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Cablegate: Infrastructure Development Update

DE RUEHJA #9336/01 2061036
R 251036Z JUL 06





E.O. 12958: N/A

REF: A) JAKARTA 2984; B) 05 JAKARTA 975

1. (SBU) Summary: The Government of Indonesia's (GOI) is
making progress on a new infrastructure investment strategy.
Major legislative and regulatory elements are replacing the
failed pre-Financial Crisis system that relied largely on
unsolicited offers by investors. The GOI has made important
advances on ministerial risk-sharing and land acquisition
regulations, as well as an overarching Presidential Decree.
Most work has been completed on the financial risk
management plan. The GOI is facing challenges in fully
staffing the tender evaluation and risk sharing units within
government. Business contacts, the Asian Development Bank
(ADB), and some GOI officials agree that the key short-term
challenge is pushing even a single project through the new
system to prove it is relevant. Continued strong, high-
level political backing for the Jakarta monorail project and
the recently announced 10,000 MW crash electricity building
program, both of which are outside the new system, raise
concerns that the GOI is backing away from a rule-based,
market-driven, and transparent infrastructure investment
policy. End summary.

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November 1-3 Infrastructure Conference

2. (SBU) Indonesia's long-delayed second national
"Infrastructure Summit," now scheduled for November 1-3, has
been downgraded to a series of workshops aimed at creating a
few model tenders in specific sectors like airports, ports,
toll roads, gas pipelines, and electricity. Senior
infrastructure advisor at the Coordinating Minister for
Economic Affairs, Bambang Susantono, told us that the GOI
finally scuppered the previous "summit" concept,
acknowledging the clear message of unhappiness from
investors over the format and substance of the January 2005
Summit (reftel B). Potential investors may engage in give-
and-take discussions with relevant ministers and key
advisors, rather than sit through long speeches and plenary
sessions. The GOI has also unofficially jettisoned it 91-
project tender smorgasbord offered at the January 2005
Infrastructure Summit. Instead, Bambang told us the GOI
will focus on one or two model tender projects in each of
the seven core areas. The GOI is emphasizing it wants the
conference to yield concrete solutions and feasible
projects. The GOI has met some of the targets it set for
itself since the January 2005 Infrastructure Summit (see
reftel B). However, none of our contacts could give us a
precise timetable for when the various new infrastructure
units throughout the government will be fully staffed.

Rebuilding Credibility

3. (SBU) The GOI knows it bungled its initial 2005 campaign
to drum up private sector infrastructure investment
interest. A recent Wall Street Journal article said the
January 2005 Infrastructure Summit was "widely judged as a
failure by participating investors due to a lack of adequate
government planning." The GOI offered domestic and foreign
investors 91 projects worth $22.5 billion: only seven have
reached the tendering process and only one of those became
an actual deal. Those 91 projects are still officially part
of President Susilo Bambang Yudhoyono's medium-term plan for
$150 billion in infrastructure investment from 2005-2009.
That investment is needed to help meet an official annual
economic growth projection of 6.6 percent in the same
period. The government has forecast 6.2 percent economic
growth for 2006, significantly above the 5.6 percent
expansion in 2005. Indonesia's infrastructure development
has been lagging behind regional neighbors and is one of the
most serious bottlenecks to sustained economic growth.

4. (SBU) At the February 21, 2006 conference (reftel A), the
GOI announced a special stimulus package in matrix form
consisting of 85 measures to remove tax, customs and excise,
and labor obstacles to greater infrastructure investment.
Potential investors tell us that the package is a timetable
of pending regulatory changes rather than actual policy

JAKARTA 00009336 002 OF 006

initiatives, and will reserve judgment until they see the
promised measures actually implemented. Foreign investors
have told us and the GOI that their primary metrics to judge
whether the infrastructure investment environment has
improved will be keyed to: a new electricity law that
explicitly permits private sector investment in electricity
generation; standards for tender preparation and bid
evaluation that use international best practices; and strong
guarantees of international arbitration. We have annotated
below the progress to date on the GOI's major regulatory
changes proposed under the Policy Plan:

- Replacing Presidential Decree (Keppres) 7/1998 to create a
more transparent and predictable regulatory framework for
private sector participation. (Completed.)

- Revising Presidential Decree 36/2005 on land acquisition.
(Completed. See paragraph 13.)

- Adopting regulations clarifying the specific roles of
central and local governments on infrastructure projects.

- Adopting regulations on foreign loan and grants.

- Amending transportation laws (including land, sea, and
air) relating to decentralization and regulatory functions
over state-owned enterprises. (Draft law submitted to
Parliament and an administration priority for the 2006
legislative session, according to the GOI.)

- Adopting regulations on the tariff policy for Public
Private Partnership (PPP) projects for all modes of
transportation. (Pending.)

- Implementing regulations for the Toll Road Law (38/2004).

- Amending Oil and Natural Gas Regulations 35/2004 (Upstream
Activity) and 36/2005 (Downstream Activity). (Pending.)

- Amending Electricity and Energy laws. (Draft laws
submitted to Parliament but no action expected during 2006

5. (SBU) ADB Principal Economist Ramesh Subramaniam, who is
a key technical advisor to the Finance Ministry, told us he
doubts the feasibility of getting one quality tender project
in each of the seven sectors by the November conference
date. Subramaniam said that he has advised the GOI to
sharpen its focus further still. The ADB has told the GOI
at several levels that it would reap far greater benefits
from one or two well planned and credibly implemented
infrastructure projects using world-class best practices,
than from another large conference seeking a dozen tenders
across seven sectors. (Comment: Embassy has given the same
advice for many months. End comment.) Subramanian said that
the GOI remains wedded, however, to the key short-term
objective of getting high quality bidding documents for one
or two projects in each of the seven sectors. He said that
international, best-practice tender documents require
specific terms of reference for each infrastructure sector.
They must also be prepared by people with highly technical
skills and specialized knowledge. For this reason Vladimir
Bohun, a retired ABD employee who is currently an ABD-funded
Senior Infrastructure Advisor at the State Ministry for
National Development Agency (BAPPENAS), said he believed
even seven projects was too ambitious if the GOI wants to
follow international best practices.

New Regulatory Structure

6. (SBU) The key challenge for the GOI is to assure that its
offers of partial or full government support are limited to
high-quality projects. It has created an elaborate system
to evaluate both project tenders and possible government
support. Sitting atop the structure is the National

JAKARTA 00009336 003 OF 006

Committee for the Acceleration of Infrastructure, known by
its Indonesian acronym KKPPI. It is composed of line
ministers from the relevant constituent sectors, such as
energy, public works, and transport, and chaired by the
Coordinating Minister for the Economy Boediono. (Note:
Sixteen line ministries report to Minister Boediono. End
Note.) The ministerial committee will be supported by a
secretariat of professional staff split between the Office

of the Coordinating Minister of the Economy and BAPPENAS.
Each line ministry in turn will have a "Public Private
Partnership Node," which will be responsible for vetting
preferred projects to assure that only priority projects and
high-quality bid packages are forwarded to the KKPPI for
consideration. The contracting agency within each ministry
will have a PPP Node, according to the plan. For example,
state electricity company PLN, downstream regulatory agency
BPH Migas, and state gas company PGN are all scheduled to
have their own PPP Node within the Ministry of Energy and
Mineral Resources.

7. (SBU) The jobs in PPP Nodes are to be full-time within
each Ministry, though none are currently staffed. Susantono
said the KKPPI secretariat and the nodes in the Ministries
of Public Works, Transportation, and Energy and Mineral
Resources are all slated to be up and running by the end of
July. Bambang said that Minister Boediono will convene
cabinet principals in July to re-evaluate the GOI's
infrastructure targets and set their work program in
preparation for the November conference.

New Risk Sharing Package for Infrastructure

8. (U) On June 2, the GOI announced important new guidelines
for financial risk-sharing for PPP infrastructure projects.
The guidelines were overdue and had been originally promised
by the GOI for completion in March. The final regulation,
issued as Finance Ministry Decree 38/2006 ("Implementation
Instructions for the Control and Management of
Infrastructure Provision Risks"), covers risk sharing for
PPP infrastructure projects in the energy, transportation,
telecommunications, water resources, and housing sectors.
The types of risk covered are:

-- Political risk: policies, actions, or decisions taken by
government or state entities that directly and significantly
impose financial losses on a business enterprise through
expropriation, legal or regulatory change, currency
convertibility restrictions or funds repatriation

-- Project Performance Risk: Risk associated with project
implementation, which includes location risk and operational

-- Demand Risk: When demand for goods or services produced
are lower than agreed. (Note: The GOI will also structure
risk sharing agreements so that they share in the upside
risk if demand greatly exceeds forecasts.)

Risk Management Unit and KKPPI Staff Pending

9. (SBU) Officials at the Ministry of Finance (MOF) on the
Risk Management Committee told us that they were unsure when
the dedicated Risk Management Unit would be established.
The current committee, which serves on an ad-hoc basis in
addition to normal duties, will continue during the
transition period. Officials expected that a draft
Presidential Decree on the overall reorganization of the MOF
would include the new Risk Management Unit. They were
unsure if the Risk Management Unit would be housed under the
Directorate for Debt Management or the Directorate for
Fiscal Policy.

Process and Decision-Making for Risk Sharing

10. (SBU) The process for securing GOI risk-sharing support

JAKARTA 00009336 004 OF 006

as outlined in the decree is close to what Minister Boediono
announced at the February 21 conference (reftel A). The
line ministries will propose PPP infrastructure projects to
the KKPPI, providing a pre-feasibility study; a plan of the
form of public-private cooperation or risk-sharing; a plan
for project financing; a schedule and evaluation process;
and documentation of the results of public consultation on
the proposed project. KKPPI will then evaluate the proposal
according to publicly announced criteria and transparent
priorities. After being favorably evaluated for feasiblity
and priority-ordered by the KKPPI, the MOF Risk Management
Unit will evaluate the project's suitability for government
support. If the MOF concurs with government support, it
will decide an appropriate level of risk exposure and
request budget approval from Parliament. Currently the GOI
has decided that it will submit projects in groups for
budget approval by Parliament, but it is still deciding
whether to submit projects more frequently annually. Once
the Parliament has approved the funds, the project will then
be tendered, with the MOF having the final say on approval,
as a means to provide quality control over the tender

Industry Reaction Mixed

11. (SBU) Officials at the Ministry of Finance on the Risk
Management Committee said that the initial reaction from the
private sector was that it wanted more types of risks
covered. Members of the American Chamber of Commerce
(AMCHAM) tell us that they like the preliminary descriptions
of how the program will work, but they will be watching
carefully how the MOF implements it. Vladimir Bohun said he
hopes that the GOI will simply describe the risk it is
willing to share and then leave it to the private investors
to offer their bids for what they need. This will allow
maximum flexibility for businesses to be creative while
ensuring that the GOI gets the best terms for its risk.
Potential investors tell us they feel the initial $217
million requested for risk-sharing by Minister Mulyani in
May is too little to attract serious foreign participation,
particularly on larger infrastructure projects.

World Bank, ADB Infrastructure Involvement

12. The GOI has requested World Bank and ADB assistance in
financing infrastructure development through a $400 million
Development Policy Loan (DPL), $300 million of which will
come from the ADB and $100 million from the World Bank. The
DPL would not be tied to specific sectors or projects,
according to our World Bank contacts. The DPL consists of
three consecutive reform programs to be implemented by the
GOI through 2009. The programs will aim to assist the GOI
in legal and institutional reforms, policy reforms in
specific sectors (e.g. transportation, oil and gas,
telecommunications, water and sanitation), and a transparent
bidding process. World Bank and ADB contacts tell us they
will only make subsequent disbursements if the GOI shows
real progress within agreed time frames. Our World Bank
contacts tell us the GOI will need to demonstrate it can
implement a well-structured model transaction. In
particular, the World Bank and ADB will closely monitor the
effectiveness of the Risk Management Unit and the KKPPI
project evaluation process. The GOI faces a significant
challenge, as our World Bank and ADB contacts continue to
uncover fresh examples of pressure by well-connected local
investors who are seeking to undermine the role of the KKPPI
on infrastructure projects.

Land Acquisition Decree

13. (SBU) Uncertainty and bottlenecks related to land
acquisition have delayed or sunk infrastructure projects in
the recent past. Land title issues are problematic in
Indonesia, with only a fraction of land having clear legal
title. In addition, rising land prices spurred by
speculators and rent-seekers with inside information have

JAKARTA 00009336 005 OF 006

been a perennial problem in the Indonesian infrastructure
sector. The new decree will handle land issues under
project performance risk. The GOI may compensate delays in
land acquisitions by extension of the concession period or
by other unspecified means approved by the Minister of
Finance if the GOI has caused the delays. The GOI may also
compensate increases in land prices by extending the
concession period, paying a percentage of the higher price,
or by other unspecified means approved by the Minister of

14. (SBU) The GOI made only minor changes to the initial
draft presidential decree on land acquisition for
infrastructure projects, which President Yudhoyono signed on
June 6. Investors are likely to welcome the changes, while
anti-corruption NGOs and legislators continue their drumbeat
against it. Public Works Minister Djoko Kirmanto said in
early June the revisions had been finalized with several
contentious articles dropped.

15. (SBU) The decree allows the government to take over
government land for projects deemed in the public interest,
as well as the ability to strip private land owners of their
property rights if they do not agree to government
compensation offers. Legislators and NGOs which opposed the
new decree said it is too vague in its definition of "public
interest" and violates landowners' rights under the 1962
Property Law. They say they fear the new legislation will
be abused by government officials to take private land
arbitrarily. Crticis argue also that the new system, with
an independent land assessor appointed by the government,
provides too many incentives for collusion between officials
and business interests. They also criticized the deadlines
the decree sets for property negotiations, which they said
could force landowners to accept unfair compensation
offers. Still, the GOI has created a process by which
landowners can appeal compensation offers that they view as
inadequate. Previously, no such right of appeal existed.
Potential infrastructure investors are likely to applaud the
speed of the process and its streamlined nature.

16. (SBU) The GOI did significantly scale back the types of
infrastructure projects for which investors may seek a
public interest designation. The GOI initially considered
including 21 categories but settled on roads, freeways,
dams, airports, railways and flood dikes, according to the
Public Works Ministry. It specifically excluded
telecommunications infrastructure. "There has to be a
mechanism that stops people from holding the government
hostage over important infrastructure projects,
Communications and Information Minister Sofyan Djalil told
reporters recently. He added, "At the moment, we see people
blocking roads because they don't want to give up their land
to the government. The state needs a law to ensure the
process is expedited."


17. (SBU) The GOI has been working hard in certain areas,
namely in coming up with the financial risk-sharing
mechanism. The amount of money the GOI has allocated for
risk-sharing does not match the ambitious goals it has set,
according to most knowledgeable infrastructure observers.
We do believe it will be sufficient to get one model
transaction done. More troubling is the many ways in which
the GOI is working at cross purposes. For example, the
recently announced crash electricity building program to add
10,000 MW of generating capacity by 2009 will be done mostly
by direct offer, rather than through a competitive,
transparent bidding system. Vice President Kalla has made
vague public comments that the GOI may extend some form of
government support to the companies participating in the
crash program, similar to the "comfort letters" of the
past. Extending selective government support to the
companies involved in the crash program or the Jakarta
monorail project would undermine Indonesia's attempts to
show foreign investors that they have a fair and transparent
system based on international best practices.

JAKARTA 00009336 006 OF 006


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