The importance of risk assessment before investing in Indonesia

Author: | Published: 1 Jul 2012
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The 2008 credit crisis triggered a global economic downturn, the aftershocks of which continue to be felt in many Western countries. Indonesia, by comparison, has a refreshingly positive outlook. The Indonesian economy continued to grow throughout the global financial crisis, posting solid increases in GDP. In a world where lacklustre growth has recently been the norm, Indonesia's growth has averaged approximately 5.5% over the past decade. What is more, unlike many markets which have recently been the focus of much attention, Indonesia's debt to GDP ratio has declined substantially, from 83% to 24% during that same time.

In the World Economic Forum's Global Competitiveness Report for 2011, Indonesia jumped 10 places to rank 44 out of 139 countries. With a total population of 238 million, 50 million Indonesian households now have a disposable income of $3,000 or more, the globally accepted measure of middle class status, and this number is expected to reach 150 million by 2015, when Indonesia will be one of the 10 largest economies in the world. Robust economic growth has also significantly enhanced Indonesia's borrowing ability. Recently, both Fitch and Moody's raised Indonesia's credit rating to investment grade for the first time since the Asian financial crisis in 1998. In announcing the upgrade, Moody's commented that Indonesia's fiscal ratios now "surpass many of its higher-rated peers."

Much of Indonesia's growth has been driven by foreign investment, which has increased 30% to a record $5.6 billion in the first three months of this year. Indeed, there is little wonder why many Western companies, faced with subdued growth prospects in their domestic markets, are looking to Indonesia to drive future growth.

Indonesia's transformation has been driven by market liberalisation and a desire on the part of the Indonesian government to promote the market to foreign investors. The 2008 Japan-Indonesia Economic Partnership Agreement and the 2011 US-Indonesia Comprehensive Partnership Agreement are two examples of government-led initiatives to promote closer cooperation and investment in the Indonesian market. On the heels of these two agreements alone, a growing number of Japanese and US companies have entered the market, with 55,000 new working visas issued to expatriates in 2011, a 10% increase over 2010.

The prudent investor will not, however, be under any illusions about the challenges of entering and operating in the Indonesian market. Foreign investors must deal with a sprawling bureaucracy, resource nationalism, and a complex, multi-layered regulatory environment, all of which are characteristics that increase corruption-related risk. Organisations must be alive to the risks these characteristics create and ensure they have taken steps to appropriately mitigate them.

Anti-corruption laws

Indonesia's first anti-corruption laws were passed in 1999. Since then, the legislation has been regularly updated and expanded.

Introduced in 1999, Law No 28/1999, the Law on Good Governance, barred all "government executives" (civil servants) from engaging in "corruption, collusion or nepotism."

Recognising the need to criminalise the act of soliciting a bribe, Law No 20/2001, the Law on the Eradication of Criminal Acts of Corruption, was passed in 2001. This law made it a criminal offence for any individual (not only civil servants) to engage in "corrupt actions" which cause financial loss to the state.

In 2002 the government enacted Law No 30/2002, the Law on the Commission for the Eradication of Corruption, which established the Komisi Pemberantasan Korupsi (the KPK, or Corruption Eradication Commission). The KPK is authorised to investigate and prosecute corruption issues in the public sector.

Finally, in 2009, Law No 46/2009, the Law on Corruption Tribunals created the Corruption Tribunal, a special court to hear corruption-related cases. The government faced a number of challenges with this legislation, including a finding by the Constitutional Court that the KPK and the Corruption Tribunal constituted a parallel justice system, a finding that has resulted in a reduction in the number of Corruption Tribunals. At the time of writing, they exist only in Jakarta.

The new laws have also created a number of corruption offences. One such offence is the illegal act of making profits for oneself, another person or a corporation, leading to losses for the state finances or economy.

Another is the abuse of authority, opportunities or facilities, as a result of one's official position, creating losses for the state finances or economy (the aim of such abuse being to earn profits for oneself, another person or corporation).

Providing or promising something to a civil servant, with the aim of persuading the civil servant to commit an act, or not commit an act, which would violate the civil servant or state entity's obligations, is also an offence, as is providing "gratification" to a civil servant in return for a favour. "Gratification" is broadly defined and includes money, goods, discounts, interest-free loans, free medical treatment and travel. Importantly, civil servants may accept gratification provided that the gratification is reported to the KPK and the KPK authorises its acceptance.

The penalties for violating these laws can be severe, and include imprisonment and fines reaching up to $1 million as well as bans on doing business in Indonesia. Theoretically, the legislation also covers the private sector and, in many cases, enables the authorities to prosecute private-to-private corruption. The only caveat is that the corrupt act must impact the public sector or cause losses to the state or economy. In practice, however, the focus has remained on corruption in the public sector. Moreover, the Indonesian parliament is considering a bill that would specifically target corruption in the private sector. On this public side, the proposed bill would also make it a criminal act for foreign public officials to receive bribes in Indonesia, or for Indonesian citizens to bribe foreign public officials.

Western organisations operating in Indonesia must also be sensitive to their exposure under foreign anti-corruption statutes such as the US Foreign Corrupt Practices Act (FCPA) or the UK Bribery Act. Indeed, in recent years a number of organisations have been the subject of enforcement actions in the US, as well as in the UK, for conduct that has taken place in Indonesia. Broadly speaking, foreign anti-corruption laws are substantially similar to Indonesian laws and prohibit the provision of money, benefits or other items of value to Indonesian government officials in order to obtain or retain business or otherwise secure an improper advantage in the marketplace.

The Indonesian risk environment

The Indonesian public is sensitive to corruption issues and has traditionally been highly supportive of campaigns to address them. The infamous Cicak v Crocodile case in 2009 is illustrative of this point. This matter involved a conspiracy by senior police and a member of the Attorney General's department to discredit two KPK investigators by falsifying bribery allegations against them. Recorded conversations, which confirmed the conspiracy, were leaked to the media. In those conversations, a police general referred to the police as crocodiles and the KPK as cicak, a small lizard common throughout Indonesia. The police general claimed that the KPK taking on the police would be like a cicak fighting a crocodile. A public outcry ensued and, in mid-2010 under significant public pressure, President Susilo Bambang Yudhoyono released the report of a special inquiry which exonerated the KPK and reprimanded the police for their actions.

In a recent Jakarta Post report, Rizal Ramli, a former government minister noted that 33% of the country's Bupati (Regents), 20% of its Governors, and 50% of its House of Representatives' budget commission have, at one time, been charged with corruption offences. Like many other developing countries, rent seeking by Indonesian public officials is not unusual. Salaries for public officials, even for the most senior officials, are low compared to the private sector. Mid-level officials at state-owned companies or government agencies, for instance, earn only a few hundred US dollars each month. It is widely recognised that underpayment of these officials is a significant factor which has led to instances of public sector corruption and active steps are being taken to address the issue. For example, the State Secretariat, the Finance and Administrative Reforms Ministries, the Judicial Commission and the Supreme Court, will soon release recommendations on salary increases for judges, a big step towards reforming the judiciary and reinforcing judicial independence.

Indonesia's corruption risk is increased even more because the officials receiving low wages are working within a decentralised system of licensing. More than a decade ago, Indonesia's political power was significantly decentralised through enactment of the so-called Autonomy Laws. Under these laws, the central government delegated responsibility for licensing to the provinces. Interestingly, while these laws were designed to reduce instances whereby senior public officials gained control of lucrative offices, they have actually served to increase opportunities for rent seeking. Investors are now required to obtain licences and permits from both the central government (company and expatriate visas) as well as from local government officials such as the Governor and the Bupati (environmental, mining or drilling permits). Organisations doing business in the more remote regions of Indonesia must frequently deal with three of four levels of administration, and require letters of approval and other licences from each layer of government.

But the risks are not just structural: there are also cultural challenges. Like many other cultures, Indonesian culture embraces practices such as giving gifts when joining meetings or simply as a thank you. Such gift giving is not uncommon in the administration of public affairs, from the central government to the local Bupati who issue permits and operating licences. Indeed, situations that begin with a traditional grease payment or gift designed to obtain assistance in expediting what would otherwise be a lengthy bureaucratic process, have been known to escalate into the provision of substantial financial awards designed to assist in obtaining favours such as large business contracts or important operating permits such as mining and forestry licences.

Apart from the structural and cultural issues, the manner in which Indonesian business is carried out often significantly impacts the risk environment. It is common for organisations to use third-party sales agents to assist in sourcing business, or to use third-party consultants to assist on a government tender, in the customs process, or in obtaining important operating licences or permits. The use of these third parties is not without risk. To be sure, under domestic anti-corruption laws, as well as under the FCPA and UK Bribery Act, an organisation faces the prospect of liability for payments or benefits provided to officials by third parties acting on its behalf even if it did not specifically direct or authorise those payments or benefits. In fact, most infractions of anti-corruption laws arising from conduct in Indonesia relate to an organisation's use of third parties to facilitate improper payments or benefits to officials in return for favours that enhance an organisation's business prospects. Accordingly, the use of third parties must be carefully controlled and monitored. At the least, organisations must know well any third parties they retain and also take steps to ensure that those third parties are not acting in an improper manner.

In summary, before commencing operations in Indonesia, a detailed risk assessment should be undertaken. Once the risks are identified, an organisation should design a comprehensive compliance programme focused on mitigating the risks. Failure to do so will only serve to increase the chances of an infraction that could leave an organisation exposed to prosecution by an increasingly active, and powerful, KPK, not to mention US and UK authorities prosecuting the FCPA and Bribery Act.