With its low debt-to-GDP ratio, abundant resources, growing consumer demand, healthy political discourse and rising investment, Indonesia is set to lead the region and could become the world’s sixth-largest economy by 2030. The country has 111 commercial ports, more than 200 airports, an estimated 17,508 islands and around 245m people. But its bright future remains at risk due to bottlenecks that are the result of the lack of infrastructure and of the low quality of what is already in place. The government is working to address these problems, both directly, by spending on roads, bridges, ports, airports and power stations, and indirectly, by encouraging public-private partnerships (PPPs).

CRUCIAL MATTER: The concern now is that procedural and implementation problems could slow the much-needed development. Estimates suggest that failure to get projects moving could reduce annual GDP growth by 1-3 percentage points, with some even seeing the potential for crisis. “The economy will come to a halt unless we improve infrastructure,” said Edward Gustely, the managing director of Penida Capital Advisors.

Indonesia, with the largest economy in the Association of South-east Asian Nations (ASEAN) and the 17th largest in the world, has currently about half the length of rail track it had when the Dutch left in 1949. It has some 770 km of toll roads, which is, on a per-km-per-person basis, one-20th of what has been built in Malaysia. Over the past 10 years, on average just 7 km of toll roads have been added a year, according to the Indonesian Chamber of Commerce and Industry (KADIN). More than a third of the county lacks access to electricity, and only about half the people in Indonesia have improved sanitation facilities.

The ports, too, are inefficient and facing challenges to handle larger container vessels due to the lack of dredging. Tanjung Priok, the main international port, can only take ships up to 50,000 deadweight tonnes (DWT), whereas Singapore, in comparison, can handle ships of 150,000 DWT, Malaysia’s Port Klang 120,000 DWT and Thailand’s Laem Chabang 120,000 DWT. Tanjung Priok and Tanjung Perak Surabaya are both moving more cargo than their designed limits.

Indonesia scored 59th on the World Bank’s 2012 Logistics Performance Index, up from 75th in 2010 but behind the ASEAN 5 and Vietnam, and was also last among the ASEAN 5 in the UN’s Human Development Index. It ranked 78th in infrastructure in the World Economic Forum’s (WEF) Global Competitiveness Index, despite an overall rank of 50. In the WEF survey, electricity supply was ranked 93rd and port facilities 104th.

HISTORICAL ROOTS: The great infrastructure deficit is largely a function of history. Until the 1997/98 crisis, infrastructure investment was brisk and developing fast. After the crisis, not much happened for about a decade as Indonesia fell off the map for international investors. At the time that the crisis struck, Perusahaan Listrik Negara (PLN), the state-owned electricity distribution monopoly, failed to honour the power purchase agreements (PPAs) signed with independent power producers (IPPs), and the government initially refused to back-stop PLN. Ultimately, the PPAs had to be restructured or scrapped altogether.

Politics has also played a role. After the crisis, the “New Order” period ended, “Reformasi” arrived and freedoms increased. While the changes have been good for the country overall, some have hampered infrastructure development. Leadership has been weak, and populism has set in; every stakeholder makes demands, but few want to give anything up for the common good — a real problem especially for toll roads, where many people are needed to sell their private holdings to create the right of way. Decentralisation, a major reform following the collapse of the Suharto regime, has added to the infrastructure troubles.

DECENTRALISATION: Under the leadership of president Bacharuddin Jusuf Habibie in 1997-98, significant power was devolved to the provinces, and it became difficult to coordinate large-scale projects. “It’s not the central government. It’s autonomy that’s the problem,” said David Irving Manurung, an analyst at Indonesia Finance Today. “After the reforms, there are many small kings. They are directly elected. When someone comes from the central government, they don’t have to oblige.”

The problems caused by excessive reforms and a weak centre can be seen clearly in the terms of toll road development. Total km rose steadily from 1978 to 1997 at 16.36% a year to reach about 532 km. From 1998 to 2007, growth slowed to 2.26% a year as the total rose in fits and starts to 664 km. By 2012 there were 770.36 km of road in the country.

It was a similar story in energy. Between 1999 and 2004, no new IPP power projects were tendered and development came to a halt. Water projects have been especially difficult as they are constitutionally the responsibility of the local governments and thus suffer from the lack of institutional capacity in the provinces. It is estimated that investment in infrastructure fell to 1-2% of GDP in 2000, down from 5-6% before the Asian financial crisis. The legacy of the crash and the dark days after appear to live on in the minds of investors, and they have remained cautious on the country even in recent years. In the Indonesia Inward Investment survey of 109 respondents published in July 2011 by Norton Rose, a law firm, 61% of respondents said the “bankability” of Indonesian projects is “poor” or “very poor” when compared with other South-east Asian jurisdictions. Indonesia was considered the riskiest economy for inward investment in a list that also includes China, South Korea, Malaysia, Singapore, Thailand and Vietnam. In terms of infrastructure projects in Indonesia, the respondents were most positive on those telecoms-related and most negative on rail.

LAND ISSUES: Perhaps the most serious problem for infrastructure development is land acquisition. The expropriation of property by the government for the public interest was mentioned the 1945 Constitution and again in acts that followed. Land, air and natural resources are seen as the property of the all the people to be put to use for common benefit and general welfare when appropriate. In practice, the state has been hesitant to exercise its power over national assets, especially in light of reforms and an increased emphasis on individual freedoms. One academic could find no case of acquisition through the forced withdrawal of land rights in a 10-year period ending about 2010. The result is long delays in acquiring land needed for large projects. Local communities usually reject efforts by the state to acquire their land, and compensation is invariably deemed too low. The government, at a time of heightened sensitivities and when human rights are very broadly interpreted, has been reluctant to make any moves that offend anyone at all. Several committees, teams and boards have been established to follow best practices and purchase the land needed, but progress has been slow as the focus has been more on the mechanics of land acquisition than on the underlying issue of individuals’ rights. The contract for the Surabaya-Mojokerto toll road, a 34.1-km highway, was signed in April 2006. By 2010, only 30% of the land had been acquired. The contract for the 21.6-km Depok-Antasari toll road was signed the same year, and only 1% of the land was acquired by 2010. The story is the same for the Gempol-Pasuruan, Pemalang-Batang, Semarang-Batang, Cikarang (Cibitung)-Tanjung Priok, Ciawi-Sukabumi and Pasuruan-Probolinggo toll roads.

BROAD CONSENSUS: But much is changing, and for the better. A broad consensus has been reached on infrastructure problems, and everyone from the country’s leaders to the person on the street understands that unless something is done, the economy will suffer.

The presidency of Susilo Bambang Yudhoyono, which began in 2004 and continues following his 2009 reelection, has brought a modicum of stability and focus to politics in Indonesia. While the country remains highly populist, Yudhoyono ended the half-decade era of uncertainty under his predecessors and has been a relatively strong leader. More importantly, perhaps, is the election of Joko Widodo as governor of Jakarta in September 2012. While populist, Joko is also an effective pragmatist who has a record of implementing projects and cutting through resistance. In 2005 he was elected the mayor of Surakarta – a famously corrupt and violent city of half a million people some 400 km from Jakarta on the island of Java. There he was able to build a consensus among disparate elements of society and proceed to do what to date had been impossible. He relocated street vendors to improve traffic conditions, addressed the needs of the poor, and streamlined licensing and related services by opening a one-stop shop. The businessman-turned-politician struck a balance between individual rights and the greater good, and as a result struck a chord with the people of Jakarta. His election as governor of the capital, winning almost 54% of the vote, was seen as a referendum on traffic. “I like the result of the Jakarta election. This will create change in Indonesia,” said Edimon Ginting, senior country economist at Asian Development Bank’s Indonesia Resident Mission. “It was the traffic election, a barometer for the whole country.”

STRONG RULE: While reforms are greatly valued by most Indonesians, they are seen as having gone too far, and a general willingness to rein in democracy through the democratic process has emerged. Indeed, a certain nostalgia is developing for the days under President Suharto, who was able to accomplish a good deal when in power — in km terms, a full two-thirds of the toll roads in the country were built during his rule. Industry participants and observers say that the issue is not money, technology or other resources, it is simply a matter of leadership and consistency at the top. Decision-making is Balkanised and territorial.

For example, Jakarta has invested in electronic traffic management systems, but they are ineffective as the departments with these systems are not coordinated with each other and with the police. “Many vendors try to provide effective electronic solutions,” said Aully Grashinta, the secretary of the Jakarta Transportation Council. “But there is no coordination among the state departments. They don’t listen to each other.”

NEW PROGRAMMES: The leadership will be tested over the next few years as Indonesia undertakes a series of programmes, policies, initiatives and reforms designed to help transform the country’s infrastructure, and by extension, its economy. The efforts began a few years ago with the National Long-term Development Plan 2005-25 (RPJPN), which focuses on administrative reform, the strengthening of democratic institutions, education and poverty reduction, and mentions and recognises the need to develop infrastructure.

Along the way, the country has also been refining its approach to PPPs. The government believes that the public budget and the balance sheets of state-owned enterprises (SOEs) do not have the capacity to fund all the development needed, so it is making sure that outside investors have an incentive to get involved. The projects, says the Ministry of Public Works, will need $192bn of infrastructure investment between 2010 and 2014, but the government and related entities can only provide about $56bn of that, with other public and private sources of funding providing some $104bn. There remains a $32bn financing gap. (The National Development Planning Agency, or BAPPENAS, gives slightly higher figures, though the ratios remain similar.) Indonesia has a long history of PPP development. In the 1990s, IPPs and partners of operations cooperation (Kerja Sama Operasi) companies for telecoms and toll roads utilised these cooperative structures. After the 1997/98 crash, activity dropped off, but over time the government has been addressing some of the weaknesses that led to earlier failures. In Presidential Decree No. 67/2005, it systematised the process for evaluating projects, clarified the need for proper due diligence and, most of all, set out the parameters for risk management and stipulated that guarantees had to be designed so as not to create moral hazard by being too generous. These principles were further strengthened in Presidential Decree No. 13/2010.

GUARANTEES: The Indonesian Infrastructure Guarantee Fund (IIGF) was established in December 2009 and helps to stabilise the guarantee side of the infrastructure equation. It was capitalised at Rp3.5trn ($350m), with an additional Rp1trn ($100m) authorised, and is designed to act as a one-stop shop for official backstopping of infrastructure projects. The contractual obligations of contracting agencies (the national government, regional governments and state-owned enterprises) are covered. Eight types of projects are eligible — water, power, transportation, toll roads, waste, irrigation, telecommunications, and oil and gas — and the projects need to have been put together following a list of best practices. Competitive bidding is required. The PPP agreement must have a binding arbitration clause, and the projects must be environmentally as well technically viable and socially desirable.

The IIGF was created to provide guarantees, but guarantees that will not themselves be the source of future problems. It replaces blanket commitments with agreements that target and take on specific risks, doing away with support letters and introducing sophisticated contracts. The IIGF, as a separately capitalised institution, will act as a buffer for the state budget, taking the force of large claims and thereby offering fiscal protection and a limit to potential losses. The guarantees for PPP projects can cover risks related to land acquisition, licences, permits, approvals, financial closing, changes in laws and regulations, contract violations, revenue, demand and price. In addition, the government provides direct, non-contingency, support to PPP projects like land contributions, tax incentives, capital contributions and permits. The extent of direct support will depend on the nature of the project, and a wide range of possibilities are contemplated.

NEW LAND LAW: Infrastructure projects may be helped considerably by the new Land Acquisition for Public Interest Development Law, passed December 16, 2011 and followed by implementation regulations ( Presidential Regulation No. 71/2012) on August 7, 2012. The law and related rules supersede Presidential Regulation No. 65/2006 and put into place a precise system for evaluation and appraisal, and a timeline for relinquishment of land rights. Acquisitions will be completed within 260 days in cases where there is no dispute and 583 days if the takeover is challenged. Laid out in the law are the type of projects that qualify, and the list includes roads, ports, power plants, airports, railways and dams, and the various stages of escalation, beginning with a local teams, going then to the State Administrative Court, and finally to the Supreme Court.

The hope is that the law will tip the scale in favour of public interest and away from individuals enough that projects that benefit society will be able to move ahead. For foreign investors, this will add certainty that will allow them to commit and raise funds. “The land release is the big problem,” said Manurang. “For public interest, the government issued the land law and there is optimism that infrastructure will develop quickly.”

“To the eyes of private investors this is a positive step, because you’ve taken out the land acquisition risk and you’ve taken out the completion risk,” added Raj Kannan, founder and managing director of Tusk Advisory, a Jakarta-based infrastructure consultancy firm.

Indonesians will often note how land acquisition is not a problem in places like China. With an authoritarian government, property rights do not get in the way of development, and public interest projects, especially toll roads, are quickly built. China has an estimated 100,000 km of toll roads, 70% of the world’s total. While few would say they want the level of centralisation found in the Communist state, there is a growing sense that at very least effective right of eminent domain will help the country. “If we compare with China, the land there is prepared for the investors,” Irwan H Marbun, the chairman of Committee on Office Development Infrastructure, Construction and Property at KADIN, told OBG. “It’s totally different from our country.”

MP3EI: Perhaps the most significant driver behind infrastructure development will be the Master Plan for the Acceleration and Expansion of Indonesian Economic Growth 2011-25, or MP3EI, issued on May 27, 2011 as Presidential Regulation No. 32/2011. This programme augments rather than replaces existing government initiatives, such as the RPJPN. But what makes MP3EI so significant is that it is a far more focused document, and one that places particular importance on infrastructure. It does have broad goals: to make Indonesia one of the top 10 advanced countries by 2025, and top six by 2050. It also provides specific recommendations for meeting these targets.

MP3EI identifies 22 main economic activities, from information technology to cocoa, and six economic corridors (ECs) that will be growth centres. The corridors are: the Sumatra Economic Corridor, for producing and processing natural resources and for energy reserves; the Java EC, for industry and services; the Kalimantan EC, for mining and energy; the Sulawesi EC, for agriculture, fishing, oil, gas and mining; the Bali-Nusa Tenggara EC, for tourism and food; and the Papua-Kepulauan Maluku EC, for food, fishing, energy and mining industries. Key to the whole set up is connecting all the various parts, and this will require the building of infrastructure or the improvement of that which is already in place. The goal is to connect the corridors efficiently for the movement of people, goods and information and then to connect the country via international gateways to Asia, the US and Europe. This will involve constructing roads, improving shipping lanes, developing railways, revitalising ferry transportation, improving air transportation, strengthening communications networks, and building and improving the various international ports and airports.

The government has estimated that a total of Rp4012trn ($401.2bn) will be spent on MP3EI, with Rp2226trn ($222.6bn) going towards the 22 main economic activities and Rp1786trn ($178.6bn) going towards infrastructure. Of the latter, Rp339trn ($33.9bn) will go to roads, Rp117trn ($11.7bn) to ports, Rp681trn ($68.1bn) to power and energy, Rp32trn ($3.2bn) will go to airports, and Rp326trn ($32.6bn) will go to rail, with the rest being allocated to water utility, information and communications technology and other infrastructure, according to the government’s master plan . The government will contribute about 10% of the Rp4012trn ($401.2bn). Around 18% will come from SOEs, 51% from private enterprise and 21% from PPPs. Of the 79 projects in MP3EI, 32 are PPP projects.

SLOW PROGRESS: Despite these programmes and policies, little has been accomplished over the past few years. The 24 toll roads are still stalled and only 12.89 km of toll roads were added in 2011 (for a total of 770.36) compared with 44.85 added in 2010. Tenders have been signed and some financing has been raised, but progress has otherwise been slow.

Investor confidence is one of the main difficulties. While many international funds are interested in getting involved, many of the same issues remain. They cite corruption, inefficiency, lack of leadership, overlapping regulations, lack of transparency and weak public institutions. Rather than encourage investors, the new frameworks in some cases have had the opposite effect.

Land acquisition remains the biggest hurdle, despite the new law. For one, the new law will not apply to existing projects until 2014, so it does little to break the current bottleneck. There is also a growing sense that the law itself may not work. The appeal process provides the public with three opportunities to stop a project. While deadlines do exist and cases will be heard, and decisions will be made within prescribed deadlines, the courts and administrators could still side with the public. Grounds do exist in theory for effective challenges. For example, the law requires that a project be in the public interest, and it could be argued that some proposed projects do not meet this requirement.

The appraisal process is also the source of concern. Given the level of corruption, developers could interfere; even the possibility of this sort of interference could be enough to mount an effective challenge. Investors want to see “some runs on the board” in the PPP space, but it will be difficult to prove that the current PPP programme will function unless foreign investors are able to successfully use it. The government has promised to fast-track five projects, but even if five projects get completed, it is difficult to know whether the sixth project will be as easy. The Central Java Power Plant is a case study in what can go wrong despite the reforms. The project, a 2000-MW coal-fired power plant, was initiated in 2005, bidding was completed in 2011 – Japan’s J-Power and Itochu Corporation and Indonesia’s Adaro Power won – and project agreements were signed in October 2011. The PPP structure was employed, as were guarantees under the new regulations.

It was to be a showcase project for development using the latest reforms. However, the financial close has been delayed by a year due to local protests and land acquisition issues. The plant, which was to be operational in 2016, is now scheduled to be up and running at some point during 2017.

OUTLOOK: To many, the lively democracy at work is what stands in the way of development, but while it may slow down the pace, the vocal public makes sure that infrastructure is front and centre. In the end, this may lead to better, more balanced outcomes.

If a few infrastructure deals get done in the next year, and if there is clear and verifiable progress and a commitment of actual investment funds to these transactions, many more agreements could follow and a significant amount of infrastructure could be built. The new land acquisition law needs to be tested, and the market needs evidence to demonstrate that the legislation works in practice. International funds are waiting on the sidelines and are eager to participate, and the overall sentiment regarding Indonesia is positive. All of the players are in place and ready to go. If just a couple of projects get under way, beyond the stages of expected, anticipated and promised, these investors will deploy capital. That could lead to a virtuous circle of more infrastructure leading to strong economic growth attracting still more investors to infrastructure.