Unlocking potential

Author: | Published: 24 Apr 2015
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Indonesia has tremendous potential, but has traditionally been held back by poor infrastructure and graft, as Wayne Palmer of CLSA Capital Partners explains

Indonesia is already the fifth largest economy is Asia and the largest in Southeast Asia. It managed to sustain growth throughout the global recession and its potential as a place to do business is underscored by favourable trends reported by the World Bank, as well as the advantages conferred by its demographics and natural resources.

The country's new president, Joko Widodo, popularly referred to as Jokowi, swept to power in last year's elections promising widespread economic reform. Jokowi is the first businessman to lead the country and his presidency looks to be a friendly one for investors coming to Indonesia's shores.

The president is aiming to see growth hit 5.7% this year, with a target by the end of his five-year term of seven percent. Since taking office on October 20 2014, Jokowi has cut fuel subsidies and introduced a state budget focussed on a much-needed increase in infrastructure spending.

"The shift away from fuel subsidies to infrastructure is widely regarded as being a positive driver of growth"

Indonesia had been subsidising fuel since the 1970s and it kept prices at less than $0.20 per litre until 2005. Fuel subsidy cuts have traditionally led to widespread protests in the past, including riots over the cost of living that helped to bring down the regime of General Suharto. However with the impact cushioned by falling oil prices, the response this time has been relatively muted, allowing Jokowi some leeway to pursue his economic reform programme. And with around $18 billion in savings from the fuel subsidy cut, the new government will be able to double spending on transport, agriculture and public works such as housing.

However the country has traditionally faced a number of challenges, not least graft. Meanwhile, improving Indonesia's creaking infrastructure will not be a quick or easy task. Jakarta sees constant traffic jams and roads outside the capital are even worse. Manufacturers complain of difficulties getting their products from factories to sea ports and airports.

Wayne Palmer, chief operating officer and head of legal & execution, SE Asia, at CLSA Capital Partners, the alternative asset management arm of CSLA – explains that responding to these challenges successfully, as well as enacting judicial reform, will be key to unlocking Indonesia's potential.

The World Bank's latest Doing Business report sees Indonesia up three places from last year. What do you think makes Indonesia an increasingly attractive place to do business?

Where Indonesia is concerned, it has huge potential as a consequence of its favourable demographics and natural resources. Widodo's government has come to power with promises to tackle some of the graft issues that have held Indonesia back in the past and also with promises to accelerate spending on infrastructure. These are two good indicators of the reasons for increased optimism going forward.

Nevertheless, navigating the business environment in Indonesia remains challenging for overseas investors and change is unlikely to be straightforward or fast.

A long-term, broad ranging and coherent infrastructure spending programme is critical. Improvements in many government agencies are required and, crucially, there would need to be serious improvement to the judicial system for the ambitious economic growth plans that Widodo has to bear long-term fruit in taking Indonesia's economy to the next level.

How has graft held Indonesia back in the past?

Graft is not an Indonesia-only issue, but the array of cross-border anti-bribery legislation to which offshore investors are subject – be they financial investors or strategic – can make the process of investing in or doing business in jurisdictions with acknowledged issues with graft more challenging and must have been a contributory factor which has led to investment that may otherwise have come into the country being held back entirely or at least scaled back.

How is the judicial system currently letting down offshore investors?

The judicial system is inefficient and outcomes very unpredictable. This is exacerbated given the ambiguous nature of many of the laws themselves which make it a difficult environment to operate with at least some confidence of how commercial disputes that may arise may be decided and, once decided, judgments enforced.

Are Bank Indonesia's 2014 rules requiring corporates to hedge their external commercial borrowings too heavy-handed?

I would not categorise them as heavy-handed. On the contrary, I am of the view that the measures have the potential to be sensible ones to enhance prudence in foreign exchange planning.

"Navigating the business environment in Indonesia remains challenging for overseas investors"

However, like all such measures, there is a period of adjustment and reaction required from the market. Primarily, the extent and scope of application needs to be ascertained and then the mode of enforcement and extent of sanctions for non-compliance will take some time to crystallise.

In addition, the possibly unintended consequences of the range of the measures may need to be ironed out. For example, in the initially published regulations there was a view that companies with their revenues denominated in US dollars may be disproportionately caught by the hedging ratio rules because of the way 'Foreign Currency Liabilities' and 'Foreign Currency Receivables' were defined. This has now been rectified by a revision to the rules that was issued very quickly but is perhaps an indication of the impact of the regulations not having been comprehensively thought through.

What reforms would you like to see to enhance Indonesia's investment climate over the coming years?

There are a number of issues that have and will continue to hinder Indonesia's growth and investment climate. One of these is poor execution of the infrastructure expansion plans as this will ensure that Indonesia's weak infrastructure will continue to be a drag on the productivity and investment climate.

However, for the infrastructure programme to be most effective, other, more structural issues need to be addressed. For example, the process by which the infrastructure projects are awarded needs to be robust and transparent and the court system needs to be improved in order to give, particularly offshore investors, the confidence that proper, efficient and impartial legal redress is available in the event of commercial disputes. This will not be easy to achieve on the timescale within which the infrastructure programme needs to be rolled out and so it remains an obstacle.

Finally, there needs to be a continued investment in education to deepen the talent pool available. Whilst Indonesia has favourable demographics, it needs to combine this with increasing the education and skills levels of those people to compliment the ambitious economic growth plans.

Where do you see opportunities in Indonesia over the next two years?

Infrastructure, being a focus of the Widodo government, presents many opportunities in the near-term. The shift away from fuel subsidies to infrastructure spending is widely regarded as being a positive driver of growth and the ambitious plans the Widodo government has for a large scale increase on existing road, port, airport and power capacity will present many opportunities.

Given Indonesia's burgeoning middle class, the consumer sector has long been regarded as being full of opportunity. The share of GDP represented by consumer spending is relatively high in comparison to other parts of Southeast Asia and is a reason why Indonesia has for some time been on the radar for companies looking to expand in the retail and food and beverage spaces.

About the contributor

Wayne Palmer
Chief operating officer and head of legal & execution – SE Asia, CLSA Capital Partners (Singapore)

T: +65 6512 2359
M: +65 9788 6870
E: wayne.palmer@clsa.com
W: www.clsa.com

Originally based in the UK, Wayne Palmer has spent over 10 years in Asia, initially with global law firm Clifford Chance, moving to CLSA Capital Partners in 2009.

While at Clifford Chance, he focused primarily on equity and quasi-equity investment work for financial investors with a particular focus on Indonesia and India. He has spent time living in Jakarta. Since moving to CLSA Capital Partners, he has been primarily covering South East Asia, China, India and Australia with responsibility for the operational, transactional, fund raising and regulatory compliance support to multiple, cross-sector private equity and hedge funds. Palmer has extensive Indonesian transactional experience across multiple sectors.