INDONESIA - NEW PACKAGES ON INVESTMENT, INFRASTRUCTURE

UNCLAS SECTION 01 OF 06 JAKARTA 001878

SIPDIS

SIPDIS
SENSITIVE

DEPT FOR EAP/MTS AND EB/IFD/OMA
TREASURY FOR IA-BAUKOL
COMMERCE FOR 4430/GOLIKE
DEPT PASS FEDERAL RESERVE SAN FRANCISCO/FINEMAN
DEPT PASS EXIM BANK

E.O. 12958: N/A
TAGS: EINV ECON EAIR EFIN PGOV ID

SUBJECT: INDONESIA - NEW PACKAGES ON INVESTMENT, INFRASTRUCTURE

REF: A) JAKARTA 13236; B) 06 JAKARTA 10361; C) JAKARTA 978; D)

JAKARTA 1282; E) 06 JAKARTA 13236


1. (SBU) Summary: On June 8, the Government of Indonesia (GOI)
issued a new Presidential Instruction with four components:
investment climate improvement; infrastructure development;
empowerment of micro, small, and medium enterprises; and financial
sector reform. These are updates to packages that were announced at
various times in 2006 by Coordinating Minister for the Economy
Boediono (reftels). They are now being issued simultaneously under
one umbrella Presidential Instruction to move the economic reform
agenda forward for the next twelve months. End Summary.

Four New Packages
--------------


2. (U) The GOI issued four broad packages of financial and
investment-related regulations on June 8 under Presidential
Instruction (InPres) 6/2007. The investment, financial sector, and
infrastructure packages are continuations of the same packages
issued by Coordinating Minister for the Economy Boediono in 2006.
The package for micro, small, and medium enterprises (MSMEs) is an
expansion of several programs previously issued under the 2006
investment package. Minister Boediono used these packages to help
to push through economic policy goals and coordinate the 16
Ministries under his purview. He has also uses them to encourage
other ministries outside his purvey to move in the reformist
direction as well.

Investment Policy Package
--------------


3. (U) The GOI claims it implemented 80 of the 85 actions in the
2006 package, the most important being the passage of the new
investment law in March 2007. This year's Investment Climate Policy
(ICP) package consists of three sections: Institutions, Customs
Clearance and Taxation. Section I focuses on institutional reform
goals intended to improve Indonesia's institutional capacity to
facilitate increased investment, including:

-- Formulating clearer distinctions of authority between the Central
Government and Regional Government in regard to investment;

-- Reduction of taxes and tariffs for investors;

-- Simplifying procedures for establishing a business.

The second section addresses customs reform, and outlines various
objectives, including:

-- Development of an online investment licensing system;

-- Establishment of a National Single Window for customs and cargo
clearance;

-- Streamlining of customs clearance procedures to allow non-suspect
goods to be released within 30 minutes.

The final section, Taxation, proposes to improve tax service
through:

-- Increasing the number of taxpayer offices;

-- Establishing a code of ethics for tax officials.

The GOI's record on implementing reforms remains decidedly mixed.
However independent observers tell us they appreciate GOI's
ambitious goal-setting and are impressed to see responsibilities
specifically tasked to particular ministries. The ICP also provides
valuable insight into GOI's own assessment of its progress. It also
has potential to serve as an effective tool of reform, despite its
status as a non-binding Presidential Instruction.

Unrelated to New Investment Law
--------------


4. (U) The ICP package serves as a political document that has no

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direct relationship to the new 2007 Investment Law. It is neither
part of the law, nor part of the law's implementing regulations.
The package of initiatives is, however, a useful policy analysis
guide in that it serves as a separate, independent document designed
to outline President Susilo Bambang Yudhoyono's vision to improve
the investment climate, as well as his reform agenda. The package
is related to the investment roadmap originally conceived by the
Indonesian Chamber of Commerce (KADIN) during SBY's election
campaign and has since been institutionalized by the President as an
annual report. It serves primarily as a strategic paper intended to
establish goals and influence policy direction, but lacks the legal
standing of a Presidential Decree.

What's New for 2007
--------------


5. (U) The ICP 2007 package reflects several updates from last year,
including realigned milestones and target dates, but also lists some
goals that have already been achieved (most likely as a means to
document "easy" successes in the run up to the 2009 Presidential
election.) The most noteworthy difference from 2006 is that the new
package more clearly designates responsibilities for specific
outcomes among competing government agencies and ministries. This
is significant because rivalries within the GOI are often blamed for
the slow pace of investment climate reforms. The most often cited
example is the bitter divisions between the Ministry of Trade and
the Investment Coordinating Board (BKPM). Delineating
responsibilities with greater precision may also signal the ICP
package becoming more of an implementing document than a strategy
paper.

Not Perfect, but Better
--------------


6. (SBU) Local expat consultants familiar with the ICP package
expressed admiration for the document's intentions but remain
concerned with quality control issues. "Just because the package
identifies reforms as completed does not mean they were done well,"
one widely respected expat consultant told us. Impressed to see the
2007 document identify ministries responsible for specific outcomes,
some experts defended the document's lack of detail, arguing that
strategically "less is more." As one senior expat consultant with
over 20 years of experience in Indonesia explained, "In Jakarta's
Javanese, consensus-driven culture, publishing a goal with too much
precision can weaken the ability to reach that goal." In his view,
deliberate vagueness is a virtue that serves to avoid hardening the
positions of potential adversaries. Some analysts told us this is
particularly important for the credibility of a document with no
force of law behind it. Indonesia's local media has been less
impressed, dubbing the package "SBY's wish list" and describing it
as "ineffective" and "lacking priorities". More specifically, local
media note the absence of incentives for government officials to
implement the reform measures, which in many cases run in direct
conflict with their own rent-seeking opportunities. In short,
without significant accompanying bureaucratic reforms, local critics
remain skeptical of the package's overall effectiveness. Meanwhile,
local government observers acknowledge that although the ICP package
is far from perfect, they appreciate the goal-setting and hope the
newly-included designation of responsibilities will help forestall
governmental rivalries that have slowed the pace of reform.

Infrastructure and Transportation
--------------


7. (U) Last year's package purported to address several policy
improvements, the major one being regulations for public-private
partnerships for infrastructure development (ref E). However, many
investors tell us that they will need to see significant reforms and
improvements in investment climate before international investors
bring financing for major infrastructure projects. The GOI said it
plans to accelerate transportation infrastructure through the
passage of four new bills in the transportation sector,
establishment of a National Transportation Safety Board, and
provision of institutional guidelines for mass rapid transit (MRT)
management in Jakarta.


8. (U) Ministry of Transportation (MoT) sources tell us that it

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plans to send four bills to Parliament this year concerning Railway,
Maritime, Aviation, and Land Transportation. Current legislation in
the four sectors dates back to 1992 and does not provide for an
effective mechanism for private investments in the transportation
sector or regional transportation planning after decentralization.
Transportation projects have attracted few investors despite the
GOI's strong marketing efforts to attract investment during the 2006
Infrastructure conference (ref B). Despite the public relations
blitz, the GOI has failed, for example, to provide tender documents
for its model transportation projects, leaving private investors
without the basic mechanism for participation. Still, in step with
the ongoing decentralization process, many regional governments have
implemented transportation projects, but they have done so in a
piecemeal fashion with little consideration for capacity, other
infrastructure links, or transportation projects in neighboring
districts. Our MoT sources say the new legislation will focus on
increasing opportunities for outside investment in the sector and
streamlining the procedure to do so. However, they provided few
specifics on how they hope to achieve these twin goals. The new
bills also target better strategic planning and coordination for
transportation links and infrastructure at the regional (provincial)
level. Parliament passed the Railway Bill in May. They may pass the
Maritime Bill by August 2007 and perhaps the Aviation Bill by the
end of 2007, according to our MoT contacts. That high level of
productivity would be a sharp break from recent years, however.

Increased Foreign Investment for Air Carriers
--------------


9. (U) Heru Prasetyo, Director of the Legal and International
Cooperation Bureau, stated that the Transportation sector will
welcome increased foreign ownership under the new negative list
(issued July 4),including increased foreign ownership of air
carriers (49% under the new Negative List). However, he noted that
foreign firms would have difficulty reaching that level of ownership
under the current investment climate. Prasetyo also stated that
over the next five-to-ten years the Department of Transportation
will reduce the number of regional transportation ports (such as
international maritime ports) and increase coordination of
multi-region, large-scale infrastructure projects through dialog
with regional governments. Prasetyo stated the actions will
hopefully lead to a more efficient allocation of state and local
budget resources.

New Domestic Transportation Safety Board
--------------


10. (U) The MoT said it also intends to set up a new National
Transportation Safety Board (NTSB) to improve land transportation
safety throughout Indonesia. A National Transportation Safety
Commission (KNKT) already exists under the MoT, but it is
overburdened by the high number of transportation accidents, is
understaffed, and lacks budgetary funding and authority for
investigations. Unlike the Jakarta based KNKT, the NTSB will have
offices throughout Indonesia and focus exclusively on road accidents
at the provincial level. The provincial level will also be
responsible for funding the NTSB, however, so it is unclear if it
will have enough resources to do a credible job.

Mass Transit for Jakarta
--------------


11. (U) Jakarta's choking traffic lowers both quality of life and
economic growth. To remedy these twin maladies, the GOI
infrastructure acceleration plan calls for the creation of an
institution for Mass Rapid Transit (MRT) in Jakarta. Our GOI
contacts express the hope that this institution will also serve as a
role model for MRT development authorities in other large cities.
The MRT authority's primary function will be to manage the
controversial Jakarta monorail project (ref A),which is being built
primarily by companies associated with Vice President Jusuf Kalla.
The on-again-off-again monorail project is now underway again after
a recently issued government regulation (No. 103/2006) granting
minimum ridership guarantees to the monorail project. The monorail
project is scheduled for completion in 2010. Prasetyo told us that
the local Jakarta administration will be responsible for
establishing this authority.

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Micro, Small and Medium Enterprises Package
--------------


12. (U) The new package for "Empowerment of Micro, Small and Medium
Enterprises" (MSME) consists of three major elements:

Section I seeks improved access of MSME's to financing by:

-- Improving MSME access to financial resources;

-- Strengthening MSME credit insurance;

-- Better use of non-bank funds to empower MSMEs.

Section II aims to improve private entrepreneurship and human
resources by:

-- Better education and training including graduate school
programs;

-- Encouraging technology-based entrepreneurship;

Section III's goal is enhancement of market opportunities for MSME
products by:

-- Expansion of MSME product promotional institutions;

-- Encouraging partnerships between producers and both traditional
markets and modern shops; expanding market synergy.

-- Expanding information on shipping and transportation for goods.

-- Tax incentives for MSMEs.

-- Finalizing the preparation of a draft law on MSMEs for submission
to Parliament by December 2007.


13. (SBU) The GOI has had several iterations of assistance packages
for MSMEs, some of which have been successful. However, high
interest rates, inadequate access to capital, corruption and
bureaucratic red tape continue to hinder many entrepreneurs. An
additional shortcoming for Indonesia's MSME development is a lack of
good entrepreneurship training and only a handful of well-respected
business schools. Indonesia's venture capital industry is also
underdeveloped, and commercial banks lend directly to
small-and-medium firms. According to the World Bank, few offshore
venture capital compaiies have shown an interest in investing in the
cu ntry due to transparency and corporate governance issues. One of
the program elements in the financial sector reform package (see
below) is to enhance the role of venture capital in MSMEs: it calls
for an assessment report by November 2007.


14. (SBU) Tax incentives for MSMEs will likely face a slow battle
through the Directorate General for Taxation (DG Tax): DG Tax still
has insufficient capacity for good tax policy study, review and
decision-making. According to an International Monetary Fund
economist based in Jakarta, the parts of this MSME package with the
best chances of success are the credit schemes and the educational
improvements. One noteworthy positive development is the program
element to develop a warehouse receipt system as a financing
instrument for MSMEs. A system of designated warehouses providing
officially, centrally registered receipts for commodities stored,
allows MSME traders and farmers to store their goods for as long as
needed without having to dispose of them, and use the receipts as
collateral for loans. This was also a required program action under
the third Development Policy Loan (December 2006) provided by the
World Bank.

Financial Sector Package
--------------


15. (SBU) The new financial sector package contains four main
elements:

-- Strengthening financial sector coordination;


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-- Restructuring state-owned banks and facilitating sharia banking;

-- Strengthening non-bank financial institutions, especially
insurance and pensions.

-- Increasing stability, efficiency and liquidity of capital
markets;

-- Harmonization of laws and regulations governing the financial
sector.


16. (SBU) The new financial sector package reflects the fact, though
not stated, that many of last year's items were accomplished (ref
B). The GOI has established a primary dealers market, and auctioned
its first T-Bill auctions in 2007. We were also pleased that some
of the problematic areas in the draft of this package (such as
regulation of ratings agencies),discussed in a meeting with major
donors (U.S., Australia, World Bank, Asian Development Bank and IMF)
were removed or revised in response to donors' written comments.

Financial Sector Safety
Net Law: Postponed Again
--------------


17. (SBU) One item that was not accomplished, however, and reappears
in this package again, is the establishment of the Financial Sector
Safety Net Law. This bill was supposed to be submitted to
Parliament by December 2006, but has been postponed again to October

2007. The law is in response to the 1997-98 financial crisis, to
define the role of the Central Bank, Ministry of Finance, and the
Coordinating Ministry for the Economy in the event of another major
shock. A senior manager at the State Asset Company (PPA) Raden
Pardede told us that the power relationships between the key
agencies are still complicated, "In the event of another crisis that
presented a systemic risk, important decisions would probably be
deferred to the President." The reason this draft has been delayed
several times is that, given the fallout of the crisis and ongoing
corruption investigations connected to the Indonesia Bank
Restructuring Agency and Bank Indonesia Liquidity Assistance (BLBI),
"No one wants the responsibility for the really tough decisions in
case of a new crisis actually put in writing. They're afraid they
might end up in jail," Pardede told us.

State Bank Governance
--------------


18. (SBU) One noteworthy element of the package is the development
of materials for public education in the field of finance by
September 2007. Commercial banks, mutual funds and credit card
companies have been calling for this for years. A large majority of
the banking and investing public is still poorly educated about
basic banking and investment principles, though the private sector
has been active in this area in a piecemeal way. A mandate for
improvement of state-owned banks via a decree by the Minister of
State-Owned Enterprises (SOEs) was also postponed from last year
(originally August 2006, now October 2007). A new Minister for SOEs
Sofyan Djalil was appointed in a Cabinet reshuffle on May 7 (ref D)
who may do more to support privatization, but management at
state-owned banks has a history of being heavily subject to
political interference. Indonesia's large state-owned banks are
Bank Mandiri, Bank Nasional Indonesia (BNI),Bank Rakyat Indonesia
(BRI),and BTN (which provides subsidized mortgages). Together they
control about 40% of banking assets in the country.

Insurance Regulation
--------------


19. (SBU) We were pleased to see that improvement of insurance
regulation and supervision via an amended regulation was included in
this package. Indonesia's insurance sector is in bad shape (ref C).
It suffers from weak regulation; poor enforcement; inadequate
training; low professional standards; and insufficient capital. The
goal for the amended regulation is January 2008 and involves three
agencies (Finance, Law and Human Rights, State Secretary). The
foreign insurance companies in Indonesia have been lobbying the
regulator for improved supervision for many months.


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Capital Markets, Sharia Bonds
--------------


20. (SBU) The merger of the Jakarta and Surabaya Stock Exchanges was
postponed a year from October 2006 to October 2007. The Ministry of
Finance hopes the merger will improve efficiency. The package also
seeks to improve price discovery for bond trading and valuation of
securities. Another goal added, which was not in last year's
package, is the development of Islamic Sharia Government Bonds and
other sharia financial instruments. This requires the issuance of
government regulations under the Ministry of Finance, but no
deadline was set in the new package.

HUME