The Infrastructure Conundrum: What Lies Ahead For Indonesia?

In 2017, what infrastructure should government prioritise? Why?
DS: The government must prioritise on hard infrastructure to support the connectivity of the Indonesian islands, but must not leave soft infrastructure behind as well.

CMF: It is quite difficult to determine what infrastructures the government of Indonesia should prioritise in 2017. The infrastructure problems faced by this country are massive as the country is an archipelago. Furthermore, infrastructural development has many relations or influences between one and another. For instance, when the government gives priority to build toll roads or ports in Sumatra while foregoing electricity supply development or other relevant infrastructures, priority given to the project will certainly have no significant contribution to social and economic development. Therefore, the priority issue of infrastructures (both hard and soft infrastructures) should be done on the basis of the strategic cost and benefit analysis, but not on the basis of the type and nature of infrastructural needs.

These strategic cost and benefit analysis should not only consider economic aspects alone, but also other non-economic considerations aimed to Indonesia’s sustainable development and the well-being of the people. Note that hard infrastructures here are defined as roads, airports, ports, electricity supply and the like, while soft infrastructures include education, social welfare
and healthcare.

WU: To set the context on the government prioritisation for infrastructure, it is important to understand the key reason why infrastructure development is required and how serious our infrastructure deficit is.

Firstly, let us look at the key reason. In order to escape the middle-income trap, the government of Indonesia has set an aggressive target of 7 Merah Putih Bridge, Ambon, Maluku, Indonesia. Indonesia’s 2017 develop percent annual economic growth in the Medium Term Plan 2015-2019. Hence in order to achieve such growth sustainability, Indonesia requires three types of development: industrial development infrastructure development and human resources development.

Infrastructure development is considered urgent and highly important because Indonesia requires to make up for over a decade of underinvestment in infrastructure. Prior to the Asian financial crisis in 1998, Indonesia spent 7 percent of its GDP for infrastructure development. However, after the financial crisis, the investment dropped to 4 percent of GDP, which was insufficient to support the economic growth required by Indonesia to escape the middle-income trap.

A study from Bappenas and AIPEG indicates that compared to 1995, Indonesia now produces twice the amount of real GDP but with only 1.5 times the infrastructure. The poor infrastructure has strained our economic growth. This is reflected in the Indonesian high logistic costs of 26 percent GDP in 2016, compared to Malaysia with 14 percent and Singapore with 8 percent. As a result, imported goods are cheaper than locally produced goods. Little wonder that the domestic industry has not grown despite our rich natural resources. This is why infrastructure development becomes the priority of the current government.

The government has identified logistics cost as a key bottleneck and this has also been reflected in President Nawa Cita manifesto in which he has set the target to reduce the logistics costs to 19 percent of GDP by 2019. To achieve such a target, the Medium Term Plan 2015-2019 focuses on the provision of logistics (transportation) and energy infrastructure for development. Within the Plan, the government aims to develop 2,650 kilometres of roads, 3,258 kilometres of railways, 24 new seaports, and 15 new airports. The government also plans to develop 35 gigawatt of new electricity generation capacity and increases electrification ratio to 96 percent.

Efforts have been allocated since 2015 to realise the Plan and therefore, the priority in 2017 is to continue the development efforts and to ensure the Plan targets are achieved by 2019. How will Indonesia create connectivity throughout this archipelagic country?
DS: Infrastructure like railways and seaports are extremely important. We must move to mass transportation rather than building highway and airports, although the latter is also important. By providing mass transportation via land and sea, Indonesia will have efficient connectivity and will be able to reduce the distribution cost.

CMF: Former Indonesia president Susilo Bambang Yudhoyono, has already created the master plan for connectivity throughout Indonesia—The Master Plan for Acceleration and Expansion of Indonesia’s Economic Development (MP3EI). MP3EI, which was coined in the national long-term development plan (RPJPN 2005-2025), must be re-examined and adjusted to accommodate changes of the present and future conditions faced by the current government under Jokowi and Jusuf Kalla (JK).

By achieving this, the country can accelerate its realisation of becoming a developed nation where the fruits of labour will be enjoyed equally among the people throughout Indonesia. It will be too costly and time consuming if Jokowi-JK’s administration intends to create another new replacement. Therefore, Jokowi and JK must be wise enough to inherit any good development plans established by the previous government.

WU: We need to appreciate the driving factor in creating connectivity. Connectivity is often linked with logistics costs. Logistics costs in Indonesia amount to 26 percent of GDP. Often this high yield boils down to the fact that Indonesia is an archipelago of 17,000 islands with 6,000 inhabited islands; however, in reality the biggest contributor to the logistics costs is the land transport costs at over 70 percent, while the sea transport only accounts for 22 percent.

Based on this fact, the key bottleneck is the connectivity within the major islands of Indonesia such as Java, Sumatra, Kalimantan and Sulawesi, where the quality of roads are below par and land connectivity between production centres and ports, and from suppliers to buyers are inefficient.

Hence to create connectivity, the government has focused on developing both inter-island and inland connectivity. For an inter-island connectivity, the government has committed to setting the sea toll through development of seaports across Indonesia. Additionally, it has also put its effort to develop medium and small airports across the country in addition to refurbishment of the existing terminals, as well as building bigger ones to improve handling capacity since the number of passengers per year is increasing. For in-land connectivity, the government has committed to building new roads and toll roads in addition to resurfacing and improving existing roads.

In building connectivity across Indonesia, we would surely need a massive budget; how can we cope with that?
DS: This is something of a challenge to the government and I am confident they know how to handle this issue.

CMF: There is no doubt that building massive connectivity across Indonesia requires a massive budget. As stated in the Midterm National Development Plan (RPJMN) 2015-2019, the estimated budget for financing the infrastructures for the period is about 6,780 trillion rupiahs or US$506 billion (note: IDR/USD based on RAPBN 2016 = 13,400). However, the government budget to finance infrastructural development is limited with a shortage of about 4,000 trillion rupiahs, which is expected to be financed by non government financial sources.

The following three policy measures can be considered by the government. First, the government should expand fiscal space for infrastructure investments. This will be achieved by increasing government revenue through tax and other reforms, reorienting public spending toward infrastructure and expanding spending, while keeping public debt sustainable. Next is to improve and optimise the planning and implementation of projects. The third is by improving regulatory and institutional framework to attract private participation both in the forms of public private partnerships (PPP) and non-public private partnerships (non-PPP).

However, the implementation of these measures should be carefully done as it can have a negative impact on the social welfare of the people and economic growth. Increasing tax revenue through taxation, for example, may affect consumption as well as investment, and hence this will result slowing down growth. Similarly, the involvement of private participation, particularly those from foreign countries, may result in adverse impacts such as crowding out effect, the balance of payment deficit and limiting the expansion of employment creation in Indonesia. Crowding out effect occurs when increased government involvement in a sector of the market economy substantially affects the remainder of the market. Hence, any policy measures that are going to be introduced by the government to cope with financial limitation should not negatively impact the country’s sustainable development.

WU: The Medium Term Plan requires an investment of 4,796 trillion rupiahs (US$369 billion) until end of 2019. With such an ambitious target, only 41 percent of the investment needs can be provided through state and regional budgets.

The remainder has to be provided by state-owned enterprises and private investors. To achieve that, the government has to redirect state and regional budgets to projects that are not financially feasible through private funding and private financial feasible projects. The strategy is to encourage private participation through public private partnerships schemes or pure/direct private investments.

Other than budget, what will be the other challenges in building connectivity in Indonesia? And how should they overcome it?
DS: The government must not neglect soft infrastructure. Soft infrastructure refers to all the institutions that are required to maintain the economy, health, cultural and social standards of a country, such as financial system, education, healthcare, law enforcement, as well as emergency services. Building the character of the nation is also very important—our attitude, spirit and ethics.

CMF: Indeed, there are other challenges faced by the government in building connectivity other than budget constraints. These challenges include the three Ls, namely, local regulations, legal certainty, and labour capacity and quality. In terms of local regulations, apart from further removing any local regulations that are not conducive to attract any investors to invest in infrastructural development, both the central and local governments should have good coordination and commitment to build infrastructures in their regions.

Problems associated with land access and labour regulations, for example, have to be solved by the government. The legal certainty is also a must. This, for example, can be done by introducing regulations that are able to protect infrastructural investments owned by private investors on one hand, and minimising the investment risks as well as political and other potential risks that will be faced by the private investors on the other hand.

Also, there is a need to introduce institutional regulations that are able to manage good cooperation between the governments (both the central and local) and private investors. Finally, the capacity and the quality of labour should also be improved to minimise the inflow of foreign labour. This can be done by providing professional training and the like to our labourers.

WU: There are a number of challenges apart of budget to build connectivity and in summary, they can be split into non-financial and financial. For the former, we are still facing common issues such as quality of project preparation documents, land acquisitions, multi-stakeholder coordination and permit/licensing. For the latter, there is a need to obtain funding outside the state due to the limited regional budget from the banking sector.

The banks are not in the capacity to finance gaps for infrastructure investment needs. As known by investors, infrastructure finance consists of equity and (senior) debt components. The equity component will depend on the infrastructure investors’ financial capacities and banks would rarely like to participate in this sector.

On the debt component, local banking sector contribution is fairly limited due to unfamiliarity of long-term project financing in Indonesia. Infrastructure projects are usually financed with corporate finance. With project and corporate finance, debt is provided based on the project’s financial strength. Under this scheme, investors will have limited ability to invest in projects. Banks will also have limited ability to provide loans to the investors before hitting their lending limits to a single company.

In the case of Palapa Ring Broadband projects, banks still require full guarantee from investors despite the availability of funds from the government. A shift in processes is needed for local banks to be relied upon for infrastructure financing.

The challenges of financing can be divided into internal and external. Internal challenges in the financial market are regulatory climate and risk aversion. The current regulatory climate does not accommodate the full objectives of private investment. For example, insurance and pension funds have regulations that strictly constrain their asset allocation, leaving little space for infrastructure investment.

Another issue is risk aversion in the market. Sixty five percent of investments in Indonesia are short terms of less than 2 years. Only 3 percent of all investments are long terms of more than 10 years. Even bank loan period are limited to 10 years, which clash with the infrastructure investment cash flow, where concessions can reach between 30 and 40 years. This mentality needs to change, starting by nudging insurance and pension funds towards long-term investments. External threats range from upward trending interest rates following potential rate increases by the Federal Reserve and political uncertainties, such as trade policies by the Trump administration in the United States.

The government indicates that some infrastructure projects in Indonesia will come from government and private partnerships. In your opinion, how will this affect our infrastructure industry?
DS: This is a very normal solution. When the government is not rich enough to pay for all the developments, why not partner with private sectors? What is important is the fairness and accountability of the partnership. Concise guidelines and procedures must be introduced and made available for the partnership to run smoothly.

Most probably partnering means opening the market as I do not see any harm in this. The industry must brace itself for international
competition. As insiders, we should understand the working conditions better than international companies, and this will be to our advantage. So we must prepare to ‘fight’ in fair terms and conditions.

CMF: The forms of public private partnerships (PPP) and non-public private partnerships (non-PPP) cannot be avoided as the main solution toward infrastructural development in Indonesia. These partnership packages may have adverse effects on our infrastructure industry. These effects include the massive use of import products at the expense of domestic infrastructural products, markets structures of infrastructure industry, and the continuing growth of small medium enterprises, to name a few.

However, the adverse effects on our infrastructure industry can be minimised if both central and the local governments take into account the following notes. Firstly, there should be clear and detailed agreements between the governments and private sectors in terms of working mechanism of the infrastructural projects built as well as the nature and the time length of cooperation management agreed by both parties.

Next, the government must carefully select the types of infrastructures that are going to be built by both parties. It is true that the motive of private sectors to establish partnership is profit. For this reason, the governments should limit any infrastructure partnerships that have negative effects on public needs, while keeping the private sectors and earning reasonable profits. Finally, both the central and local governments should continue improving the quality and the capacity of human resources and innovative technologies, needed to improve the development of national infrastructure industry.

WU: This will affect not only infrastructure industry, but also other industries. In order to accelerate the investment climate to encourage a government and private partnership, Indonesia has enacted regulatory and institutional reforms to support the infrastructure sector. On the regulatory front, the government has revised the Presidential Regulation No 38/2015 to unlock private
investments in infrastructure.

Now the government can offer fiscal supports such as direct lending with availability payments and viability gap funding. Availability payments refers to the government entity will make monthly payments to a concessionaire for making the infrastructure asset available for use, regardless of whether the infrastructure asset is actually used by the government entity.

In addition to instruments to improve project feasibility, the government has revised negative investment list to increase opportunities for foreign investments into infrastructure sectors.

To resolve land acquisition issues that hinder many projects in Indonesia, the government has issued Law No 2/2012 and its implementing regulations, which provide clarity and certainty of acquiring land for public infrastructure projects. Riding on the success of implementing the new land law, the government is currently establishing the Land Acquisition Fund and a land bank to provide assurance for land acquisition funding as well as to optimise the management of government assets.

Another new initiative is the One Map Policy programme. This policy was originated from the acknowledgement that map inconsistencies often lead to issues, such as overlapping permits, spatial conflicts, border disputes, and many more. With the stipulation of Presidential Regulation No 9 Year 2016, the government is on track to develop a synchronised map to be used for spatial planning and permit issuance, eventually leading to a more conducive investment climate.

On the institutional front, the government has set up a PPP Unit under the Ministry of Finance to provide project development facility (PDF). PDF is aimed at ensuring that a PPP project is well prepared for international standards. In addition, the Ministry of Finance can also provide transaction advisory support to ensure that the project is well prepared for tender. Furthermore, the government has established PT SMI and PT IIF to fund projects and assist with project development. It has also established PT IIGF (Indonesia Infrastructure Guarantee Fund) to provide guarantee for government obligation in PPP projects.

To coordinate debottlenecking effort and develop best practices in infrastructure delivery, the government established Committee for
Acceleration of Priority Infrastructure Delivery (KPPIP) supported with a professionally-staffed programme management office.

With the abovementioned reforms, the government intends to deepen the financial market by providing various financial instruments to attract retail and institutional investors with various risk appetites, such as asset backed securities, project bonds, zero coupon bonds, etc. These would reshape how the industry operates and open opportunities to encourage foreign investors to come forth and local companies to grow.

Once connectivity is built in Indonesia, how will it affect the country in general, and especially the infrastructure industry?
DS: When we have good and efficient connectivity, which means we will have the structures, systems, and facilities to serve the economy of a business, industry, for the country, city, town, or area—the distribution cost will be lower and the economy in all areas will develop. After the main infrastructure facilities are open, the smaller networks are needed, and it will present new opportunities to the industry.

CMF: The development of connectivity in Indonesia has many positive as well as negative effects on the economy and on the infrastructure industry. The general positive effects of connectivity will not only improve productivity and competitiveness of the Indonesian economy, but also economic growth as is experienced by many emerging economies such China, India, South Korea and Brazil.

However, these general positive effects on the economy will be achieved if the central and the local governments are smart enough to introduce policy measures that can keep inflation, employment creation, income distribution and balance of payment under control. Any infrastructural development that is going to be undertaken by the private sectors, by the government and the cooperation among them, should also be in line with the above policy perspectives.

Again, the development of infrastructure industries in Indonesia should be based on the social economic welfare judgement for all the people rather than based on economic judgement. I think there are no single and simple answers to all of the questions; hard work is certainly necessary, but a good and reliable leadership is a must. Thus, much remains to be done by the government. I trust the government is able to do all of these matters. It’s now or never.

WU: The impact will be as I addressed previously. The improvement of connectivity will reduce logistics costs. Such lower costs will help to grow our domestic industry and subsequently, achieve the goal to escape from the middle income tax for the economy. For the infrastructure industry, a better connectivity and lower logistics costs will open more doors to develop infrastructure in remote areas of Indonesia.

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DAVY SUKAMTA
CHAIRPERSON, INDONESIAN SOCIETY OF CIVIL AND STRUCTURAL ENGINEERS
Davy Sukamta graduated from Parahyangan Catholic University, majoring in civil engineering. Since starting his professional career, he has been involved in the construction of 343 projects. He also founded Davy Sukamta and Partners in 1989. The company specialised in construction engineering of high-rise building with multi-level basements. In 2003, he received the Karya Konstruksi Indonesia award in the category of high-rise building and Amartapura Planning by Minister of Housing and Infrastructure of Indonesia. Currently, he is the Chairperson of Indonesian Society of Civil and Structural Engineers for 2014-2017. He is also a member of the Indonesian Society for Geotechnical Engineering, American Society of Civil Engineering, American Concrete Institute and Council on Tall Building and Urban Habitat. Sukamta is also actively writing for national and international journal. Some of his papers were presented at various international seminars.

CARUNIA MULYA FIRDAUSY
RESEARCH PROFESSOR, ECONOMIC RESEARCH CENTRE, INDONESIAN INSTITUTE OF SCIENCES
Carunia Mulya Firdausy currently works as a research professor at the Economic Research Centre, Indonesian Institute of Sciences (P2ELIPI), Jakarta. He also served as a professor of economics at the Faculty of Economics, University of Tarumanagara, Jakarta. His first executive position was as a special adviser to the state secretary in charge of writing presidential speeches between 1995 and 1997. Other notable executive positions held include director of the Economic Research Centre, P2E-LIPI (1996-2001); special adviser for Indonesia’s National Defence Council (Wantannas) for economic affairs (2001-2002); chairman of Transportation Technology and management committee at the Office of the Minister of State for Research and Technology (2005-present); national chairman for ASEAN Committee on Science and Technology (2005-2010); President of Non-Align Movement on Science and Technology (2005-2010), and as deputy for social dynamics of the Minister of State for research and technology (2005-2010). His papers published in international journals include the study on poverty in Indonesia, published by the Asian Development Review in Manila and the Bulletin of Indonesian Economic Studies.

WAHYU UTOMO
HEAD OF IMPLEMENTATION TEAM, COMMITTEE FOR ACCELERATION OF PRIORITY INFRASTRUCTURE DELIVERY (KPPIP)
Wahyu Utomo graduated with a Bachelor of civil engineering degree from the Bandung Institute of Technology and a postgraduate diploma in regional science from Cornell University, New York. He also achieved his doctorate in regional science from the same University. He has served various positions in ministry offices of the Indonesia Government. In 2009, he received the Satya Lancana Karya Satya award for his 20 years of service to the government. Currently, he serves as the head of implementation team of the Committee of Priority Infrastructure Development Acceleration (KPPIP) and Head of executive team for the National Council on Special Economic Zone. He is also a lecturer at for a post graduate programme at the Faculty of Civil Engineering and Planning, University of Indonesia.