Infrastructure projects important, but selective

Umar Juoro, Jakarta

The government has unveiled ambitious programs for infrastructure development. President Susilo Bambang Yudhoyono has himself said on various occasions that Indonesia needs US$72 billion for infrastructure development over the next five years. The government expects that around 70 percent of this funding will come from the private sector.

Coordinating Minister for Economy Aburizal Bakrie disclosed a plan to build 1,500 km of toll roads connecting Java-Bali that will require investment of around Rp 80 trillion ($8.6 billion) over the next five years. This is certainly an ambitious project, remembering that in the last 25 years, Indonesia has only been able to develop around 600 kilometers of toll road.

The government expects domestic private sector participation in this toll road development. The domestic banking system is expected to contribute to financing a significant portion of the funds needed for the project. Foreign investors would only be interested in this project if tariffs were sufficiently attractive, and if problems such as land acquisition were taken care of.

The Indonesian Chambers of Commerce (Kadin) strongly supports the infrastructure development programs, as do multilateral agencies and foreign countries like Japan. Bankers, especially in the state banks, pension funds, and state owned enterprises, are also very supportive of the program. Certainly infrastructure development is urgently needed because the country's infrastructure is now in poor condition, with the possible exception of the telecommunications sector.

Infrastructure development is important in boosting economic growth and creating employment. The question is, how realistic is the program, given Indonesia's weak legal frameworks and the inadequacy of capital?

Is the government really prepared for such ambitious projects so as not to repeat the mistakes of the previous administrations? Governments in the past have often had to bear the burdens of problematic projects. The Karaha Bodas power plant is a case in point, with settlement with the government still not being achieved.

Meanwhile investors in the electricity sector are still waiting for tariff adjustment to the level of 7 cent per kwh. Investors in fixed line telecommunications are also still waiting for the realization of the government's promise to increase telephone tariffs. Meanwhile investors in toll roads complain not only about low tariffs, but also about prolonged land acquisition problems.

Tariff increases are always problematic. Ideally tariffs should be adjusted in accordance with inflation and changes in costs. But politically this is often very sensitive and risky for any government.

Land clearance remains a headache for both investors and the government, because they often become involved in prolonged disputes with land owners. There is still no effective mechanism to settle such disputes, and a new body perhaps needs to be assigned to handle these matters.

There is also a need to implement reliable dispute resolution mechanisms. For new infrastructure projects, investors usually insist on letters of guarantee, or at the very least, letters of comfort from the government. The government should be very cautious in issuing such letters, because there are financial consequences that can impact the public purse should the project get into trouble.

Another sensitive issue for investors concerns good governance, especially due to the country's own poor track record in corruption.

Meanwhile, for domestic investors this is an attractive time for them to invest in infrastructure especially as domestic banks have about Rp 400 trillion in uncommitted funds. However, although banks are keen to allocate credit for infrastructure development, they have to carefully consider issues of fund matching as most third party funds in banks are mainly on short term deposit.

Pension funds also need to be careful in putting infrastructure developments into their portfolios because of the risks involved. The domestic capital market is very limited in its ability to finance infrastructure development. The government can issue bonds, but it must be careful in using such money in order to maintain fiscal sustainability.

Clearly then the government must be prudent in carrying out its ambitious infrastructure developments. Toll road projects should be focused in those areas that desperately require them, where the market is promising, where land acquisition can be handled effectively, and where the government can guarantee attractive tariff structures.

Similarly, for the power generation sector, the main concern for investors are fuel supplies, tariff adjustments, government guarantees, and dispute resolution mechanisms.

The telecommunications sector remains very promising, except in the matter of tariff adjustments for fixed lines. For drinking water -- and learning from the experience in Jakarta -- this business is still not very attractive for investors. Local governments must continue to play a major role.

On the airport development sector, selectivity is also very important to make the project as realistic as possible. The government should present details of project selection, so that investors can better assess whether to participate.

Infrastructure development often has a quite high elasticity- to-growth of around 0.18 percent with rate of return above 20 percent. This means that the contribution to employment is also significant. However, we should be careful in selecting infrastructure projects so that the government and banking sector do not fall into debt traps. What Indonesia really needs are realistic programs and reliable policies that can be supported by investors, both domestic as well as foreign.

The writer is the Chairman of Center for Information and Development Studies (CIDES); and Senior Fellow at the Habibie Center.