Indonesian budget crisis hits inward investment

Indonesian budget crisis hits inward investment
 
During the last ten days of May and first ten days of June Jakarta hosts several conferences in inward investment and finance, notably the Euromoney Indonesia Investment Conference on 21st – 22nd  May in Bali ; the Indonesian Regional Investment Forum  on 26th -27th May in Jakarta; the Third Annual Arab Asian Financial Forum  on the 5th -6th June in Jakarta  and the Investment IQ Indonesia conference in Jakarta on 9th – 10th June.
 
All of these events should help bring Foreign Direct Inward Investment into Indonesia but they will all be confronted with the consequences of upside down economics  affecting investment in infrastructure :
 
(1) the hoped for contribution to infrastructure from the state budget and state owned enterprises is likely to be reduced because of pressure on the state budget from the rising costs of the oil subsidy (2)  this will decrease the prospects of providing state backed co-financing alongside foreign investors in public-private partnerships (3) it is hoped that this pressure might be relieved by the rapid mobilization of Islamic bonds (Sukuk) but this will depend, as will the quality of project proposals, upon improved project preparation capacity and faster reactions from public administration.
 
Meanwhile the mathematics of upside down economics are stunning.
 
The Ministry of Mines and Energy confirmed in late March 2008 that the House of Representatives had agreed to allocate RP 126.8 trillion in fuel subsidies or about three times the orginal 2008 budget allocation of Rp 42 trillion ( an increase from about US$4.3 billion to US$12.9 billion.  Energy & Mineral Resources Minister Purnomo Yusgiantoro confirmed that “ state income from the energy sector will be about $30 billion and  about half of it will be allocated for fuel subsidies”.
 
However by the third week of    May 2008 Finance Minister Sri Mulyani gave fresh figures on the cost of the subsidy in the light of constantly increasing oil prices spiking up to $136 dollars per barrel. Now the Government argued that the average 28.7 per cent increase in fuel prices would cut the annual spending on fuel subsidies by Rp 64.6 trillion ($6.6 billions) so that subsidy cost would fall from an estimated   Rp 265.6 trillion to Rp 201 trillion ( that is from  US$27 billion to $20.5 billion).
 
So in six months,  the estimated cost of the fuel subsidy to the state budget has risen from an original estimate of Rp 42 trillion in the original budget to a revised total of Rp 201 trillion, five times the original estimate , and this is taking into account the implementation of the 28.7% fuel price increase to consumers.
 
 
The total state budget was projected for 2008 at Rp 987.5 trillion ( or US $ 107 billion). The cost of the fuel subsidy as a percentage of the state budget has grown from a projected 4.2% of the state budget at the start of 2008 to 20.4% by the end of May. So expressed as a percentage increase in the budget it has increased in five months  by 500%. It would be 27% of the state budget without the implementation of the fuel increase. There will need to be another large fuel price increase during 2008.
 
The main impact of reducing the subsidy and of increasing fuel prices to consumers will be to remove a subsidy from the rich. The main grounds upon which the removal of the subsidy is opposed is that it will harm the poor. A recent Jakarta Post Editorial (May 14) estimated that 82% of the Rp 126 trillion fuel subsidy (US$13.7 billion) or Rp 103 trillion (US $11.2 billion) would go to motor vehicle.
 
It is true that  more realistic fuel prices will indirectly have negative effects on the poor. Also that poor people have been using kerosene as cooking fuel.  The state budget, which all parties in the House of Representatives agreed to, is unsustainable without the fuel price increase and reduction in subsidy. The use of kerosene as cooking fuel is also totally unsustainable and has to be stopped.
 
The Government has said that to mitigate the increase in fuel subsidies it will allocate Rp 14.1 trillion in direct cash assistance to poor families in 4,000 districts  ( the same 19.1 million families who were assisted in 2005, a total of 76.4 million people) plus Rp 13.2 trillion in (hopefully productive) credits , and another Rp 5.3 trillion to 400,00 Small & Medium Enterprises. The combined cost of these measures is equivalent to spending the total state revenue from oil and gas sales for one year on social mitigation measures to compensate for bringing fuel prices nearer to market rates.
 
Some Regents and regional assemblies are opposed to direct cash assistance to the poor because it will be allocated on old social and economic data and is likely to cause conflict.  The cash handouts, of RP 100,000 per month over seven  months,  are also opposed by NGOs, research organizations and politicians with experience of similar measures in 2005. There are also doubts that these funds will reach the poor.
 
The Chairman of the Regional Representatives Council, Ginandjar Kartasamita wrote recently (mid May) to President Susilo Bambang Yudhoyono arguing that although the fuel price increase might save the state budget it would not save the economy. Peoples purchasing power and industrial competitiveness would remain weak.
 
The size of the fuel subsidy and the cost of mitigation measures to reduce it should be put alongside the figures given by the organizers of the second Indonesian Regional Investment Forum ( mid May) that Rp 151 trillion is expected to be secured from State Owned Enterprises for investment in infrastructure in 2008, (about US$$15.4 billions) compared to Rp 93.1 trillions, ($9.5 billions) in 2007.
 
The cost of the subsidy should also be compared with total amount invested in Indonesian bonds in 2007 which was Rp 91.15 trillion or US $9.3 billion, and the total amount issued in Islamic Bonds (sharia mutuals) in Indonesia in 2007 which was  Rp 2.9 trillion or $296 million dollars.  Fortis Investments Jakarta confirmed these figures in mid April, when they announced 31.6% growth of Islamic bonds in quarter one of 2008 compared to 2.12% growth in conventional bonds. Conventional bonds grew by $111 millions whilst Islamic bonds grew by $93 millions in quarter one of 2008.
 
These figures should also be compared to recent figures for corruption cases. The Anti Corruption Court is now trying the case of the Pelalawan Riau Regent Tengku Azmun Jaafar who is accused of illegally issuing forest clearance permits causing losses 1.12 trillion of state funds (US$122  millions). In one corruption case the alleged loss to the state was greater than three months growth in private or Islamic bonds.
 
Recently Vice President Kalla made an interesting speech acknowledging that the prevailing mode of decision making for major business & project proposals in Indonesia  was still reliant on political rather than technical or professional support.  In a speech read for him at Tanjungpura University he underlined the failure to recover from the 1997 crisis or to push growth above 7%, with the main problem being lack of capacity and poor human resources.  “ We are not even obtaining half of our targeted average investments  (for public spending)” he said.
 
During the New Order 75% to 80% of all business investment was controlled by a small elite of businessmen close to government, confirmed Chris Kanter Deputy Chief Investments for KADIN. This pattern is changing, but slowly.
 
The Government is shortly to issue its last economic development promotion package of this administration prior to the 2009 general election. This will  be based on a document called “ Focus on Economic Programmes 2008-2009” issued by outgoing  Coordinating Minister for the Economy, Boediono and includes new laws on special economic zones, financial safety net provisions and improved credit management. New ministerial decrees also include immigration priviliges for foreign direct investors and accelerated import procedures for equipment, plus fiscal incentives including a 30% income tax reduction for 6 years. At present 17 firms with $7bn of foreign direct investment committed are awaiting this new rule to become effective.
 
As Mohammed Hidayat, the Chairman of KADIN (the Indonesian Chamber of Commerce and Industry has recently confirmed there remain doubts about the new package and the relationship between private and public sectors in Indonesia .” The previous economic packages have run aground because of bureaucratic problems , All of the business problems in this country stem primarily from bureaucrats “.
 
Despite these doubts and problems there is an infrastructure crisis and the foreign direct investment has to be found. Paradoxically the budget crisis means more opportunities for foreign investors not less, and probably on better terms with less state enterprise participation than might have been planned. The gap in the budget also creates an investment gap that has to be filled. Now is the right time for the new Islamic bonds and Islamic Finance generally to come into play. Investments need to be deployed with eyes open to the main problems of the recent past, with sensible joint venture deal structuring, reflecting fair risk sharing and comprehensive risk mitigation, externally referenced and monitored financial control requirements  and arbitration clauses based on international treaties or agreed international arbitration mechanisms, to help enforce contracts.