Indonesia: An economic masterplan

Author: | Published: 1 Dec 2012
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Ibrahim Assegaf and Yanu Wiriasmoko of AHP describe how PPP deals are beginning to take off in Indonesia, thanks to a series of government initiatives

With a yawning infrastructure deficit, a population of almost 250 million, an economy growing by nearly seven percent a year that has proved immune to global economic turbulence, and surging inward foreign direct investment, Indonesia would at first sight appear to be a dream destination for project financiers looking to seal public-private partnership (PPP) deals.

Unfortunately, this was not the case until recently, despite the fact that the alleviation of infrastructure bottlenecks was one of the key campaign promises of President Susilo Bambang Yudhoyono. With the government lacking funds to tackle the infrastructure gap, several conferences have been convened over the last few years to drum up interest among investors (with the latest taking place in August 2012). However, progress has been slow until recently for a number of reasons, chief of which was fears over security of return on investment, with both banks (particularly foreign banks) and project sponsors insisting on government guarantees that were frequently not forthcoming: the Ministry of Finance has been a strong advocate of fiscal prudence and rectitude ever since the Asian economic crisis of 1997/98.

The second major problem was land acquisition. This was the result of a number of interrelated factors, including the absence of a concept of eminent domain, an inadequate compulsory land acquisition mechanism, chaotic land title administration, speculation and insider dealing leading to land-price inflation, and a local culture of opposition to land procurement by the state dating back to forced land seizures under Indonesia's authoritarian former president, Suharto, who ruled for 31 years from 1967 until 1998.

As a consequence, PPPs have been slow to develop in Indonesia. Now, however, the key problems have been addressed by the Government through a number of innovative laws and regulations that would appear to position the country on the cusp of a new dawn for project finance based on the PPP concept.

The masterplan: MP3EI

The 2011-2025 Indonesian Economic Development Masterplan, formally adopted in May 2011 and better known by its Indonesian abbreviation, MP3EI, is being touted by the government as a game changer in the infrastructure sector as the state has pledged to play a robust role both as regulator and facilitator. Given that it has often been said that Indonesia's economy grows despite and not because of government, this represents something of a new development.

The Masterplan, which aims for annual growth of seven to eight percent over its term (up from around 6.5% in 2012), sees Indonesia becoming one of the world's top 10 economies by 2025, with a GDP of $4.5 trillion and a per capital income of $15,000, compared with around $3,000 at present.

The plan consists of three elements: (a) the creation of six integrated economic corridors connecting economic growth centres on five islands: Java, Sumatra, Kalimantan (Indonesian Borneo), Sulawesi and the Indonesian half of Papua island; (b) strengthening national connectivity through better communications; and (c) promoting scientific and technological development.

Total spending on the plan is estimated at $468.5 billion over the next 14 years, with 774 infrastructure projects to be developed at a cost of $240 billion at current prices. As the government has recognised it does not have the resources to fund the infrastructure component of the plan itself, it is hoping that the private sector will finance at least half of the projects, primarily through PPPs.

A special committee (the KP3EI) has been established to monitor and report on the progress of the Masterplan. According to the KP3EI, since the launch of the plan in 2011, the government has broken ground on 99 projects worth Rp356 trillion ($37 million), or 87% of 114 targeted projects budgeted at Rp420 trillion. However breaking ground is defined very broadly, with just about any project-related activity (such as discussions with potential investors) considered enough to satisfy the definition. Given that various state institutions use different parameters, it is difficult to accurately quantify progress.

PPP framework

The role of the private sector in infrastructure development in Indonesia dates back to the early 1990s, before the Asian financial crisis. By 1997, over $20 billion had been invested in the sector, with power accounting for $10.2 billion, telecommunications $8.4 billion and transportation $2.1 billion. Following the Asian financial crisis in the late 1990s and a number of bitter disputes with foreign investors, particularly in the power sector, private infrastructure investment came to a virtual halt. As a result, the Indonesian government was forced to redesign its PPP framework so as to attract additional investment and compete on a stronger footing with other countries.

The current PPP framework is built around Presidential Regulation 67/2005, as subsequently amended in 2010 and 2011. This provides an accountable foundation for the implementation of PPP schemes. The selection of PPP concessionaires or licensees must be done on a competitive basis and unsolicited offers are discouraged. In addition, proper due diligence must be conducted by the relevant government authorities prior to a project being put out to tender.

New laws have also been enacted to encourage PPP schemes in a number of sectors that were previously the domain of state monopolies, such as the Railways Act (2007), the Shipping Act (2008), the Electricity Supply Act (2009) and the Aviation Act (2009)

Furthermore, project development is now supported by the new Land Acquisition Act (2012), and its ancillary regulations, which significantly streamline the land acquisition process for public infrastructure projects, with the maximum period required to complete the acquisition process now being set at 583 days.

Yet there is one major difficulty – the Act only applies to acquisition processes commenced since its coming into effect, while processes underway prior to that will continue to be governed by the old ineffective mechanism.

On the financing side, the government has established a number of special schemes and institutions to provide financial support to PPP projects. These include the setting up of a land fund (Minister of Public Works Regulation 12/PRT/M/2008), under which the government will cover any losses resulting from increases in land acquisition costs of more than 110% over the price agreed in the concession agreement, or two percent of the total investment cost, whichever is the higher.

The land fund was followed in 2009 by the Ministry of Finance's creation of Sarana Multi Infrastructure (SMI) as a form of holding company to 'act as a catalyst in the development of the Indonesian infrastructure sector'. SMI received equity of $120 million from the Government, while the Asian Development Bank and World Bank each provided loans of $100 million. SMI then established Indonesia Infrastructure Finance (IIF) in 2010, in collaboration with the ADB, International Finance Corporation (IFC) and Germany's DEG, to provide financing to qualified projects.

Crucial support for the PPP framework was also put in place in 2010, with the establishment of the Indonesia Infrastructure Guarantee Fund (IIGF), the purpose of which is to extend guarantees to PPP projects, thereby helping boost their creditworthiness. The risks that may be covered by the IIGF include those that arise at both the pre-construction stage, such as land acquisition risks, and the operational stage, including breaches of contract, legal and regulatory changes, and problems in closing financing. While the IIGF is a state-owned company, it operates on a commercial basis. It does not guarantee risks that can be insured in the private market, and has proved itself highly professional and competent since its establishment, insisting on tightly drafted project documentation and conducting close monitoring of progress.

In addition, the Ministry of Finance has drafted a decree on viability gap funding, although this is not yet on the statute books.

The Indonesian National Development Planning Agency (Bappenas), the body charged with progressing PPP schemes, has identified 100 projects valued at around $47.3 billion available under the PPP programme, including one marine transportation project ready for offer valued at $36 million, 27 priority projects (18 toll roads, six water supply and three sanitation projects) valued at $8.3 billion, and 72 other potential projects worth $38.9 billion.

Despite significant advances on the regulatory and financing sides, overall progress has been slow to date, with only two of the PPP projects offered since 2006 now actually under construction. These are the 2000 MW, Central Java IPP coal-fired power plant (which is being built at a cost of $3 billion under the new PPP regulations and is expected to serve as a model for other projects), and the 9.7km Nusa Dua – Ngurah Rai –Benoa tolled expressway in Bali.

Progress to date by sector

Power

The power sector in Indonesia continues to be dominated by the State Electricity Company (PLN), which enjoys a monopoly over electricity transmission. The company both generates its own power and purchases electricity from independent power producers (IPP). While demand has been growing by between 7% and 10% over the last five years, the electrification rate across the country stood at only 70.4% in 2011, one of the lowest rates in the region. As a result, some 80 million Indonesians, primarily in the countryside, have no access to reliable power sources.

To counter the country's lack of investment in the power sector, in 2006 the Government launched phase 1 of its 10,000 MW Generating Capacity Development Programme, which focused on the construction of new coal-fired power plants across Indonesia. This was followed by phase 2, which concentrates on the development of renewable power sources, particularly geothermal.

Unfortunately, phase 1 turned out to be a less than resounding success, with only about 45% of the planned capacity on stream for the end of 2012. There are a number of reasons for this, most significantly the non-availability of government guarantees (in addition, tender winners frequently turned out to lack the capacity to develop their projects). As regards phase 2, government guarantees are available, but only since earlier this year. It is only now that work is actually getting underway, with guarantees having been issued for four projects so far.

The Ministry of Finance is no longer willing to extend blanket guarantees. This is a result of its traumatic experiences at the end of the 1990s and early 2000s, when Indonesia found itself on the losing end of a number of multi-million dollar arbitration suits (the Karaha Bodas case, for example). The Ministry also appears intent on restricting coverage to lenders, rather than sponsors, and to reducing the terms of guarantees from 20 years to 15 years.

The IIGF will also provide a guarantee, backed by government or multilateral agencies, for a qualified project provided it is initiated by central or local government, or a state-owned enterprise.

As for geothermal, the development of this sector in the past was hampered by the legislation's treatment of it as something of a hybrid creature, and as a result of both PLN and the state oil and gas firm Pertamina competed with each other for control. That problem was remedied by the Geothermal Act 2003, under which rights to exploit geothermal resources are granted through concessions awarded on the basis of competitive bidding.

However, the geothermal sector continues to be plagued by pricing difficulties. The whole ethos of competitive bidding appears to be somewhat undermined by the government's issuance of a new regulation that will set maximum feed-in tariffs at between 10 and 17 US cents, as compared to a ceiling of 9.7 cents at present. It is difficult to conceive how competitive bidding can be achieved if the price is already fixed beforehand.

To date, Bappenas has identified a total of six potential PPP projects worth some $6,478.50 in the power sector, of which only one is currently underway (the Central Java IPP project, as mentioned earlier).

Toll roads and railways

The development of tolled expressways in Indonesia has been painfully slow, with the bulk of the existing network being built prior to the Asian financial crisis of 1997/98. The principal reason for the slow progress has been persistent problems with land acquisition. In addition, government guarantees are not available for the development of expressways.

On the land acquisition issue, it is expected that the new Land Acquisition Act (2012), and its ancillary regulations, will help to significantly speed up the process. However, as mentioned earlier, the legislation only applies to acquisition processes commenced subsequent to its enactment, while acquisitions initiated prior to its enactment will continue to be governed by the previous regulations, thereby perpetuating the uncertainty that has plagued a number of major expressway projects, particularly in Java.

To date, a total of 87.51km of new expressway (mostly in Greater Jakarta) are at the contract negotiation stage with PPP sponsors, while 9.7km are currently under construction in Bali. In all, a total of 14 potential PPP expressways worth $33,147.53 million have been identified by Bappenas.

In the rail sector, the bulk of Indonesia's rail network is focused in Java, which is densely populated and thus ideal for both passenger and freight services. Despite this, the history of Indonesian railways since independence has been a sad one, at least until recently, with many lines being closed or abandoned since the 1970s. At present, the country has some 6900km of track, of which only around 4800km is in use.

Until the Railways Act (2007) and its subsequent amendments, Indonesia's rail sector was the domain of a state railway monopoly. The sector has now been liberalised and PPP schemes are encouraged. However, the uptake has been slow in populous Java, possibly due to government-mandated fare caps and the poor reputation of state rail operator PT KAI.

The story outside Java is different, with a number of major railway projects (both private and PPP-based) planned for Sumatra and Kalimantan (Indonesian Borneo) on the back of the coal boom of recent years.

Indonesia has become the world's biggest exporter of thermal coal, mainly from Sumatra and Kalimantan. To date, the coal has been transported along narrow country roads in Sumatra, much to the chagrin of local people, or by barge along Kalimantan's wide rivers, such as the Mahakam.

In all, Bappenas has identified three potential PPP schemes in the railway sector worth a total of $4783 million. Only one project is actually underway: a dedicated coal railway in Central Kalimantan Province from Puruk Cahu to Bangkuang and eventually onwards to the coal port of Lupak Dalam. The project has commenced but has been delayed due to the need to revise the proposed alignment as a result of its likely impact on protected peatland areas.

Ports

If Indonesia's economy is to achieve its long-term growth potential and meet the targets set in the MP3EI, it is essential that its port infrastructure be upgraded. The country has some 2000 ports, most of which are state-owned and managed, and almost all of which fail to meet modern efficiency standards. Bappenas has identified four port projects worth $2875.12 million that are suitable for development as PPP schemes. While work has not yet begun on any of these, one project is ready for offer, namely, the Tanah Ampo Cruise Terminal in Karangasem, Bali.

Aviation

As an archipelagic nation made up of 17500 islands, Indonesia has become enormously dependent on air travel since the liberalisation of the sector a decade ago. With the advent of low cost carriers, the country now boasts one of the most rapidly expanding domestic air traffic markets in the world, with passenger numbers increasing from 43.8 million in 2009 to 58.85 million in 2011. The Ministry of Transport's directorate general of civil aviation predicts that the industry will grow between 15 and 20% this year.

Bappenas has identified a total of four projects worth $1,354 million in the aviation sector for development as PPP schemes, of which none are as yet underway.

Environmental technology

Indonesia has fallen badly behind many of its neighbours in terms of environmental health and sanitation, and now faces an uphill struggle to bring adequate clean water and sanitation to a rapidly growing population. Demand for clean water is increasing on the back of economic development in both urban and rural areas, plus a burgeoning middle class. While it is expected that around 50% of the Indonesian population will have access to clean water by the end of 2012, this proportion is still far below the Millennium Development Goals (MDGs) for clean water access. Similarly, the level of access to adequate sanitation is also extremely low.

Bappenas has earmarked 24 sanitation and water supply projects worth $2431.82 million for development as PPP schemes, with negotiations or work having commenced on three of these.

How much longer for the Masterplan?

Among the most entrenched of the challenges for PPPs are corruption and legal uncertainty. There is also a lack of coordination between governmental agencies at central and local levels. This is related to regional autonomy, introduced in the late 1990s, which accords wide-ranging powers to municipal governments. This has given rise to constraints in many sectors as inadequate governmental capacity, corruption, vote-buying and other abuses have resulted in local governments frequently clashing with the centre over the issuance of mining permits and zoning rules, among other things. A recent example is the Sei Mangke special economic zone in Simalungun County, North Sumatra Province, where the local government is adamantly refusing to rezone land from agricultural to industrial use for the construction of a new Unilever plant.

Other constraints persist, such as the fear of changes in government policy in response to short-term political exigencies, the continued unavailability of gap funding (hopefully to be remedied soon), and weak preparation of PPP schemes, all of which tend to discourage investment by financial institutions.

In addition, with President Yudhoyono having less than two years left in office, many wonder whether the MP3EI will survive the advent of a new administration.

Nevertheless, the Government to date appears serious about implementing the Masterplan, and has produced an impressive collection of documentation, facts and figures to back up its intentions. The PPP regime seems quite robust and workable, as evidenced by the progress of the Central Java IPP scheme, while the establishment of the IIGF, SMI and IIF should help kick-start financing flows.

Ibrahim Assegaf
 

AHP

Ibrahim Assegaf is a partner at AHP and a member of the firm's general corporate practice group. He advises both domestic and international financial institutions on project, corporate, and government financings, as well as on insolvency and debt-restructuring issues. He has been closely involved over the last few years in the Indonesian Government's 10,000 MW power sector development programme. With an undergraduate degree in law from the University of Indonesia (1997), he spent time as a visiting research fellow at Harvard Law School's East Asian Legal Studies Program (2002-2003), before earning an LLM in 2009 from the University of Melbourne. He has played an active role in various reform initiatives, including advising the Indonesian Supreme Court's Judicial Reform Committee, and a law-reform project funded by the Australian government. In 2005, Assegaf was presented with an Asia Foundation 50th anniversary award in recognition of his contribution to legal reform in Indonesia.


Yanu Wiriasmoko
 

AHP

Yanu Wiriasmoko is a banking & finance partner at AHP. A licensed capital markets attorney, he has brought his considerable knowledge to bear on a wide range of project financings in the Indonesian power and toll-road sectors. He also advises on debt restructurings and private placements, and has played key roles in a series of major transnational M&A deals. A member of the International Swap Dealers Association (ISDA) and the Asia Pacific Loan Market Association, Mr. Wiriasmoko holds degrees in both economics and law from the University of Indonesia, and has attended courses on advanced lending in Hong Kong and derivates in Singapore. He is currently studying Islamic finance in Malaysia.


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