Post-Busang syndrome affects new mining deals

Mining analysts and foreign investors have criticized the Indonesian government's recent move to change the terms of the seventh generation contracts of work (COW) which were initialed last year. Hartojo Wignjowijoto, a senior economist and president of Asian Pacific Economic Consultancy Indonesia, explains why the policy changes are ill-timed and could be counterproductive.

JAKARTA (JP): The Indonesian government seems to be suffering from a post-Busang syndrome at the moment, as indicated by the 16 points of change recently offered by the Directorate General of Mining to foreign contractors applying for the seventh generation Contracts of Work (COW).

The drafts of the seventh generation COWs have been initialized by both the government and the mining companies and are now on the way to the House of Representatives.

But a heated controversy arose after the government suddenly moved to enter the 16 points to the seventh generation COWs to develop a leverage and improve its bargaining position. This was in anticipation of political pressure for the government to better control foreign mining companies.

There are two points which especially drew strong reactions from the mining companies. One is related to the demand for the contractor to give the government a 10 percent share for free even before the mine is built. The other is the right for the government to share in the capital gains from share issuance overseas.

Foreign companies have been so outraged by the demand that they have threatened to leave the country and forget about the Indonesian geological potential. If this took place, mining activities would adversely be affected.

Foreign mining companies argue that what they need is transparent ground rules to play the investment game in the high risk mining sector so that once the companies commit their risky money, they can plan and implement it in an orderly manner.

They see the proposed changes in the contracts as additional uncertainty in the mining investment climate. At the same time, the government has felt compelled to strengthen its bargaining position because of its bitter experience with the Busang gold scam.

The Busang gold scam refers to what was claimed by contractor Bre-X Mineral Resources of Canada to be the world's largest gold find in the Busang area in East Kalimantan. But independent audits in April discovered that the claim was the biggest hoax of the century, causing an embarrasment and losses of billions of dollars to investors around the world.

Foreign mining companies objected for the simple reason that if one was caught in a criminal or gold scam, it does not mean the rest of the foreign mining companies here are all crooks.

This chaotic situation will have a significant impact on the forthcoming investment flows to Indonesia. According to a recent survey by the Indonesian Mining Association, almost US$100 million is about to leave Indonesia due to the new uncertainty caused by changes proposed for the seventh generation COWs.

The question then is to what extent long-term investors still believe in Indonesia's geological potential and to what extent the potential long-term investors believe in overcoming Indonesia's institutional problems.

In my opinion, if potential mining investors are long-term oriented they will leave the short-term institutional problems to the government. This means they will leave the political problems to the politicians and will focus on long-term mineral development and its associated regional economic development.

The government has already acknowledged that COW is the best scheme to accommodate article 33 of the Indonesia constitution, whereby the government is still in control of mineral resources.

The government contracts the exploitation of natural resources out to foreign mining companies which have the technology, equity capital and the ability to attract high risk capital.

Why has the government suddenly asked mining companies for a 10 percent free share? Is it not enough to collect up to 60 percent of mining contractors' revenues through royalties, a 30 percent income tax, and other indirect taxes?

The government has to consider several factors in deciding to amend the seventh generation COW. These include the alternative option for investors in other countries in the emerging mining countries, the urgent need to accelerate mineral-based regional economic development.

Above all, since the government and contractors have already mutually agreed upon the seventh generation COWs, the amendment should be directed to the eighth generation COW.

The government should carefully examine the structure of the incentives offered to foreign investors, the cost and benefits of foreign investment in the mining sector and the national value- added generated from mining activities.

I believe the House debates on the 16 points of changes proposed to the seventh generation COWs will create a lot of political uncertainties for foreign investors and cause a negative image on the credibility of the government's policy.

The middle of the road solution would be to reschedule the proposed changes for the next generation COW.

But before changes are entered into negotiations the government should again review the socioeconomic, financial and political cost-benefits of the new terms, focusing on the role of the capital inflow (including the development of infrastructure) for regional development.

The present day mining sector in Indonesia is facing new types of uncertainties. The completion of the full cycle of one COW generation and the institutional problems are currently reaching a crisis of confidence.

Even though the fundamental geological properties are strong, as long as the fundamental institutional problems are not overcome in the next cabinet, there will be a long setback to the well-known COW.