Scrapping oil subsidies frees up funds to invest in Indonesia's new infrastructure projects

One key development in the new wave of Indonesian infrastructure programmes is a major change in the way they will be funded. The government is set to play a much bigger role in financing, directly through increased central and local government budgets, and indirectly through enhanced funding opportunities for state-owned enterprises (SOEs). The private sector stands to benefit from this public sector boost, too, as projects become more attractive to private investment when risks are more appropriately shared – and state guarantees and incentives ease the burden of infrastructure’s classically low internal rate of return (IRR), although there is still room to improve the legislative environment.

Putting an end to Subsidies

One major change to Indonesia’s budget has freed up a large sum that will be spent on infrastructure development: the elimination of oil and gas price subsidies. The extent of the burden these imposed was made plain in the budget unveiled by President Joko Widodo’s predecessor, Susilo Bambang Yudhoyono, back in September 2014. Fuel subsidies accounted for $22bn – or 19.8% – of all central government spending, and had been paid since the 1970s, when Indonesia was still a net oil exporter. But the system did not change when Indonesia shifted to being net oil importer in the mid-2000s, leaving the exchequer with an increasingly unmanageable payout, particularly as oil prices rose.

Oil prices have fallen from a high of $114.77 a barrel in June 2014 to a low of $46.18 around the end of 2014 and were at just under $70 per barrel in May 2015. The decline in prices in 2014 created a good opportunity for the new government to act, and on January 1, 2015, petrol subsidies were scrapped, letting pump prices find market levels at Rp7600 ($0.63) per litre, which was lower than the Rp8500 ($0.70) per litre state oil giant Pertamina charged during subsidised times. Diesel subsidies do remain, but with a cap of Rp1000 ($0.08) per litre, protecting state finances from a future spike in prices, while also providing some support for fishermen and those in extreme poverty.

Redirecting Funds

An 83% reduction to the subsidy bill has freed up an estimated $18.4bn for the government to invest in other areas. President Widodo has long campaigned for increased spending on infrastructure – both social and physical. In February 2015 a revised budget passed that targets 5.7% GDP growth, down slightly from an earlier aim of 5.8%, but still supported by the expected high levels of infrastructure spending. The budget adds up to a 1.9%-of-GDP deficit, which is lower than the 2.21% deficit in the original plan, yet with spending still up substantially, thanks to the subsidy abolition. Total state spending is set at Rp1980trn ($164bn), with the share spent on infrastructure up 50%. Capital expenditure, which mostly goes towards infrastructure, went from Rp260trn ($21.49bn) to Rp276trn ($22.81bn). This marked the first time since 1997 that capital spending had outstripped subsidy spending, with productive expenditure now taking up 21% of central government spending, as opposed to the 2007-14 average of just 14% (energy subsidises averaged 21% over the same period).

The budget also provides for a further Rp39.9trn ($3.3bn) equity injection into SOEs. This is key for infrastructure, as many of the major construction, engineering, power and water outfits in Indonesia are SOEs. Additionally, the budget also allows SOEs to reduce their level of dividend payments, enabling them to concentrate more financial resources on new projects.

Spending It

With this major improvement in finances, infrastructure is almost certain to get a significant boost in the years ahead. Indeed, the president has outlined plans for some 2600 km of new roads plus 1000 km of new toll roads, 15 airports, 24 seaports, 3258 km of railway and 49 dams. How much of a boost will actually be delivered, though, also depends on how the government negotiates some tough hurdles when it comes to implementation.

Capital disbursement averaged 85% over the 2010-14 period, compared to target amounts, indicating the need for a re-examination of government procedures – although even at 85%, capital expenditure would still rise by more than 50% year-on-year in 2015.

Aware of the need to boost disbursement, however, the government has begun pushing the ministries to speed up. A March 2015 deadline was set by the president for ministries to complete their annual tendering processes. At the same time, the government has also been moving to tackle a variety of long-standing regulatory and administrative issues in infrastructure, particularly around the implementation of its public-private partnership (PPP) strategy.

PPPS

A major focus of government infrastructure initiatives since they were first introduced back in 2005, very few PPPs have managed to make it to the construction and operation phase despite fiscal support being made available through the Private Development Facility and special clauses in land legislation for such partnerships. A report by global consulting firm McKinsey from 2013 states that the reasons for this include: perceptions in the private sector of a lack of transparency and consistency in project status; a sense that PPPs, because of their complex nature often involving many different stakeholders, are relegated to lower priority projects; and that government agencies often lacked the skills for putting together the complex legal, financial and commercial frameworks for a successful PPP, leading to valid projects sometimes failing to get off the ground. In addition, a variety of regulations and laws have been passed governing PPPs, often overlapping across different levels and types of government. Some 40 permits and licences, for example, were required from different agencies for a new PPP entity.

The new government has thus moved fast to address these issues. PPP roll-out had been generally under the control of the State Ministry of National Development Planning (BAPPENAS), although internationally, PPP units have often been more successful when able to access the extra financial leverage that comes from being under Treasury or Ministry of Finance (MoF) control. In July 2014, the government therefore formed the Committee of Infrastructure Priorities Development Acceleration (KPPIP) and placed it under the Ministry of Economic Affairs. The KPPIP specifically targets social and physical infrastructure projects.

The MoF, meanwhile, is working on setting up the PPP Centre, a central body to handle all future PPP project preparation and auction. The centre is also working on producing standardised PPP documents, addressing past issues of regulatory discrepancies and writing the PPP Book, in which a definitive list of projects will be outlined for prospective investors.

At the same time, Sarana Multi Infrastruktur and Indonesia Infrastructure Finance have been established to facilitate project financing and the Government Investment Centre to finance land acquisition. The MoF has also set up a viability gap funding mechanism for projects that are deemed strategically necessary, but continue to have funding issues.

Back to The Land

The land law, one of the main long-term bugbears of Indonesian infrastructure development, has also been targeted, with a presidential regulation issued in early 2015 that eases the process of compulsory acquisition. All new and ongoing projects are to benefit from this, with new permissions to the private sector to finance land acquisition, speeding up the process. Previously, a state disbursement had been the method of compensating landowners. The new regulation also promises to speed up acquisition times overall, enforcing a 2012 land law commitment that the procedure should never take longer than two years.

Major Opportunities

For foreign investors, the infrastructure programme presents multiple opportunities. Much of the construction work requires materials that cannot currently be obtained in-country (see Construction chapter), along with expertise in the fields of planning, design and delivery. The Indonesian government is working hard to bring in foreign investment as indicated by the president’s March 2015 visits to Beijing and Tokyo, which elicited pledges for more Chinese and Japanese involvement. High-speed railways, ports, airports, roadways, power plants and industrial parks were all explicitly mentioned.

Whether private sector firms will take up the PPP challenge with more enthusiasm depends on the terms available when the PPP Book is complete, and when and if the negotiations begin. There are, however, already signs that the terms to come will be much improved. Challenges remain, including implementing new rules and regulations and holding government tendering to stricter deadlines, as well as a shortage of civil engineers, but the mood among foreign investors appears to be more positive than it has been for many years.