An infrastructure boom is under way in Indonesia, after the administration of President Joko Widodo committed to developing Rp5500trn ($414.6bn) worth of new public works projects between 2015 and 2019, including large-scale transport, utilities and ICT projects, as well as new schools, hospitals, and water supply and treatment plants.

In recent years the government has mobilised a coordinated effort to deliver planned projects, with dozens of state actors collaborating to develop new infrastructure policy, including an organised framework for public-private partnerships (PPPs), new finance models and risk management reforms. Public expenditure on infrastructure is expected to hit a historic high in 2017 (see analysis).

OPERATING ENVIRONMENT: The infrastructure development agenda faces notable challenges. Land acquisition issues continue to dampen private investor sentiment, while local government regulatory requirements have proven a hurdle for PPP development, and the country’s infrastructure deficit will require substantially more private financing for successful mid-term delivery.

Indonesia’s mid-2017 sovereign credit rating upgrade should support a recent upswing in public and private bond issuances, with state-owned enterprises (SOEs) active in the ports, utilities, aviation and construction industries tapping international bond markets to finance projects. Assignment of projects to SOEs has led to a brightened outlook for infrastructure development, with construction set to accelerate in the coming years as a result.

OVERSIGHT: The development of infrastructure is overseen by dozens of separate government entities, most notably the National Development Planning Agency (BAPPENAS), the Coordinating Ministry for Economic Affairs, the Ministry of Finance (MoF) and its Government Investment Centre (PIP), the Ministry of Energy and Mineral Resources, the Ministry of Transportation (MoT), and the Ministry of Public Works and Housing.

PPP development is also supported by the Committee for Acceleration of Prioritised Infrastructure Delivery (KPPIP), formed in 2015 to expedite PPP implementation, as well as the Indonesia Investment Coordinating Board, which offers a one-stop centralised licensing point for investors in sectors such as manufacturing, power, tourism, and oil and gas.

SOE SUPPORT: Dozens of SOEs are also active in infrastructure development, financing and construction. Sarana Multi Infrastruktur (SMI), for example, is active in financing major infrastructure projects. SMI was established in 2009 to provide financing, project preparation and advisory services. It supports PPPs through partnerships with private and multilateral lenders, and its mandate includes both hard and soft infrastructure projects. The company was financed through Rp1trn ($75.4m) of government equity, with the World Bank and the Asian Development Bank (ADB) both providing separate $100m loans. SMI’s project portfolio was valued at Rp231.9trn ($17.5bn) as of April 2017. Of this total, 43.6% was allocated to toll roads, 13.9% to electricity projects, 8.5% to transport, and 6.5% to oil and gas projects, followed by telecommunications with 4.1%, irrigation with 3.3%, clean water (2.1%), non-toll roads (0.54%) and hospitals (0.16%).

SMI also partly owns Indonesia Infrastructure Finance (IIF). Established in August 2010 by the Decree of the Minister of Finance No. 439 of 2010, IIF provides infrastructure financing and advisory services for commercially viable infrastructure projects. IIF is active in the provision of fund-based products such as long-term loans and guarantees, which are financed by shareholders, and long-term loans from the World Bank and the ADB.

GUARANTEE FUND: The Indonesia Infrastructure Guarantee Fund (IIGF) is an independent SOE established in December 2009 as the sole institution responsible for appraising, structuring, processing claim payments and providing government guarantees for PPPs. The IIGF offers two types of guarantees: those backed by its own capital and those supported by the World Bank under its IIGF Project.

In May 2017 IIF reported that it had disbursed 50% of its Rp12trn ($904.5m) financing target for 2017, most of which was allocated to power plant, telecommunications and transport projects, including the 498-km Trans-Java Toll Road. According to the company, the remaining Rp6trn ($452.3m) will be disbursed to geothermal power projects in East Java. The firm noted, however, that IIF money is only allowed to contribute up to 35% of a project’s budget; the remaining amount will have to be sourced from other investors.

Project implementation has also increasingly been undertaken by SOEs, including Perusahaan Listrik Negara, which holds a monopoly on electricity distribution; Angkasa Pura I and II, the country’s airport operators; port operators Pelabuhan Indonesia (Pelindo) I, II, III and IV; toll road developer Jasa Marga; railway operator Kereta Api Indonesia (KAI); and numerous state-owned construction firms.

INFRASTRUCTURE DEFICIT: Indonesia has struggled to reduce a wide and growing infrastructure deficit in recent years, with logistics costs increasing to become the highest in South-east Asia, equating to 26% of GDP (see Transport chapter), in turn affecting competitiveness, investor appetite and foreign direct investment inflows.

In the World Economic Forum’s “Global Competitiveness Report 2015-16”, the country ranked 62nd out of 140 economies surveyed in the category of infrastructure development. Meanwhile, Indonesia’s rank fell 10 places on the World Bank’s 2016 Logistics Performance Index, to 63rd out of 160 countries. A significant portion of the problem is a result of decades of underinvestment following the collapse of President Suharto’s “New Order” government during the late 1990s.

Although the country’s economy surged after recovering from the 1997/98 Asian financial crisis, infrastructure investment has not kept pace. Urban infrastructure spending averages 3% of GDP, according to a 2016 ADB report, compared to 8% of GDP in the years to 1997. The country’s infrastructure deficit carries significant ramifications for macroeconomic growth, in addition to weighing on domestic industry and investment. For example, until recently it was cheaper to import oranges from China than buy from Indonesian farmers, owing to the elevated shipping costs for domestic produce.

High logistics costs have created significant regional price differences, hampering the country’s growth outside of Java and Sumatra, with economic monitoring service Indonesia Investments reporting that rice and cement are far more expensive in eastern Indonesia than in the more developed and densely populated western islands. “Although infrastructure development is gradually moving forward, the progress is relatively moderate. We hope this will accelerate further in the upcoming year,” Takashi Ikematsu, president director of Hitachi Asia Indonesia, told OBG.

DEVELOPMENT AGENDA: The Widodo administration has adopted a multi-faceted approach to tackling these issues, although significant challenges pertaining to financing, local government regulations and land acquisition continue to weigh on project delivery. President Widodo was elected in 2014 after campaigning on plans to invest significantly in new infrastructure, later releasing a five-year National Medium-Term Development Plan (RPJMN) which is to run until 2019. The RPJMN aims to enhance national connectivity to achieve equitable development; accelerate the provision of basic infrastructure, including housing, clean water, sanitation and electricity; guarantee water, food and energy security; support national defence; and develop urban mass transport systems. In January 2015 the government announced its infrastructure development agenda would require up to Rp5500trn ($414.6bn) over the next five years.

PLANS & SPENDING: Major planned projects under the MDTP and its corresponding infrastructure development agenda include the construction of 49 dams, the building and improvement of 1m ha of irrigation networks and the rehabilitation of 3m ha of additional irrigation networks.

In the energy sector, the government plans to build two new oil refineries, each with a 300,000-barrel-per-day capacity, as well as five floating storage regasification units across Java and in Lampung, which will connect 90,000 households to natural gas supply networks. The government also hopes to build 75 natural gas fuelling stations and boost its electrification ratio to 96.6% by adding 35,000 MW of power to the national grid. The original plan was for the additional 35,000 MW to be installed by 2019, but this deadline looks likely to be extended or postponed indefinitely, as GDP growth has lagged behind expectations when the target was announced.

ICT infrastructure development is also slated to accelerate, with plans to connect 100% of the population to a national fibre-optic network, supported by the Palapa Ring projects, a large infrastructure initiative that seeks to install a total of 35,000 km of undersea fibre-optic cables – 13,000 km located offshore and 22,000 km onshore (see ICT chapter).

Planned transport projects include the construction of 2650 km of new roads, including at least 1000 km of new toll roads; the establishment of 15 new airports and 24 seaports; and the building of 3258 km of rail lines, split between 2159 km of intercity railways and 1099 km of city railways. Urban mass rapid transit systems have been planned for six metropolitan areas. The government has also envisioned the construction of 5257 twin block apartment towers with space for 515,711 families, and expanding urban clean water coverage to an additional 21.4m households.

Budgeted infrastructure spending has surged under the Widodo administration, rising by 51% in 2015 to hit Rp209trn ($15.8bn), according to PwC, and jumping a further 51.7% to Rp317trn ($23.9bn) under the revised 2016 budget. The 2017 draft budget originally forecast Rp346.6trn ($26.1bn) for infrastructure, but this figure was later revised upward to Rp387.4trn ($29.2bn), a record allocation.

SOE INJECTIONS: President Widodo has appointed dozens of SOEs as developers of key infrastructure projects, as they own more assets than privately held companies and can benefit more easily from state-owned bank lending. The central government moved to provide 24 infrastructure-oriented SOEs with capital injections in 2016, allocating Rp48.2trn ($3.6bn) in total, with the infrastructure and maritime transport sector receiving 48% of funding.

The country has made notable progress in delivering its transport agenda in recent years, opening a new terminal at Soekarno-Hatta International Airport in Jakarta in August 2016 and launching the first phase of the new Tanjung Priok port the following month. Progress is additionally being made in delivering new rail infrastructure, including a planned Jabodebek light rapid transit system, which is being developed by Adhi Karya while KAI will be the operator (see Transport chapter).

However, in June 2016 the House of Representatives announced it was cancelling capital injections for three SOEs from the 2016 budget. Trading houses Perusahaan Perdagangan Indonesia and Pelindo III were both originally set to receive Rp1trn ($75.4m), while small and medium-sized enterprise lender Bahana Pembinaan Usaha Indonesia had been due an allocation of Rp500bn ($37.7m).

In a separate announcement, state-owned construction contractor Hutama Karya had its capital injection cut from Rp3trn ($226.1m) to Rp2trn ($150.8m). Total SOE budget lines were revised to Rp36.2trn ($2.7bn) in 2016, and fell to just Rp7.2trn ($542.7m) in 2017, with total spending in 2016-17 decreasing as a result of revenue collection shortfalls (see Economy chapter).

FINANCING GAP: Financing remains the most significant challenge facing infrastructure development in Indonesia. Although the RPJMN called for a total of Rp4796trn ($361.5bn) in infrastructure investment through to 2020, central and local government budgets are only able to contribute 41% of total financing needs, according to Indonesia Investments. In February 2017 the ADB reported that Indonesia’s infrastructure investment requirements could reach as much as $1.2trn in the years leading to 2030. The country currently spends an estimated $23bn per year, with an annual financing gap of $51bn, equivalent to 5.1% of GDP.

According to the ADB, Rp387trn ($29.2bn) has been allocated to infrastructure development in 2017, accounting for nearly one-fifth of total spending, with local media reporting in April 2017 that overall public expenditure for the year had been revised to Rp2085.5trn ($157.2bn), 0.12% lower than 2016 levels. The MoT reported a Rp1trn ($75.4m) budget cut as one of the results, telling media it had re-allocated Rp5trn ($376.9m) from “unproductive” projects in a bid to improve spending realisation and efficiency (see Transport chapter).

The government has identified private sector participation and investment as a critical component in maintaining long-term infrastructure development. Although PPPs are emphasised, state actors have increasingly turned to international debt markets to meet their financing needs.

STATE OF PPP PLAY: Under the previous administration of President Susilo Bambang Yudhoyono, PPPs were highlighted as an important support mechanism for infrastructure development. However, until recently, PPP implementation was largely limited and there were many projects in the PPP catalogue that were not moving according to plan.

Since 2017 concerted efforts have been made to start properly preparing PPP projects, and ongoing government reforms aim at reducing risk and facilitating speedier implementation. “More PPP transactions are now being prepared to international standards, and the understanding of regulatory issues is improving across the government,” Julian Smith, director at PwC Indonesia, told OBG. “However, the PPP programme could still benefit from more direction from the central government if it is to realise its full potential.”

BAPPENAS publishes an annual PPP book, with projects categorised by their stage of development, including already tendered, ready to offer and under preparation. Analysis of previous iterations of the PPP book demonstrates that the total number of PPPs under development has dropped in recent years, as BAPPENAS has removed projects that were not ready or making progress. There were 87 PPP projects under development in 2009, and although none had been tendered, eight were ready to offer, 18 were prospective and 16 were potential. Projects under development fell to 79 in 2011 (13 ready to offer, 21 prospective, 45 potential and five tendered) before dropping to 58 in 2012 and 27 in 2013.

In 2013 none of the government’s PPP projects had been tendered or were ready to offer, while 14 were listed as prospective and 13 as potential. In 2015 a total of 39 PPP projects were on the list, including seven ready to offer, eight prospective and 24 potential, as well as 22 tendered projects.

In the 2017 edition of the PPP book, BAPPENAS listed 21 projects currently under preparation, and one – the Bandar Lampung Water Supply project – as ready to offer, valued at $8.39bn. PPP projects classified as under preparation included five port and two railway projects, with a total value of $6bn, as well as five toll road projects priced at $1.6bn. Four solid waste and sanitation projects worth an estimated $121.33m are also under preparation, as well as three social infrastructure projects valued at $276.1m and a $318m satellite project (see analysis).

One of the main obstacles to project development is the current lack of government capacity to properly prepare projects for the market. Long-term, capital-intensive projects could also be at risk of delays, cancellation and land acquisition challenges.

NEW FINANCE MODELS: The government is moving to address these challenges through the adoption of new financing models, with the aim of increasing PPP investment, encouraging bond-financed construction and improving risk management in guarantee issuance. IIF, for example, reported in May 2017 that it was preparing staple financing and take-out financing schemes in a bid to speed up PPP implementation. Under a staple financing scheme, the PPP would be bundled with IIF’s financial package, meaning contractors would not need to allocate their own project financing.

Under the take-out financing model, parties would agree to a contract in which the IIF would take over future financing. Using this method, a bank could finance a 15-year project for the first five years, after which it would be sold to IIF. This should go a long way in reducing long-term financing risks, thereby incentivising PPPs and offering a short-term boost. In addition, a series of regulatory reforms – the PPP Regulations – promulgated in 2015 and 2016 established the availability payment scheme (APS) as a new financing mechanism (see analysis).

Before the government established a Viability Gap Fund (VGF) in 2005, PPPs were developed under the traditional and widely used build-operate-transfer (BOT) model. The VGF is only for economically viable projects when there is no other alternative to making it financially feasible. VGF projects must implement a user-pay principle, with a minimum project investment value of Rp100bn ($7.5m), while beneficiaries are required to complete a comprehensive pre-feasibility study prior to VGF approval.

BOND FINANCING & GUARANTEES: In February 2017 local media reported that Waskita Karya, a toll road SOE, had successfully financed nine sections of toll road valued at Rp70trn ($5.3bn) under its pilot non-state budget infrastructure funding (PINA) model, which channels pension funds and other institutional investment funds to an intermediary for bond issuance. Proceeds from the bond sale are used to buy equity in companies executing projects, with the intermediary selling its equity in the project once it becomes operational.

The PINA model should complement existing financing models, in addition to providing support for future bond-financed infrastructure development. At the same time, recent reforms to government guarantee issuance should further mitigate long-term investment risks, reducing budgetary pressure and insulating public infrastructure developers from potential financial shocks (see analysis).

LAND ACQUISITION: Outside of financing, land acquisition poses the most significant obstacle to infrastructure development. Indonesian farmers and landowners are often reluctant to sell plots to developers, with land price escalation during a project’s development driving up costs and delaying construction. Lengthy court processes have often dragged out project delivery, as was the case with the Rp54trn ($4.1bn) Batang power plant project, a 2000-MW facility that was delayed repeatedly due to challenges securing land. A planned high-speed railway linking Jakarta to Bandung has also faced obstacles since it broke ground in 2016, stalling just days after its May launch, and remaining unfinanced as of September 2017 due to land acquisition requirements mandated by its largest financier, the China Development Bank (see Transport chapter).

Ongoing decentralisation initiatives have also often brought central and local governments into opposition, with project development – especially PPPs – becoming increasingly complicated as local government participation increases (see analysis).

REFORMS: At the end of 2011 the Indonesian Parliament passed the Land Acquisition Law No. 2 of 2012, which aimed to expedite the acquisition process by addressing the issue of revoking land rights to serve the public interest, setting time limits on each procedural phase and establishing safeguards for landowners. However, the law has yet to be fully implemented or enforced, and although President Widodo has personally presided over the launch of several land-intensive projects, including the Batang power plant and Balikpapan-Samarinda toll road, local communities continue to resist land sales.

The government offers a number of funds for this area, including the Land Capping Fund, which provides compensation to toll road investors in the event of a significant increase in land prices, and the Land Revolving Fund, which temporarily covers land acquisition costs for projects. The MoF’s PIP offers pre-financing for land purchases, while the MoF manages the Geothermal Fund Facility, which provides exploration data for geothermal projects.

The government is making significant progress in restructuring its land acquisition financing, with the MoF’s State Asset Management Agency (LMAN) announcing in April 2017 that it had launched a new scheme to fund land acquisition for strategic national projects. Under a 2016 presidential regulation, LMAN is now responsible for funding and utilising land banks, in addition to paying compensation for land acquisition. The Ministry of Public Works and Housing and the Toll Road Regulatory Agency signed a memorandum of understanding with 23 toll road companies as part of the new regulations, with LMAN set to receive Rp20trn ($1.5bn) of allocations in 2017, up from Rp16trn ($1.2bn) in 2016.

Indeed, there is still uncertainty surrounding land acquisition processes, and although there were improvements after the law in 2015, this area remains a challenge for infrastructure development.

OUTLOOK: Land and financing obstacles are likely to continue to weigh on infrastructure activities, and delays of some projects have made it unlikely that the country will meet its medium-term infrastructure development targets. Still, legal reforms, new innovative financing models and the successful tendering of some large-scale PPPs provide reasons for optimism, with progress continuing at a steady pace into 2018, supporting macroeconomic growth.