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.