Collaborating for success: Regulatory reforms accelerate private sector participation in infrastructure development

Indonesia, with an average GDP growth of around 5-6% per annum during the past three years, has emerged as one of world’s potential economic powerhouses. As a member of the G20, Indonesia is already in the process of transforming into one of the developed nations. This fourth-most-populous country in the world has most of the requirements to reach a higher economical level. Natural resources, population, political stability and solid macroeconomy provide the foundations for Indonesia in achieving its full economic potential. As part of the government’s initiative in accelerating and expanding the economy, a Master Plan for the Acceleration and Expansion of Economic Development of Indonesia (MP3EI) has just been initiated. The MP3EI aims to provide the building blocks to transform Indonesia into one of the world’s major economic powers by 2025. To achieve this, real economic growth must reach 7-9% per year, on an ongoing basis. Implementation of MP3EI will include eight main programmes, which consist of 22 main economic activities. The implementation strategy of MP3EI will integrate three main elements: 1)Developing the regional economic potential in six Indonesia Economic Corridors: Sumatra Economic Corridor, Java Economic Corridor, Kalimantan Economic Corridor, Sulawesi Economic Corridor, Bali-Nusa Tenggara Economic Corridor and Papua-Kepulauan Maluku Economic Corridor; 2)Strengthening national connectivity locally and internationally; 3)Strengthening human resource capacity and national science and technology to support the development of the main programmes in every economic corridor. The government recognises that the provision of sufficient infrastructure, such as energy facilities, seaports, airports, railways and roads, is in line with its overarching goal of achieving faster economic growth and is fundamental to its ability to attract foreign investments, support the growth of businesses and communities and reduce income inequality and poverty. According to the agency responsible for national development planning, Badan Perencanaan Pembangunan Nasional (The National Development Planning Agency – BAPPENAS), around $150bn (or 3% of GDP) will be needed for infrastructure development during 2010-14 to meet the country’s economic growth target of 6-7% per annum during that period. Of this amount, the government’s budget can only cover around 30% ($45bn) of total planned infrastructure investment, leaving around 70% (or $105bn) of the needed investments expected to come from the private sector under the public-private partnership (PPP) scheme.

BAPPENAS has set up the Government and Private Sector Cooperation Centre to facilitate cooperation in infrastructure projects between the government and private investors. The Bappenas “PPPs Infrastructure Projects in Indonesia 2010-2014” report shows 100 projects valued at around $47.3bn available under the PPP programme. These include one marine transportation project ready for offer valued at $36m; 27 priority projects (18 toll roads, six water supply and three sanitation projects) valued at $8.3bn; and 72 other potential projects valued at $38.9bn.

Private investor participation in the Indonesian infrastructure sector started in the early 1990s. By the end of 1997 it had attracted over $20bn in investment, dominated by electricity ($10.2bn), telecommunications ($8.4bn) and transport ($2.1bn). In the wake of the Asian financial crisis in the late 1990s and a much more competitive global PPP environment elsewhere, the government was forced to reassess its PPP framework to attract additional investment to Indonesia and compete with other countries. Regulatory reforms have been initiated since then with the purpose of allowing more competitive and transparent private sector participation in infrastructure development.

Several challenges, however, may hinder the progress of PPP development in Indonesia. The main impediments can be categorised as follows:

• Political, legal and regulatory challenges, for example, the decline in institutional strength and/or adverse policy or rule changes;

• Financial challenges, for example, unfavourable changes to the fiscal regime, inability to bill customers and collect cash;

• Construction and operational challenges, for example, environmental risks, land acquisition risks, social risks, water supply risks, construction risks, performance risks; and

• Market risks, for example, new entry, demand risks, price or service competition. Of all of these challenges, land acquisition remains the most significant because of cost uncertainties and timing risks. The government has put into place several initiatives to address these issues. The initiatives include regulatory reforms and financial initiatives.

REGULATORY REFORM: Indonesia has made significant efforts to improve the legal framework at all levels. The umbrella regulations for each sector have been amended and are now more amiable to private investors. PERPRES 13/2010 (presidential decree), superseding PERPRES 67/2005, provides a cross-sector regulatory framework for private sector participation in infrastructure projects. This framework provides a clear, transparent and accountable basis for PPP. Procurement of the PPP concessionaire or business licensee must be done on a competitive basis, and the unsolicited approach is discouraged. It stipulates that proper due diligence must be conducted by the government contracting agencies before any PPP project is put out to tender.

FINANCIAL INCENTIVES: The government, through the Ministry of Finance, has established several financial instrument agencies to support the PPP programme in the infrastructure sector. These are:

• Land Fund: The land fund consists of a land capping fund and a land revolving fund. The land capping fund is currently available for toll road investors and provides private investors with downside risk protection should land acquisition costs significantly exceed initial estimates. The government will cover any changes in land acquisition costs above 110% from the agreed price in the concession agreement or 2% of investment cost, whichever is higher (regulation of the Minister of Public Works No. 12/PRT/M/2008).

• Guarantee Fund: The guarantee fund will be provided by the Indonesia Infrastructure Guarantee Fund (IIGF). IIGF was set up in 2010 with the aim of being a guarantee provider for PPP projects. It will have a detailed appraisal and claim system for guarantees and therefore facilitate the deal flow for contracting agencies. Possible risks that can be covered by IIGF include specific issues related to the pre-construction phase such as land acquisition, as well as issues in the construction and operation phases such as breach of contract, change in law and delay in financial close. The aim of IIGF is to improve the creditworthiness of PPP projects. The company is 100% owned by the government and will be run as a commercial entity. It will work as a single window for the appraisal and structuring of guarantees for the government. This will allow for consistency in policy, process of claims at a single window and will hopefully streamline procurement for complex PPP projects. IIGF, however, will not guarantee risks for which coverage can be purchased in the private market.

• Infrastructure Fund: While there is a sizeable banking market in Indonesia, the local project finance market (especially local currency) is very limited. This has significant cost implications in the financing of infrastructure projects in Indonesia. The development of PPP will help spear this segment of the market if properly facilitated by financing institutions, such as PT Sarana Multi Infrastruktur (SMI). SMI was set up in February 2009 by the Ministry of Finance in order to act as a catalyst and provide funding for infrastructure projects. Both the World Bank and ADB have provided initial funding for SMI. The government provided equity of Rp1trn ($120m), while the World Bank and ADB provided loans of $100m each through SMI for infrastructure financing. The company provides finance in terms of long-term loans, equity, contract financing and invoice financing.

RECENT DEVELOPMENTS: Under the new PPP regulatory framework (PERPRES 13/2010), the government has successfully tendered the Central Java IPP project (CJPP), which is the largest power project in Indonesia.

The CJPP serves as a model project, which enhances the transparency and competition of the tender process. One of the key elements that distinguishes it from the previous bidding process is on the matter of negotiation. In the CJPP, the negotiation process was conducted at the beginning of the tender process before the bid submission. In this way, the process involved all the tender participants and enhanced the transparency and competitiveness of the process. By doing this, the process of signing of the power purchase agreement (PPA) is expected to be accelerated. The provision of a government guarantee is also clearly disclosed under this regulation; which includes the guarantees from IIGF and Ministry of Finance.

Indonesia’s long gestation period for the regulatory reform and financial support initiatives contributed to the slow development of infrastructure facilities. Issues facing the infrastructure sector include inadequate capacity building, especially at the regional level. The government and the private sector are working towards risk allocation to the party best able to handle it. Imbalance in risk allocation leads to failed projects, which negatively affect the acceptability of future projects.

Recent developments on those areas, however, have set Indonesia in the right direction in ensuring the delivery of infrastructure projects. Continuous and open communication between key government departments and the private sector would create an environment conducive to successful collaboration. Consistency in policy and transparent procurement processes would help attract both funding and expertise to Indonesia.