A result of decades of underinvestment, creaky infrastructure has long been the Achilles’ heel of the Indonesian economy. The archipelago has not been able to build the hard infrastructure essential for sustaining growth. The World Economic Forum’s “Global Competitiveness Report 2013-14” ranked Indonesia 61st out of 148 countries for the state of its infrastructure, and improvements have not kept pace with the robust economic expansion that the country has witnessed since recovering from the Asian financial crisis of 1997-98.
Infrastructure investment as a share of GDP lingers at 3% – well below its pre-crisis level of around 7%. It is now acting as a drag on its growth. According to Van der Schaar Investments, Indonesia could potentially see its GDP expand by 7-9% per annum if it could fix its infrastructure woes. Indonesia has fallen behind in part because the sources of financing for infrastructure dried up in the aftermath of the Asian financial crisis. Foreign investors shied away from large-scale projects in an uncertain policy environment, and budget constraints prompted the government to curtail public funding for new projects. Decentralisation of decision-making has also contributed to the slow development.
Coming Up Short
“Indonesia’s lack of infrastructure is the main thing preventing the economy from reaching its full potential,” Scott Younger, director at Nusantara Infrastructure, said. “The country is in need of a complete infrastructure overhaul in terms of focus and financing.” Lack of adequate infrastructure also hurts Indonesia's competitiveness.
Over one-third (35%) of Indonesians lack access to reliable electricity, and even where the power grid does extend, outages are frequent. Clean water and decent sanitation remain out of reach for around half of the population. Access to safe drinking water ranged from 87% of households in Java to 66% in Sumatra and around 50% in Kalimantan in 2007. Overall, 73.43% of urban households had access to improved sanitation in 2011, against 43.51% in rural areas, according to the World Health Organisation. There is also a wide disparity when it comes to electricity supply, ranging from a high of 73% of households in some provinces to a low of 37% in others. This has had implications for investment patterns too. For example, in fourth-quarter 2013, Java received 66.23% of total foreign direct investment (FDI), while Kalimantan took in 10.21% and Sumatra 8.73%.
Regional disparity in infrastructure can also limit Indonesia’s ability to benefit from important regional initiatives, such as the Indonesia-Malaysia-Thailand Growth Triangle – a potential market of more than 70m consumers. Ramping up infrastructure spending, the government is inviting the private sector to foot part of the bill. Under the Master Plan for the Acceleration and Expansion of Indonesia’s Economic Development (MP3EI), a total of Rp1786trn ($178.6bn) is expected to be invested in infrastructure. Out of this, Rp68trn ($6.8bn) will be spent on power and Rp291trn ($29.1bn) on water utilities and other services. The government will finance 28% of the cost, while the rest will need to come from the private sector (see analysis).
First presented in 2011, the MP3EI is a framework document that divides the country into six development corridors and emphasises infrastructure projects as the foundation for success in all other growth target areas. However, there is still a need for legislation to better address the challenges involved in public-private partnership (PPP) projects.
The announcement in late 2013 by the Indonesian Investment Coordinating Board (BKPM) that the foreign equity portion in airports and ports would be raised to 100% was shortly followed by controversy that it contradicted the Civil Aviation Law No. 1/2009, which limits foreign ownership to 49%. Such uncertainty has affected the infrastructure segment in particular. Some have emphasised that FDI in the sector is by necessity a long-term investment, which is crucial to providing for stable economic growth. In the case of airports and ports, Raj Kannan, the managing director of Tusk Advisory, said in January 2014 in Forbes to ensure the operations of these assets are efficient and profitable and thus prefer majority control. ... It’s not that I am saying that local investors don’t have the capacity, I am simply arguing that we need more FDI in the infrastructure in general and in the airports and seaports sectors more acutely.”
The Asian financial crisis left a legacy of suspicion between private investors and the government. Many projects were cancelled and disputes were settled by arbitration. Since then the government has eased regulations to make the infrastructure sector more investor friendly. This includes amending the law on PPPs and passing a land acquisition act. It has also put in place a legislative and institutional framework to accommodate private sector interests in the infrastructure sector and addresses concerns regarding the apportioning of risk between the government and the investor. It has moved away from providing blanket guarantees to offering those that cover specific projects. Infrastructure investment planning is coordinated by the National Development Planning Agency, which prepares the country’s five-year development plans. An inter-ministerial policy committee contributes to the evaluation process for investment needs. It reports to the president and is responsible for policy coordination across ministries. The BKPM coordinates PPP projects and assists government agencies with preparing bankable projects for private sector participation. It also publishes a PPP book that lists infrastructure projects on offer.
The Indonesia Infrastructure Financing Facility was established in 2010 to act as a non-banking financial intermediary to mobilise capital for infrastructure and to help develop capacity in the financial sector to finance PPP projects. The Indonesia Investment Guarantee Fund, meanwhile, was created to improve the creditworthiness of PPP projects by providing financial guarantees to investors in the event of a change in government policies that would result in their cancellation. Established as a state-owned firm with its own budget, the fund allows the government to manage its risk by ring-fencing its obligations vis-à-vis guarantees. A risk management group within the Ministry of Finance evaluates projects prepared by the PPP unit and decides on the appropriate level of financial support.
PPP LAW: In 2012 the government amended the law on PPPs. It requires all PPP projects to be awarded through an open tender process after conducting feasibility studies and public consultation. The new law also empowered the federal government to provide direct support for projects through funding and cover risks that cannot be managed by private investors. Procurement processes have been simplified and a land fund now makes it possible for the government to acquire land pre-tender, thereby removing a critical uncertainty that investors faced when bidding for projects.
It has sought ways to identify efficient mechanisms for channelling subsidies, and the opaque practice of “hidden input subsidies” has been replaced by direct compensation to the infrastructure service provider (based on the difference between prevailing tariffs and the cost of supply). Provision of public services, such as water and electricity, is cautiously being advanced through competitive bidding, paving the way for gradual privatisation of infrastructure. Such measures resulted in the successful tender for the Central Java power plant in 2012. Seven consortia bid for the two 1000-MW coal-fired power plants. In 2013 Indonesia received over $1.46bn worth of FDI in power, gas and water supply, data from the BKPM shows.
Energy demand has outpaced supply in recent years. Generation facilities are outdated and insufficient, operating at an average capacity of 66%. Homes across the country experience daily blackouts lasting up to four hours a day on average. While power demand continues to grow at around 9% annually, the electrification rate has fallen from 67% to 65%. The number of people without access to electricity has increased by over 2.5m per year since 2008, according to “The Indonesia Electricity System - An Overview”, a report published in 2012 by Differ Group. Indonesia is falling behind its goal of reaching 90% electrification by 2020. According to Perusahaan Listrik Negara (PLN), the state-owned electricity monopoly, the country needs $9.75bn in investment to reach the target.
Indonesia does not lack energy resources. It is believed to hold 40% of the world’s total geothermal resources and has 76 GW of hydropower potential, but it has yet to exploit these. Instead, the bulk of the grid power is generated through oil. Indonesia also has a structural issue with its electricity supply. The government subsidises power through PLN, which provides it at discounted rates. As a result, the power monopoly remains cash-strapped and is unable to make sufficient investments in either expansion or maintenance. For 2014 alone, the budget for electricity subsidies set aside by the government was Rp81.7trn ($8.2bn). The power grid consists of eight domestic interconnected systems and 600 isolated ones, all operated by PLN. A proposed grid linking Sumatra and Malaysia is expected in 2020 that would, for the first time, enable the two countries to trade electricity.
If power demand continues to grow at the current pace of around 9% per annum, it will reach 400 TW by 2019. The island nation has few options but to increase domestic capacity to handle this. Renewable energy accounts for 10% of the total on-grid installed capacity. Some 5% of the total of 170 TW of on-grid electricity in 2010 came from renewable energy sources. On-grid renewable capacity consists mainly of large-scale hydro and geothermal power plants, while off-grid generation capacity includes diesel generator sets, small-scale hydro, biomass and solar power generation, according to Differ Group. Hydropower accounts for 13% of distributed generation, whereas geothermal made up less than 1%. Small-scale hydropower generation is gaining popularity and has increased by more than 700% since 2000.
Over the past seven years renewable energy generation in Indonesia has increased by more than 5% annually. More recently, private developers have also entered the market. So far, their focus has been on large-scale projects. The government has stated its intent to raise the capacity of micro-hydropower plants to 2846 MW by 2025; of biomass to 180 MW by 2020; of wind power to 0.97 GW by 2025; of solar to 0.87 GW by 2024; and of nuclear power to 4.2 GW by 2024. By 2025 the total investment required for the development of new and renewable energy is projected to be $13bn, as per a 2013 US government report on the power sector.
Power generation in Indonesia is projected to grow at an average of 6.5% per annum from 2014 to 2022. The government’s plan includes constructing power plants that would supply 20,000 MW of electricity in the next 10 years, according to the International Finance Corporation. In 2004 it announced a “crash” programme in which electricity generation capacity would be fast-tracked in two phases. The government is implementing the second phase of the programme, which seeks to create more than 10 GW of additional capacity by 2014. Nearly half of the 70 projects will go to independent power producers (IPPs). It has also raised the price of electricity by 15% since the start of 2013. Despite resistance, all four increments of 4.3% were implemented successfully in January, April, July and October 2013. In addition, the feed-in tariff for geothermal energy was raised for a second time in June 2013, making the sector more attractive to private investors.
The government is shifting focus from expensive oil-fired power plants, which account for 27% of the total energy generation, to those fuelled by coal and gas. Coal is abundant and represents the most attractive quick fix for short-term capacity expansion. Over 70% of the 9900 MW of capacity developed by PLN under the first phase of the crash programme was coal fired. Around half of the coal-fired capacity is operational, and the remainder is expected to come on-line in 2014. In the next phase of the programme coal will account for 3 GW of the total of 10 GW of power generation capacity. PLN will develop around 1.8 GW, while the rest is expected to come from private IPPs. The programme is set to run until 2016 and presents an attractive opportunity for investors.
The government has budgeted $8bn for four nuclear plants with a total generation capacity of 6 GW, to be operational by 2025. It aims to meet 2% of the country’s power demand from nuclear energy by 2017. But the country sits on a tectonic plate and is vulnerable to earthquakes. The National Atomic Energy Agency was eyeing locations on Bangka Island to build two nuclear power plants worth Rp54trn ($5.4bn) and expected to become operational in 2030. In February 2014 local media reported that a nuclear power plant with a capacity of 30 MW would be built in the western part of Java.
The most immediate opportunities for private investors are in geothermal, biomass, hydro and solar power. Geothermal sources have the potential to provide 27,510 MW of power, the highest in the world, though not much more than 1000 MW has been developed so far. Biomass resources have the potential to provide 49,810 MW of power, but less than 1000 MW has yet been utilised to date. Geothermal companies currently benefit from the 2003 law, which established long-term licences for land use and a regulated price for geothermal energy, though PLN’s position as the main energy supplier complicates matters.
Private firms have tapped into fast-growing crops such as cassava, jatropha and sweet sorghum for biofuel development, and PLN in partnership with General Electric will launch the country’s first biomass gasification project, which could produce more than 750 KW. The government has also announced a plan to conduct auctions for solar and geothermal energy. In 2013 it launched a tender for 80 solar photovoltaic projects with a combined capacity of 140 MW and worth Rp2.8trn ($280m). Hydropower, particularly mini-hydropower, has potential as well, given Indonesia’s geography. Large hydropower facilities are virtually non-existent and production hovers around 5000 MW.
The government is currently drafting a law on new and renewable energy that will offer new incentives to investors along with the tax breaks that have been available since 2008. It expects at least 1000 MW of new power supply will come from IPPs. The Karama hydroelectric power plant in West Sulawesi is anticipated to be put up for tender in 2014. The project, which has an estimated cost of $1.34bn, will provide 450 MW of electricity to the region, according to BKPM.
The water supply sector suffers from years of underinvestment, partly as a result of the poor financial condition of the 400-odd regional water supply enterprises. Lack of private investment is often attributed to low tariffs, an uncertain regulatory environment and the state’s less-than-favourable attitude towards private sector involvement in what is considered by many as a social good. According to the OECD, as of 2006 an estimated 8% of the water supply system in Indonesia was handled by PPPs.
Agriculture accounts for some 91% of the freshwater consumption in Indonesia, followed by industry (8%) and then domestic use (3%). Just 9m Indonesians are connected to water networks. The water supply network covers only 42% of urban areas and 11% of the countryside. The main responsibility of providing water rests with local governments, although the central government provides extensive financial and technical support. The Ministry of Public Works aims to reach 62% coverage of piped water supply in urban areas (it is currently around 50%) and 40% in rural areas by 2015. An evaluation of the investment needs estimated that this will mean 10m new water connections.
The Water Supply Development Supporting Agency established in 2005 oversees the water supply, acting as promoter and mediator in the PPP process. The 2004 Water Resources Law allows for private sector participation through concessions granted by the local government.
The government has envisaged nearly 70% of water infrastructure investments between 2010 and 2014 to come through PPPs, community participation and the private sector. However, private sector involvement in water services is still limited. Some projects have nevertheless been arranged using the PPP scheme.
One project that is up for bid in 2014 is the $20m Pondok Gede water supply project in Bekasi, West Java aimed at supplying 300 litres of water per second from the West Tarum canal to households and industrial units. Another one that will be put up for bidding in 2014 is the southern Bali water supply project, which will provide 1000 litres per second of water and is estimated to cost some $218.84m.
Access to clean water is a challenge. The government’s target is to provide clean water to 68% of the population by 2015. According to a 2011 survey by the Ministry of Public Works, only 44% of people have access to clean water, and the scale of the problem will only increase in size as the population grows. The Population Reference Bureau data shows that by 2050 Indonesia is expected to have more than 310m inhabitants.
Improving infrastructure will continue to be a priority. With Indonesia’s sovereign rating upgraded to investment grade and its economy growing at a steady pace. According to the government’s 2011 development plan, the private sector and state-owned enterprises will need to finance 70% of the infrastructure investments through PPPs over the next 12 years.
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