A series of high-profile projects should help narrow Indonesia's infrastructure gap

When Joko Widodo rode to power on a wave of pro-business rhetoric in Indonesia’s 2014 presidential election, a key plank of his economic development platform was rooted in shoring up the country’s outdated and inadequate infrastructure. Now firmly entrenched in the midst of his second year at the country’s helm, the Widodo administration is going to significant lengths to make good on these campaign promises. It has begun channelling an unprecedented amount of cash into all manner of domestic infrastructure projects.

The spending spree began with the addition of Rp112.4trn ($8.2bn) in the 2015 supplementary national budget, which was earmarked specifically for infrastructure outlays. This represented a 39% increase over the 2014 budget, funded largely by fuel subsidy savings made possible in part by the drop in oil prices at the time. These additional funds were being dispersed far and wide, spread across projects in diverse sectors including oil and gas, power, water supply and waste treatment, roads, urban transport, rail, ports and airports.

Spending Levels 

The transport sector is expected to be the largest beneficiary of heightened spending levels, accounting for around 37% of total infrastructure spend through to 2025, followed by utilities at 26% and manufacturing with 21%. The remaining 16% will be split among the extraction, telecoms and social sectors. Although starting from a relatively small base, investment in health and education infrastructure is expected to expand most rapidly, growing on average by more than 10% annually from 2015 through to 2025. Taking these projections into account, social spending is expected to account for 10% of infrastructure outlays by 2025, up from 7% in 2014.

As large an increase as these resources are on their own, the funds in the 2015 budget represent only the beginning of planned central government infrastructure spending over the five-year period from 2015 to 2019, which the Ministry of Finance (MoF) originally projected at Rp2216trn ($161.8bn), equal to 2.9% of annual nominal GDP. However, given the scale of planned projects laid out in government plans, the Ministry of Development Planning recommended even greater levels of spending to meet these requirements, to the tune of Rp5519tn ($402.9bn) over the same five-year timeframe, equal to 7.2% of annual GDP. With the increase in capital expenditure, the government will be unable to fund these projects directly, even with the planned increase in GDP and the decreased expenditures on energy subsidies.

Finding Funding 

Much of the funding therefore will come from other sources. These new spending levels are more than double the previously estimated expenditure. They will rely heavily on state funding, which is projected to account for 50% of total investment. Another 19% is expected to come from state-owned enterprises (SOEs), with the private sector making up the remaining 31% of financing requirements. Allocations from the public sector, including both those covered by government revenues and those funded from SOE budgets, could also be sourced from foreign, sovereign or other debt instruments.

These types of lending practices are already being carried out in some instances, as evidenced by the government’s signing of a $20bn memorandum of understanding with the China Development Bank in June 2015. Specifically, the plan is to finance infrastructure by funnelling the cash into relevant SOEs. State-run construction firms Wijaya Karya and Adhi Karya, port operators Pelindo I and Pelindo II, airport operator Angkasa Pura (AP) II and mining firms Bukit Asam and Aneka Tambang, are all slated to receive the loan facilities, which are expected to cover the majority of the $23.8bn packages of construction works for the companies, according to local media.

Extra Funding 

These funds came on top of substantial funding earmarked for infrastructure development in the 2015 budget. This included Rp81.3trn ($5.9bn) for the Ministry of Public Works and Public Housing – up from Rp74.5trn ($5.4bn) in 2014 – to be used in part for the construction of roads, bridges, underpasses, railway lines, rolling stock, and new and rehabilitated airports and ports. The Ministry of Energy and Mineral Resources was also allocated Rp10trn ($730m) for the construction of new transmission lines and substations, as well as end-user installation points, the expansion of natural gas pipelines and increasing oil and gas production. Lastly, the Ministry of Public Works and Public Housing received Rp4.6trn ($335.8m) to construct 120 twin-block flats for low-income communities along with supporting infrastructure.

Starting in early 2015, additional funding was already beginning to trickle down to SOEs tasked with carrying out major infrastructure projects. These expenditures included Rp49trn ($3.6bn) delivered in January 2016 and disbursed to a number of different companies, including airport operator Angkasa Pura II, construction companies Hutama Karya, Waskita Karya and Adhi Karya, mining company Antam and port operator Pelindo IV, according to information collected by PwC Indonesia. Looking at spending patterns within the programme, transport, utilities and manufacturing are in line to take on the lion’s share of these investments based on need and previous distribution.

Alternative Costs 

At a time when the economy has begun to experience a slowdown, the large sums of money being diverted from the national budget into big-ticket spending items has given some pause. However, there is little debate that new investment is sorely needed across the board.

The country’s impressive and rapid economic rise has enabled measurable gains in terms of poverty reduction and the extension of basic social services, but slowing economic growth and ongoing urbanisation are now putting increasing pressure on the constraints of Indonesia’s infrastructure.

Exacerbated by decades of inadequate investment, the poor state of infrastructure has been a drag on the economy. It has pushed up production and transport costs and saddled domestic industries with handicaps in an increasingly competitive global marketplace. Infrastructure spending from the mid-2000s through to 2014 lagged well below levels necessary to maintain efficient operations. Spending averaged around only 3-4% of GDP annually, compared to roughly double that during the mid-1990s at the end of the Suharto administration. This was more in line with spending levels in China and other East Asian nations in recent years, according to a November 2015 study by Australia’s Department of Foreign Affairs and Trade.

The cumulative result of this sustained chronic underfunding has affected nearly every economic sector of the country, adversely impacting businesses and international competitiveness. The Indonesian Chamber of Commerce and Industry estimates that around 17% of a company’s total expenditure in Indonesia is absorbed by logistics costs, whereas in peer regional economies this number is generally less than 10%.

In the transport sector, travel speeds on arterial roads are among the slowest in South-east Asia, with longer journey times contributing to high logistics costs, estimated at approximately 24% of GDP. Increased health care costs and lost labour due to illness are also substantial due to poor potable water distribution, with 18% of the population lacking access to drinking water and 80% without of piped water. The sanitation system is another problem. Currently, 98% of the population does not have access to adequate sewage systems, including in the capital city of Jakarta. Challenges with water accessibility and usage rights also remain a challenging and contentious issue for industrial operators, which often face obstacles in securing the large amounts of stable supplies necessary to carry out processing activities.

The power sector fairs little better, remaining undersupplied, with many regions continuing to suffer from load-shedding, while more remote regions such as Indonesian Papua only manage electrification ratios of around 30% of the population. While internet connectivity has increased in recent years with the spread of smartphone penetration in urban areas, Indonesia had an estimated 1.2 fixed-broadband connections per 100 persons in 2015, compared with 8.4 in Malaysia and five in Vietnam. The cumulative effects of these shortcomings on the economy is estimated by the World Bank to amount to approximately one percentage point of lost additional GDP growth per annum over the last 10 years. “We consider the current situation of infrastructure in the country as being in a critical condition. Whether it is in rural electrification, roads or public transport, the country’s project delivery record is not good, when compared to its neighbours,” Raj Kannan, managing director of Asia-based infrastructure strategic advisory firm Tusk Advisory, told OBG.

Top Down 

To facilitate the substantial infusion of capital into new big-ticket infrastructure projects, the government went back to the drawing board to develop an entirely new entity, whose sole responsibility is the implementation of priority infrastructure projects. The Committee for Acceleration of Prioritised Infrastructure Development (KPPIP) was created by presidential order in 2014 to address the long-running problem of often delayed, inefficient or incomplete implementation that has continued to dog the country for years.

The KPPIP acts as a coordinating agency to get all the relevant governing stakeholders on the same page, with representatives from the Coordinating Ministry for Economic Affairs (as the chair), the National Development Planning Agency ( BAPPENAS), the MoF, the National Land Agency (BPN), along with other professionals within the sector. “The idea is to have an entity with a specific mandate to deliver infrastructure that combines civil servants and professionals familiar with the private sector,” Tirza Reinata, director of Tusk Advisory, told OBG. “It will also be better to have different line ministries together to talk to each other.”

One of the critical issues still being worked out by the KPPIP and the government is how to determine funding for each project. The issue is further complicated by the fact that certain sectors are classified as national strategic interests. Key sectors such as water and sewage infrastructure bar private participation in their development, while the construction of other large-scale projects entails land appropriation.

Land Acquisition 

Historically, the Achilles heel of big-ticket infrastructure projects has been acquiring the land needed to secure the right-of-way necessary for projects such as railways, toll roads, power lines and the like. Some of these problems were addressed through the 2012 law revising rules governing government land purchases for infrastructure projects carried out in the national interest, although its full effects have yet to fully trickle down to the local levels. Further implementation of the law and more training may be necessary for smoother facilitation of these types of projects going forward.

In addition to the KPPIP, the government has also assigned new responsibilities to the Indonesia Investment Coordinating Board (BKPM), which has traditionally been responsible for attracting and overseeing investment in the country. This should increase the efficiency of the investment approval process for infrastructure projects, by tasking the organisation to provide a centralised licensing point for certain key sectors.

High Priority 

More recently, the government has tapped the organisation to create a pipeline of projects following the public-private partnership (PPP) model, through the issuance in January 2016 of Presidential Regulations No. 3 and 4 of 2016 on Acceleration of the Implementation of National Strategic Projects and Presidential Instruction No.6 of 2016 on Acceleration of National Strategic Projects. Included in the new regulations was an extensive list of 225 national strategic projects across 13 sectors and one electricity programme carried out in consultation with ministries, government institutions and regional government serving as project coordinators. These were later pared down to just 30 priority projects, which will require investments of Rp851trn ($62.1bn) for the 2016-19 period, and will be subject to the political, licensing and guarantees afforded to them as stipulated in the presidential regulations.

Depending on the project, funding will come from SOEs, private sector investment or directly from government coffers. The decision to focus on only 30 projects was an effort to solve the country’s project realisation problem. The government has vowed to complete all 30 projects by 2019, which should give confidence to investors that major projects can be completed and carried out in an efficient and timely manner.

The projects range from toll roads connecting Balikpapan to Samarinda, Manado to Bitung and Serang to Panimbang, to a series of rail projects including the Soekarno-Hatta International Airport express train, the South-North line of Jakarta Mass Rapid Transit and the Makassar-Parepare railway line. In terms of electric projects, the 100-MW Karangkates IV and V hydroelectric plant is included along with the 37-MW Kesamben and 10-MW Lodoyo hydropower plants. Another key infrastructure project scheduled for funding is the refinery development master plan, which includes the revitalisation of existing refineries.

Clearing A Path 

More than a lack a funding or a lack of expertise in construction practices, perhaps the single greatest impediment to carrying out big-ticket infrastructure projects has been in securing the land necessary to build these large projects. Power stations, ports, airports and other large construction projects often require large, contiguous plots of land, often located in prime real estate near urban built up areas where land is scarce and expensive.

Other ventures such as electricity transmission lines, roadways, rail lines, and water and gas lines can often be even more problematic. This is due to the extensive concessions that needed to be secured for the length of their routes. Frequently this means dealing with numerous owners, who sometimes have opaque and conflicting ownership claims. In some cases, the uncertainty and litigation arising from land ownership issues have caused repeated delays and even cancellation in some instances. While the clouded legal framework for land purchases has been a source of serious friction for the government, it has been even more of an impediment to inviting private sector participation in these types of projects.

Many companies hold strong reservations about involving themselves in capital-intensive projects that have the potential to become bogged down in a legal morass for years.

Streamlining The Process 

Recognising this fault, past governments have carried out numerous attempts to clarify and streamline the process of land acquisition for the greater public good, many of which, were rolled out with the newer developmental plans over the past decade. In 2011 the government and Parliament jointly approved a new Land Acquisition Law No. 2 2012, which was devised as a means to accelerate the land acquisition process by focusing on the revocation of land rights to serve public interest. Of equal importance was the decision to institute fixed time limits on each procedural phase, while similarly ensuring safeguards for land-right holders. The bill was confirmed by the signing of a companion regulation by then-president Susilo Bambang Yudhoyono in 2012. Approval from both branches of government is required for land deals under Indonesian law, and this stipulation is applicable to both government projects and PPPs on state-owned land.

The result is a limitation of the land acquisition procedures carried out in the name of the public interest to a period not exceeding 583 days and allowing for the revocation of land rights in the public interest. Although these measures represent significant progress in clearing up long-running legal disputes, land acquisition remains a problem. This is particularly true with regard to municipal and district governments, as often there is friction between the central government and these localised districts. As a result, the government included new presidential regulations that addressed the subject in early 2016 in conjunction with the government’s enhanced spending package.

In addition to outlining more than 200 priority infrastructure projects, a decree also officially named the BPN as the sole government body responsible for all land acquisition for government projects. In effect, the order removes the authority of regional and local government units and centralises it in the BPN. This should further the disconnect between these two state components. “The government has done what it can do in terms of funding with new institutions such as SMI, Indonesia Infrastructure Finance (IIF) and the Indonesia Infrastructure Guarantee Fund along with the KPPIP to oversee this,” Harold Tjiptadjaja, managing director and chief investment officer of IIF told OBG. “On the other side, the government is working on the regulatory aspects. The question now is if the private sector is comfortable enough to invest, which we should find out very soon.”

Despite government efforts to create a more conducive business atmosphere, the reaction from potential private sector players has been mixed. The resource sectors of energy and water, for instance, still maintain policies that lean towards resource nationalism, making private sector participation limited and often convoluted. Some recent regulations adopted by the government for the water sector roll back liberalisation policies implemented in 2004 to restrict private participation. Passed in 2014, the new rules disallow private projects that involve the public consumption of water. This in turn limits private concessions to the fringes of the sector such as waste treatment and water collection along with water supply for private ventures such as residential projects.

Outlook 

The government’s strong commitment to infrastructure development, as reflected in its regulatory regime and funding, bodes well for the sector moving forward. That said, the ambitious targets are unlikely to be reached due to a number of factors, including the sheer scale and quantity of projects and the government’s institutional capacity to carry them out. As such, much will depend on how well received the government’s ongoing efforts are in assuaging private sector concerns over PPP projects, particularly in terms of liberalising of and land acquisition laws. As economic growth slows and fuel prices begin to slowly recover, the government will need to remain vigilant in its resolve. The country cannot backtrack from scrapping fuel subsidies and should maintain its new, higher levels of spending on these projects to maintain continuity in these programmes.