To talk about Indonesia’s negatives might seem absurd at this point. For one, GDP growth is expected to be 6 percent in 2012, with the government estimating it to go up to 7.2 percent in 2013. Over the next several months, the country is slated to join the exclusive club of countries with an annual GDP of more than $1 trillion. In 2011, foreign direct investment reached a record $19.3 billion and exports grew by 29 percent, reaching $203.62 billion. Two of the three ratings agencies – Fitch and Moody's – now rate the country as investment-grade, a spectacular turnaround from the economic basket case that it was some 14 years ago following the Asian Financial Crisis.
However, one of the major roadblocks to Indonesia’s growth was highlighted recently by the third ratings agency, Standard & Poor’s. In a report titled “Greater Investment In Infrastructure Could Rev Up Indonesia's Growth Engine,” it noted that the country scored poorly in efficiency and productivity mostly because of the poor state of its roads, airports, and other economic lifelines. These were resulting in increasing congestion in urban areas, high transport costs, electricity blackouts, and limited access to improved sanitation. “The inadequacies in Indonesia's transportation infrastructure are likely to hinder the country's global competitiveness unless addressed,” said S&P credit analyst Rajiv Vishwanathan in the report. “Indonesia is also at risk of deeper power shortages over the next few years as demand multiplies.”
It is not something the government is unaware of. In June, finance minister Agus Martowardojo noted a number of growth challenges, singling out infrastructure issues. "There are still many obstacles to land acquisition," he said. To tackle this problem, Indonesia in December 2011 passed the Land Acquisition Law, which is set to reduce uncertainty in acquiring land for development, and allow for the acceleration of road, port and airport projects. “The Land Acquisition Law is an important milestone for infrastructure development,” says Ken Hawkes, partner at White & Case. “In the past, with no compulsory acquisition for land to support public infrastructure or other governmental uses, there was only the ability to acquire land privately and for negotiated prices. Projects that placed a heavy emphasis on land – such as toll roads – had to rely on separate negotiations with many land owners. This caused delays, and ultimately led to the termination of many projects.” Hawkes adds that while there are other causes of project delays in Indonesia – a complex bureaucracy, for example, when it comes to seeking approvals – the passage of the Land Acquisition Law should provide a boost to those infrastructure projects that have been delayed or affected in some way due to issues related to land acquisition.
Luke Devine, Jakarta-based consultant with Baker & McKenzie, agrees on the importance of the law. “Land acquisition risk has been the single-largest problem in recent years which has held back the development of infrastructure projects, particularly in those land-intensive projects such as toll roads and transmission lines for power projects,” he says. “Having a clear, streamlined process with clear deadlines for the steps involved in the land acquisition process will significantly help turn a number of these projects from plan to reality.” He adds that the law will also enable state-owned companies that have public service functions (such as PT Perusahaan Listrik Negara Persero, or PLN, the government-owned electricity company that has a monopoly over electricity distribution in Indonesia) to avail themselves of these new land acquisition powers, which will speed up the development of power generation projects. “To date, PLN has been reluctant to take on the responsibility of acquiring land corridors to connect new power plants to the existing grid because PLN does not have compulsory land acquisition powers, and PLN has instead been trying to push this responsibility to the private sector developers who similarly have no power to compulsorily acquire land,” says Devine. “It is expected with these new powers, PLN will take on the responsibility of transmission corridor land acquisition.”
James Harris, managing partner, and Justin Patrick, associate at Hogan Lovells Lee & Lee term the law to be of “fundamental importance” as they see it facilitating the development of privately funded public infrastructure. “The law represents a formal statutory regime giving the government a power roughly equivalent to ‘eminent domain’ or compulsory purchase, so it is rightly receiving a lot of media attention,” they say. “Depending on its implementation, the law could potentially provide a huge boost to the government's public private partnership (PPP) programme.”
Waiting for the law
The law may have been passed in December 2011, but it cannot be practically implemented because the government has yet to issue a presidential regulation on it. However, with local media quoting representatives of the private sector as saying that acquiring land is equal to between 75 and 85 percent of an infrastructure project’s completion, the pressure is mounting with every passing month. Even an IMF mission to Indonesia in early July pointed out the fact that the implementation of the law was sorely needed to accelerate infrastructure projects. “There is significant pressure on the president to issue the implementing regulations required by the new law, as without it, the compulsory acquisition powers and processes under the law itself cannot be utilised,” says Devine. “As a result, there is a high likelihood that the regulation will be issued this year.” He adds that the issuance of this regulation is expected to enable government and the relevant state-owned companies to take on a stronger commitment in infrastructure concession agreements in relation to completing land acquisition in a timely manner. This will help reduce the risk level for developers, which in turn, will attract a larger number of developers. “As these projects are awarded and move into project financing, it will certainly be a boon for project finance lenders,” he says.
According to Devine, the biggest trend he expects to see once the law is implemented relates to the willingness of more developers to seriously commit to bidding for these new projects. “This is on the assumption that with these new powers, the government and state-owned companies take on firm obligations to deal with land acquisition under concession agreements, rather than leaving land acquisition as a risk that the private sector developers must find a way to deal with,” he says. “Hence, the volume of deals and higher levels of interest from serious developers is what is expected.” Meanwhile, Hawkes expects to see more investment coming from domestic developers and banks. “The Land Acquisition Law would benefit those projects that have the greatest need for land, such as toll roads,” he says. “Traditionally, investment in the Indonesian toll road sector has come from domestic construction and toll operating entities.”
Harris and Patrick say that the passage of the law's implementing regulations - which is anticipated this year - should be viewed as the first step in improving Indonesia's land acquisition regime. “After the regulation is promulgated, there will have to be a period of settling into the new regime; that could take a few months or longer,” they add. “The market would also benefit from further reforms in relation to registering title to unregistered rural land and how rights of way are to be established.”
Keeping that in mind, they do not expect the new regulation to have an immediate impact on the project finance market. “Most immediately, the law should allow the government to acquire land for infrastructure projects more easily,” they say. “Naturally, infrastructure projects, such as roads and transmission lines, could facilitate project finance for private businesses indirectly, such as for pulp processing plants and industrial facilities. There is also tremendous potential for the law to facilitate PPP projects. But project finance for PPP projects in Indonesia will continue to be constrained by the speed at which the government can get bankable projects to market and complete tenders.”
Areas of focus
Hawkes says that toll roads will probably be the initial area for investment once the new law comes into effect. “Anyone having experienced the traffic delays and seen the overloaded transportation infrastructure in Indonesia would agree that this is a high priority!” he quips. Devine agrees that the toll road sector will be of great interest to developers, and explains why it is likely to see more domestic interest than foreign. “However, as the revenues from these toll road projects are not linked to U.S. dollars, unlike, for example, the revenues from the power projects, the toll road projects lend themselves more to domestic developers and domestic financing, where the currency of revenues can be matched with the currency of financing and equity return requirements,” he says. “That said, as the Indonesian rupiah has maintained a relatively stable level over the past decade, if the government can tighten up the bankability of the concession agreements, a healthy amount of foreign interest in these projects is expected.”
Toll roads aside, he notes that the offering to the private sector for concessions in the other transportation sectors are more sporadic. “Indonesia's current master plan (Masterplan for Acceleration and Expansion of Indonesia, or MP3EI) does contemplate a number of airports and seaports being offered to private sector developers. But as there is not a long track record of private sector concessions for seaports and airports – and these projects may be exposed to issues around the ability of the government to dictate revenue levels by controlling tariffs to consumers and users – the level of risk around these projects is higher than for toll roads, and certainly much higher than the tried and tested models for power generation projects,” he adds.
However, for Devine, power generation projects continue to be the most fertile area for project finance lenders. “The government is currently pursuing Indonesia's Second Fast-Track Program which is 10,000MW power projects, the majority of which are to be awarded to the private sector for development and financing. Hence, there has been significant interest from developers and lenders in these projects, and as there is a long-established model for internationally financed private sector power generation projects, a number of developers and lenders are familiar with the structure of these projects and the risks arising from these projects. Hence, the award of these projects has been moving relatively quickly.”
Harris and Patrick at Hogan Lovells Lee & Lee say that coal-fired power plants may continue to receive a majority of funding because PLN's power-purchase agreement (PPA) terms for these projects are well established. “We can see from Genting's Banten 660MW IPP project that there may be appetite to finance these projects without a government guarantee,” they say. “However, multilateral support for such projects seems to be on the wane. The government has also indicated that, from an energy mix perspective, new projects will include cleaner energy sources (such as natural gas and renewables). The recent indications that natural gas exports may be subject to moratorium are one result of these policies.”
They say that outside the power sector, however, the government's PPP programme has been relatively slow in ramping up. “However, the government has port, water, waste management and toll road projects in the pipeline, in addition to three mine mouth IPP projects proposed for Sumatera,” they add. “Development of transportation infrastructure is expected to be critical in facilitating the government's private development goals. Toll road projects appear to have made the most progress, but railway and port projects have also been in planning stages. Additionally, the Tanah Ampo terminal expansion in Bali is one project that has been recently promoted, with a formal tender process expected to kick off soon.”
Harris and Patrick add that after the implementing regulations of the land acquisition law are promulgated, they expect to see an immediate positive effect on projects, such as some toll road projects, where the government initiator has been awaiting guidance on how to proceed with land acquisition. “We also expect that the government initiator will select the sites for most (if not all) new projects coming to market,” they say. “This is a departure from previous procurement schemes, where in some cases, the private sector would be required to select its own site based on criteria set by the government initiator.”
A different kind of market
Baker & McKenzie’s Devine says that project finance in Indonesia differs from many of its neighbours in two ways. Firstly, a number of other markets in Asia, such as Thailand and Malaysia, have developed very deep liquidity in the domestic bank market, and have moved away from reliance on foreign currency borrowing to develop infrastructure projects. But Indonesia is different. “The depth in the market and the willingness of domestic banks to whom true project finance may still be somewhat of a novelty, has meant that Indonesia continues to rely heavily on foreign currency project financing,” he says. “Additionally, Indonesia is still perceived as a jurisdiction where developers and lenders face political risk in relation to the long-term concession agreements, and accordingly, most of the cross border project finance transactions will necessarily involve commercial project finance lenders needing political risk cover provided by export credit agencies and multilaterals such as the IFC, the Asian Development Bank and the like.” He notes that in other jurisdictions in Asia, even some developing jurisdictions such as Thailand, foreign lenders have been willing to provide uncovered financing to those infrastructure projects.
Hawkes of White & Case also points out the lack of governmental support for key infrastructure projects. “For example, the lack of any direct guarantee for any of the state-owned entities that are engaging in infrastructure development – like PLN, the monopoly state utility,” he says. “This is gradually changing with the need for more infrastructure investment from the private sector. The Indonesia Infrastructure Guarantee Fund has been recently established to facilitate infrastructure investment though a structured guarantee from a state entity.”
Devine says that the biggest problems faced by developers and lenders in Indonesia, however, are front-end issues, rather than issues with implementing the project finance model. “For instance, for a lot of the sectors where PPP models are still relatively new in Indonesia, such as airports and seaports, the challenge is to ensure that the concession model that is adopted by government is one which meets the ‘bankability’ requirements of international lenders,” he says. “Without a bankable model, potential bidders lose interest, tender processes become fraught with danger as winning bidders seek to knock the contracts into shape post-bid, and the biggest loser in this is Indonesia.” Additionally, he notes that as infrastructure concessions must be awarded through a competitive tender process, since internal government delays in preparing projects for the bidding stage have been a source of frustration for developers who are actively seeking new opportunities.
Finally, he notes that in the past, issues surrounding the creditworthiness of the entity awarding the infrastructure concession to a private sector developer had been a big concern, as the authoriser took the form of a limited liability state-owned company, such as PT Jasa Marga (Persero) in the toll road sector, PT Pelindo (Persero) in the seaports sector, and PT Angkasa Pura (Persero) in the airports sector. “This led to concerns as to how these entities were going to be able to fund termination and buy-out payments under the concession agreements in the event of a government-related default under those concessions,” he says. “However in recent years, the government has removed the ‘authority’ role from these state-owned companies, and taken it back. Accordingly now, the government-related obligations under the concession agreements are supported by the full government balance sheet, hence reducing these creditworthiness concerns.” Devine says that the moves of the government bode well for the sector in general. “If these front end problems can be resolved, we expect to see a significant increase in the number of deals closed,” he says.
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