Key challenges facing Indonesia’s infrastructure market in 2017

As Southeast Asia’s largest economy, with a population of 200 million, Indonesia needs to accelerate development of its infrastructure.

The rapid growth in urban areas, coupled with migration to cities, is sending a strong message to the Indonesian government that it needs to provide adequate urban infrastructure for its people.

Infrastructure development has been a primary goal of the Indonesian government for the last 15 years, and even more so today. Infrastructure development plays a key role in national development strategy, which will both impact on the liveability and sustainability of cities in Indonesia and raise the sustainable growth rate.

The government’s emphasis on infrastructure investment and the targets set out in its National Medium Term Development Plan (Rencana Pembangunan Jangka Menengah or RPJM) for 2015 to 2019 demonstrate how seriously it is taking this issue.

Under the 2015-19 national development plan, investment of around US$507 billion is being targeted to fund Indonesia’s infrastructure projects. In support, the government has allocated US$29 billion from the 2017 budget for infrastructure development – a 22 per cent increase on 2016. 

Strategic and priority projects are being monitored and coordinated by the Committee for Acceleration of Priority Infrastructure Delivery (Komite Percepatan Penyediaan Infrastruktur Prioritas or KPPIP), which has been tasked with expediting these projects by the Coordinating Minister for the Economy. The six top priorities are power, roads, water sanitation, airports, seaports, and urban transportation.

In the transportation sector, the government is planning two major railways, including the Jakarta–Bandung high speed rail link, which already has construction permits for the entire length of track and has almost reached financial close.

Since September 2015, the government in its efforts to expedite infrastructure development, has already issued 14 economic stimulus packages. These packages aim to boost economic growth through a range of measures:

• Deregulation;

• offering incentives for private sector investment;

• issuing new policies to harmonize land utilisation;

• opening up opportunities for foreign investment;

• simplifying the processes and procedures to obtain permits; and

• improving cost efficiency.

Infrastructure development in Indonesia faces several challenges, including financing, bankability, project procurement, regulatory issues and land acquisition.

Access to the funds needed to finance infrastructure projects is probably the greatest challenge, considering the massive amounts needed to improve the quality of Indonesian infrastructure.

Under the RPJM, Infrastructure development is to be 50 percent funded from the state budget, 19 percent from state enterprises (SOEs) and 31 percent from the private sector.

To help meet these funding needs, the government established two major financial institutions – PT Indonesia Infrastructure Finance (IIF) and PT Penjamin Infrastruktur Indonesia (Indonesian Infrastructure Guarantee Fund or IIGF). IIF is a subsidiary of PT Sarana Multi Infrastruktur (SMI) that has been structured as a private non-bank financial institution to provide debt finance and equity participation. IIGF operates through a guarantee mechanism to enhance funding through the public-private partnership (PPP) mechanism.

The PPP scheme encourages private sector participation to help overcome financing challenges. To complement this, the government has been seeking financing alternatives, most recently the government’s non-budget investment financing (Pembiayaan Investasi Non-Anggaran Pemerintah or PINA) scheme. PINA is being used to construct nine toll roads as a pilot project. The initial equity for PT Waskita Toll Road comes from SMI and state pension fund PT Taspen (Persero).

Studies have found that the problem with infrastructure financing in Asia and especially in Indonesia is not actually a shortage of funding but a lack of availability of viable and bankable projects.

Bankability and financing issues are closely related, and the challenges in private sector funding are usually driven by bankability issues.

It is often difficult for the sponsors to present to lenders project contracts that are bankable. This is because the structures of the projects and the tender documentation, are not always familiar to international lenders. Projects may also struggle to demonstrate a reliable source of revenue.

For infrastructure projects in particular, the project owners commonly look for either no recourse or limited recourse financing. The risk of default will be higher when the source of the revenue is unreliable.

Risk allocation among the parties can also lead to bankability concerns. The rule of thumb is that risks should be allocated to the party best able to manage them. For example, the risk of the government cancelling or changing the terms of project agreements, or of a change in law which adversely impacts the project, is best managed by the government or the SOE contracting with the company. This risk can be addressed in the agreements, with the government or SOE taking on liability for compensation payments based on a pre-agreed calculation.

Government procurement of infrastructure projects through private sector participation has traditionally used either a public or limited tender, or in some cases direct appointment. Depending on the funding source, the procurement may be subject to either the standard government procurement regulations or the particular SOE’s own procurement rules.

In 2005, in response to the growing need for private sector participation, Indonesia started using PPPs to attract competitive bidding for infrastructure projects.

Various PPP projects have since been tendered, but only a few projects have so far been awarded. Whether using traditional procurement or a PPP scheme, in some cases the procurement process has been delayed, with bid dates extended or bid scope changed.

It can take at least a year from issuance of a request for proposals, to announcement of the winning bidder and the signing of the project documents. The longer this process, the harder it is for participants to comply with their original bid, as they become exposed to price increases and changes in law.

In this fashion, not only can the procurement process be delayed, but so will implementation of the project itself.

While the private sector generally considers that procurement processes in Indonesia have improved, concerns do remain over transparency.

One challenge facing all investors considering the Indonesian infrastructure market, is the regulatory framework which can be uncertain. Historically, the sources of this uncertainty have included political transition, centralization/decentralization of various layers of authority, and overlapping and inconsistent regulations.

In more recent years however, Indonesia has worked to improve the regulatory certainty in the infrastructure sector. Specifically, the government refined the PPP rules in 2015 to broaden the scope of the scheme and introduced availability payments as a form of investment return. The issuance of economic stimulus packages also reflects the government’s desire to minimize regulatory uncertainty.

Land acquisition can pose significant problems in the project development process and can ultimately prevent projects attaining financial close on schedule.

There are three common challenges facing land acquisition in Indonesia:

1. Lengthy negotiations with local communities, especially where there are lots of land owners. The process can take even longer if the plots do not yet have a land certificate and customary land has first to be converted.

2. Land disputes, where one group claims to be the rightful owner when settlement has been reached with other parties presenting documentation or witnesses confirming their ownership.

3. The huge amount of funds required for land procurement.

Various laws and regulations have been issued to accelerate the land acquisition process, notably the 2012 Land Acquisition Law. There are also now implementing regulations designed to revoke land rights where it is in the public interest to do so, to limit the length of each procedural phase and generally, to safeguard the interests of land owners. This improved process leads to the pertinent question of how these regulations are being implemented. For without proper implementation, land acquisition issues will continue to delay execution of infrastructure projects.

 The four key matters that need to be kept in mind by stakeholders are:

1. The importance of staying up to date on infrastructure projects, including the latest procurement mechanisms and procedures being used by the government.

2. The need for well prepared and fit for purpose project documents as well as efficient finalization of contractual arrangements, in order to overcome bankability issues and shorten the negotiation process.

3. Whilst the regulatory framework has improved notably, with fewer licenses and permits now required, further regulatory reform and improvements are needed to help infrastructure projects to move forward at a faster pace.

4. Consistent application and implementation of land acquisition regulations is needed to help prevent delays in project execution.

This article is based on a presentation by Nadia Soraya at a seminar titled “Future Ready: Sustainable Cities – Indonesian Infrastructure in Focus” held in Jakarta on 7 March 2017.