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8 October, 2016
Despite already being one of the largest economies in the Asia-Pacific region, the Indonesian economy is poised to undergo significant expansion over the coming years. By 2030, it is expected to be the seventh largest economy in the world, its middle class to more than triple, and its skilled workers to more than double. Against this background, it is unsurprising that Indonesia’s foreign investment laws are expanding and modernising at a rapid pace.
For all of its opportunities, investing in Indonesia has significant challenges. It is an unfamiliar place for many international companies, and its legal traditions are likewise unfamiliar to those already operating elsewhere in the Asia-Pacific region.
This article discusses the opportunities for foreign investment in Indonesia, some of the laws that are relevant to those investments, including the manner in which disputes may be resolved both domestically and internationally.
Indonesia’s economy
From being a humble agricultural-based economy only decades ago, Indonesia’s economy is now the sixteenth largest in the world, with a mixed base and significant output from its manufacturing and services industries.
Indonesia is part of the G20, resource rich (it is the world’s largest exporter of coal) and like its neighbours counts, Japan, China and Singapore as some of its largest trading partners. It has all the hallmarks of, and potential to be, one of the world’s most successful economies.
In 2015, Indonesia’s gross domestic product (GDP) grew by 4.9%. At a time when regional growth is contracting (East Asia and the Asia-Pacific is expected to decelerate by 0.2% from 2016 – 2017), the Work Bank forecasts growth in the Indonesian economy of 5.1% for 2016 and 5.3% for 2017. This growth is being driven in large part by significant increases in public infrastructure spending, fiscal reform packages and growth in exports of manufactured products and commodities.
Opportunities
The rapid expansion of Indonesia’s economy has given rise to significant opportunities for foreign investors. President Widodo has unveiled a series of 13 economic packages aimed at boosting economic growth since September 2015. Most recently, the ‘Negative List’ of foreign investment, which serves to regulate which sectors are open to foreign investments, has been liberalised. The revised Negative List has opened up new sectors for investment (including investing in toll roads, restaurants, the rubber industry and cold storage and non-toxic waste management) and permits majority foreign equity stakes in healthcare facilities, telecommunications networks, warehousing and consulting services in construction. These reforms are part of the Government’s broader strategy of increasing foreign direct investment, especially in infrastructure and services industries.
There are particularly strong opportunities in the construction, engineering and energy sectors. The Indonesian government has earmarked IDR 313.5 trillion (USD 22.9 billion) for infrastructure development in the 2016 State Budget, the highest budget ever allocated to the country’s infrastructure development. The 2016 budget shows a continuation of fiscal reform to improve the efficiency and quality of government spending and the reallocation of fiscal resources from energy subsidies to infrastructure, as well as health and social assistance programmes, all of which are expected to support growth in 2016.
Indonesia’s power generating infrastructure will need substantial investment to meet demand and keep up with Indonesia’s economic growth. Generating capacity, currently at around 53 GW, is struggling to keep up with the demands of the Indonesia’s growing middle class and its manufacturing sector. As a result, the Indonesian government has launched the ‘35 GW Programme’ to increase power generation capacity by 35 GW over the next five years using a combination of state funds and private investment.
Indonesia also has significant potential to generate clean energy, given its vast wealth of renewable resources, such as geothermal power – Indonesia holds 40% of the world’s geothermal reserves. The Indonesian government has set a development target of 5GW of electricity to be sourced from geothermal energy by 2025 which will require a capital investment of more than USD20B. With foreign ownership of up to 95% being permitted in the geothermal business, there is a huge opportunity for major foreign investors.
To support the significant investments being made in public infrastructure, the Government has developed a strong framework for private-public partnership (PPP) delivery that would be familiar to many international investors. The primary state-owned entities involved on the financing side include:
- PT Sarana Multi Infrastruktur (PT SMI) which is wholly owned by the Government;
- PT Indonesia Infrastructure Finance (PT IIF) which is a private enterprise jointly funded by the Government, the Asian Development Bank, the International Finance Corporation and two private financing institutions; and
- PT Penjamin Infrastruktur Indonesia (PT PII) which is another Government-owned entity created to issue guarantees against the political risk involved in PPPs – it is the government’s representative for appraising infrastructure projects, structuring guarantees and processing claims.
In terms of services industries, Indonesia is currently estimated to have a population of around 252 million making it the fourth most populous nation in the world after China, India and the United State of America. People between the ages of 15 to 64 make up approximately 66% of the total population. By 2030, Indonesia’s middle class is expected to more than triple, and its skilled workers to more than double, meaning that there is significant capacity for services industries and a skilled workforce.
Perceived risks
The slow and considered movement with which international commerce has sought to take advantage of the abovementioned opportunities is perhaps explained by the perceived risks of doing business in Indonesia.
Despite recent attempts to increase foreign direct investment in Indonesia, starting a new business in Indonesia remains a burdensome process by both world and regional standards. According to the World Bank Doing Business Index, Indonesia ranked 109 out of a total of 189 global economies in 2016. Starting a business in Jakarta takes on average 48 days and includes 13 procedures (nearly double the average in East Asia and the Asia-Pacific).
Indonesia does not perform well on the Transparency International Corruptions Perceptions Index at 88 out of a total of 167 (with a score of 36 out of 100). Over the past years, however, Indonesia’s Corruptions Perceptions Index score has been improving.
Moreover, a large risk perceived by many investors are the layers of bureaucracy that their investmets may be subject to. Examples of this risk include inconsistent regional and national regulations, broad discretionary powers being held by Government departments, and a general lack of certainty in terms of relevant laws/regulations that may apply.
Investment treaty protections
The perceived risks discussed above could be addressed (or at least mitigated) by foreign investment treaty projections. However, in 2014, the Government announced its intention to terminate 60 bilateral treaties that contained investor state dispute settlement (ISDS) provisions. Such provisions allow foreign investors recourse to arbitration at the World Bank administered International Centre for Settlement of Investor Disputes where they believe actions taken by a government are in breach of commitments made under an investment treaty (commitments such as to treat foreign investors similarly to domestic investors, and only permitting expropriation for fair and equitable compensation).
The Indonesian Government has taken the view that claims made under ISDS provisions are an affront to its sovereignty. The pending case of Churchill Mining and Planet Mining Pty Ltd, formerlyARB/12/14 v. Republic of Indonesia1 is an example of such claim. Churchill and Planet Mining allege that Indonesia contravened its treaty obligations under respective bilateral investment treaties between the United Kingdom and Indonesia, and Australia and Indonesia (namely, its expropriation obligations) by revoking a mining exploration permit on the island of Borneo. In July 2015, the arbitral tribunal (constituted by the International Centre for Settlement of Investment Disputes) ruled that it had jurisdiction over the dispute, rendering Indonesia potentially liable to pay compensation exceeding USD 1.35 billion.
Despite having already terminated a number of investment treaties containing ISDS provisions, and consistent with its broader policy of opening its doors to investment, Indonesia continues to negotiate other investment treaties. It is part of the negotiations for the Trans-Pacific Partnership Agreement and it recently announced the re-activation of negotiations for a free trade agreement with Australia.
Dispute resolution
The scaling back of investment treaty protections means that foreign investors are increasingly required to consider the risks associated with dispute resolution in Indonesia.
Indonesia’s legal system is based upon the civil law tradition of the country’s former Dutch occupiers. Judges are not bound by precedent, trusts are generally not recognised, and contracts are subject to the requirement of good faith – whereas the common law position may differ. For those reasons, the litigation process in Indonesia can be unpredictable and the general nature of the Indonesian litigation process can involve numerous formal hearings and substantial delays. Judges are also frequently subject to allegations of corruption.
In 2015, the World Bank ranked Indonesia 170 (out of a total of 189) in respect of the ease of enforcing commercial contracts. Poor performance was attributed to the high costs of litigation, absence of ‘fast-track’ procedures for small claims and a low score on the ‘quality of judicial processes’ index.
Accordingly, most international investors prefer to agree on foreign law for their commercial contracts and to resolve their disputes in Indonesia by arbitration. However, there are some mandatory law requirements that must be complied with, for example:
- some contracts must be governed by Indonesian law, such as domestic building contracts; and
- the so-called ‘Language Law’2 (Article 31 of Law 24/2009) stipulates that Bahasa must be used in any memorandums of understanding or contracts involving Indonesian government institutions or agencies, Indonesian private institutions or Indonesian citizens.
In that regard, Indonesia’s arbitral landscape has developed somewhat independently from international norms. Indonesia does not have arbitral law based on the familiar United Nations Commission on International Trade Law Model Law on International Commercial Arbitration. Instead, domestic commercial arbitration is regulated by the 1999 piece of legislation, ‘Arbitration in Indonesia Law’. Indonesia has three domestic arbitral institutes, the largest of which is the Indonesian National Board of Arbitration (BANI), and domestic arbitral awards are suggested to be more readily enforceable in domestic courts.
In that regard, although Indonesia is a party to the Convention on the Recognition and Enforcement of Foreign Arbitral Awards, domestic Courts have been inconsistent with respect to the enforcement of foreign arbitral awards. For that reason, many parties attempt to agree for arbitration under a foreign law to be seated in Singapore, and then first attempt to enforce that award in a foreign jurisdiction (if possible).
Indonesia is not currently a party to any convention for the recognition of foreign judgments.
Conclusion
Indonesia is one of the largest and fastest growing economies in Asia-Pacific region. Although there are risks associated with operating in the jurisdiction, the Government is taking rapid steps to address those risks and to open itself up for significant foreign direct investment. The opportunities are increasingly becoming too big to ignore.
First-movers should rightfully enter the jurisdiction with caution, however, not entering at all risks missing a huge wave of investment in the region’s biggest economy, at a time when neighbouring economies are slowing. The importance, as always with developing markets, is to understand the domestic framework within which to operate and how to resolve disputes quickly and efficiently when they arise.
We will keep you updated with the exciting developments being made in Indonesia.
For further information, please contact:
Glen Warwick, Partner, Clyde & Co
glen.warwick@clydeco.com
