Big challenges of improving investment climate

Big challenges of improving investment climate

Vincent Lingga, The Jakarta Post, Jakarta

Although the government claims otherwise, Indonesia remains
the least attractive among East Asian countries for foreign
direct investment (FDI).

Its political stability -- one of the strategic factors for a
good investment climate - did in fact strengthened after the
peaceful, clean and fair general elections last year. But most
other fundamentals for a conducive investment climate remain
acutely weak.

True, FDI has started flowing in, but most of it has been for
acquisitions and not green-field projects, the very kind of FDI
the country badly needs to create new productive assets and jobs.

Judging from the presentations by panelists from developed and
developing countries at the Organization for Economic Cooperation
and Development's (OECD) two-day Conference on Investment for
Asian Development that ended here on Wednesday, the challenges
are indeed formidable for Indonesia to regain investor
confidence.

Most of Indonesia's fundamentals for a conducive investment
climate -- macroeconomic stability, legal certainty, policy
consistency and predictability, and good basic infrastructure --
are still very weak. And the government would be well advised to
realize that special incentives for foreign direct investment
(FDI) are no substitute for sound macroeconomic policies and a
conducive investment climate.

This clearly shows the crucial role of the government in
creating a good investment climate. While the government has
limited influence on natural resources and other fixed factors
such as geography, its policies and behaviors play a key role in
shaping the investment climate. Put another way, good governance
reduces the costs and risks of doing business and minimizes
barriers to sound competition.

Its rationale is that strong and consistent law enforcement is
key to minimizing government policy-related costs and risks --
which are quite high in this country -- as well as those
regarding regulations on taxation, customs, labor, local autonomy
and basic infrastructure.

Strong legal certainty in turn helps build the credibility and
certainty of government policies and curb corruption and other
forms of rent-seeking behavior.

Policy credibility, certainty and predictability, which also
are acutely lacking in Indonesia, are vital for both domestic and
foreign investors because direct (not portfolio) investment is
inherently forward-looking and long-term in nature.

Investors expect risks associated with changes in such factors
as competition, customer behavior, and market preferences, but
the government can offset these risks by helping to maintain a
stable and secure environment for business operations.

A stable regulatory and policy environment apparently is not
sufficient to woo FDI, especially in such countries as Indonesia
with strong nationalistic sentiments. Even though the benefits of
FDI in developing countries have been well documented, an
atmosphere of supportive public opinion is also necessary to
nurture conducive political and social conditions for FDI
operations.

The experiences of China, Thailand and Vietnam, which have had
great success in attracting FDI, shows that investment promotion
cannot just be aimed at foreign investors. Such campaigns should
also be targeted at local consumers and workers to persuade them
to accept the presence of FDI and for all branches of government
to convince them of the advantages of less and more efficient
regulation of business.

Vietnam, a socialist country, which experienced long and
bitter experiences with foreign colonialists, is the paragon,
attracting US$48.5 billion in FDI in 5,500 projects between 1987-
2004. Vietnam's investment officials Nguyen Van Cuong and Nguyen
Huy Hoang recounted this at the conference, that enlightening
their own people of the benefits of FDI has been central in their
investment promotion campaign.

This is highly relevant for the Indonesian government that is
drafting legislation for both domestic and foreign investment to
replace the 1967 FDI law and the 1968 domestic investment law.
Providing equal treatment to both domestic and foreign
investment, as the new legislation is being designed to do, is a
politically sensitive issue that needs a strong public-opinion
support at the House of Representatives.

Another strong opinion emerging out of the conference warns
the government against putting too much emphasis on the
development of a "one-stop service center" for investment
licensing, because what is designed as a one-stop shop often
turns into just another additional stop with an extra
bureaucratic layer.

The government's recent decision to dilute the authority of
the Investment Coordinating Board (BKPM) and put it under the
oversight of the trade ministry was seen an appropriate move,
especially in light of regional autonomy.

BKPM, like most similar agencies in most developing countries,
has never been able to operate as a one-stop service for
investment licensing because most line ministries resist ceding
their regulatory authority to another agency.

It would be much better for the government to purse a more direct
approach by improving the efficiency of each individual ministry
responsible for particular aspects of investment approvals and
increasing the institutional capacity of investment bureaus at
the provincial and regency-level administrations.

It would be more appropriate for the BKPM to function mainly
as an investment promotion and facilitation agency and as a
central source of all practical information for businesses,
including as a matchmaker for joint-venture projects.

But then, however important investment is for generating
growth and reducing poverty, it is not a panacea for specific
poverty alleviation policies, especially in a country like
Indonesia where the level of inequality in society is quite high.

The government should design an investor-targeting strategy
focusing on stimulating a defined set of investment to selected
categories of industries the government wants to develop in line
with its objective to promote development with equity.

Such a strategy also allows the government to choose the kinds
of FDI it wants and direct them to support its objectives related
to employment, technology transfer, export competitiveness,
skills development and other development goals.