Legal Red Tape and Out of Control Security Forces? The Challenges of Investing in Indonesia

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Indonesia has that much vaunted phrase: “potential” with its strong recent economic growth rates, stable government and a large young population, a fair number of emerging market investors have been seduced by its charms. But it is also fair to say it is does not get as much attention as India, Russia, Nigeria and other emerging markets, below I take a look at the country’s political, security and human rights risks for foreign investors with a special emphasis on the oil and gas sector.

Introduction

Indonesia is an emerging democracy, which has moved along way from its authoritarian past, the country has a thriving civil society, independent media and its recent economic growth has been strong (6.5% GDP growth in 2011), withstanding the financial crisis with aplomb. The Government of Susilo Bambang Yudhoyono is generally investor friendly and there are strong oil and gas prospects throughout the country. But there are political issues associated with government regulatory agencies, ongoing violent separatist movements affecting the Country, as well as military and police forces heavily implicated in human rights abuses, all of which threaten its status as an attractive investment destination.

Political Risk

Indonesia’s central government remains strong, stable and investor friendly, but the performance of government agencies dealing with the oil and gas sector is often poor. The upstream regulator BPMigas is slow in responding to requests from the private sector, there are delays in announcing and issuing acreage, and decision making by the body remains opaque and inconsistent. The regulator has now been dissolved by the government, but it is unclear if the new regulator will improve matters. In any case oil and gas companies are advised to develop strong relations with these bureaucratic bodies in order to speed up the regulatory process.

The level of corruption in Indonesia remains a major problem, the country is ranked 100 (out of 182) on the Transparency International Corruption Index, and the risks of expropriation, rent seeking by officials and nepotism in awarding contracts by the government and private sector remains extremely high. Naturally these risks are amplified for any company operating in the natural resource sector.

The Government has not yet updated the 2001 Oil and Gas law which governs investment in this field. Unfortunately the legislation is not particularly investor friendly, as it requires that 25% of production must be reserved for subsided domestic use, and is currently being revised with many seeing the law as too generous to foreign interests while others decrying the uncertainty around the law as putting off foreign investors and hurting inward investment to the country. The Fraser Global Petroleum Survey of 2013 ranked Indonesia an abysmal 132 out of 157 jurisdictions in the world for perceived ease of doing business in the hydrocarbons sector, an drop from 111 in the 2011 survey.

Although there has been pressure on the Government to improve the investment climate by reforming regulators and changing the law to favour oil and gas companies, the likelihood of this is low as elections are due in July 2014 and any perception that the Government are acting to help foreign companies rather than its own people will cause the ruling party to suffer at the polls.

Uncertainty over the Country’s tax code remains, as the introduction of Government Regulation 79 (affecting tax and cost recovery) is in conflict with other parts of Indonesian oil and gas legislation. In addition there are also issues with the Production Sharing Contracts (PSCs), as there is a lack of consistency as to how they are applied to each different foreign oil and gas companies. Unfortunately the courts have been unable to clarify these matters, making the investment and legal environment even more uncertain for the oil and gas sector.

Security Risk

Indonesia is an archipelago, made up of thousands of often mountainous islands, which has often made state building difficult as regional identities clash with the central governments’ vision of a unified state.  Separatist clashes have been a frequent feature of Indonesian politics, most famously with the conflict in East Timor which led to that Country’s independence from Indonesia. More recently violence in West Papua has erupted, pro-independence militants have been fighting for independence from Indonesia; shootings of non-Papuans in the local capital Jayapura (seen as a revenge for the deaths of militants in police custody) are a warning that outsiders could be increasingly targeted if the violence escalates. In addition there has been violence in the remote gold mining area of Paniani, which is allegedly connected with the corrupt control of natural resources by the Indonesian security forces. Add to the mix a chaotic local government, which is often heavily divided itself and at odds with the federal government, a poorly implemented economic policy to help growth in the region (the Unit of Accelerated Development in Papua), all of which ensures there is a high degree of uncertainty for outsiders in West Papua.

The Country has also been affected by Islamist groups, violence has erupted in Western Java, Banten and Sulawesi, as mobs have attacked different groups, including Christians, the police and other religious minorities. The risk to outside companies in the area is significant, as foreigners are always a prominent and easy target for such groups. In addition, just to make things even more tasty, the threat from Al-Qaeda and subsidiaries also remains high in the region. The Bali bombings in 2005 are a reminder of the danger from this particular quarter.

Human Rights Risk

The Indonesian Government rejected a draconian new law which would have given arrest and detention powers, freer rein with wiretapping and interception along with other powers to the state intelligence agency, (Badan Intelijen Negara). Rejection of these new powers has bolstered the Country’s liberal democratic credentials, but critics fear it will embolden separatists and terrorists, as the intelligence agency will be less able to deal with their threat. The Government remains committed to human rights protection on paper, but in reality often lacks control over elements of the military, particularly in regions with separatist movements.

The Indonesian police and military have come under increasing scrutiny as they have been accused of corruption and an over readiness to shoot first, ask questions later. Association with law enforcement and military should therefore be handled with care, as their unpopularity and lack of accountability may seriously damage a company’s reputation, if seen to be working closely alongside the police and military.

The human rights situation in West Papua remains particularly poor, with foreign journalists unable to travel freely without close monitoring from the government and the military are strongly associated with human rights abuse. The situation is similar in Aceh and Ambon, where separatist violence has flared and with it military and police human rights abuse.



Categories: Country Investment Analysis, Frontier Markets

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