Indonesia’s massive infrastructure dreams today depend heavily on outside finance, and Japan is fast becoming a key provider through loans and investment. However, they face a challenging legal and regulatory landscape. 

Indonesia is the largest country in Southeast Asia in terms of geographical area and population, and it also has the largest economy by far. However, the country currently suffers from a chronic infrastructure deficit. According to a report from PricewaterhouseCoopers (PwC), annual infrastructure spending in Indonesia is expected to increase to some $165 billion per year in 2025. This is seven times more than anticipated infrastructure spending in the Philippines in 2025, which PwC estimates will amount to $27 billion.

The scarcity of infrastructure, given the size of Indonesia and its population, obviously creates a huge demand for infrastructure construction, particularly in the areas out of Java Island, where proper infrastructure has not yet been developed. Thus, the poor quality of the existing infrastructure provides room for upgrade and renovation.

Enter Japan. Japanese investors are very keen on Indonesia, as evidenced by their spending. Between January and September of last year, Japanese investment in the Southeast Asian country reached a whopping $4.5 billion in total, double that of the same period last year.

In terms of infrastructure projects, Japanese lenders are getting involved in a number of Indonesian projects. One is the 80 MW Muara Laboh geothermal power project in South Solok in West Sumatra, which recently received a $440 million loan from the Japan Bank for International Cooperation (JBIC) and three of the country’s megabanks. Another project is the $40 million co-financing for a coal mine in North Kalimantan Province– JBIC provided $24 million of the capital, with the rest coming from Chiba Bank, Mie Bank and North Pacific Bank.

Japanese Prime Minister Shinzo Abe’s visit to Indonesia yielded several potential areas of cooperation. These include a railway project linking Jakarta and Surabaya; a loan of 73.9 billion yen ($646 million) to help finance port development, irrigation facility construction and beach protection projects in West Java; and joint development of the Patimban deep-sea port and the Masela gas field, among others.

OBSTACLES GALORE

That said, Japanese investors, much like other investors in Indonesia, face a number of challenges. “In terms of regulatory difficulties, other than the set of regulations for toll-road construction, the  regulations for other type of infrastructure are still under way,” says the firm Christian Teo & Partners. “In addition, the implementation of the regulations is not always a clear-cut issue, given the multiple interpretations by the relevant authorities, and the lack of proper coordination of the relevant government agencies in this regard.”

Another issue that continues to arise in the infrastructure sector is land acquisition. Not all land in Indonesia has been registered, and this can create difficulties during the acquisition process and heighten the risks facing investors. These differences can be bridged by having foreign counsel who are familiar with both the legal system of the investor’s home jurisdiction and the Indonesian legal system. Such advantages can help to significantly expedite the work.

These concerns clearly create uncertainties and challenges for both lawyers and market players. However, since Indonesia is still a beginner in infrastructure industry, those difficulties somewhat create good opportunities for lawyers to add value to the quality and number of infrastructure regulations in place by giving inputs to the regulator based on clients’ experience on the ground on how to make implementation of regulations feasible and effective.

According to Luke Devine, a foreign legal consultant at Hadiputranto, Hadinoto & Partners, the infrastructure hurdles presents huge opportunities on a number of fronts. “Firstly, as the infrastructure sectors in Indonesia are very heavily regulated – and often this regulatory framework is not altogether clear – clients are looking for their lawyers to be able to walk them through the framework. Not just the letter of the law, but [also] the policy behind it [and] the history of how the regulations have evolved so that clients can then make an informed investment decision,” he says.

Secondly, lawyers have the ability to provide input and feedback to the Indonesian government on private sector concerns regarding a particular framework, enabling the government to consider implementing changes to further attract investment. Capacity-building activities are also a good opportunity for lawyers to assist in moving an entire sector forward.

Moreover, infrastructure projects in Indonesia are subject to various ministries and government institutions and, in most cases, unwritten policies and common practices play a significant role in a project.

“Thus, in addition to the written rules and regulations, infrastructure lawyers need to familiarize themselves with common practices and keep themselves updated on new developments. For foreign investors from countries where unwritten rules and common practices do not play a significant role, the situation in Indonesia may be difficult to understand and assess,” says Kanya Satwika, an infrastructure partner with Assegaf Hamzah & Partners (AHP).

SPECIFIC TO JAPAN

Japanese investors have had a long history of investing in Indonesia, and are a very well-respected investor class within the Indonesian government institutions.

In addition to the general challenges, the obstacles for Japanese investors and other foreign investors are investment restrictions and licensing-related issues. The restrictions are in the form of foreign shareholding limitation and requirement to form a consortium with local construction companies. There are also some technical restrictions in the form of minimum capital requirement and minimum level of technology and risk to be entailed.

Japanese investors typically ask for government guarantee, something which is not necessarily requested by investors from other countries.

“This is in a way a hurdle for Japanese investors,” notes Christian Teo & Partners, “since such request would in a way make them less interesting compared to the other investors, especially Chinese investors, who have been very aggressive in pitching for government’s infrastructure works in Indonesia.”

What has made Japanese investors particularly successful has been their ability to mobilise attractive debt financing through Japanese government funding institutions, such as JBIC. “This has made the Japanese investors very price competitive when bidding for projects,” explains Devine. “However, with the advent of recent additional funding agencies and renewed interest in Indonesia from multilateral and bilateral agencies, this competitive edge has started to erode.”

In the renewable energy sector, for example, there is an endless source of multilaterals and bilateral agencies from Asia, the Middle East, the Americas and Europe, which are very keen to support renewable developments and are offering very competitive debt-funding terms. “So the entire landscape has become a lot more competitive,” adds Devine.

With the exception of the upstream oil and gas industry, foreign investors are only permitted to invest in infrastructure projects in Indonesia through an Indonesian limited liability company. Such a company can either be established directly by the foreign investor, or it may acquire an existing Indonesian company. It should be noted that foreign investment in most of infrastructure areas is restricted by the Negative Investment List, a government list of business lines that are fully open, conditionally open or fully closed to foreign investments.

This means that they are not 100 percent open to foreign investments, so getting an Indonesian partner is necessary. There are occasional complaints from Japanese companies planning to invest in existing projects through the acquisition of special-purpose companies established and operated by Indonesian partners.

“These complaints sometimes follow on from due diligence findings of flows of cash for informal payments to the authorities in return for required licenses or permits. This is a significant issue for Japanese investors as they are required to strictly comply with Japan’s Anti-Bribery Act, as well as the FCPA, UK Bribery Act and other anti-corruption laws around the world,” says Satwika.

Also, the enforceability of contracts and loan security and the required legal and administrative procedures to proceed with a project are not always clear or predictable in Indonesia. Therefore, it is difficult for Japanese investors to predict the necessary time and costs that will be required to complete a project.

In addition, Japanese investors often find it difficult to find suitable local partners as the Indonesian parties may not be as concerned with legal and contractual compliance as they would be. This, in turn, can cause Japanese investors strain in maintaining good relations with their Indonesian JV partners. Finally, competition on price has become much fiercer since the large-scale entry of infrastructure players from China.

“Also, investors from China do not always insist on as many changes to transaction documentation, leader to faster closing times,” says Heru Mardijarto, a partner with Makarim & Taira S. “Therefore it is a major challenge for Japanese investors to find ways to become more competitive on price and on other terms and conditions, without sacrificing profitability and the perception of quality from which Japanese infrastructure players derive their main competitive advantage.”

INVESTING PRECAUTIONS

Prior to taking any step, investors in Indonesia should get all the general information available on investment from the country’s Investment Coordinating Board and data on its infrastructure programme from the Public Works Ministry.

Investors should be clear what type of activities they are plan to do in Indonesia. This will help them identify the relevant regulations and restrictions to be applied. In addition, this will be useful in preparing the required minimum capital and choosing a local partner as early as possible.

Investors should also manage their expectations when it comes to the work speed of ministries or government agencies in Indonesia. This is related to actual timeline required for establishing a legal presence in the country, particularly for licensing procedures, including work permits, and the tender process.

Investors also need to be prepared that not everybody in Indonesia can speak fluent English. As such, certain documents that have to be filed with the government or regulators must be written in or translated into Indonesian.

Indonesian law requires all legal contracts involving Indonesian parties be written in local language, Bahasa Indonesia. Dual-language contracts are permissible, provided that one of the languages used in the contract is Indonesian.

ADVISING CLIENTS

President Joko Widodo’s administration is constantly looking at ways to make the infrastructure sectors attractive for private sector investment. This has led to a constant stream of new regulations or changes to the existing regulatory framework.

As a result, a number of legal challenges against regulatory changes are being made through the Indonesian courts including the Constitutional Court. “Accordingly,” says Devine, “a big part of our practice is advising clients on these regulatory changes, and occasionally, legal vacuums left by successful court challenges… so we have been assisting clients to navigate their way through that framework.”

Satwika of AHP says that her clients mostly seek advice on what they can and can’t invest in, in light of the Negative Investment List. “They are also interested in the safeguards for foreign investors and the rules governing dividend payments. Specifically as regards infrastructure, clients are seeking advice on government incentives, land acquisition procedures and general advice on loan security and its enforcement, as most, if not all infrastructure projects are primarily financed by banks and financial institutions,” she adds.

TO THE FUTURE

As Devine observes, “While there are big plans, the challenge remains with implementation. However, some sectors are moving along at a good speed such as the power and toll roads sectors. And after many years of slow activity, we are starting to see projects being awarded in seaports and the water sector. Sectors such as airports still have a long way to go. But there are plenty of opportunities for investors.”

Given the current condition of Indonesia’s infrastructure, the level of demand in this area is expected to be high in the next couple of years. It is also important to take into account how urbanisation will impact Indonesia, as there will be more urban areas in the country in the next 10 to 15 years.

The government will continue to execute projects that are currently in the pipeline, but revisions to planned targets may also occur. Case in point: the 35,000 MW generating capacity development project, which turned out to be overly ambitious and has since been reduced to 19,000 MW.

Satwika says given that the next general election is set to take place in 2019, it is difficult to predict Indonesia’s infrastructure outlook beyond that date.

“Nevertheless, given the grossly inadequate state of Indonesia’s infrastructure at the present time, it is safe to assume that there will be a need for large-scale infrastructure investment for at last the next one or two decades to come,” she concludes.