Infrastructure investment need political support

Lalu A. Damanhuri, Senior Specialist Committee on Policy
for the Acceleration of Infrastructure Development (KKPPI),Jakarta

Indonesia will need to invest in new infrastructure facilities in the period 2004 to 2010 -- US$50.7 billion in all -- to build toll road, electricity, gas pipeline, telecommunications, water supply and transportation facilities.

Infrastructure investment is not about constructing large and costly projects. It is about providing the basic services that people need for everyday life -- power, water, roads, railways, other modes of transport and access to modern communications technology. A state-of-the-art factory will not be very productive if it does not have access to a reliable source of power. Construction of buildings, schools and clinics will not yield any benefit unless people have all-weather roads, and some form of transportation to access these facilities.

Diversification of industry into value-added activities like food processing will not be possible unless a network of cold storage facilities with access to reliable power is set up. By promoting connectivity of producers and markets, and lowering transaction costs, a reliable infrastructure network sets the economic foundations for growth and poverty reduction.

To understand why infrastructure investment has not kept pace with overall financial flows to private entities, it is necessary to recognize how infrastructure differs from other industries. First, infrastructure services are often considered essential public goods by consumers, and are frequently provided by monopolists. Together, these factors increase political sensitivity to the prices charged. Pressure from consumers to keep prices low makes it politically difficult for governments to maintain prices that cover costs fully.

Second, infrastructure projects typically require large sunk investments that take 10 years to 30 years to recoup. Over such long periods of time investors are exposed to serious risks, in particular the risk that public authorities will not honor their agreements on tariff policy and payments to investors. Once investors are committed to projects -- and can pull out only by incurring a huge loss -- governments may be tempted to lower prices or not raise them as agreed.

Since the onset of economic reforms, the public sector has had a virtual monopoly over the provision of infrastructure facilities in Indonesia.

However, for various reasons, including political considerations in setting user charges, imposition of social obligations on public sector enterprises, inadequate funding, neglect of operations and maintenance, over-staffing, poor management and lack of competition, there has been a severe deterioration in the quality and availability of infrastructure services over time.

In recent years, the government of Indonesia has embarked upon an ambitious program to revamp and expand Indonesia's growth prospects, which hinge critically on the success of these initiatives. What are the main challenges facing the infrastructure sector? What are its prospects in the context of the recent initiatives launched by the government?

The economic reforms being undertaken over the past decade have brought about significant structural change in the Indonesian economy. Unfortunately, the aging infrastructure network cannot handle the needs of the changing economy. Severe bottlenecks -- power shortages, poor telecommunications, traffic congestion and an overburdened road network, have hampered economic growth.

It is clear from the any indicators that Indonesia's infrastructure is in a poor state indeed. It shows how Indonesia lags behind countries such as China and Malaysia in terms of basic infrastructure indicators.

Indonesia clearly has a lot of catching up to do in terms of upgrading its infrastructure network. The overall poor quality of infrastructure facilities in Indonesia masks significant regional disparities. The infrastructure investment programs of the central and regional governments must aim at redressing these disparities.

To attain a target growth rate of 5 percent in the next five years, a revamping of the entire infrastructure sector is absolutely essential. Unless and until the infrastructure bottlenecks are removed, a jump in the growth rate from the current level of around 1 percent to 3 percent will not be possible.

The Indonesian government realized early on in the process of economic reform that, without involving the private sector, it would not be able to revamp the infrastructure sector. It has neither the financial resources nor the technical/administrative resources to undertake such a mammoth task on its own. It has therefore, undertaken several initiatives since 1992 to open up the infrastructure sector, and to provide incentives to private parties.

Apart from the technical and engineering challenges of undertaking such massive infrastructure projects, which would be daunting under any conditions, the following critical hurdles will have to be surmounted before any real improvement becomes visible.

The infrastructure challenges facing Indonesia are daunting, to say the least. If the government remains committed to infrastructure reforms, then the public and private sectors, working in partnership, and in collaboration with development agencies, will definitely be able to bring about significant and sustainable improvements to Indonesia's infrastructure in the years ahead. Success in the sector is critical, since it will ultimately determine how Indonesia fares in terms of overall growth and poverty reduction.

Therefore, it could provide government support in relating to "comfort" to investors: A country's interests are better served by thorough-going policy reform. The best way of attracting private investment is by establishing stable macroeconomic policies, adequate tariff regimes, a track record of honoring commitments and reasonable economic policy-making.

In an emerging market, however -- as in Indonesia -- investors may not find the right policies in place, or they may doubt the government's ability to sustain such policies over long periods of time. The government still has a variety of options for reducing the need for special project support.

In the long run, the government can attract private investment in infrastructure without providing support if it has good policies in place. The most difficult challenges arise during the transition from publicly to privately funded infrastructure, when government support is most common. Even during the transition, however, government support simply postpones the day of reckoning.

Assuming the private sector cannot consistently be duped into investing in unsustainable projects, providing support imposes costs on taxpayers in the future. For this reason alone, governments should develop ways of quantifying all their exposure to private infrastructure projects and plan for it fiscally.

The government must also recognize its exposure that arises from implicit support. Ways must be found to manage implicit support by letting investors (at least equity investors) go under in case of failure. Mechanisms must be established that allow new investors to take the place of old ones to ensure service continuity to consumers. If this cannot be done, implicit support should be treated in the same way as explicit support, and reserves should be budgeted to cover these contingent liabilities.