Tuesday, May 31, 2011

Memo to Indonesia:  clear the red tape

Despite decades of reform, Indonesia's potential as a strong growth economy fuelled by investment won't be realised until all levels of government learn to get out of the way.

Like a lot of countries throughout south-east Asia, Indonesia came through the global financial crisis relatively well.

Working from a low base, its growth has been consistently around 5 and 6 per cent annually and it had low exposure to American and European markets in comparison with the growth markets on this side of the Pacific Ocean.

Despite continuing uncertainty, in the first quarter of this year the growth rate was 6.5 per cent, according to official government statistics, and Australia has been part of the charge.

Australia is one of the few countries that has been increasing foreign direct investment in the archipelago since dips resulting from the global financial crisis.  While Australian investment has plateaued in some sectors, considerable capital has flowed into the construction industry over the past three years.  And direct investment makes up more than half of all capital invested.  The trend should hardly come as a surprise.

Since the mid-1980s, the national government has staggered liberalisation of investment laws and regulations to make Indonesia a more attractive destination.

The impetus for doing so has been the dramatic need to tackle poverty alleviation, the realisation that international companies are needed for their skills and expertise to build industries, and to compete with other countries in the region.

Major investment reforms passed in 2007 were a watershed, affording foreigners the same treatment as domestic investors and removing opaque regulations about industries open to investment.  Instead, the government introduced a transparent ''negative'' list that made it clear which sectors were out of bounds.

Coupled with other reforms, the market has rewarded reforms and Indonesia's international investment reputation has improved.

But the challenge isn't over.  Faced with international capital constraint as developed markets pull themselves out of recession, Indonesia now needs to act to keep itself internationally competitive.

And the challenge is more urgent because of the investment risks now being posed by the country's mass-democratisation.

Recent examples show local governments are becoming the source of unnecessary investment risk resulting from petty bureaucracy, inconsistent local regulations and conflicts with the national government.

It's a reality now being faced by international mining company Newmont, and its investment on the island of Sumbawa.

The company's investments are being squeezed in a fight over a divested 7 per cent ownership share in its Sumbawa gold and copper mine that both the national and local government wants.

With the national government making the acquisition, the local government, with the support of politicians in the national House of Representatives, is threatening to revoke the mining licences altogether.  In retaliation, the House of Representatives is even considering sacking the Finance Minister.

Examples of investors being caught in between political struggles are hardly new.  But for a country in a fragile state of economic development, political struggles undermine Indonesia's capacity to soften perceptions of risk when it is already known for corruption and weak governance.

These risks go well beyond Sumbawa, with a Standard & Poor's report concluding that recent investment reforms provide greater investor clarity.

In the latest Organisation for Economic Co-operation and Development index, Indonesia ranks as one of the most restrictive investment destinations among the countries surveyed.

Combined, the consequences of investor experiences and poor international ratings may already be playing out in investor's minds, with some sectors not attracting the same level of investment before the global financial crisis.  Faced with a capital-constrained world, Indonesia will need to be both an attractive as well as competitive destination for investment.  To do so, further reform is now needed.

Instead of managing the problems of politics, the government should be removing the remaining investment restrictions by extending the principles of transparency and certainty that underpinned the 2007 reforms.

Reformers should look at liberalising mandated government ownership that will only heighten the perceptions and realities of risk from all levels of government in an immature democracy.

The Indonesian national and sub-national governments have a right to secure appropriate income from developing natural resources, but that can be secured through well-designed licences and contracts.

Sophisticated contracts are even more important since the government is looking to utilise public-private partnerships to attract investment finance to tackle under-investment in infrastructure that is also holding back the country's attractiveness as an investment destination.

Liberalisation should also seek to reduce the number of sectors on its negative list, particularly in utilities, considering national infrastructure priorities.

The investment dividend that could flow from further reforms would help Indonesia build the industries needed to further harness opportunities during the next round of the region's economic growth.

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