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.