On the move

Indonesia may be viewed with caution by those who have in recent years placed bets on the country taking a turn for the better. Following last year's “taper tantrum”, when the US Federal Reserve signaled it may bring a premature end to its Quantitative Easing programme, countries with a current account deficit such as Indonesia and India were hit particularly hard, with their currencies falling as much as 20 percent.

As pundits speculated on Indonesia's chances of success in unlocking its growth potential, sources near the newly-instituted government feared that, without President Joko Widodo's bold move on fuel subsidy cuts, the new government would have little room for manoeuvre in delivering the promised core and social infrastructure assets needed to ensure modernisation and inclusive growth. 

Asian Development Bank (ADB) deputy country director, Edimon Ginting, when speaking to Infrastructure Investor last October, welcomed the decision announced by the government which has since been acted upon with an $18 billion fuel subsidy cut: “The idea is that if the government cuts subsidies by say 2,000 rupiah per liter it will go far enough – close to two-thirds of the current $30 billion subsidy. In one year, it could amount to $20 billion a year in subsidy cut, and $20 billion is about 2 percent of GDP – which is about the size of government capital expenditure in 2014,” he said.

“Part of the $20 billion saving will go to social programs, but most is expected to be used for financing infrastructure,” said Ginting, who also expects that increased spending for basic infrastructure will benefit construction and related companies involved in operations cross-border.

CAUTION

There is, however, reason for caution, according to law firm Berwin Leighton Paisner's (BLP) partners Marius Toime and Alistair Duffield. 
On the positive side, clear laws were drawn up, prior to Widodo's election, to make some segments of the energy sector a priority, due to a heavily resource-reliant economy. Attractive policies on the renewables front include competitive tariffs for mini-hydro power, biomass, and geothermal for instance.

The 2012 land acquisition law, which came into force in early 2013, has helped put a deadline on authorities' procedures when issuing titles and construction permits as well as enforcement mechanisms. 

Although land right acquisition processes – today legally lasting up to 382 days – still need shortening, the government indicates it is acting on recommendations from multilaterals like the World Bank's IFC. It recently announced the creation of a body to coordinate improvement of existing processes and expedite funding of ongoing projects – the “Land Bank”- to be directed jointly by the ministries of finance, public works and transportation.

LEGALLY SOUND  

Equally, the public-private partnership (PPP) framework, which was used for the first time with the setting up of the Java Central Power Plant project, is legally sound, says Toime.

Under former President, Susilo Bambang Yudhoyono, the country prioritised the development of a sound PPP framework with the aim of fairly balancing risk between private and public sectors. It was aided by the ADB in this task, notably with the creation of a guarantee and viability gap fund, key to the bankability of projects. 

During a recent encounter with Widodo, ADB President Takehiko Nakao showed renewed confidence by offering him a $1.5 billion supplementary loan to help expedite delayed land infrastructure projects in the region.

“Infrastructure development is a high priority for the government, which wants to strengthen maritime connectivity including new ports and ships, and build roads, airports, dams, irrigation networks, power plants and industrial parks. These infrastructure investments would cost more than $500 billion over the next five years,” Nakao explains. 

To pool the required funding, Nakao supports the government's plan to diversify financing by tapping public and private resources as well as external financing from international financial institutions. 

In principle, the liberalisation of the infrastructure scene seems to promise good days ahead. In practice however, there is room for doubt about the efficiency with which policies will be implemented on the ground.

COMPLEX CONCESSIONS 

Although from a legal standpoint the PPP framework is sound, it is yet to be seen how well agencies, which have no experience at tackling the inherent granularity of complex concession agreements, will cope with the lack of track record and the strong public funding dependence the country is emerging from.

Although the Java Electric Power Plant, backed by the ADB, is branded as a success story, it was delivered with significant delays, notes BLP partner Duffield.

Furthermore, “corruption is still an issue as well as enforcement risk – the Indonesian judiciary does not have a great track record, particularly at the district court level, so investors need to carefully consider contract structure and terms. The constitutional and supreme courts both enjoy more respect from the local legal community, but they won't be of any immediate help should a dispute arise,” maintains Toime.

“Under the decentralised system, dealing with local agencies and the diverse cultures within them is unavoidable – especially when dealing with land acquisition issues in some more remote provinces.  A rigorous system to deal with timeframe issues around land acquisition is also lacking – investor uncertainty as to what time the process will take is a problem,” Toime adds. 

The words echo the statement made public by Nakao's administration on the day of his recent presidential meeting in which he emphasised the importance of boosting domestic tax and non-tax revenues through “better administration and enforcement” and the removal of “regulatory uncertainties that have deterred private investment in infrastructure [and which] would also help generate financing through public-private partnerships”

CALLING THE MULTILATERALS

The BLP partners believe that the best chance for the country to successfully develop its infrastructure sector resides in increased participation from multilaterals and credit export agencies in PPP projects, acting alongside international investors. They not only bring credibility to a project, but are the “substantial incremental and differential factors that increase the prospects of a successful project,” according to Duffield.  Good news is that interest and activity from Japanese, Korean and French investors and institutions has already been picking up

However, as Duffield points out: “Bankability and risk allocation may not be seen in the same way in Indonesia as in the UK or Australia. In Indonesian projects, historically there has been a tendency to push all risk and financial responsibility to the private sector, especially in the power sector. If project economics are to work, the public sector needs to bear some of the risk.”

A pertinent example is the $3 billion geothermal exploration programme the ADB recently signed off which requires prodigious capital expenditure for the drilling of deep holes and carries high upstream risks, unbearable for institutional investors alone

For smaller-sized ticket projects, Armstrong Asset Management 's take on the Indonesian environment is encouraging. PT Nusa Konstruksi Enjiniring (NKE), a subsidiary of the asset management firm, in August 2014 took on a portfolio of mini-hydro power projects in the country.

Armstrong's strategy has a strong emphasis on risk aggregation and a generally incremental approach to portfolio building, with the aim of growing scale to compensate slightly lower rates of returns on some of the assets.

VOLATILE

Michael McNeill, an Armstrong partner, says he forms a view at the time he makes the investment about the overall economics of the project in question, including the tariff levels that apply. “Ultimately, we do look at the returns on a US Dollar basis. The exchange rate in Indonesia can be volatile and, although the currency has generally tended to trade within a range, historically it's very difficult to predict what's going to happen over any particular period,” he warns.

Although he believes there is no way to entirely hedge against currency depreciation (Indonesia being no exception), the fact that hydro has a large civil  (hence local) cost component means that local debt financing at the project level helps to reduce currency exposure. “We also have a reasonable degree of flexibility over exit timing, since the Armstrong South East Asia Clean Energy Fund has a base 10-year fund life,” he notes

More generally, risk is spread through investment via a platform that aggregates multiple small projects, and on a fund-wide basis across different countries and renewables sectors. 

While tariffs in Indonesia are lower than in the Philippines, generally speaking so are local costs, and good projects are still feasible. The platform approach means that individual hydro plants of up to 10MW can be aggregated together to achieve a scale that makes them a very attractive portfolio opportunity for prospective buyers, he concludes.