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Indonesia has changed little since the fall of the Suharto regime and the regional crisis that led to the highest levels of restructuring and defaults ever seen in Asia. It has lagged behind most of its neighbours and been regarded as somewhat of a pariah. Given the potential of this resource-rich nation, are the risks so very high and the returns – however attractive – uncertain


Indonesia remains at the mercy of its history. During a recent visit by Singapore’s founding father, Lee Kuan Yew warned Indonesia’s lawmakers against slipping back into the KKN (or corruption, collusion and nepotism) mentality. KKN lay at the heart of the negative business environment at the end of the last century; inefficient and contradictory bureaucracy, poor rule of law with no binding precedents, corruption at the highest levels and a total lack of transparency.

A decade on, has anything changed and perhaps more importantly, what are the priorities for change

  • Mark Cooper, Managing Director of TFCB Brokerage in Hong Kong, explains.

    Worthy progress made
    The administration of the current president, Susilo Bambang Yudhoyono (SBY) has received international plaudits for its reform in foreign direct investment (FDI) rules, proposed revision of tax regulation, its high profile fight against Islamic extremism and corruption.

    Other successes include: removal of fuel subsidies and greater governmental efficiencies, especially within debt ratios that are expected to fall to 30% by 2009 (The Economist, May 27, 2007). Gradual and considered autonomy for the provinces has been granted allowing local authorities a share of revenues from production. The establishment of special economic zones, such as Bintan and Batam, have been a success, not least because of their proximity to Singapore and confidence from foreign investors, especially the Japanese.

    The administration has entered into, or proposes cooperation, with many foreign governments including Japan, Korea, Malaysia and Australia. Many of the free trade agreements are based around the overriding desire of Indonesia’s partners for commodity security; primarily energy. Indonesia as a non-aligned country, convenient for the manufacturing regions of Asia and offering a welcoming smile to investors, is high on shoppers’s lists.

    SBY’s government is less popular with its electorate; satisfaction ratings at 38% have halved following his accession and disapproval of a wide range of issues is both vocal and damaging reform. The 2003 Labour Law may be regarded as having the most negative effect upon FDI, yet proposed revision is seen by workers’s groups as being an attack on their rights.

    The penalties and lack of flexibility both discourage FDI and indirectly lead to abuse of workers’s liberties, such as the PT Dong Joe Indonesia factory in a suburb of Jakarta. The owners of the factory manufacturing shoes for Reebok declared bankruptcy in 2006 and, no doubt due to the enormous costs of retrenchment, immediately abandoned the facility. Some 6,500 employees were still in occupation in April 2007 when they staged the latest in a series of rallies in support of Rp100mn of unpaid wages.

    Such social unrest is not uncommon, although not widely reported. It is likely that greater influence of corporate social responsibility (CSR) programmes and Equator Principles application will lead to such situations becoming a greater source of dissent.

    Despite the recent positive sound bites some recent developments, especially emanating from the judiciary, are a cause for concern:

    • Discriminatory legal ruling against the Manulife Group.
    • Cancellation of an international bond by Indah Kiat – part of the Asia Pulp & Paper group – allowing the issuer to default on US$257mn of debt. The Supreme Court ruled that the original transaction was illegal.
    • Ongoing legal action against a Newmont Mining Corp executive. The company admits its share price is underperforming gold, and problems in Indonesia, which include sabotage at one of its sites and unclear legal positions, have contributed to this situation.
    • Energy ministry cancellation of an exploration contract with Exxon Mobil. Negotiations continue, but Exxon Mobil had reportedly spent US$360mn on the Natuna D Alpha field.

    Nationalist views regard the above and other similar actions as ‘correcting’s a situation where foreigners were allowed to negotiate contracts that were regarded as being exploitative. Unfair or not, the contracts were legal and the discriminatory practices have led to an ongoing crisis of confidence.

    Driving the economy
    Many trade and project finance transactions are being proposed in Indonesia. How many will be completed will depend upon a series of factors.

    Ongoing demand, return on investment, contract certainty, sovereign protection and operational security will all contribute to projects under review. The trade sectors involved are skewed towards energy in the widest sense: coal, oil, power purchase agreements, and palm oil and related products and assets.

    These sectors, and the economy generally, are benefiting from increased commodity pricing. The use of prepayments and other pre-export financing tools are being supported by an increasing level of insurance, in all areas of the supply and investment chain.

    Longer and larger transactions are being supported; lenders’s cover includes third party assets and the interlinking of the ‘chain’s offers opportunities for both greater protection and increased income for the insurers who are well-rated and flexible to seize the opportunity.

    The current economic situation for Indonesia is relatively positive:

    • Consumer confidence rose to a five-month high in May 2007 (Bank of Indonesia/Central Bank survey).
    • Inflation has fallen to 5.77% in May due to a stable rupiah and rice prices.
    • Interest rates have been cut to a low of 8.25% in July 2007.
    • Banking sector results have been positive, despite mismatches in Bank of Indonesia and commercial banks benchmark rates.


    • Inflation is unlikely to fall much further.
    • Bank credit growth of 16.5 year-on-year is still below desired levels.
    • Money supply growing faster than bank lending = potential inflationary pressure.
    • Investment plunged year-on-year in 2006; by 32% for domestic, and 33% for FDI.
    • Infrastructure bottlenecks remain, especially in manufacturing and transportation.
    • High levels of unemployment and declining purchasing power of the poor.

    The Investment Law announced in 2006 was recently clarified by the publication of further details concerning both encouragement (banks, power sector and the oil and gas industries and others) and restriction (public health, environmental). The trade minister claimed that 69 sectors would be more open than before, with 11 becoming “more restrictive”.

    The key features include: improved tax incentives and property rights for foreigners, equal treatment and nationalisation compensation, incentives, easier immigration and licensing procedures and the introduction of special economic zones (SEZs). It remains to be seen how these will operate in practice and if they can be translated from press releases to legislation.
    Blueprint for success

    There are certain immediate changes that should be made:

    • Clarify the FDI laws with a greater clarity regarding dispute resolution.
    • Revise the Labor Laws – if not by legislation, the regulatory changes.
    • Link projects and government income to success, including the use of sovereign guarantees. Many projects are stalled because prospective investors do not feel that the government is taking enough responsibility.
    • Demonstrate the rule of law and reliability of legal decisions.
    • Improve transparency and encourage socially responsible investing.
    • Combine government departments and reduce bureaucracy.

    In order to impact positively upon the 2009 elections, the government would be advised to introduce these amendments now, despite the inevitable protests. If the poor are subsidised, as with benefits that replaced fuel subsidies, and it is the wealthy that must pay a more equitable share, SBY may weather the storm.

    There are several motivations for success, but simply put, given the current interest rates, the GDP is too low at 6% growth. It is estimated that 2.5mn people per year will be looking for work and FDI will be a necessity to support the growth required for job creation.

    All of the above changes will have a positive effect upon the ongoing concerns exhibited by potential and current investors. Whilst resource nationalism, social and Muslim disagreements and economic and natural disasters are inhibitors, growth will be set on a positive path.

    There are no ‘good or bad countries’s in emerging markets, and there are no risk mitigators that will transform a bad risk into a good one. However, if the fundamentals of a transaction are solid, then insurance will assist in the transfer of perils, essentially spreading the risk. Political risk insurance has never been more cost-effective and its usage may encourage uptake of transactions.

    The medium-term path is positive. If the current administration can walk a fine and determined line, that line may lead to a sustainable improvement in the stability and standards of living in one of Asia’s largest markets.