How to deal with investment decline

How to deal with investment decline

By James Castle

JAKARTA (JP): It is clear that Indonesia is undergoing
dramatic socio-political changes. It is fair for the leadership
to ask for patience in addressing the multitude of problems it
faces. But the economy cannot wait much longer. It is in decline
and fresh investment is badly needed.

New investment, both foreign and domestic, however, will only
come in dribs and drabs until anti-investment practices and
policies in state ownership, labor regulation and taxation are
reversed. The practices and regulations in question have been
promulgated by this administration and its bureaucrats.
The current crop of bureaucrats made these anti-investment
regulations and can be instructed to reverse them.

New investment in assets owned by the Indonesian Bank
Restructuring Agency (IBRA) and state-owned enterprises is also
being discouraged. These are areas where the government can and
should take control of the process.

Divestment of state-owned enterprises and restructuring of
IBRA assets by new investors will result in a flood of new money
into Indonesia, a sharp upturn in job creation and an improvement
of corporate governance in troubled sectors.

Any money the government itself loses in the short term
whether from reduced dividends or low valuations is trivial and
would be replaced tenfold by increased tax revenues from
successful operations that actually pay their full tax bill to
the central government coffers.

In principle, Indonesia remains a very attractive site for
foreign investment. This is demonstrated by the willingness of a
wide range of companies to commit significant amounts of money to
Indonesia. This is true in hi-tech areas like telecommunications
and information technology as well as in more traditional areas
like mining, power and cement.

Unfortunately, because the national government does not have
the political will to pursue robust policies of its own making,
policies are being determined by relatively low level officials
and executives of state-owned corporations.

Frequently they do not have the interest of the public at
heart and they seem determined to discourage investment,
especially foreign investment.

The government badly needs to have a clearly stated public
policy on investment against which the actions of all government
officials and employees can be measured. In the absence of clear
policy guidelines, followed by effective, consistent
implementation, the investment climate will not improve.

There is clearly a great deal of concern about the low level
of new investment. While gross domestic product growth last year
reached an impressive level of over 4.5 percent, analysts are
very pessimistic about the current year.

Our own forecast is for growth as low as 2.5 percent with
inflation well over 10 percent this year.

Two important factors were primarily responsible for the
strong economic performance last year. These were increasing
exports and strong domestic consumer demand. Both of these are
now under threat, and there is little Indonesia can do about it.

There is an economic slowdown in the United States and Japan
remains in the doldrums. This puts even greater pressure on
domestic consumer demand to maintain economic growth. In the
absence of fresh money coming into the economy in the form of new
investment, however, savings must drop steadily if consumers
continue buying. Eventually they will run out of money,
particularly as imported inflation caused by the steady weakening
of the rupiah erodes purchasing power.

The government should eliminate regulations and practices that
are discouraging new investment and prevent acquisitions of new
properties by state-owned enterprises in sectors where private
investors, particularly foreign investors, have shown themselves
extremely eager to step in.

The government must also accelerate the restructuring of IBRA
assets and the divestment of the traditional state-owned
enterprises. Nothing else will attract new investment in any
significant way because the region is over-capacity in most
important industrial sectors making greenfield investments
extremely unlikely.

There are three broad reasons as to why companies invest in
Indonesia: First, to develop natural resources, primarily for
export; Second, to access the domestic market; and, third, to
take advantage of Indonesia's competitive wage structure to
produce labor intensive manufactured goods for export.

Each of these sectors has been harmed by certain domestic
conditions.

In terms of natural resource exploration, mining and on-shore
oil and gas development have been most seriously hampered by
uncertainties related to increased regional autonomy. Most of
these uncertainties are, for the most part, beyond the direct
control of the central government as reduction of central
government control is the essential element in devolution.

The radical shift from the excessive centralization of the
New Order economy to reasonable regional autonomy will take time.
There are no short cuts and the process inevitably creates
uncertainty. In a climate of legal and regulatory uncertainty,
companies cannot easily commit the large sums of money that
natural resource developments generally require. This is an acute
problem because the mining sector has been one of the leading
sources of new investment since 1997.

Equally bad, mining experts report that failure to invest in
new exploration and in the development of current sites today
will lead to sharply declining production in the medium term.

The second natural investment target is the domestic market.
Investment in manufacturing in this sector is severely
compromised by two factors: First, the political decision at the
highest levels not to sell any significant amount of the
manufacturing assets now under the control of IBRA to new
investors and, second, the desire of bureaucrats and politicians
to retain a maximum amount of control of state-owned enterprises.

It is taken as a fact in the business community that failure
to protect foreign buyers in the Bank Bali and Manulife cases
results from lack of political support for these sales at the
highest levels. Without the constant, public support of the
President and the leaders of Indonesia's major parties,
particularly the Indonesian Democratic Party of Struggle (PDI
Perjuangan) and Golkar, it is unrealistic to expect IBRA's mid-
level civil servants to be able to withstand forces hostile to
the divestiture of these assets into new hands.

The sale of such assets with an original book value of nearly
US$60 billion is a fundamental political decision and should not
be taken without the highest levels of political support. So far
this support has not been forthcoming. Some policy-makers seem to
believe that the original owners should be protected and that new
investors should focus on building new factories, not
restructuring old ones.

Unfortunately for this point of view, sectors in Indonesia
and throughout the region are still working off the over-capacity
created by the Asian Boom of the mid 1990's. There is little
interest in building new factories in Indonesia because the
current overhang of IBRA-owned excess capacity has not been
worked off.

The same is true of state-owned enterprises. The government
has been unwilling to take advantage of new, multi-million dollar
offers of investment in telecommunications, power and cement
because of a lack of political will. On the contrary, latest
reports show that PT Telkom plans to not only expand its own
level of new investment projects but also to buy out foreign
investors who are already here.

The same process seems to be taking place in mining with the
forced dilution of foreign investors in Kalimantan and statements
by Pertamina that it will expand its investment in oil field
development. In the current circumstances, this is a devastating
strategic blunder.

The third reason new investors come to Indonesia is to take
advantage of the country's competitive wage structure. Indonesia
should be well-positioned to produce products with high labor
content for export. Such products can also be sold domestically
to help reduce imports and provide higher quality products to the
Indonesian consumer at lower prices.

Nevertheless, recent regulations promulgated by the Ministry
of Manpower have dramatically increased cost per employee, and
made the labor market more rigid by increasing the cost of the
redundancy adjustments. Incredibly, regulations even call for
compensation for voluntary departures.

As a result, while few of the large labor intensive employers
have actually closed shop here, virtually all have dropped
Indonesia from their plans for new investment and expansion.
Mergers and consolidations also make little sense while these
regulations are on the books.

The political competition now being waged between President
Abdurrahman Wahid and his opponents in the legislature is a
direct cause of the investment slowdown. This political struggle,
however, is distracting the leadership both in the administration
and in the House of Representatives (DPR) from constructively
addressing many of the economic problems the country faces.

Because they are spending most of their time fighting for
political advantage, they have little time to focus on economic
recovery. In this way the political struggle has contributed to
the decline of direct investment in Indonesia, both foreign and
domestic. The political struggle also creates a high degree of
uncertainty and uncertainty is the enemy of business.

The best thing for investment would be for the political
struggle to have a conclusive outcome. From an investment point
of view it is not a question of whether or not President
Abdurrahman stays or is replaced.

The important issue is that whatever settlement is reached, it
be respected by all parties.

The writer is chief business consultant at PT Jasawenang
Citrasempurna, a subsidiary of the Castle Group, in Jakarta.