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Cablegate: Indonesia's New Investment Law - Good News and Grey Areas

VZCZCXRO1062
RR RUEHCHI RUEHDT RUEHHM
DE RUEHJA #1212/01 1200934
ZNR UUUUU ZZH
R 300934Z APR 07
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 4537
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUEHKO/AMEMBASSY TOKYO 0498
RUEHBY/AMEMBASSY CANBERRA 0708
RUEHBJ/AMEMBASSY BEIJING 4071

UNCLAS SECTION 01 OF 05 JAKARTA 001212

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DEPT FOR EEB/IFD/OIA AND EAP/MTS
TREASURY FOR IA-SEARLS
SINGAPORE FOR BAKER
USDOC FOR SBERLINGETTE/4430
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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

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