How is Infrastructure Hampering Indonesia's Economic Development?

Lack of adequate infrastructure causes Indonesia's logistics costs to rise steeply, thus reducing the country's competitiveness and attractiveness of the investment climate. According to data published by the Indonesian Chamber of Commerce and Industry (Kadin Indonesia) around 17 percent of a company's total expenditure in Indonesia is absorbed by logistics costs. In peer regional economies this number lies below ten percent. In particular transport costs are high; for land as well as sea. Despite Indonesia's archipelagic geography, the country's sea transport is yet to be developed substantially. Currently, sea transport is even more expensive compared to land transport. The weak circumstances for fostering a conducive inter- and intra-island trading network result in inflationary pressures on domestic produced products. This partly explains the paradoxical situation that sometimes domestic produced fruit is more expensive compared to imported fruit. It also leads to substantial regional price differences. Rice or cement, for example, are much more expensive in eastern Indonesia than in Java or Sumatra due to extra costs that arise from point of production to end user. It also means that Indonesian entrepreneurs are losing out on lucrative opportunities as logistic problems (which includes transport, warehousing, cargo consolidation, border clearance, distribution and payment systems) kills or prevents certain businesses from expanding. One might assume that Indonesia - being the world's largest archipelago and, as such, having large quantities of waters as well as seas at its disposal - contains a flourishing seafood business. However, it is far from flourishing, largely due to a lack of cold storage transport. This same matter is hampering Indonesia's horticulture businesses.

Indonesia is often plagued by blackouts because of shortages in the country's electricity supply. Despite the abundance of energy resources, Indonesia has a structural problem regarding the public energy supply. Part of the problem is that state-owned electricity distributor Perusahaan Listrik Negara (PLN), which has a monopoly on electricity distribution in Indonesia, is heavily dependent on government subsidies as the cost of production is higher compared to the fixed selling price. This means that PLN loses money with each kilowatt-hour (kWh) of electricity that is sold, if it was not supported by huge government subsidies. Thus, having had few financial resources for large-scale investments, energy demand has outpaced energy supply in recent years. Currently, the government is shifting its focus from (expensive) oil-fired power plants to the establishment of new coal and gas fired plants. But it will still take some time to ensure decent electricity supply throughout the country and, therefore, will continue to hamper Indonesian businesses in the near future.

It should also be mentioned that the lack of good-quality physical infrastructure in combination with weather phenomenons (such as heavy tropical rainfall) or forces of nature (earthquakes) can cause disruptions to the flow of goods and services. Indonesia is located on the Pacific Ring of Fire and therefore has to absorb many earthquakes. But even a relatively minor one can seriously damage the infrastructure.

Regarding (soft) social infrastructure (such as the education system, healthcare and social welfare) Indonesia also still has a long way to catch up. In order to provide a healthy and skilled workforce, necessary to grow into an innovation-driven society, these matters need to be resolved. The government has made new efforts in these fields in recent years. A new healthcare system is about to be introduced covering all Indonesians and spending on education has increased markedly. However, as with physical infrastructure, there is usually more planning than action as well as a gap between desired targets and accomplished results.

Why are Investments in Infrastructure a Problem?

The main problem for the Indonesian government to invest in the country's infrastructure is the lack of financial resources. Therefore, private sector participation - both foreign and domestic - is needed. However, in order for the private sector to join in, a conducive investment climate is required and - although improving - Indonesia is struggling to provide such an environment. Apart from other factors mentioned in our Risks section, the legal framework involving land acquisition has been a serious obstacle for infrastructure projects to materialize and makes investors hesitant to invest. Due to land disputes infrastructure projects have been idle for years or canceled altogether. But there have recently been taken steps to improve the land situation. At end 2011 the government and parliament approved the new Land Acquisition Law (UU No. 2/2012) that is regarded to speed up the land acquisition process notably as it deals with the revocation of land rights to serve public interest, puts time limits on each procedural phase and ensures safeguards for land-right holders. The bill, confirmed by the signing of a presidential regulation by president Susilo Bambang Yudhoyono in August 2012, is expected to be implemented in 2012. Both government projects and public-private partnerships (PPPs) on state-owned land are protected by this bill.

In recent years the government has given infrastructure spending a relative small allocation of public spending. In 2011 only 2.1 percent of the country's GDP was reserved for infrastructure (and mismanagement as well as bureaucracy reduces effectiveness of spent funds). In comparison, countries such as China and India spend almost 10 percent of their GDP on infrastructure. The government has, however, put infrastructure as a top priority on its agenda in order to accelerate economic growth. Regarding funding for infrastructure projects, the government has set targets in both the National Medium‐Term Development Plan 2010-2014 (RPJMN) and the Masterplan for the Acceleration and Expansion of Indonesia's Economic Development Plan (MP3EI 2011-2025) which - to a large extent - will be financed by the private sector. It is projected that more than 70 percent of both the USD $150 billion investment needs in the RPJMN and the USD $468 billion investment needs in the MP3EI will be contributed by the private sector through public-private partnerships. Approximately 45 percent of the MP3EI is reserved for infrastructure development.

However, up to date these public-private partnerships have not yet showed satisfying results. To provide more assurance for private investors, the government has established the Indonesia Infrastructure Guarantee Fund (IIGF). This institution gives certain guarantees against infrastructure risks for projects under the PPP scheme.

The paragraphs above explain why Indonesia suffers from a lack of quantity of its infrastructure, but it also faces a lack of quality: damaged roads, collapsed bridges, aging ports are just a few examples. Besides the common lack of financial resources to be used for maintenance purposes after infrastructure has been built, mismanagement, corruption and incompetence are frequent causes of inadequate infrastructure.