A change in Indonesia’s mineral export laws is threatening financial growth in the short term, but those investors looking to wait it out are set to reap the benefits. Shannon Manders reports.
Indonesia’s January ban on raw mineral exports coupled with rising export taxes is changing the face of the country’s mining industry. The imposed rules have been met with mixed reviews: the move has been hailed as a manifestation of what foreign investors call ‘resource nationalism’, with many believing that it will wipe out billions of dollars in revenue. On the other hand, the Indonesian government has insisted that the decision is in line with the growth of what it refers to as a “value added” economy and that it will lure investment into processing capacities, create more jobs and keep profits onshore.
It’s only natural for a country as mineral rich as Indonesia to at some point move from a pure extractive industry to one that’s more all-encompassing and, ultimately, profitable. Hotly-contested Mining Law No4/2009 stipulates that Indonesian minerals have to be processed domestically before they’re allowed to be exported.
“Indonesia wants investors to continue to support the economy, but in a different way,” says Michael Lum, underwriter for Beazley’s political risks and contingency group in Singapore, speaking to GTR on the back of a visit to the country.
The Indonesian authorities have also been criticised for not giving historical investors a clear picture of the new policies from the outset, which some believe has led to decreased confidence in the market.
“My own view is that investors generally want certainty over anything; if they knew what was coming, they could ensure there is adequate provision for that,” Lum adds. Even though the law was first passed in 2009, foreign investors anticipated that it would never see the light of day. “Perhaps that surprised them – that it came in very short order in January this year,” he says.
The way in which the government proceeds with its plans is critical. With a strong need for investment, the country cannot afford to grind down the confidence of investors, who equally don’t want to miss out on an opportunity to earn big profits.
“How the government takes this forward will be crucial,” says Aashish Pitale, group treasurer of Essar Services India. He tells GTR that clarity on the rolling out of the implementation plan and timely regulatory approvals, coupled with simple processes for the setting up of smelting and processing capabilities will be the “need of the hour”. “Recently there was news of 20 ships to China being held up for unclear documentation: wait and watch on that front,” he adds.
Nevertheless, those investors that feel that they may have been burned by the new rules and choose to give up are likely to simply be replaced by new investors keen to take a chance and reap the benefits.
“Indonesia will continue to remain a place where investors want to do business,” says Lum.
The role of banks doing trade finance business in the country could be set to change too: those that previously financed exports may now turn to invest in the mineral smelters and other infrastructure that the country needs. Risman Firmansyah, Citi’s senior vice-president of trade product in Indonesia believes the situation presents an “open opportunity” for banks. “Yet full due diligence and credit assessment must be conducted to see the feasibility and opportunities for the names,” he says.
Specifically, only nickel and bauxite ore exports have been completely banned; other mineral exports will be regulated by a piecemeal tax that will rise from the current rate of 20% to 60% in 2016. The government is still considering how to proceed with the export tax – it may be delayed until 2017.
Interestingly, copper has been excluded from the ban. One of the theories is that when it comes to the export of copper concentrate, the bulk of value-adding takes place in the mining and concentrating of the mineral – it is little enhanced during smelting and refining.
The country’s major resource exports of LNG and coal, which account for the largest share of total resource exports, are also unaffected by the ban. Indonesia is the world’s biggest exporter of nickel ore, thermal coal and refined tin.
By banning the export of unprocessed mineral ore, authorities are forcing miners to develop smelting capacity in country – and the 66 companies that have committed to developing processing facilities are exempted from the export ban until 2017.
Unsurprisingly, the initial effects of the new rules have not been favourable. According to the Indonesian Mineral Entrepreneurs Association, the ban has already led to the lay-off of almost 30,000 mine workers as mines scale back their operations. More than 100 mining companies have been forced to reduce or shutdown their operations.
“Some banks have asked miners to repay loans, and some have already had difficulties with their buyers and suppliers because of the regulation,” Firmansyah at Citi tells GTR. “Smaller miners have no capacity to invest in smelters.” Even the larger mining companies, such as Freeport McMoRan and the Newmont Mining Corporation have complained about the costliness of building the infrastructure, Firmansyah says.
Those mining companies that have committed to build smelters are allowed to continue exporting until 2017, when the building is expected to be completed. However, they are only permitted to do so on the condition that they deposit US dollar-denominated guarantees in a local bank to ensure that they meet the deadline. “If they don’t build, they will lose their money and the government will stop their operations,” says Firmansyah, who explains that a monitoring system will be put in place by the government, which will track each company’s progress.
Although it’s difficult to quantify the impact at this stage, it is expected that the ban will have a drag on the country’s current account. “A fair estimate could be around 0.3% to 0.5% of GDP,” says Essar’s Pitale. The government’s loss of revenue from this ban could be around 0.1% of GDP, he predicts. (Mining only represented 7% of the country’s GDP in 2013.)
But it’s expected that a temporary drop in government revenues in the short term will be offset by a potential commodity price surge for the relevant minerals, additional jobs and longer-term profits
for the country.
“In the long-run, it will prove a huge advantage for Indonesia’s trade balance and the competitiveness of the industry,” says Margaret Tjahjono, head of trade product management at Bank Danamon. Indonesia’s economy minister has said that the law will become beneficial to Indonesia after 2016.
Of the hundreds of nickel miners in Indonesia, only PT Antam and PT Vale Indonesia currently process their ore domestically. The country has issued business permits for 28 smelter projects, but only three are expected to come online this year.
“Many of these planned smelters face high hurdles that prevent them from going ahead, including political risk, poor infrastructure and difficult labour laws,” says Rajiv Biswas, Asia Pacific chief economist at IHS.
Those miners that have pledged to complete their builds are speeding up their construction plans. Local company PT Bintang Delapan (BDM) is one of the few that have started building a nickel smelter, and started putting plans for the US$1.2bn project in Sulawesi last year in response to the new export laws.
Russia’s Solway is among the handful of international investors to have locked in their commitment to developing the country’s nickel business. The company is set to invest US$3bn to build a nickel smelter in North Maluku with the capacity to produce 50,000 tonnes of the metal a year. Production on the project is expected to begin this year.
Beazley’s Lum tells GTR that investors are concerned not just with the capital costs of investing in smelters and refineries, but also with the country’s poor infrastructure.
“If they want this bill to work for the good of the country, they need to improve their infrastructure and power. That is where they may face their biggest challenge,” he says.
A large portion of BDM’s budget will be spent on the development of its own power plant and infrastructure, while approximately US$900mn of the Russian firm’s investment will go towards supporting infrastructure, including transportation and communication set-ups.
If more investors don’t step up to the plate, then the likelihood that the world will look elsewhere for the banned mineral exports is high.
“If the escalating export tax is not postponed and remains in force, it is likely that some importers of Indonesian ore will seek other sources of production,” agrees Biswas at IHS. For example, Japan imports around 40% of its nickel from Indonesia, and may look to switch to alternative sources of supply such as Australia, the Philippines and New Caledonia. Also, “China is a significant importer of Indonesian bauxite and could switch to sourcing from other bauxite mines in Guyana and Ghana”, says Biswas.
“Australia will remain the first option, but Russia, Canada and South Africa may also be options,” adds Danamon’s Tjahjono.
Shares in a number of Australian mining companies have already rallied as investors bank on the fact that they’ll benefit as a result of Indonesia’s ban.
“Provided it remains a resource-rich country, which it is, investors will weigh up the cost and benefit analysis regarding whether or not a smelter or refinery will be a good idea, and I suspect the answer will be yes,” says Beazley’s Lum.
Beazley has seen a “huge” uptick in Indonesian enquiries, a flow which Lum believes will continue until the election period and beyond.
“To me, that’s an indication of two things: first that foreign direct investment is going into Indonesia, secondly that there is some concern from the investors as to the political climate,” he explains.
Whether or not the Indonesian government is overly-concerned with the challenges facing the economy at this point is hard to tell from the many press reports that have been put out.
The country is facing other problems too: political uncertainty in an election year, the tapering of US monetary stimulus, and a slowdown in China are just some of the factors currently at play. But an economic crash as a result of the mining crisis alone is unlikely, as the sector represents such a small portion
of total GDP.
Political and economic overview
One of the biggest questions hanging over Indonesia’s political outlook is whether or not the stability of the past decade can be maintained. Michael Lum, underwriter for Beazley’s political risks and contingency group takes a closer look.
Between the end of Suharto’s rule in 1998 and Susilo Bambang Yudhoyono’s (SBY) ascent to power in 2004, Indonesia was wracked with mass unrest, four changes of president, religious violence, separatist rebellions, terrorist attacks and coup rumours. SBY successfully imposed stability, but his tenure is coming to an end. Legislative elections are due in April, followed by a presidential election in July.
Success in the legislative election to the house of representatives determines which parties are entitled to put forward candidates for the presidency – only those with 20% of seats or 25% of the popular vote can, as a mechanism for ensuring broad-based appeal and preventing fragmentation. At one point there were 48 parties running for parliament. Now, SBY’s Democratic Party, and the Democratic Party of Struggle (PDI-P) and Golkar dominate. During the current parliament, Golkar has been a key ally to the Democratic Party in the governing coalition, but has raised the prospect of a long-term alliance with the PDI-P. Ideology doesn’t really enter into the picture; Indonesian politics is all about personalities. There is little clarity on economic policy on the frontrunners: the governor of Jakarta, Joko Widodo (Jokowi), former general Prabowo Subianto, former president Megawati Sukarnoputri and business tycoon, Aburizal Bakrie. Jokowi, appears to be the nation’s favourite but rather strangely, he is in fact not yet even a candidate.
Indonesia’s heavy dependence on foreign investment inflows will probably necessitate an easing off of resource nationalism, post-elections.
Other protectionist measures the government has passed in recent years have been a ceiling on foreign ownership of mining assets (requiring forced divestments of foreign ownership), and increased export tariffs and royalty payments. Offset against this, however, are more recent moves to improve the investment climate, such as allowing foreigners to own up to 49% of airports and 100% of power plants built under PPPs. The problem for the incoming government will be to create a more stable and predictable business climate to ensure that foreign investment decisions have not been permanently undermined by the recent protectionist measures, especially in an environment of global capital retrenching.