Indonesia Investments wishes all Muslims a happy & generous Ramadan
25 May 2018 (closed)
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One particular subject of the Indonesian economy that has been hampering Indonesia's economic and social development is the lack of quality and quantity of infrastructure. Whether it is 'hard' infrastructure (such as roads, airports and electricity supply) or 'soft' infrastructure (such as social welfare and healthcare) Indonesia seems to have a hard time pushing for structural and rapid development.
In World Economic Forum (WEF)'s Global Competitiveness Report 2015-2016, Indonesia ranks 62nd out of 140 economies in terms of infrastructure development, a mediocre ranking, and one that causes major problems. Since the era of reformation replaced Suharto's authoritarian New Order government in the late 1990s, expansion of Indonesia's infrastructure has not been able to keep up with robust economic growth that occurred after the recovery from the Asian Financial Crisis amid the lucrative commodities boom. As a consequence, Indonesia's economic growth fails to reach its full potential.
How is Infrastructure Hampering Indonesia's Economic Development?
When the state of infrastructure is weak it implies that the economy runs in a highly inefficient manner as logistics costs are high, businesses lack competitiveness (because the costs of doing business are high), and there exists a high degree of social injustice when, for example, it is difficult for part of the population to reach healthcare facilities, or, for children to reach a school.
In fact, infrastructure development and macroeconomic development go hand-in-hand (have a reciprocal relationship) because infrastructure development gives rise to economic expansion through the multiplier effect, while economic expansion gives rise to the need to enlarge existing infrastructure to absorb the larger flow of goods and people that travel across the economy. However, when existing infrastructure cannot absorb rising economic activity (and not enough new infrastructure is developed) then there occur problems, similar to blocked arteries in the human body that cause life threatening conditions.
This partly explains the paradoxical situation that domestically-produced fruit is sometimes more expensive compared to fruit that is imported from abroad. Several years ago consumers in Jakarta would often complain because imported oranges from China were cheaper in Jakarta's supermarkets compared to domestically-produced oranges. Furthermore, Indonesia's notoriously high logistics costs also lead to substantial regional price differences across the archipelago. Rice or cement, for example, are much more expensive in eastern Indonesia than on the islands of Java or Sumatra due to extra costs that arise from point of production to end user. In other words, the weak inter- and intra-island trading network in Indonesia results in inflationary pressures on domestically-produced products.
Lack of adequate infrastructure also seriously undermines the attractiveness of Indonesia's investment climate. Potential (foreign) investors are hesitant to invest in manufacturing facilities in Indonesia when, for example, the supply of electricity is uncertain or transportation costs are high. Despite the abundance of energy resources, Indonesia is often plagued by blackouts - particularly outside the bigger cities on Java and Bali - because of shortages in the country's electricity supply. Meanwhile, according to data published by the Indonesian Chamber of Commerce and Industry (Kadin Indonesia) around 17 percent of a company's total expenditures in Indonesia is absorbed by logistics costs, while in peer economies this figure is below ten percent.
These matters obviously make investors think twice before deciding to invest in Indonesia (this particularly applies to foreign direct investment). Meanwhile, logistic problems (which includes transportation, warehousing, cargo consolidation, border clearance, distribution and payment systems) make it tough for existing entrepreneurs and businesses to expand.
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 and tsunamis) can cause major disruptions to the flow of goods and services. Indonesia is located on the Pacific Ring of Fire and therefore has to absorb many earthquakes. Even a relatively minor one can cause serious damage (including casualties) as part of Indonesia's infrastructure is not strong enough to absorb the power. Meanwhile, during the rainy season, lack of adequate infrastructure leads to floods, and thus, inflation due to supply shortages as the distribution network is disturbed.
Regarding (soft) social infrastructure (including the education system, healthcare and social welfare) Indonesia still has a long way to catch up. In order to develop a healthy and skilled workforce, which are necessary to grow into an innovation-driven society, these matters need to be resolved.
Indonesian Governments & Infrastructure Development
Therefore, the Indonesian government is well aware about the importance to offer a more attractive investment and business climate by improving the nation's infrastructure. Currently, there are not enough roads, harbors, airports, and bridges in Indonesia (Southeast Asia's largest economy), while - not unoften - the quality of existing infrastructure is weak. However, developing Indonesia's infrastructure (both hard and soft) is not an easy task. The Archipelago consists of about 17,000 islands (although it is fair to say that many of these islands are not inhabited and show no economic activity) which makes it more complex (thus more expensive) to enhance connectivity and implies there exists a need to focus on maritime infrastructure. Currently, sea transport is more expensive than land transport as the country's sea transport is yet to be developed substantially. This also explains why - despite being the world's largest archipelago and, as such, having large quantities of waters and seas at its disposal - Indonesia's seafood business is far from being a flourishing business (this is largely due to a lack of cold storage transport facilities, which also hampers Indonesia's horticulture businesses).
Governments in the post-Suharto era have not been as successful as Indonesia's second president Suharto in achieving infrastructure development. This is primarily caused by the different political context: democracy and decentralization in the post-Suharto era imply that the central government can no longer use military force to acquire the necessary land for infrastructure projects. Instead, governments in the era of democracy have to rely on the ruling of courts, a lengthy process and one that not always goes in favor of the developers or government. Meanwhile, the decentralization of power led to the present situation in which local governments sometimes fail to support the central government's infrastructure plans because there is not enough (direct) financial gain for local government officials.
A less strong central government also means that it has become more complex to develop big infrastructure projects that cover land in more than one province. Indonesia's regional and central authorities lack smooth cooperation and coordination, a situation that is usually blamed on the weak quality of human resources at the local level. Meanwhile, there also exists a high degree of bureaucracy (red tape) in Indonesia - both at the central and local level - that often leads to the delay (or complete cancellation) of an infrastructure project as parliamentary rule-making usually covers macro issues, while the fine-tuning is done through numerous ministerial regulations as well as regional legislation, allowing bureaucracy to play a big role and which causes an unclear regulatory framework as coordination between center and regions is not optimal.
Lastly, a problem occurs due to the close ties between the political and corporate elite in Indonesia (both on the central and local level). Both groups are primarily focused on increasing their own welfare, not the welfare of the local society. This sometimes leads to a delay in infrastructure development as the local elite grants concessions to befriended companies (that may have helped to finance campaigns of the local elite), while these companies are not able to complete the infrastructure project. Instead, they sell the concessions to a third-party for a profit. This means that valuable time has passed before projects are handled seriously.
In this difficult context Indonesian President Joko Widodo seeks a new approach to achieve much-needed breakthroughs to boost infrastructure development. For example, the government budget for infrastructure development has risen sharply since Widodo entered office (something which is partly made possible by his decision to scrap a large chunk of energy subsidies).
Funds Allocated to Infrastructure Spending in the Government's Annual State Budgets:
Furthermore, Widodo appointed a number of state-owned companies as developers of key infrastructure projects. The state-owned companies usually have bigger assets compared to privately-held companies and are also able to raise additional funds from (state-owned) banks more easily. There has also been an increase in capital injections from the state budget into several key state-owned construction firms. Another new tactic is to organize tenders in the year before the infrastructure project is expected to see groundbreaking.
Land Acquisition: Key Obstacle to Infrastructure Development
Besides the lack of financial resources, the biggest obstacle to infrastructure development in Indonesia seems to be land acquisition. This has been a very tough process (lengthy and costly) as landowners either refuse to sell their land for infrastructure project (for example many Indonesian farmers are reluctant to sell their land to developers of power plants or roads) or demand very high prices. Due to these disputes many infrastructure projects in Indonesia have been idle for years or canceled altogether.
At end-2011 there seemed light at the end of the tunnel as the Indonesian government and parliament approved the new Land Acquisition Law (UU No. 2/2012) that was designed to speed up the land acquisition process by dealing with the revocation of land rights to serve public interest, putting time limits on each procedural phase and by ensuring safeguards for land-right holders. However, contrary to initial optimism, this Land Acquisition Law failed to speed up infrastructure development. This failure is attributed the lack of will on the part of the government under the leadership of Susilo Bambang Yudhoyono. Presumably it was reluctant to use this law to force land acquisition as the government was already plagued by declining popularity rates due to the emergence of several corruption cases and indecisive governance. Forcing people to sell their land would do more damage. Several studies show that forced land acquisitions in Indonesia lead to conflicts as well as the loss of income of the displaced persons.
President Widodo seems less concerned about human rights accusations and prefers to look at the larger benefit for society rather than the benefit for a handful of people. Widodo threw his support behind big infrastructure projects such as the Batang Power Plant and Balikpapan-Samarinda toll road by forcing groundbreaking (and being present, personally, at the ceremony), even though part of the local community continues to protest against the projects and refuses to sell their land. This should also be considered a sign to investors that the Widodo administration will not let key projects remain idle. Critics, however, point out that people who are forced to relocate struggle to find new sources of livelihood (they receive one-time cash compensation) and face difficulties to adapt in new social environments. These critics also say ordinary people have very little room to negotiate for fair compensation under the Land Acquisition Law.
Financial Resources for Infrastructure Investment
Possibly the biggest problem - related to infrastructure development - is to find all necessary funds. Based on the National Medium‐Term Development Plan (RPJMN) 2015-2019, a total of IDR 4,796 trillion (approx. USD $358 billion) worth of investment in infrastructure is required to meet the government's targets by 2019. However, the central and local state budgets can only contribute 41 percent to the financing, while state-owned companies can contribute up to 22 percent. This implies that 37 percent of funds (equal to IDR 1,752 trillion) need to originate from the private sector.
The problem is, however, that - generally - there is few enthusiasm from the private sector to commit themselves to long-term and capital-intensive projects. Moreover, in the case of Indonesia such long-term and capital-intensive projects are plagued by several risks due to the non-optimal investment climate. As described above, projects can be delayed years (or cancelled altogether) due to land acquisition problems or other bureaucratic hurdles. This could mean that before groundbreaking there may as well be a change of government with a new president who has other priorities than this particular infrastructure project. Considering legal and regulatory certainty are already weak in Indonesia, the private sector tends to be very careful when it comes to such long-term and capital-intensive projects (and therefore it is a wise decision of Widodo to use state-owned enterprises to finance and construct a significant part of projects).
Earlier, during the Yudhoyono administration, the government put its hope in public-private partnerships (PPPs) for infrastructure development. However, these schemes have shown very limited satisfying results. To provide more certainty to private investors, the government also established the Indonesia Infrastructure Guarantee Fund (IIGF). This institution gives certain guarantees against infrastructure risks for projects under the PPP scheme.
However, it will require real breakthroughs to achieve Indonesia's much-needed infrastructure ambitions both in terms of schemes to finance the projects as well as breakthroughs to enhance the quality of Indonesia's investment climate. We do believe, however, that the Widodo administration is on the right track in terms of infrastructure development: it is eagerly raising spending on infrastructure development in the state budgets (and through state-owned enterprises), while it is also taking efforts to improve the investment climate through deregulation and by siding with developers of key infrastructure projects that experience land acquisition troubles.
Lastly, we want to point out that the text above primarily explains why Indonesia suffers from a lack of quantity of infrastructure. However, there also exists a lack of quality: damaged roads, collapsed bridges, and aging ports are just a few examples. Not unoften, a new road is badly damaged after a flood. This is partly due to developers' eagerness to use cheap materials and low quality human resources to realize the project but also due to the common lack of financial resources for maintenance purposes (after infrastructure has been built). Mismanagement, corruption and incompetence are traditional causes of inadequate infrastructure in Indonesia.
Last update: 23 June 2017