Cablegate: Indonesia - Slow Progress On Investment Reforms

DE RUEHJA #7944/01 1741048
R 231048Z JUN 06





E.O. 12598: N/A


REF A) Jakarta 3563 (GOI Unveils Investment Package)
B) Jakarta 2315 (GOI Readies Investment Package)
C) Jakarta 5420 (Tax, Customs Chiefs Replaced)
D) Jakarta 5704 (GOI/Unions Assign Blame)
E) Jakarta 4465 (Worker Protests Against Labor Law)

1. (SBU) Summary: The Government of Indonesia (GOI), led
by Coordinating Minister for the Economy Boediono, continues
to move ahead with the broad array of reforms outlined in
its February 27 investment climate policy package.
Parliament held hearings on the GOI's draft investment law
(Ref A) on June 7 and June 23, but has raised many of the
same contentious issues that delayed the GOI's finalization
of the draft law for over a year. In a development that
cheered the business community, Finance Minister Sri Mulyani
removed the powerful and seemingly untouchable Director
Generals for Taxation and Customs on April 21 (Ref C),
paving the way for an agreement between the GOI and the
business community on revisions to a package of
controversial tax law amendments pending in Parliament.
Employers and some labor groups are gently exploring ways
forward on revisions to Indonesia's restrictive labor law
after mass demonstrations in May led the GOI to back down
from its plan to submit comprehensive revisions to the law.
Some of the less sweeping measures in the investment package
are also bearing fruit: business contacts say the GOI has
reduced the time needed to start a business and clear goods
through customs. Although keeping implementation of the 85
measures in the package on schedule will be a major
challenge, senior GOI officials hope a private-public
"external monitoring group" will exert effective pressure on
mid-level bureaucrats to achieve results. End Summary

2. (SBU) The GOI, led by Coordinating Minister for the
Economy Boediono, is moving ahead with a package of reforms
designed to make Indonesia's economy more friendly to
foreign and domestic investors. The reform package,
contained in Presidential Decree 3/2006, tracks closely with
the recommendations of an Indonesian Chamber of Commerce and
Industry (Kadin) "roadmap" for improving the business
environment and a Consultative Group of Indonesia (CGI)
paper outlining high priority policy areas. Most of the
package's 85 outputs are revised decrees, regulations, or
draft laws, making it difficult to gauge the real-world
impact of the measures. Nonetheless, there has been
significant progress on three of package's four cornerstones
-- the enactment of new investment, tax and customs laws --
which, if completed, would be a significant boost to the
investment climate. Progress on amending Indonesia's
restrictive labor laws has proven much more difficult, but
neither the GOI nor Kadin are ready to give up yet.

Parliament Begins Consideration of Investment Law
--------------------------------------------- ----

3. (SBU) After a year of jockeying between Minister of Trade
Mari Pangestu and Investment Coordinating Board (BKPM)
Chairman Muhammed Lutfi, the GOI finalized its draft
investment law and submitted it Parliament on March 21.
The draft law would replace separate laws for domestic and
foreign direct investment and create equal treatment of
both. It would also codify a number of international
investment principles including unrestricted repatriation of
profits and capital, rules and compensation for
expropriations, a clear and concise negatives list, and
removal of limits on investments and forced divestments.
The GOI intentionally left the language of the draft law
very general in order to allow it the flexibility to address
a number of contentious issues through separate implementing
regulations. Pangestu has stated the GOI intends to issue
the regulations at the same time Parliament passes the
investment law, and the World Bank is providing technical
assistance. Forthcoming regulations include:

--Two Presidential Decrees listing sectors closed to foreign
investment (negative list) and open to investment with
conditions. Pangestu told the CGI on June 14 that the list
will be clearly defined using SITC codes and linked to
Indonesia's national interests (i.e. not solely driven by

JAKARTA 00007944 002 OF 004

demands by specific sectors for protection).

--A decree spelling out the provision of integrated
registration and licensing procedures by regional
governments for investors.

--A list of tax and other incentives available for investors
as well as procedures for applying for them.

--A decree outlining the role and functions of a
restructured BKPM, emphasizing its role as an investment
promotion body.

--A decree streamlining the investment process.

4. (SBU) The most controversial issue has been the GOI's
stated intention to shift the GOI's investment regime from
an approval to a registration system by stripping the BKPM's
approval authority and turning it into an investment
promotion body, reforms Lutfi has strongly resisted. While
Pangestu may have prevailed in her scuffle with Lutfi, the
battle over the fate of the BKPM and other challenging
issues could continue in Parliament. Parliament's
Commission VI held its first hearing on the proposed law on
June 7, during which Pangestu fielded a wide range of
concerns from representatives of major political parties.
These included the future role of the BKPM in investment
policy and approvals, the absence of a clear negative list
and non-tax investment incentives, and the wisdom of
including provisions for national treatment and unrestricted
repatriation of profits and capital. At a subsequent June
23 hearing, Pangestu responded to comments from Commission
VI members, emphasizing that the GOI produced the draft law
after inter-agency discussion and that both the Ministry of
Industry and BKPM participate in the committee that drafted
the law and will prepare the regulations.

GOI Resubmits Draft Tax Laws to Parliament

5. (SBU) After less than five months on the job, Finance
Minister Sri Mulyani replaced her notoriously corrupt and
seemingly "untouchable" Director General of Taxation Hadi
Purnomo on April 27, who had served under three Presidents
and five finance ministers. Mulyani also replace Director
General of Customs Edy Abdurrahman. The move cheered the
business community, which has long viewed corruption and
inefficiency at the two agencies as glaring examples of
Indonesia's poor business climate. The new DG for Taxation,
Darmin Nasution, is taking an active role in modernizing tax
administration, reforming internal procedures, and making
the tax service more customer friendly.

6. (SBU) Purnomo was responsible for sabotaging months of
GOI and private sector consultation to produce amendments to
Indonesia's income tax, value added tax and luxury tax, and
taxation procedures laws (Laws 17/2000, 18/2000, and 16/2000
respectively). The amendments aimed to strike a better
balance between taxpayer rights and protections and tax
office authority, but business community displeasure with
the final package led Parliament to delay consideration of
the amendments until 2007. As one of its first investment
policy reform tasks, the GOI in March decided to recall
Purnomo's amendments from Parliament and discuss revisions
to them with the Indonesian Chamber of Commerce (KADIN).
The GOI then, on June 5, submitted its latest drafts to

7. (U) According to a World Bank report, the new amendments
would allow taxpayers to be present during audits and view
their results, pay only their own self-assessment during
appeals (instead of the disputed amount), face
administrative rather than criminal sanctions for first time
violations, and enjoy some safeguards if tax authorities
freeze their assets. The amendments would also cut the
statutory limit for tax assessments from ten to five years,
extend filing deadlines for corporate income tax filers,
allow automatic extensions, and remove the requirement that
every refund request first undergo and audit. They would

JAKARTA 00007944 003 OF 004

also drop a GOI plan to make mutual fund dividends taxable,
reduce the corporate tax rate to 28 percent immediately and
to 25 percent by 2010, and cut taxes on dividends. Low
income earners would also face lower taxes, and minimum wage
earners would be exempt from taxes altogether. The draft
VAT law amendments would exempt unprocessed agriculture
products, electricity and water.

Parliament Helps Improve Customs Law

8. (SBU) The GOI submitted a draft customs law to
Parliament in September 2005 that focuses largely on
combating smuggling, under-invoicing, and customs fraud by
imposing harsher penalties and fines and greater authorities
for customs officials. Critics of the draft complain that
by expanding the authority of customs officers, it will
encourage even greater rent-seeking behavior while doing
little to improve the efficiency of customs processing. On
this issue, Parliament may be playing a constructive role.
Ministry of Finance officials are holding weekly closed-door
meetings with a special Parliament committee to consider
revisions to the draft law. According to contacts at
Customs, these discussions have focused on implementation of
a customs single window and other measures to speed up
customs processing, as well as a more clearly defined list
of restricted products.

Labor Law Revisions Remain in Limbo

9. (U) The GOI made labor law reform one of its highest
priorities for 2006, with emphasis on reducing Indonesia's
relatively high severance payments and tough restrictions on
outsourcing and contract workers. According to a World Bank
report, the GOI's draft law would reduce the average
severance pay from nine to seven months, length of service
pay from 19 to six months, and remove distinctions between
severance levels for dismissals with cause and those due to
economic factors. The draft law would also permit employers
to use fixed-term contracts for all work activities for up
to five years, and permit the expansion of outsourcing.

10. (SBU) The GOI worked closely with the Indonesian
Employers Association (APINDO) in formulating the drafts,
but failed to properly consult labor. The labor movement,
which initially seemed somewhat amenable to a more
competitive labor law held a series of demonstrations in
April and May, including one on May 3 that ended in a minor
riot in front of the Parliament. Shortly after the
demonstrations, President Yudhoyono announced the GOI would
drop its plan to submit the draft law to Parliament in the
near future and would instead create a group with
representatives from five universities to study the issue
further. The protests also prompted House of
Representatives Speaker and Golkar Deputy Chairman Agung
Laksono on June 2 to officially request that the GOI abandon
its plans to amend the labor law.

11. (SBU) Since the May demonstrations, APINDO Chairman
Sofjan Wanandi has held discussions with the Confederation
of Indonesian Prosperous Trade Unions (KSBSI), and both
parties have agreed to hold a "national bipartite summit"
that would include employers, unions and academics towards
in late June. Wanandi tells us he is upbeat about the
process and still optimistic about the possibility of seeing
new labor laws (or more likely regulations) enacted by the
end of the year. However, the Confederation of All-
Indonesian Workers' Union (KSPSI) and other labor
federations have yet to agree to the proposed June bipartite

Some Reforms Already Having an Impact

12. (U) Some reforms are already having an impact. A World
Bank consultant who is closely monitoring the investment
climate reforms has told us the Ministry of Justice's (MOJ)
implementation of an electronic business registration filing

JAKARTA 00007944 004 OF 004

and notification system has reduced the number of days
needed to register a company from 45 to 21 days. The MOJ
hopes to further reduce this figure to just ten days by
fully decentralizing the registration process to its
district offices. This could turn out to cause new delays,
however, as most MOJ district offices lack computer
equipment and training to run their own on-line registration
programs. In addition, the Ministry of Manpower and
Transmigration has simplified procedures for to obtaining
expatriate work permits, cutting the process from seven to
four days, and extended their validity from one to two

13. (SBU) Other reforms, however, may not be having the
desired effect. The Ministry of Trade has taken credit for
streamlining the issuance of eight types of business
licenses, including the "business trading license" or SIUP
most companies operating in Indonesia are required to
obtain. However, the World Bank consultant told us that
Minister of Trade Mari Pangestu blew up at her staff after
learning that she had approved new regulations for SIUP
applications that actually expanded their coverage and
reporting requirements.

Government Sets Up Monitoring Bodies

14. (SBU) Although the Coordinating Minister for the Economy
has spearheaded the GOI's investment climate reforms, it has
very limited authority over the 16 line ministries it
oversees. Minister of Trade Mari Pangestu and Minister of
Finance Sri Mulyani are preoccupied with difficult reform
agendas inside their ministries. The result is that the GOI-
wide effort to monitor the progress and content of the 85
measures in the package remains weak, despite the fact that
the package was issued under cover of a Presidential
Instruction, one of the highest forms of GOI regulations.
The Coordinating Ministry's strategy for overcoming its own
institutional weakness has been to establish a private-
public "external monitoring group", led by respected
economist Faisal Basri, to put private sector pressure on
the GOI to perform. But monitoring the many items in the
package is a very large task, and the group is struggling to
organize itself effectively in the absence of GOI budget
support. The World Bank has agreed to support the group
with both operating costs and technical assistance.

Comment: Implementation is Key

15. (SBU) GOI missteps, particularly on the draft labor law,
have resulted in setbacks in key areas of the reform
process. But the business community remains optimistic, if
impatient, and still hopes that the GOI will complete most
of its ambitions investment climate reforms on schedule by
year's end. The battleground on the most significant
reforms has largely shifted to Parliament, where nationalist
sentiments and opposition politics are certain to be
significant hurdles. Much may depend on whether Vice
President and Golkar Party Chairman Yusuf Kalla throws his
political weight behind passage of the four proposed laws in
Parliament. The challenge on the smaller items in the
package will be to keep pressure on the entrenched
bureaucracy through the monitoring group, the CGI process,
and other business interventions.


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