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Jokowi’s infrastructure policy dilemma

President Joko “Jokowi” Widodo’s recent victory speech indicated that infrastructure will once again be emphasized in his second term

Linda Yanti Sulistiawati and David K. Linnan (The Jakarta Post)
Yogyakarta
Wed, August 14, 2019

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Jokowi’s infrastructure policy dilemma

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span>President Joko “Jokowi” Widodo’s recent victory speech indicated that infrastructure will once again be emphasized in his second term. Its role is as a tool to boost the country’s development, logistics and investment, particularly outside Java. So, why are we not celebrating more success in creating this badly needed infrastructure? We cited below some of the main reasons.

Infrastructure projects involve significant time lags in construction and planning, so that in the short term, the projects are more a form of government stimulus than quick contributions to the nation’s capital stock. So, many presidential first-term infrastructure projects may not be ready yet, while many — if not most —second-term projects will likely not be completed before the end of Jokowi’s second term.

Public-private partnerships (PPP), regulated in Presidential Regulation No. 38/2015 on PPP, have had little weight in current decision-making on infrastructure projects. Most projects are given to state-owned enterprises (SOEs) which are supposed to ensure fast project delivery. But there is no standard for a government contracting authority (GCA) to determine whether a project has to be competitively tendered (under PPP) or given to the SOEs, through business-to-business (B2B).

Private investors, foreign and domestic, are up against SOEs that can accept risk allocations and rates of return that the private sector cannot. There should be standards in place for a GCA to evaluate the projects more broadly, for example, less burden to the state budget, involvement of the private sector, legal ability to do project finance, etc. Setting those standards, however, requires a better understanding of the hidden downside risks of consigning projects to SOEs, which, after all, the President embraced during his first term as a politically popular decision.

The government has been careful to keep the official deficit within a maximum three percent of gross domestic product (GDP), as international and constitutional standards for fiscal prudence. Just like in China, Indonesia wants SOEs to finance 30 percent of the national strategic projects, twice as much as the state budget contribution. Most financing for these SOEs comes from state-owned banks. Bank loans to nonfinancial SOEs recently reached 8 percent of the Indonesian banking system’s total (Bank Indonesia, 2018). Meanwhile, there is a certain sleight of hand in moving infrastructure expenditures from the formal government budget into state bank balance sheets as loans.

There are a variety of hidden legal issues that account for reciprocal reliance between state banks and SOEs here. Among them, SOE assets are normally considered to be state assets and so not subject to hypothecation and bankruptcy in secured financing terms. Private sector financers are also uncomfortable with the idea of SOEs as basically noncommercial entities that might favor political considerations over economics in decision-making.

The overly generous state bank lending is really more an accounting fiction to keep the official deficit under 3 percent. If the SOEs cannot repay state banks the infrastructure loans from project revenues in the longer run, the state will simply have to recapitalize the banks, in which case the recapitalizations will be characterized as a special case (remember the 1998 banking crisis).

There are a few things we need to be cautious about. We must acknowledge that the Indonesian infrastructure problem is an economic problem, above anything else, although it has political consequences visible in different areas of Indonesia. The government’s decision to involve SOEs in infrastructure development is a strategy to do things outside the state budget. It eventually must be paid for by the government via SOE capital increases, forgone dividends, etc.

Meanwhile, involving SOEs in the heavy lifting of infrastructure development seems largely a choice based on ideological reasons. SOEs are supposed to be “agents of development” in traditional terms and should be building infrastructure for national unity and economic development in all areas in Indonesia. Subsidies and preferential treatments may be needed along these lines, but we must be clear about costs and benefits.

The classic calculation in project finance is that the more users there are for infrastructure, the more revenue there will be under user fees to service (non-recourse) debt incurred to build the infrastructure. So, it is relatively easier in economic terms to support building infrastructure in heavily populated Java, as opposed to thinly populated eastern regions.

But on the political side, as Jokowi insists, national unity will not be realized by a Java well-endowed with infrastructure, while the rest of Indonesia starves. So, if there is a legitimate role for SOEs in infrastructure, it is more likely in Eastern Indonesia rather than just building another toll road on Java.

We understand that SOE involvement in infrastructure will eventually wind up on the state’s balance sheet. Either Indonesia will bust the state budget in exceeding the 3 percent deficit cap or acquire the funding outside the state budget.

But increasing the 3 percent deficit cap with heavy SOE involvement in the sector is not prudent. Private investment must be the golden key in order to maintain the deficit cap and sufficiently continue with infrastructure development. With that in mind, the most basic consideration for a GCA should be the real long-term burden on the state budget of any SOE-sponsored project. Employing the state banks to fund more SOE infrastructure projects would simply store up trouble for the future.

Experts have warned China on the possibility of a sudden, major collapse of asset values based on credit cycles, recognized as the Minsky moment. We must avoid the Minsky moment. The same might also happen in Indonesia, since we are experiencing a similar situation in the infrastructure sector. The government needs to control the banking system and make sure it is fiscally prudent.

This is the problem of external shocks, meaning just because financial markets have supported increasing state bank indebtedness to date does not mean such generosity will continue indefinitely. Jokowi is right to reduce SOE involvement in infrastructure for his second term, and the challenge is what adjustments should be made better to empower the PPP approach.

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Linda Yanti Sulistiawati is director of the Center for Asia-Pacific Studies and an associate professor of law at Gadjah Mada University (UGM), Yogyakarta. David K Linnan is an associate professor of law at the University of South Carolina, the United States. The views expressed are their own.

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