INDONESIA'S NEW INVESTMENT LAW - GOOD NEWS AND GREY AREAS

UNCLAS SECTION 01 OF 05 JAKARTA 001212 SIPDIS SIPDIS SENSITIVE DEPT FOR EEB/IFD/OIA AND EAP/MTS TREASURY FOR IA-SEARLS SINGAPORE FOR BAKER USDOC FOR SBERLINGETTE/4430 DEPT PASS USTR DKATZ E.O. 12958: N/A TAGS: EINV ECON ETRD PGOV KCOR ID SUBJECT: INDONESIA'S NEW INVESTMENT LAW - GOOD NEWS AND GREY AREAS ¶1. (SBU) Summary. After a two year delay, Parliament passed a new Capital Investment Law on March 29 that provides a range of protections for investors including equal treatment for foreign and domestic investors, protection against nationalization, international arbitration for foreign investors, free repatriation of profits, and extended land usage periods. Investors were hoping that the Investment Coordinating Board's (BKPM) burdensome approval authority would be curtailed in the new law. The new law does not provide explicit authority for the BKPM to issue investment approvals, which may herald a shift to a streamlined investment registration system. However, the BKPM retains authority to issue recommendation letters for granting certain investment incentives, a potential backdoor approval. The new law leaves unresolved a number of policy and operational issues, the clarification of which will determine the degree of openness and competitiveness of Indonesia's investment regime. These include the content of a forthcoming "negative list" of open, restricted, and closed sectors for investment, the future role of a strengthened BKPM, and the balance of authority between the BKPM, Jakarta line ministries, and local governments in the issuance of investment permits and licenses, traditionally an area of widespread rent seeking in Indonesia. We encourage Washington agencies to use available opportunities, including the May 21 visit by Trade Minister Mari Pangestu, to urge the GOI to use forthcoming Presidential Regulations for a more open, transparent, and competitive investment regime in Indonesia -- by reducing the number of sectors on the negative list and maximizing the openness of investment licensing. Suggested talking points are in paragraph 18. End Summary. Main Features of New Law -------------- ¶2. (U) On March 29, Parliament (the DPR) passed a new Capital Investment Law creating a single umbrella law for both foreign and domestic investment and replacing the 1967 Foreign Investment Law and the 1968 Domestic Investment Law. The law provides a range of investment protections: - Article 6 provides "equal treatment for all investors, regardless of their country of origin, who undertake investment activity in Indonesia in accordance with prevailing laws and regulations." - Article 12 specifies that all business sectors are open to investment activity except those which are explicitly closed. - Article 14 entitles investors to "certainty of rights, law and protection" as well as "transparent information." - Article 32 (4) mandates international arbitration in the event of disputes between foreign investors and the government based on agreement between the parties. - Article 7 provides protection against nationalization, noting that any taking over of ownership rights must be in accordance with the law, and be compensated at market value. Any dispute, along with compensation, will be settled through arbitration. - Article 8 gives the investor the right to freely transfer and repatriate capital, profits, bank interest, dividends, and other earnings, as well as funds required to purchase raw materials, replace assets, repay loans, or conduct a range of other transactions. Transfers and repatriations must take place "in accordance with prevailing laws and regulations." - The new law does not repeat provisions requiring forced divestiture and limiting the duration of foreign investment that existed under the 1967 Foreign Investment Law, Articles 18 and 27. Investment Incentives -------------- ¶3. (U) Article 18 provides for special tax incentives for certain types of investment under specified conditions. Capital investment qualifying for special treatment must fulfill certain criteria such as employing a large number of workers (not specified); infrastructure or SME projects; investments in remote or undeveloped areas; or investments promoting innovation, research or "pioneering" industries. Incentives offered to these industries include income tax reductions; exemptions or reductions of import duties and VAT for JAKARTA 00001212 002 OF 005 capital goods and raw materials; accelerated depreciation; and reduced property tax. Article 20 states that these incentives will not be granted to foreign capital investment which is not in the form of a limited liability company. ¶4. (SBU) However, the relationship between the incentives contained in the new Capital Investment Law and the GOI's recent investment incentive package outlined in Government Regulation 1/2007 of January 2007 is unclear. The implementing regulations for Government Regulation 1/2007, Ministry of Finance decree 20/HMS/2007, outline a similar, but not identical, set of incentives for investors, although they do not contain import duty reductions. Lengthy discussions between the Ministry of Finance, BKPM, and Ministry of Trade are likely as the GOI seeks to harmonize the new law with Government Regulation 1/2007 and its implementing regulations, as required by Article 39 of the new law. Negative List Pending -------------- ¶5. (SBU) Although the law contains a comprehensive set of investment protections, the degree to which it proves to be liberalizing in practice will depend on the implementing regulations, particularly forthcoming Presidential Regulations on the negative list and investment licensing. Article 12 of the law states that the "Government, based on a Presidential Regulation, shall determine the business sectors closed for capital investment, both foreign and domestic, based on the criteria of health, morals, culture, environment, national defense and security, and other national interests." Trade Minister Pangestu has stated the GOI's goal is to set out a clear set of guidelines and conditions for the negative list, using standard industry codes. A joint Ministry of Trade-Coordinating Ministry for Economic Affairs team has prepared a first draft of a comprehensive negative list, which has sparked an intense bureaucratic struggle, with domestic industry groups and their allies in the line ministries seeking to ensure that the new negative list does not open their sectors to more foreign competition. BKPM Chairman Lutfi spooked the markets the week of April 16 when he made comments suggesting the forthcoming negative list could close a number of sectors currently open to investors. ¶6. (SBU) Although few observers expect the final negative list to open significant new sectors to foreign investment, the fact that the negative list will be in the public domain for the first time in a unified document represents a major step forward for transparency. Currently, Directorate Generals at line ministries with regulatory responsibilities keep their own lists of investment restrictions in the sectors they regulate, with no central document or formal process for revising the lists. This leaves them with an extreme amount of discretionary authority in accepting or rejecting proposed investments. Unlike the original optimistic forecasts that the implementing regulations would be completed within a month, World Bank consultants working with the GOI on the negative list now say it may take several months to complete the negative list. Who Licenses Investments? -------------- ¶7. (SBU) A second, major unresolved area in the new law relates to the question of which governmental bodies will license investments, and by what process. Article 26, in a roundabout way, states that "authorized institutes or institutions" have the authority to provide "one-door integrated service" to issue investment licenses. Article 28 (j) then gives the BKPM power to "coordinate and implement" one-door services (also referred to as one-roof or one-stop services). Article 29 adds that in carrying out its one-door integrated services, BKPM will "involve representatives from each relevant sector and region using officials who are competent and authorized." ¶8. (SBU) These provisions, in effect, paper over an ongoing bureaucratic struggle between the BKPM and the line ministries over which will issue relevant sectoral licenses (and control attendant rent-seeking opportunities). The BKPM's consistent objective has been to move most, if not all, issuance of sectoral licenses required for investors into BKPM-operated one-stop shops. However, the agency lacks the staff and expertise to issue licenses in specialized industries such as mining, aviation, or financial services, and also lacks the ability to evaluate environmental impact statements. At the same time, line ministries are extremely JAKARTA 00001212 003 OF 005 reluctant to give up their authorities. ONE possible compromise would be to make the BKPM a "post office" for receiving license applications that it would then pass to line ministries for processing, but World Bank experts note that similar systems in other countries have worked poorly. In any event, fierce bureaucratic fighting is likely as the GOI drafts the Presidential Regulation on provisions and procedures for the one-door integrated services as required by Article 26. Role of BKPM: A Work in Progress? -------------- ¶9. (SBU) The new law strengthens the BKPM's status by turning it into a "non-governmental institution" with its chairman directly responsible to the President. However, it contains little information on the policy or operational role of the BKPM, which has won little affection from foreign investors over the years because of its non-transparent and lengthy approval system. Minister Pangestu had pushed since 2005 for BKPM's role to be ONE of investment promotion and registration, rather than approval. But Article 27 wields the imprecise verb "coordinate" five times in four sentences when discussing the roles of the Government and BKPM. The law gives government the authority to coordinate capital investment policy, while giving the authority for implementation of that policy to the BKPM. ¶10. (SBU) ONE key unresolved issue is whether the BKPM will continue to approve investments. Article 30 (7)(e) notes that the authority of the GOI (not BKPM, which is a non-governmental institution) covers "foreign capital investment and investors using foreign capital, capital from a foreign government based on an agreement between the GOI and the foreign government...." The law does not explicitly grant the BKPM the authority to approve investments, as it has done throughout its existence. (Note: The BKPM administers a two-stage investment approval system that is separate from the business licensing procedures and corporate legalization process required of all foreign investments. The BKPM process is not included in the International Finance Corporation's much-cited "151 days".) However, other portions of the law grant the BKPM the authority to issue letters of recommendation for foreign investors to receive immigration and residency permits. "The BKPM fought hard to keep approval of FDI," ONE IFC consultant noted. Strengthened GOI Authority to Terminate Contracts -------------- ¶11. (SBU) ONE provision of the law causing concern among the oil, gas, and mining communities is Article 33 (c),which appears to greatly strengthen the GOI's authority to terminate oil and gas Production Sharing Contracts (PSCs) or mining Contracts of Work (COW). According to the article, the Government is required to terminate an agreement or cooperation contract with an investor if that investor "commits a corporate crime in the form of a tax crime, inflating recovery costs, and other markups to minimize profit, resulting in loss to the state, based on a finding or investigation by authorized officers, and after a binding court decision..." Although this provision, which Parliament asserted on its own initiative, only makes formal the de facto situation on this issue, it highlights the lack of trust between Indonesia and foreign investors in the resource sector. ¶12. (SBU) Paragraph (a) of the same article prohibits all investors from "entering into agreements and/or statements which assert that share ownership in said limited liability company is for and on behalf of another person. This appears designed to limit the use of nominees and is again likely aimed at PSCs and COWs in the oil, gas, and mining sector. Land and Labor Issues -------------- ¶13. (SBU) Articles 21 and 22 grant capital investment businesses rights over land. Most observers view these measures as a strengthening of property rights for investors. The issue of land use was a sensitive point of deliberation in the DPR and has caused some controversy since its announcement. Under the two articles, the GOI can grant the right to cultivate land for 95 years (60 years initial application plus a 35-year extension); the right to build for 80 years (50 plus 30); and the right to use for 70 (45 plus 25). JAKARTA 00001212 004 OF 005 These land use rights are intended to support long-term investments that help the Indonesian economy become more competitive, do not require a large area, and do not damage the public interest. Rights can be renewed after evaluation. However, there is some question as to whether the new land use provisions conflict with the 1993 Agrarian Law. ¶14. (SBU) Article 10 specifies a preference for Indonesian manpower, but grants investors the right to hire foreign experts for particular positions. However, foreign workers are obligated to conduct training and transfer technology to Indonesian workers. Article 23 (3) states that foreign capital investors may be granted a limited stay permit for two years, which can be converted to a permanent residence permit after two years consecutive residence. This provision replaces the current one-year permit and six-month visa, and may represent a major win for foreign Chambers of Commerce in Jakarta. However it is unclear if the "foreign capital investors" the article cites includes foreign managers of companies or just equity investors/shareholders. Article 23 (4) notes that the limited state permit is granted by the DG for Immigration "based on a recommendation of the BKPM." This provision concerns some observers, because it could provide the BKPM the discretion to keep certain foreign investors out by withholding a recommendation. Criteria for granting the recommendation are also unclear. Article 23 will require an implementing regulation from the Ministry of Labor. Investment Promotion and Special Economic Zones -------------- ¶15. (SBU) ONE of Trade Minister Mari Pangestu's original goals for the investment law was to use it to strengthen the BKPM's investment promotion function. Article 28 (f) gives BKPM the "duty and function...to promote capital investment" but without further details or clarification. There is no indication as to what investment promotion should consist of, or how it should be carried out. Article 31 grants the Government the authority to determine "stand-alone investment policies" for SEZs, and require the GOI to set out the provisions governing Special Economic Zones in a law. ¶16. (U) According to Article 35, international agreements approved before this law, shall remain valid, i.e. are grandfathered. However draft agreements not yet concluded, must be adjusted according to the provisions of the law (Article 36). This may have an impact on future discussions of an updated OPIC bilateral agreement. Observers: Mixed Sentiments -------------- ¶17. (SBU) "We're just glad the law finally passed after two years," one international investment bank noted, "but the devil is still in the details." Some analysts estimate that at four presidential regulations and several ministerial decrees will be required to manage the various provisions of the new law. Sofjan Wanandi, head of the Indonesian Employers Association told the press, "whether the investment law will manage to attract investors will depend on its implementation. Investors will take a wait-and-see attitude until the regulations are issued." Despite reports sourced to BKPM Chairman Lutfi that the GOI was considering restricting foreign ownership in several sectors, Sahala Gaol, Deputy to the Coordinating Ministry for Finance and Macro Economy in the Coordinating Ministry for Economic Affairs said, "The goal of the new law is to increase FDI, not to restrict it. We'll push back on efforts to limit foreign ownership. We want the negative list smaller, and much more clear." Suggested Talking Points -------------- ¶18. (SBU) Key features of Indonesia's investment regime still remain to be fixed by regulation, particularly the degree of openness to foreign investment and the nature of Indonesia's investment licensing regime. We encourage Washington agencies to use available opportunities, including the May 21 visit by Trade Minister Mari Pangestu, to urge the GOI to ensure forthcoming Presidential Regulations on the negative list and investment licensing lead to a more open, transparent, and competitive investment regime in Indonesia. Embassy recommends the following talking points be JAKARTA 00001212 005 OF 005 raised with Trade Minister Pangestu during her visit, and with other GOI officials as appropriate. --Passing a comprehensive investment law represents a major step forward for Indonesia's investment climate. We expect the new law to encourage U.S. investors to give Indonesia a closer look. It is time now to follow-up the law with forward-leaning regulations. --Important that the regulations to be issued under the law continue the shift toward a more open, transparent, and competitive investment regime. Backtracking on the basic, pro-investment nature of the law through restrictive implementing regulations would be harmful to Indonesia's investment climate, likely attract negative press attention, and encourage potential investors to look elsewhere. --In particular, we hope the forthcoming investment list will both clearly describe the restrictions facing investors in ONE authoritative document, and open up new sectors for foreign investors. Opening up previously closed or restricted sectors would help meet the Government's goal of attracting new investment, and send a signal that Indonesia is serious about competing for scarce investment dollars. --Also encourage the Government to adopt as flexible as possible investment licensing system, and avoid giving licensing and permit issuing monopolies to any ONE ministry or level of government. Allowing competition in the issuance of non-technical licenses is the surest way to create a more streamlined investment system. A competitive licensing and permit issuing system would also help Indonesia reduce further the number of days to start a business toward the Government's 30-day goal. HEFFERN