Infrastructure investment need political support

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.