Poor infrastructure remains a drag on Indonesian performance

Indonesia lags some of its regional peers in efficiency and productivity mainly because of the poor state of its roads, airports, power sector and other economic lifelines, according to a report published by Standard & Poor’s yesterday.

Indonesia's continued underinvestment in roads and other infrastructure threatens growth, says S&P

Deficient and deteriorating quality is visible in urban congestion, high transport costs, electricity blackouts and limited access to better sanitation.

“The inadequacies in Indonesia’s transportation infrastructure are likely to hinder the country’s global competitiveness unless addressed,” said S&P’s credit analyst Rajiv Vishwanathan. “Indonesia is also at risk of deeper power shortages over the next few years as demand multiplies.”

The report’s underlying message is that Indonesia can move towards stronger economic growth by investing in infrastructure — and there seems to be the political will to make that happen.

He pointed out that before the Asian financial crisis in 1997 to 1998, large infrastructure investments seemed to underpin Indonesia’s high real GDP growth, which averaged about 8%. But, in the following decade, domestic consumption became the main driver of an average (and lower) annual growth of 5% to 6%, while at the same time the country’s capital expenditure declined.

However, the government now has more ambitious growth targets, which will require addressing severe infrastructure bottlenecks. Its recent “Master Plan for the Acceleration and Expansion of Indonesia’s Economic Development” targets annual growth of 8% to 9% from 2015 to 2025.

But S&P points out that continued underinvestment in infrastructure could put these targets at risk. In particular, the poor state of Indonesia’s transportation infrastructure is likely to hinder its global competitiveness unless addressed. The country’s railway network is old and its roads are crowded, with their number and length lagging the increase in the number of vehicles using them due to underinvestment.

There are also risks of deeper power shortages during the next few years as demand multiplies due to a shift from agriculture to manufacturing, greater individual affluence and more urbanisation. The government itself expects electricity demand to grow at more than 9% a year during the next eight years, but new generation capacity is desperately needed.

So, its focus is on improving power and transport infrastructure. The master plan has identified several projects worth a total of Rp1,786 trillion ($196 billion) in hydroelectric and solar power plants, and new roads, including toll motorways.

Vishwanathan reckons that these areas offer a strong opportunity for investment from the private sector to bridge any funding gap.

“We believe the political will to create a sustainable framework for private-sector participation will be pivotal to attracting more long-term foreign direct investments to expand Indonesia’s infrastructure sector,” he said.

Although, policymakers have taken steps to reduce the monopoly of state-owned enterprises in infrastructure projects through laws affecting railways, ports, power and air transport, as Vishwanathan noted, they haven’t fully implemented the operational frameworks to support these laws.

On the positive side, the government is starting to create a more robust regulatory framework. It finally managed to pass a land acquisition law through the legislature in December 2011, which promises to reduce uncertainties around the costs and timing for land purchases and should mean that project participants can determine appropriately sized contingency funds for their schemes.

It has also set up an infrastructure guarantee fund to provide assurance against political risks that may result in financial losses to projects developed under public-private partnerships (PPPs), and created Sarna Multi Infrastruktur to facilitate the use of such structures.

Yet, even with more committed government promotion, Indonesia suffers from low “technological absorption and capacity to innovate”, while aggressive schedules, problems from operating in difficult terrain and complicated sequencing of construction activities can also lead to project delays and cost overruns, affecting risk profiles.

And, while Indonesia’s institutional framework appears to be improving, “investors and businesses perceive the country’s judicial independence as weak and have doubts about their ability to efficiently enforce contracts and security relative to elsewhere in the region”, noted Vishwanathan.