the poor and vulnerable for price rises. This may require updates to the DTKS (see recommendation U RG E N CY A.3.), to ensure sufficient information for targeting, managing, and monitoring C L I M AT E cash transfers. D E V E LO PM EN T E.3. Tax policy Review the inventory of tax measures to better align fiscal policy with low-car- inadequately shaping bon objectives. The review could consider: (i) opportunities to introduce an incentives for GHG emissions excise on fossil fuels after eliminating existing subsidies and introducing com- pensatory measures for the poor; (ii) removing tax incentives for carbon-inten- U RG E N CY sive sectors; and (iii) eliminating conflicting effects of tax policy on emissions within high-emission sectors. This would be aligned with Presidential Regulation C L I M AT E No. 98/2021 on the economic value of carbon. D E V E LO PM EN T B CARBON-PRICING REFORMS Fiscal reforms could include extension of Indonesia’s important carbon-pric- ing reforms that were adopted by the authorities in 2021.83 The authorities first introduced carbon pricing through a voluntary ETS in the power sector. This is slated for extension to other sectors from 2024. Any emissions above predetermined caps would be subject to the new carbon tax or will need to be offset through trading of allowances. This is an important step forward for Indonesia. As is common with the introduction of new tax instruments, implementation challenges are likely to arise, including from the interaction of different carbon-pricing instruments (tax, ETS, and offsets). E.4. Carbon-pricing Develop an integrated roadmap for carbon pricing. Develop a roadmap for instruments have expanded carbon pricing based on a review of the impact, cost, and feasibility complex interaction effects of alternative instruments for sectors beyond 2024. Ensure alignment across different carbon-pricing instruments (ETS, carbon tax, and potential offsetting U RG E N CY schemes). Estimate baselines disaggregated by subsector and projected an- nual emissions. Explore options to trade carbon credits internationally. C L I M AT E D E V E LO PM EN T C THE FINANCIAL SYSTEM The financial system is critical to Indonesia’s climate transition; addressing two challenges will help it do so: (i) strengthening the management of climate- and environment-related financial risks; and (ii) mobilizing savings for climate mitigation and adaptation investments. Specific measures include: 83 Presidential Regulation No. 98/2021 provides the legal umbrella to introduce a price on carbon through carbon trading (cap-and-trade and carbon offsets mechanisms), perfor- mance-based payments and carbon tax/levies. The Tax Harmonization Law (2021) mandates the introduction of a carbon tax. The taxes’ introduction was on hold at time of writing. C limate & D evelopment P olicy F ramework 93 E.5. Financial system Develop a comprehensive strategy for climate-risk assessment. Building on lacks comprehensive the recent progress on regulations and roadmaps for sustainable finance, a approach to climate risk management climate risk assessment strategy could include how authorities (for example, Bank Indonesia and OJK) plan to: (i) integrate climate risks in their supervisory U RG E N CY frameworks; (ii) address climate risks within their internal organization and governance structure (for example, dedicated units to manage climate risks); C L I M AT E and (iii) allocate the needed resources and expertise to address climate risks, D E V E LO PM EN T including through outreach and capacity-building to key financial institutions. E.6. Banks do not Develop further guidance on risk management approaches and disclosure have detailed policies requirements for banks. OJK could draw on the Basel Committee on Banking and procedures for managing climate Supervision’s principles for climate-risk management (Bank for Internation- risks al Settlements 2021). Guidance would include stress testing and scenario analysis methodologies, risk identification and management approaches, and U RG E N CY procedures for disclosure of climate risks. C L I M AT E D E V E LO PM EN T E.7. Lack of detailed Develop a further climate finance strategy focused on Indonesia’s climate assessment of climate finance needs and opportunities. This strategy would build on the Sustainable financing gaps and options to fill them Finance Roadmap in that it would specifically: (i) estimate the current and pro- jected financing gap to meet the country’s climate mitigation and adaptation U RG E N CY targets; (ii) determine the priority sectors requiring climate investments; and (iii) explore potential sources of finance for priority sectors, including regulatory C L I M AT E reforms that would encourage private sector financing. D E V E LO PM EN T E.8. There are limited Incentivize the use of green bonds through diverse channels. This could in- incentives to scale up clude: (i) aggregation and securitization so that green bonds can reach the size the corporate green bond market that investors are demanding. For example, OJK could develop standardized contract templates and procedures to create consistency and simplicity in the U RG E N CY bond issuance process; and (ii) reduce listing requirements for labeled bonds and support new and existing issuers to bring these bonds to the market. C L I M AT E D E V E LO PM EN T E.9. Lack of Develop further guidance and incentives to stimulate green loans. In 2019, macroprudential Bank Indonesia issued a regulation on loan-to-valuation (LTV) for green mort- incentives could be hampering growth of gages to support green building development (Iswara 2019). This regulation green loans market enables a five percent increase in the maximum LTV for green development (to 90 percent), thereby lowering the down payment paid by borrowers. In addition U RG E N CY to the incentive framework already introduced by Bank Indonesia, there are a C L I M AT E range of other incentive mechanisms that authorities could consider for en- couraging the uptake or de-risking of these loan products‒such as guarantees, D E V E LO PM EN T subsidies, data provision, and aggregation. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 94 D INVESTMENT CLIMATE AND REGULATORY REFORMS Financial system reform will help encourage private sector participation in climate investments; this would be well complemented by investment climate and regulatory reforms. Private sector participation in green infrastructure is partially crowded out by SoEs which are buffered by fiscal support. Neverthe- less, SoEs cannot fully deliver on climate investments themselves because investment needs are too large and SoE balance sheets are too fragile to carry the load. Continued improvements in climate and regulatory reforms will help ensure private sector participation in the transition. Specific measures include: E.10. Lack of level Reform SoEs to create new opportunities for private investment in green playing field created by infrastructure. This could include: (i) reform of SoE incentives and key perfor- SoE dominance mance indicators by MSoE to encourage SoEs to mobilize private capital and U RG E N CY improve efficiency; (ii) joint venture agreements that include revenue-sharing arrangements and international standards regarding corporate governance; C L I M AT E and (iii) competitive bidding on financially viable projects, both new and asset D E V E LO PM EN T monetization projects. E.11. Private sector Reform PPP project selection, preparation, agreement, and concession pro- participation in green cedures. PPP reform could help enable SoEs to partner with private and for- infrastructure is limited eign companies, unlocking private capital and expanding access to the latest renewable energy technology. U RG E N CY C L I M AT E D E V E LO PM EN T E.12. Inefficient use Develop an asset monetization strategy to promote private sector partici- of state assets creates pation in SoE assets. This would build on SoE reforms underway that aim to lost opportunities for accelerating green help: (i) increase private sector involvement in improving SoE governance and investments performance; (ii) enhance operational autonomy from the government; and (iii) leverage the value of SoEs' operating assets to attract private investors U RG E N CY through partial monetization of those assets. C L I M AT E D E V E LO PM EN T E.13. Inadequate Consolidate the regulatory framework governing Cooperation Projects. Re- legal framework view sector-specific regulations on private sector participation and eliminate around Cooperation Projects deters private inconsistencies with regulations for Cooperation Projects where possible. To green infrastructure help streamline and avoid frequent changes, a consultation process could be investment followed for any amendments of regulations affecting Cooperation Projects, with private sector input. U RG E N CY C L I M AT E D E V E LO PM EN T C limate & D evelopment P olicy F ramework 95 E.14. Underdeveloped Unbundle investment risks and connect markets by developing foreign cur- investment rency and interest rate hedging instruments and introducing products where instruments prevent foreign participation foreign and domestic investors can co-invest. At the same time, securities is- suances in the global market, particularly by Indonesian infrastructure projects or entities, could be encouraged and facilitated to mobilize funds from foreign investors. MoF could further leverage the current momentum on Komodo U RG E N CY bonds (including green and sustainable Komodo bonds) and further develop C L I M AT E the market by extending the bond terms beyond five years, possibly with credit D E V E LO PM E N T enhancements from reputable international entities. E TRADE POLICY Adjustments to trade policies could be used to support Indonesia’s decarbon- ization objectives. Indonesia has low average tariff rates on imports of green goods and technologies (below rates for non-green goods), however, NTMs add costs to green goods that exceed tariff costs. While many represent important standards that should be maintained, there may be opportunities for stream- lining these barriers. There may also be scope for integrating environmental provisions in Indonesia’s trade agreements and for Indonesia to more fully participate in policy initiatives on green trade. E.15. Low average Liberalize remaining tariffs on imports of green goods, including through tariffs hide tariff peaks multilateral participation. While average tariffs are encouragingly low, there for green products are a few remaining tariff peaks for green goods. Reducing import tariffs will reduce key goods’ prices and boost access to lower-cost and more energy-effi- U RG E N CY cient technologies. This may be particularly important for industries that must C L I M AT E comply with climate change mitigation policies. D E V E LO PM E N T E.16. NTMs add Review and streamline NTMs on green goods. Some NTMs could be simplified significant costs to such as import approvals and compliance with SNI. Some NTMs could be con- imports sidered for removal entirely, such as PSIs and port of entry restrictions. Over time, some NTMs could be phased out as a robust national single window and U RG E N CY integrated risk management system is developed. C L I M AT E D E V E LO PM E N T E.17. Many national Harmonize existing local standards with international ones and develop standards are new standards that are aligned with international standards and practices. not aligned with international product Firms trading in green goods reported a lack of harmonization with international standards standards as a key challenge. Misalignment imposes costs on exporters and increases the time required to bring green goods to market. Working toward a U RG E N CY harmonization of product standards across markets could encourage imports C L I M AT E of green goods and boost Indonesian exports in new markets with comparable standards. D E V E LO PM E N T I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 96 E.18. LCRs are Reduce the stringency of LCRs until demand can sustain local economies prohibited under of scale. High LCRs prior to establishment of market demand large enough WTO law to support domestic manufacturing economies of scale may prevent industry U RG E N CY development, increase prices, and prevent international technology transfer. Allowing the market to first develop, such that domestic production can support C L I M AT E the economies of scale required to keep prices affordable, may be more effective. D E V E LO PM EN T E.19. Lack of Look for opportunities to include enforceable environmental provisions in participation in green trade agreements and participate in plurilateral and multilateral trade policy trade initiatives limits ability to shape policy initiatives on green goods. Environmental provisions and commitments are likely to become more detailed in terms of scope and ambition. Direct participation U RG E N CY in multilateral and plurilateral environment-related trade policy initiatives would allow Indonesian exporters to benefit from improved market access in destination C L I M AT E markets, while also giving Indonesia a seat at the table to shape the content D E V E LO PM EN T and course of discussions. F FIRM AND WORKER-LEVEL MEASURES The private sector is affected by climate change and will be integral to the low-carbon and resilient transitions. Challenges include: (i) the need to align incentives for climate-sensitive private sector-led growth; and (ii) the need to support the entry of new sustainable firms and ensure competitive pressure on existing firms (including reducing SoEs’ footprint in competitive sectors). The workforce is also integral to the low-carbon transition and long-term growth. It needs to be synchronized with changes triggered by firms. Key issues and measures include: E.20. FDI in Facilitate entry of foreign investors in renewable energy through the upcoming renewables is Job Creation Law's (11/2021) Presidential Regulation on Green Investments. insufficient FDI in renewables will be important for Indonesia’s low-carbon transition. This could be assisted by planning and prioritization with targeted performance-based U RG E N CY incentives, lowering LCRs in renewables (see recommendation E.19.), developing domestic suppliers’ capacity, and greening the energy mix. C L I M AT E D E V E LO PM EN T E.21. Industrial Develop an EIP roadmap and program through the Smart Eco-Industrial Park Estates offer initiative, including a model EIP to serve as a benchmark. EIPs have the po- opportunities for improved efficiencies tential to help reduce emissions and improve the competitiveness and resilience and resilience of industry. An EIP roadmap could help by: (i) assessing the cost of green indus- trial infrastructure upgrades needed to lower carbon intensity and improve the U RG E N CY resilience of firms in priority industrial estates; and (ii) strengthening industrial C L I M AT E estates’ preparedness and resilience by conducting vulnerability mapping and physical risks (floods) to green industrial infrastructure and firms and jobs. D E V E LO PM EN T C limate & D evelopment P olicy F ramework 97 E.22. Circular Implement circular business and low-carbon growth measures as per Bap- Economy (CE) penas’ LCDI. Develop action plans to promote circular business and low-carbon solutions require support growth models specifically in the government’s five priority sectors: construc- tion, food processing, electronics, textiles, and plastics. A strengthened policy U RG E N CY framework to support a circular economy could include incentives for circular economy development; circular economy standards (end-of-waste criteria, green C L I M AT E label products, and waste classification), and finance public good investments D E V E LO PM E N T in shared infrastructure. E.23. There is a need Finalize the efficiency and effectiveness review of business support programs. to align business Approximately US$1.15 billion is spent annually across 146 business support support with climate objectives programs. The review could consider options for targeting this support to assist firms vulnerable to higher carbon prices, and for those whose productivity is af- U RG E N CY fected by climate change. The CCDR’s firm survey highlighted three priority areas of support: (i) training and capacity building related to environmentally friendly C L I M AT E technology (80 percent); (ii) access to green financing schemes (40 percent); D E V E LO PM E N T and (iii) connections to green technology providers (32 percent). E.24. There is Continue modernizing the skills development system to respond to changes emerging demand for in labor demand. The skills development system requires frequently updated green skills but low supply of green skills labor market information to support updates to curriculums. Changes would be served well by partnerships between technical and vocational training institutes U RG E N CY and universities and the private sector. The Ministry of Manpower has started this reform and is committed to deepening it in the coming years. For the public C L I M AT E sector, climate change subjects could be included in the civil service’s DIKLATPIM D E V E LO PM E N T (National Leadership Training) I, II, III, and IV to ensure that government leaders and managers understand strategic climate-transition issues. E.25. Lack of Introduce climate change education in schools. While green jobs are likely to education on rely heavily on transversal skills (reading, writing, math, problem solving, man- adaptation and mitigation reduces agement, social and digital) and technical skills, climate change education can climate change help young Indonesians understand risk, uncertainty, and rapid change. Climate awareness change education helps nurture students’ behavior toward ecology conscious- ness and pro-environmental actions. It also helps to build citizens’ capacity to U RG E N CY adapt to natural disaster events, in addition to changing their behavior and beliefs C L I M AT E needed to make informed decisions in a dynamic context. D E V E LO PM E N T Measures to improve enabling conditions could focus on fiscal and financial measures in the short term, including setting out a roadmap for carbon pricing (Figure 79). Short-term measures will help to align tax incentives with climate goals and improve economic efficiency (for example, through incremental sub- sidy reform). Planning for carbon pricing will help inform the private sector’s medium- and long-term investment decisions. Medium-term actions that im- prove the business environment are expected to have important development benefits, including continued improvements to the skills development system, harmonization of trade standards for green goods, and electricity tariff reform. I N D O N E S I A C O U N T RY C L I M AT E A N D D E V E LO P M E N T R E P O R T 98 F I G U RE 7 9 Timeframe and Expected Impact of Enabling Condition Measures VERY HIGH Review tax measures Carbon pricing for climate E.4 roadmap DEVELOPMENT Green skills Climate consistency SYNERGIES investments financial risk assessment Reduce local SoE reforms content MITIGATION & ADAPTATION IMPACT Climate requirements education Risk man- agement E.5 Complete fuel Very High guidance E.3 E.18 E.1 subsidy reform E E.24 E.10 for banks HIGH E.6 Co-op project Low carbon regulations circular practices Foreign PPP investment reforms E.7 National climate Asset Unbundling finance strategy monetization assets High E.22 PLN Public Services LOW-MODERATE E.20 E.11 E.23 E.2 Obligation to targeted E.12 E.19 E.13 E.14 cash transfers Low- Review business mod. 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