Indonesia: Infrastructure gridlock

With nine in 10 passenger journeys and 50% of cargo traffic carried by road, stand-still traffic jams have become a daily fact of life in the Jakarta, Indonesia's capital, where the number of vehicles has tripled in the last decade. This problem has been exacerbated by the absence of long-term infrastructure projects such as the Mass Rapid Transit (MRT) system and the monorail. The latter is only just said to be restarting after a five-year pause.

Delay and inaction has long been an issue with Indonesian infrastructure. At least four of 11 infrastructure projects selected by President Susilo Bambang Yudhoyono as a priority for his second term in office are not expected to be completed in time. The worst delay has been with toll-roads; of 1,296 kilometers of highways promised between 2009 and 2014, only 296 km has been completed. Meanwhile, of the planned 954 km of railways, only 319 km is operational.

Transport is expected to account for 71% of infrastructure investment by 2014, but the country's needs go beyond that. Indonesia is one of Asia's fastest growing economies and infrastructure investment is lagging behind GDP growth, threatening to put the brakes on this rapid economic development.

"The demand for infrastructure services in Indonesia is huge," says Sarvesh Suri, Indonesia country manager with the International Finance Corporation, the World Bank's investment arm. "The economy is growing at 5-6% per annum and there is now a significant movement of people from the rural to urban areas, so there is pressure on land, pressure on water, pressure on services like power."

Fundamental need

According to the World Bank, Indonesia's infrastructure needs are the third greatest in Asia after China and India with $450 billion in capital expenditure needed between 2010 and 2020. These figures broadly correlate with the government's 2011-2025 development plan, which identifies IDR4,012 trillion ($440 billion) of investment, of which IDR1,786 trillion is assigned for basic infrastructure.

Under the nation's shorter term 2011-2014 economic plan, the infrastructure investment target is up to $191 billion for the economy to grow at its full potential. One third of this will come from the government, with the private sector providing the remaining $140 billion.

There is clearly an investment opportunity, but Suri warns the challenges are significant - to the point that it might not be a good fit for private equity. Getting traction in Indonesian infrastructure requires patience.

According to AVCJ Research, PE has accounted for a small portion investment in the asset class over the past decade, with just $2.2 billion deployed in utilities, transport and telecom. However, the real number may be less once investments in infrastructure-related services are discounted.

Anecdotal evidence suggests that a large proportion of infrastructure opportunities are greenfield. It typically takes three or more years to work through licensing and land clearance, another two years to build the asset, and a couple more to ramp up production. this means most GPs are under pressure to sell an asset before it reaches its full potential.

Mature infrastructure assets on the other hand are rarely for sale, and if they are, the asking price is high.

"This is the really the main challenge when investing in infrastructure," says Easy Arisarwindha, investment manager with Saratoga Capital. "The choice is either invest in mature infra such as telecom towers or operating toll roads, but the return is limited; or invest in a greenfield or brownfield project with the hope that a buyer will become available before the end of the fund life, which is clearly a riskier strategy."

As such, the most active investors in the space have tended to the likes of large pension funds, sovereign wealth funds and developmental finance institutions, which are able to make long-term investments in return for a steady cash flow.

Openings in energy

However, there are examples of GP participation, most notably in energy. One of the larger infrastructure PE deals to take place in recent times saw Saratoga team up with IFC to buy a 51% stake in Medco Power International for $112 million. The deal came about because the company's parent, oil and gas specialist Medco Energi, needed fresh capital to develop small independent power producers (IPPs) to serve areas outside the main Java-Bali grid.

Standard Chartered IL&FS Infrastructure Growth Fund also made investment in this space in 2011, when it committed an undisclosed sum to Navigat Group, which develops independent power systems for island locations off the grid.

"The disaggregated nature of Indonesia, a country of around 17,000 islands, means you can't put wires from island to island so you need all these independent power systems and portable power helps fill the gaps," says Andrew Yee, global head of infrastructure at Standard Chartered Bank's principal finance division. "We found a novel way of providing power in Navigat but with toll roads there is no solution. With tollroads, it is not so easy to address this Indonesian geographic disaggregation."

Indeed, the transport sector has been slower to gain traction with foreign investors compared to the power sector. One investment that closed this year saw toll road operator Baskhara Utama Sedaya (BUS) receive a IDR1.13 trillion 18-year convertible debt facility by OCBC Bank's mezzanine arm together with a consortium of investors, including Saratoga.

BUS has a 45% stake in Lintas Marga Sedaya (LMS), which was awarded a concession to build and operate the Cikampek-Palimanan Toll Road (CPTR), a section of the Trans-Java Toll Road that is scheduled for completion by September 2014.

However, the project which - kicked off in December 2011 - has suffered a number of delays. LMS only began work on the road in January of this year after running into trouble on land acquisition issues.

The lack of clear regulations on land acquisition and the provision of land compensation are among the most commonly cited barriers to investment in space. Much of this is rooted in Indonesia's history of informal land, which prompts any number of individuals to claim the rights to the land during the acquisition process.

The other frequent complaint is land owners holding on to their land as long as possible to benefit from appreciation in value while a project progresses, which has led to unexpected land cost escalation.

One way the government has tried to tackle this is through land reform legislation, allowing purchases for projects previously thwarted by private land owners to be forced through. The most significant recent development came in February when the constitutional court upheld the 2011 Land Acquisition Law, which was designed to speed up the settlement of legal problems resulting from land acquisitions.

Lacking clarity

Another area which area investors are also hoping for clarity is regarding public private partnerships (PPPs). With the two thirds of infrastructure investment expected to come from the private sector, the government will need to rely on PPPs but so far only two projects offered since 2006 have made it to the construction phase - coal-fired power plant Central Java IPP and an expressway in Bali.

"I think there is a weak public sector capacity to actually develop, transact, ward and monitor these projects," says Jon Lindborg, Indonesia country director with the Asian Development Bank. "There is still much to be done to develop the public sector capacity to implement PPPs."

The World Bank threw its weight behind the issue in September of last year, approving a project to support the newly established Indonesian Infrastructure Guarantee Fund (IIGF), an institution under the Ministry of Finance responsible for providing guarantees for PPP infrastructure projects. With the World Bank's support, the IIGF acts as a credible guarantee provider, leveraging private investments in infrastructure projects.

"The government realizing that it must regularize PPPs, not look at them as one-off projects that can cherry-picked," says Lindborg. "The government needs to treat PPP as one of the basic options for infrastructure services."

This also highlights the point that support for infrastructure investment in Indonesia is not limited to putting capital into assets.

For example, the country's Ministry of Finance teamed up with a consortium of development finance institutions to form Indonesia Infrastructure Finance (IIF), which provides local-currency financing for privately-funded projects. Meanwhile, the Ministry of National Development Planning (BAPPENAS) has established a project development facility with funding from the ADB aimed at assisting in project preparation and the selection of private partners in infrastructure services.

There may be a huge demand for infrastructure investment in Indonesia, and more capital willing to fulfill it, but the key is in bridging the gap to ensure the proper resources reach the right projects. Otherwise progress will remain stuck in downtown Jakarta traffic.

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• Topics
• Southeast Asia
• Infrastructure
• Indonesia
• Infrastructure
• Saratoga Capital Group
• IFC
• Asian Development Bank
• German Investment and Development (DEG)
• Standard Chartered Private Equity
• IL&FS Investment Managers