Look east: Infrastructure, mining and investment in Indonesia

September 2011 Authors: Nick Merritt, Lily McMyn

Contacts

Interest in investing into Indonesia is nothing new, despite the slowdown afflicting much of the Western world.  What is new, however, is an express acknowledgement from the Indonesian Government that Indonesia’s future growth is inextricably linked to the development of its infrastructure.  

In the mining sector, the current transport and infrastructure framework provides something of a headache, particularly to coal mining projects that rely on the transport of bulk coal over long distances.  One of the themes arising out of a survey1 that we conducted earlier this year on inward investment into Indonesia is that development of the transport sector is critical to overall growth in Indonesia.  Electrification and efficient transport corridors are key to economic development and these areas need to be prioritised.  Inefficiencies in the transport sector means that transport costs are relatively expensive in this archipelago of 17,000 islands - it can cost more to move goods within Indonesia than to ship them overseas.

As Indonesia is the world’s biggest exporter of thermal coal, the mining industry is a significant contributor to the country’s economy and future growth. With oil and gas prices remaining high and nuclear power continuing to be politically unattractive, demand for thermal coal is likely to remain strong, at least in the medium term.  At a local level, mining projects can dramatically alter the fortunes of remote communities, since part of the licensing process requires the mine developer to use a predominately local workforce. A commitment on the mine developer to make material contributions to the local community, which often takes the form of building schools, hospitals, bridges, may also feature.  However, a mining project’s transportation infrastructure in the form of bridges, roads, railroads and ports is an essential part of the overall business case; without it, a project may cease to be viable, to the detriment of both the local community and the country’s economy.

The Government recognizes the role that infrastructure development has to play in the Indonesian growth story. Economic growth predictions lie somewhere between 6% and 7%, based on Indonesia’s abundant natural resources, relative political stability, huge population and growing middle class. The Government’s growth aspirations are even higher, with a plan to raise growth to 9% by 2025.   However, infrastructure spending as a proportion of GDP lags behind its economic growth rate; at nearly 4% of GDP it is considered insufficient to sustain the current economic growth rate.

Addressing Indonesia’s infrastructure bottleneck is central to the Government’s Master Plan for Acceleration and Expansion of Economic Development 2011 - 2025, launched in July.  In developing the Master Plan, Government ministers have articulated the need to address the infrastructure deficiencies that are fundamental to achieving the Government’s aggressive economic growth goals.  

The role of the private sector in the Master Plan is significant, and the Government is now actively encouraging private sector participation in infrastructure as a way of increasing overall investment in infrastructure.  In early September, the Deputy National Planning Minister identified total infrastructure needs for 2010 to 2014 at US$225 billion, half of which will be funded via the state budget with the remainder coming from state owned enterprises and the private sector through PPP schemes.  Unsurprisingly, in our Norton Rose Group survey, 94% of respondents thought that the private sector has an important role to play in the development of energy and infrastructure projects in Indonesia.  

On a practical level, a number of measures have been introduced over the last few years to encourage infrastructure investment, including a swathe of new laws across the roads, railways, air and sea transportation, telecoms, power and mining sectors.  Other measures include the development of an anti-corruption commission, new tax incentives, regulations to establish a PPP framework, the introduction of the Infrastructure Guarantee Fund and the launch of the latest PPP Book produced by Bappenas2 to promote priority projects.  

While this is tangible progress, in the short term the introduction of new legislation can in itself be problematic. The mining sector, for example, has moved from a system of contractual rights over exploration areas to a system of mining licenses, which are essentially permits allowing mining activities to take place within a specified area without actually comprising any contractual rights over the land itself.   Some but not all implementing legislation has been issued, and confusion remains over tax adjustments for companies with pre-existing contractual rights converting to the new system.  Under the old system, all permits were issued by central government; under the new system the local governments issue permits, which has led to some problems of overlapping concessions and border disputes and the withdrawal or review of some 4,000 licenses.  

The issue of land acquisition continues and is relevant to mining and infrastructure projects alike; a draft new land acquisition bill to replace the 1961 law has been submitted to Parliament but it is not known when this law will be introduced.  We understand that the new law will require the central government to acquire land for certain infrastructure projects, which will avoid the issue of companies going to tender before acquiring rights over land.

Likewise, the 2010 regulations establishing a PPP framework leaves much of the detail surrounding the grant of concessions in key sectors such as ports to be established at a later date and the details of key incentives and funding are still in the process of being worked out.  Despite the difficulties posed by some aspects of the legal environment in this interim period, it is encouraging to see some real progress from the Government’s public commitment to infrastructure development.The Government’s challenge now is to channel the influx of investment in Indonesia to the infrastructure projects that will maximize the attraction of its huge reserves and proximity to an Asian market hungry for commodities.

Footnotes

1. Indonesia Inward Investment: an industry survey

2. National Development Planning Agency