Indonesia: Mining reforms

A flurry of new regulations in the mining sector over the past several months has made foreign investors cautious and threatened Indonesia’s status as a darling of emerging-market analysts. Although financial data suggests that macroeconomic risks stemming from the new protectionist stance will be limited, the government has made clear its desire to shift towards more local control of the economy.

Several recent announcements have concerned foreign mining companies, the most significant of which was a ban on exports of 14 raw minerals, including copper, nickel and gold, that went into effect May 6. The bill would apply to licences issued after 2009 but would exempt companies with a pre-existing “contract of work”, or those who agree to build local processing facilities.

Exempted companies will be allowed to export ore until 2014, albeit subject to a 20% export tax, and will be forced to show clear plans to build smelting facilities for processing ore once the full ban goes into effect. The government is also renegotiating “right of work” contracts in an effort to boost state royalties.

Jakarta also announced plans to cap mineral exports at 2010 levels. Indonesian officials reportedly considered similar restrictions or taxes on coal exports, but ultimately decided against it, although they have not ruled out increasing royalty payments. Another controversial piece of legislation could limit foreign ownership of mines to 49%, mandating a gradual divestment of foreign holdings over the next 10 years.

The speed at which these changes were implemented caught many in the mining industry off guard, leading to a temporary slowdown in exports while companies adjusted to the new regime. Copper exports plunged 90% from nearly 200,000 tonnes in May to 20,000 tonnes in June, while nickel exports dropped 80%, local media has reported.

The drop was due to companies having to acquire new export permits certifying that they are “clean-and-clear”, meaning they have paid all back payments and done the appropriate feasibility and environmental studies, and show that they plan to set up value-added processing facilities by 2014. Only 22 of 78 registered export miners had obtained these permits by early July, but the number rose to 55 in early August.

In late May and June 2012, the raft of protectionist announcements contributed to pre-existing macroeconomic worries about Indonesia’s growing current-account deficit and weakening rupiah. The central bank restricted the availability of dollars, and some were worried that the door was open to stricter capital controls.

These concerns have since mostly subsided, thanks in part to falling oil prices, which allow for more stimulus or public investment. The central bank’s promise to refrain from more capital controls – although it did not rule out intervention in foreign exchange markets – also helped calm fears. The changes to the mining regulatory regime, however, look to set to stay.

Hatta Rajasa, the coordinating minister for economic affairs, has spearheaded the mining reforms and has defended the amendments, pointing out that divestment had been planned since 2009, and that current contracts with major miners, such as Freeport, include royalties of as little as 1%.

In any case, Indonesia’s mineral resources are likely to keep foreign investors around for at least the major, profitable mines. But divestment requirements and a hefty tax may cause companies to rethink marginal investments, particularly on projects with a longer extraction time horizon. At the same time, the 2014 ban on raw exports will propel a domestic refining industry, even if the driver for the trend is regulatory and not market-based.

The mining changes are in line with Indonesia’s other recent reforms, such as its October 2011 move to cut taxes on refined palm oil, which boosted its local refineries at the expense of Malaysian refineries and local crude exporters. Indonesia is looking to shift from a raw commodity-export driven model to a more value-added approach. This transition may be a rocky one: some foreign mining companies have said they will be unable to build processing facilities in time for the 2014 deadline, in part because Indonesia’s power and transport infrastructure cannot support them.

Transforming an economy takes more than a ministerial edict: it will take years of investment and the participation of both foreign and local businesses to make Indonesia the industrial powerhouse it is seeking to become.