Long-Term Investing, Infrastructure and Development Indonesia Business

Business Working Group Indonesia...

Private investors are cautious when it comes to large and long-term infrastructure investments. In particular, they are concerned about political and regulatory risk because an infrastructure asset typically has a lifetime much longer than political cycles, and investors’ revenues and cost base depend heavily on regulation. During the different stages of a project’s life cycle, infrastructure projects are exposed to different types of political and regulatory risk. In addition, some broader risks, such as changes to sector regulation or taxation laws and endemic corruption, apply throughout the life cycle and can affect an entire infrastructure sector (or even the entire national economy). To identify all these risks, the author has developed a risk landscape that categorizes 14 types of political and regulatory risk; differentiated 2 categories - risks affecting a specific project and risks affecting the entire economy. To address those risks, the author proposed a risk-mitigation framework, which lists 20 measures that can be taken by the public sector, the private sector and jointly by the various stakeholders. The framework enables policy-makers and companies to undertake a comprehensive effort to mitigate political and regulatory risk.

The public sector can enhance political and regulatory stability by enacting and enforcing appropriate laws and regulations. The specific regulation of each infrastructure sector should be robust, with changes to sector rules that are as predictable as possible. Beyond specific sector regulation, the overall legal architecture must also be considered; it should be conducive to a stable regulatory environment, by providing constitutional guarantees or dedicated investment stability laws. Legislation alone is not enough, however. The laws and regulation need to be stringently implemented by the country’s executive branch. To mitigate the risk of unexpected and adverse administrative decisions, governments need to ensure a reliable agency set-up, with efficient procurement and permit processes that never compromise on their integrity, as well as strong anticorruption measures. Investors and the government also need to have confidence in the available dispute-resolution mechanisms, so countries must ensure a judicial capacity that administers the law in an independent, timely and efficient way. Further protection for investors can be provided by international commitments, bilateral investment treaties (BITs) and investment protection clauses in free trade agreements.

Within the framework set by the public sector, the private sector has to find ways of managing and mitigating political and regulatory risk. For “hard” risks, such as expropriation or currency inconvertibility, companies can use financial instruments such as political-risk insurance or guarantees, issued by multilateral organizations, national providers and the private market. In addition, political and regulatory risk can be mitigated by a carefully crafted ownership structure. International co-owners and co-financiers – such as multilateral development banks or institutions from an investor’s home country – can have a “deterrence” effect on political intervention, and joint ventures with local partners can enable an infrastructure operator to be viewed as more than just a “foreign investor”.

Mitigating political and regulatory risk enough to boost private-sector investment is a huge challenge and will take a dedicated effort by all stakeholders involved. A balanced and conducive regulatory environment with low political and regulatory risk is not something that can be created overnight. It will emerge only through a sustained and cooperative effort by all stakeholders. In addition to discussions at the global and regional levels, multistakeholder dialogue is needed to align views on the actual manifestations of political and regulatory risks at the national level, considering the particularities of domestic political landscapes, country infrastructure programmes, and country-risk profiles. More importantly, such analysis is necessary to design effective mitigation strategies that respond to the specific country conditions. Therefore, the author has conducted a series of country-level assessments to identify and characterize the main manifestations of political and regulatory risks in infrastructure projects.

A typical assessment exercise consists of gathering 15- 20 participants from government, regional development banks, experts, industry associations and decisionmakers from the relevant economic sectors (private and institutional investors, banks, insurers, and infrastructure and construction companies). The discussion sequentially focuses on risks that have the greatest impact and likelihood of occurrence. The second part of the exercise acknowledges the actions taken by the public and private sectors to mitigate such risks and identify the areas with greatest need of development.

Country Profile...

Indonesia is the world’s 16th largest economy and the country’s infrastructure investment opportunities are abundant. The Ministry of National Development Planning has estimated that $366.7 billion needs to be invested in infrastructure development from 2015 to 2019. The private sector will need to play a significant role as fiscal constraints leave the government little room for expanding public investment at the scale required.

As acknowledged by the BWG, the Indonesia government has pursued a range of regulatory and institutional measures in recent years to reduce risk for investors. These include establishing a guarantee fund, viability gap funding, expanding the number of sectors eligible for public-private partnerships (PPPs), and introducing availability-based PPPs. Despite this, Indonesia has yet to experience the much-awaited breakthrough to establish it as a legitimate and competitive destination for privately financed investment in infrastructure. Even though PPP schemes have been in place in Indonesia for almost 10 years, only a few projects have been awarded. This has been mainly attributed to the difficulty of land acquisition, the high degree of regulatory uncertainty and the general lack of attractive PPP deals for the private sector.

Moreover, Indonesia has been subject to frequent highlevel political changes recently. In July 2016, in his second cabinet overhaul in less than two years in office3, President Joko Widodo reallocated 13 posts and brought in nine new faces, which included new appointments to strategic positions in finance, industry and trade. These frequent changes are not only disruptive to the development of long lead-time projects, such as those in infrastructure, but can also make investors wary. Paradoxally, a majority of BWG members take a more positive view. They see President Widodo in a stronger domestic position as a result of the changes and a smart assignment of more progressive and experienced ministers to his cabinet. The BWG agrees that if the new cabinet pushes reforms, it will have an overall positive impact on Indonesia’s infrastructure programme. In the meantime, the country is pursuing its ambitious objective to become ranked 40 in Ease of doing business (currently ranked 109). Success will depend on Indonesia’s ability to increase investors’ confidence by getting the risk model right – including a solid, predictable and wellstructured political and regulatory framework. In this effort, the BWG continues to play an important role in fostering valuable private-public dialogues and by continuing to empower policy-makers that have the courage to bring positive change and innovate. The sections below highlight the main manifestation of political and regulatory risk in Indonesia and include countryspecific examples.

Assessment: Manifestation of Political and Regulatory Risk in Indonesia...

The BWG identified two baskets of risks in Indonesia, namely risks with the greatest impact and risks of the greatest likelihood. Among those are:

- Cancellation and change of scope risk

- Environmental and other permit risk

- Change of industry regulation risk

- Community opposition risk

The BWG members were broadly concerned with two areas that are fundamental to the risks listed above. First, the proliferation of regulatory agencies and number of required permits; and second, the unpredictability of regulatory/policy changes because of political discretion and other factors. Therefore, the required mitigation measures seek a roadmap for navigating the bureaucracy and provide an “early warning” to possible policy U-turns. The BWG continues to call for improvements in this area, which would reduce the risks and costs of participation in any PPP and free up resources both for the Indonesian government and industry to concentrate on making more rapid progress.

Assessment results...

Among the major risks identified in Indonesia, cancellation and change of scope was pointed out as the one with the highest impact. There was a consensus that project cancellation represents heavy financial losses for private companies as they usually have made large investments in preparing their project proposal. In addition, a decision by public authorities to change the project scope at a late stage has costly consequences for the private participants in the project.

Examples:

- Cilamaya Port: cancelled

- PLTU Jawa 5: auction cancelled

- Priok Port: changes in project scheme from PPP project to designation to Pelindo II/IPC

- Soekarno-Hatta International Airport to Manggarai railway Link PPP project: PPP scheme cancelled

Regarding the risks associated with the greatest likelihood, it seems that Indonesia’s biggest challenge remains environmental and other permit risks. Construction permit delays have a severe impact on a project’s profitability, as cash flows start later than anticipated. Even permits issued promptly sometimes contain unforeseen and costly conditions, such as compensation requirements or usage restrictions.

BWG members highlighted the need for more transparent and predictable mechanisms, including an adaptation of the current legal framework.

Examples:

- Energy sector: 1,400 different permits required for one project

- Reclamation project in Jakarta area: environmental experts and activists opposed to the project

- Jakarta-Bandung high-speed train project: delay in permitting and licensing

The change of industry regulation risk is also a main area of concern for investors (impact and likelihood). The BWG would encourage the government to increase the stability and predictability of its regulatory frameworks. Equally important would be a continued engagement of industry players on regulations and policy changes, and implementation of any changes in a phased, measured and consultative manner that gives companies enough time to adapt and adjust.

In addition, weak coordination and cooperation between the central and local governments makes planning difficult, causing regulatory uncertainty. An increased level of communication and coordination between agencies involved in Indonesia’s infrastructure development would help to accelerate the country’s infrastructure project delivery. This will require enhanced dialogue and education at all levels. In this context, BWG members agreed on the importance of increasing capacity-building both at national and subnational levels. Some of the key PPP agencies are also focusing significant efforts in this area, as illustrated by the establishment of the Indonesia Infrastructure Guarantee Fund (IIGF) Institute to support capacity-building and increase PPP awareness.

Examples

- Water projects: revocation of the Water Resources Acts by the constitutional court

- Go-Jek case

Some types of risk, such as community risk (likelihood), were raised. Those risks can be especially high if projects involve land expropriations and relocations, as illustrated by the uncertainty around the planned Indonesia-China high-speed railway development programme, or the land rights issues which complicate the government’s intention to offer more toll-road projects as infrastructure PPPs. The BWG highlighted the importance for industry to engage its community stakeholders actively and for the government to ensure that the community is brought along in an inclusive manner for a smooth transition from a project’s planning to construction/operations.

Example:

- Jakarta IPALT (Instalasi Pengolahan Air Limbah Terpadu) project: rejected by community because of project location near a residential area

Even though the anti-corruption and transparency risk hasn’t been specifically identified during the assessment exercise, there seems to be a consensus among the BWG members that a strict implementation of anti-corruption and transparency standards remains a concern in some areas. Sometimes, the manifestation of corruption is institutionalized and appears under different forms of risk, up to and including cancellation of projects. In other cases, there is a feeling of “invisible barriers” on the part of the government to develop and execute infrastructure projects. Transparency standards and their implementation are very different between federal and local levels. There are also disparities at the subnational level. Therefore, standardized anti-corruption training of public officials should be extended to all levels of government. It also requires developing mechanisms to increase accountability of public actors.

Mitigation Measures: Availability and State of Development in Indonesia...

Assessment results

The mitigation measures with the greatest degree of development in Indonesia are: effective interaction with the public sector (monitoring political developments and advocacy strategy) and inclusive community engagement (ongoing community involvement during project operation). The BWG believes that the private actors generally make a conscious effort to facilitate constructive interaction with the public sector and local communities at a project level. Specifically, the BWG gave credit to Indonesian e-commerce regulators that have been actively conducting studies with industry associations and key business players, and have also sought to involve both established and new players to better understand market momentum and regulatory concerns. There was also a balance struck between enabling entrepreneurs, while protecting consumers. The BWG encouraged a broader application of such an inclusive process to other sectors and to include foreign companies, especially for infrastructure PPPs, to prevent misunderstandings and create transparency.

Examples:

- Batang coal-fired power plant (PLTU Batang): first PPP project to reach financial closure

- Cipali toll road project: ongoing CSR programmes monitored by an independent consultant Another area of existing mitigation measures is risk guarantees and political-risk insurances. The BWG recognizes that the risk model has fundamentally changed in recent years. The government established the Indonesia Infrastructure Guarantee Fund (IIGF) to improve the creditworthiness and quality of PPPs in infrastructure projects. The fund establishes a clear and consistent appraisal and claim framework, provides guarantees to wellstructured PPPs, and minimizes sudden shocks to the state budget.

Example:

- Palapa Ring project: guaranteed by the IIGF On the other hand, rules that are adaptive in a predictable way represent the greatest need for development in Indonesia. The BWG members would welcome more predictable rules while maintaining a balance between public and private interests over time. Automatic adaptation mechanisms could be a good solution as they buffer exogenous revenue and cost risk, thereby eliminating the need for parliament or government agencies to intervene.

Example

- Renewable power: implementation of feed in tariff for renewable electricity such as mini hydro, solar power and biopower

An additional need for improvement manifests in the area of reliable administration & clear agency set up & anticorruption standards. At the state level, the working group recommends the government to restructure and reorganize the working relationship of the key PPP agencies, namely the Infrastructure Priority Unit – KPPIP under the Ministry of Coordinating Economic Affairs, the PPP Unit under the Ministry of Finance and the National Development Planning Agency or Bappenas. The different agencies still require a high level coordination to overcome current barriers to implementation. At the individual level, public officials are not incentivized to move project implementation forward. One suggestion was to evaluate public officers according to the quality and number of projects they were able to achieve, copying the private sector performance evaluation model.

Outcomes and Next Steps...

–– To increase transparency and accountability, the BWG will continue to support the development of a transparent project information platform in close collaboration with the Committee for Acceleration of Priority Infrastructure Delivery (KPPIP).

–– The BWG is keen to increase capacity-building by providing sector-specific training (at project, municipal and national levels). The BWG members expressed interest in in working with some of the standard operating environment in the energy, transport and water sectors. The BWG will further explore possibilities of collaboration with different Indonesia stakeholders to enhance capacity-building within the public agencies.

–– One major area for further development remains an open multistakeholder dialogue beyond specific projects. The BWG will persist in having open and continuous discussions with the public agencies and pursue its dialogue with the key regulators (Bank of Indonesia, OJK and Ministry of Finance) to facilitate access to local currency, long-term finance and guarantees. The BWG will also continue to build a strong relationship with key players such as the IIGF.

–– It was agreed that the Ministry of Development Planning of Indonesia can play a critical role in supporting the BWG efforts.