Mobilizing Finance For Infrastructure Development In Indonesia

By 
Jemal-ud-din Kassum
Vice President, East Asia and Pacific
The World Bank
January 17, 2005, Jakarta, Indonesia

Mr. Chairman, Minister Jusuf Anwar, distinguished guests: it is my honor to be invited to this Infrastructure Summit and to have the opportunity to speak at this session on “Mobilizing Finance for Infrastructure Development in Indonesia”.  I would like to congratulate the organizers for bringing together all the key players involved in Indonesian infrastructure and preparing such stimulating agenda.  The strong interest shown in this Summit is evidence that this is the right event at the right time.

I also want to say, at the outset of these remarks, how privileged and excited I am to be here in Indonesia on this, the 90th  day of this new Government, led by President Susilo Bambang Yudhoyono.  Like many others, I feel that we have an unusual opportunity to help this new Government build a new Indonesia, an Indonesia which fulfills the national hopes and aspirations of all Indonesian people.  I can assure you that we in the World Bank are here to help, and you can count on us.

Before turning to the main topic of my remarks, I must say a few words about the recent tsunami and horrific damage it has caused to so many communities, especially in Indonesia.  We have been overwhelmed by scenes of total devastation, stories of hope and survival, and the outpouring of support from around the world.  We must all sustain our efforts to help the affected people and communities rebuild as quickly as possible, and in a way that makes the poor more secure and less vulnerable to future disasters.

The World Bank, for its part, has signed a Memorandum of Understanding with the Government of Indonesia committing more than US$300 million,  to help rebuild livelihoods and physical infrastructure in Aceh and North Sumatra, and are also assisting the Government to assess the cost of the damage  – we will do all we can to provide support during this time.

Indonesia’s Infrastructure Challenge

Now, while we focus our immediate attention on the areas affected by the tsunami, we must not forget the longer-term development needs of the rest
of the country.

There is another, less obvious crisis that is affecting the lives of many poor people in Indonesia: the growing shortage of quality infrastructure services. We’ve heard some startling statistics already this morning, and I won’t repeat all of them. The bottom line is that these infrastructure constraints are holding back both economic growth and access to basic services, especially for the poor. Unless they are addressed Indonesia will not be able to achieve its development goals of job creation and poverty reduction.

This Summit therefore comes at a very critical time; and, in my opinion, the outcome should be a shared commitment to improve the quality and efficiency of infrastructure services – in ways that will make a dramatic difference not only to the competitiveness of Indonesian businesses over the next 3-5 years, but more broadly, to the lives of millions Indonesians.

What could a different Indonesia look like?  What would we like to see?  It’s not hard to imagine the wish list of what we would want to see in this new Indonesia.

• high-grade highways connecting the major economic centers in the country;
• nearly 90 million people currently without electricity benefiting tomorrow, thanks to new, small-scale producers of renewable energy;
• a gas pipeline that will connect abundant gas fields in Kalimantan to the power plants and industrial consumers in Java;
• ramping up access to potable water throughout the country through local government initiative with private sector support.

All exciting goals for the new Indonesia of tomorrow –  but we must start today.

We know this will be expensive.  It is estimated that Indonesia will have to invest at least US$15 billion per year over the next five years on infrastructure to support an annual growth rate of 6 percent.  This implies an extra investment of 2 percent of GDP -- over and above what is being currently spent.  In addition to this investment, funding will be needed to maintain and optimize existing assets, to ensure they provide high quality infrastructure services and efficient investment returns.  Some of this spending will be for large projects such as power generation or construction of major highways, while others will be smaller-scale projects in local roads and water supply.  There is also an important spatial dimension – rapid urbanization will increase the demand in Indonesia’s cities for already over-stretched supplies of clean water, sanitation and urban transport, while special efforts will be needed to reach the poor in isolated rural areas.

In fact this agenda is so expensive, in investment terms, that the Government simply cannot afford to do it alone.  The private sector has to invest as well – and on a scale that has not been seen for years, dating back to before the East Asian financial crisis.  For that to happen, investor perceptions of Indonesian risk have to shift fundamentally.  Is this realistic?  Can it be done?

My answer is yes.  In my view, recent progress on both the political and economic fronts has set the stage for an immediate and massive push on infrastructure development, in partnership with the private sector.

We know this will take political will.   I applaud the level of commitment evident in the statements we have heard this morning from the President, Vice President and senior ministers to move ahead with urgently-needed reforms to improve the investment climate and reduce corruption.  Actions already taken and still being taken, including new regulations issued in recent days, give me some confidence that these statements will be followed through.

And we know that it will take time and persistent effort to change the status quo.  There are strong entrenched interests in both the civil service and the private sector that will resist efforts to put in place a more transparent and cost effective framework for infrastructure development. Nevertheless, if the policy direction is clear, and if visible milestones are achieved, step by step we can turn this around.

And I do mean we: both the size and complexity of this agenda makes it essential that we all play our part in helping Indonesia consolidate recent infrastructure reforms and put in place new models of public-private partnership.

Roles of the Public and Private Sectors

It’s easy to talk about public-private partnerships but much more challenging to actually implement.  There have been ideological swings around the world, and that includes in development agencies like the World Bank and the IFC, about the roles of the public and private sector in infrastructure provision.  With the experience of the 1990s behind us, and a large infrastructure gap to be closed, it is time to put these ideological debates behind us.

We simply must find solutions that recognize the complementary roles of the public and private sectors, and reflect the political and social realities of different countries.  In Indonesia, this means taking account of recent political changes, including decentralization, which open up new opportunities for inclusive development but also pose new challenges for effective policy coordination.

Experience teaches us one important lesson: whether infrastructure is owned, managed and financed by the public or private sector, a sound policy environment is the key to success:

• those familiar with Indonesia’s past can likely give many examples of well-intentioned investments which went sour because of poor governance or poor policies.
• You simply cannot move ahead with infrastructure development without competitive and well-regulated markets, where tariffs are increasingly free from political interference, where projects are tendered in an open and transparent manner,  contracts are upheld by the courts and the public interest is protected.

In Indonesia, as in most countries in East Asia,  a significant share of the funding for infrastructure will continue to come from the public sector in the near future.  But, given the constraints on budget resources,

• it’s important that public funds are used strategically to catalyze private investments in infrastructure and support projects that are important but cannot attract private finance.
• And, it must  be accepted that the public sector will remain a major provider of infrastructure services in the near term, and therefore, public utilities must be made more efficient so that they make the most of existing assets. This will prove vital since less new investments will then be needed and the pressure on the budget and other sources of funding will be reduced.

More broadly, the central government has an important role to play in providing direction to Indonesia’s infrastructure strategy, and to coordinate activities across sectors, space and time.  This is especially important in the new Indonesia, where more responsibility for implementing infrastructure projects is given to local governments.  Greater clarity in the

responsibilities and resources of different levels of government for delivering infrastructure services, along with clearer mechanisms for coordination between local governments, would go a long way to improving the institutional framework for infrastructure development.

The private sector will be expected to provide a growing share of the financing for infrastructure development.  Despite a recovery in private investment over the past year, and a recent upgrade in Indonesia’s foreign currency credit rating, the overall investment climate in the country still ranks very low in the region.  Potential investors complain most loudly about political, interference, policy uncertainty, corruption and enforceability of contracts.  This in turn holds back infrastructure development, which is seen to be a major factor raising costs in other sectors.  So, there is much work to be done to improve the investment climate and we have to be realistic, and welcome the new Government’s commitment to fixing the investment climate.

Moreover, the private sector is needed for more than just money.  In many instances, private provision may be the most efficient and effective way to deliver infrastructure services – provided it is able to operate in an environment characterized by competition,  adequate pricing arrangements, and fair regulation.  At the same time, the private sector also has a responsibility to behave as good corporate citizens, holding themselves to the same standards of good governance, transparency, and accountability which they themselves would ask for from government, and also meeting world class standards of environmental and social sustainability.

Local communities have a major role to play as well through mechanisms which give them a say in infrastructure decisions and sector governance. We have seen this approach work well in the Kecamatan Development Project, financed by the World Bank, which is now being used to help rebuild tsunami-affected communities in Aceh and North Sumatra.

So, we must all agree that the infrastructure puzzle cannot be solved through a single entity.  Instead, it takes all stakeholders – central government, local authorities, private sector and communities – focusing on their distinct roles, but working together in partnership to provide Indonesians with the quality of infrastructure services they deserve.

Role of the Financial Sector

Let me now turn to the role of the financial sector, which plays an essential supporting role in channeling funds for infrastructure development.

• The first, most important point is that financial engineering cannot substitute for good projects or policies.  I don’t mean simply the physical project, but the entire investment package.  If investments cannot generate an adequate return or if an expected payback is uncertain because of excessive risks, including those that stem from policy failings, private funding is unlikely.  And shifting the risks of poor projects and poor policies into financial markets is a recipe for a major mess.
• Second, finding long-term sources of finance is very important – given that even sound infrastructure projects may be difficult to finance because these investments are often capital intensive with long gestation periods.

Financial instruments such as infrastructure private equity funds can also be useful in mobilizing both domestic and international institutional investors where they can pool their investment risks.  Domestic capital side-by-side with international capital will also build more confidence in the sector as it can display local commitment and understanding. Local government financing should also play an increasingly important role as they provide greater levels of infrastructure services.  The central authorities should find ways to enable them to borrow prudently so they can  finance these projects.

Policy reforms to establish a credible investment and operational framework are crucial for the long-term development and financing of the sector – but we must also acknowledge that implementation is key, and that it will take time before all reforms take hold and the necessary performance track record is established. For example, a revised electricity law is now a priority, but so are the corresponding regulations thereafter.  This needs to be followed by an independent regulator, who will take time to build capacity and be empowered. So, a rationalized system of independently set tariffs may realistically be some time away.  It’s the same thing in other sectors as well.

Investments in infrastructure, however, cannot wait, and therefore, some intermediate solutions are needed that acknowledge and address the risks associated with policy failings that deter investors.  An important and welcome step in this direction would be for the government to develop a sound risk management framework where the public budget is protected while investments are catalyzed.

The Government is right to shift away from providing “blanket” guarantees in the form of comfort letters and the like, which resulted in

heavy contingent liabilities in the past.  As outlined by the Minister of Finance, the government is now looking to provide assurances to investors on specific risks that arise as a result of government policy failings, which the private sector is unable to mitigate.  I fully support this approach. The list of guarantees that would be included in such a risk management framework should be dynamic, so that the government can reward itself for implementing good policies through progressively reducing the need for such assurances.

Role of the World Bank Group

Let me now turn to the role of the World Bank Group. In investment terms, official lenders, such as the World Bank, play a relatively small role in infrastructure financing.  Our own lending for infrastructure in the East Asia and Pacific region has doubled over the past two years to US$1.8 billion last year.  But this is still less than 1 percent of the region’s financing needs.  The value of this official financing is more in what it can do to improve the environment for private investment, and providing policy advice in areas such as energy and power, roads and transport, water and sanitation, based on our experience in many countries around the world – while funding socially-important infrastructure projects that cannot attract private finance.

Our sister institutions, the International Finance Corporation (IFC) and Multilateral Investment Guarantee Agency (MIGA), have significant experience in financing private sector infrastructure around the world.  In order to accelerate private investment in infrastructure in Indonesia, IFC would be willing to develop a select number of demonstration projects where the World Bank Group brings together a comprehensive financing package and risk management framework, along the lines I have described earlier.  We believe this would send a very positive signal to private investors that the Government of Indonesia, supported by institutions like the World Bank Group, is committed to attract private investment in infrastructure.

We believe this new Government is on the right track and we want to help it succeed: to improve the investment climate, to focus on long-term, comprehensive sectoral and regulatory reforms, and to develop innovative public-private partnerships for infrastructure development.

In conclusion, let me urge all of our collective efforts – those of the Government officials, private investors and development partners – to build on this current momentum, and the evident commitment of the new Government, to make a real push on infrastructure development.  The time for action is now, the opportunity is now.  Indonesia is ready to move in this new direction.

We know this will be a long and at times difficult task.  But the World Bank is a long-term partner.  We should judge our success by how well Indonesia does in providing quality infrastructure services to its people, and the results in terms of sustainable growth and poverty reduction.  We should set ourselves some concrete goals against which we can measure progress over the next few months and years.

Hopefully we will see the benefits of this Summit in the lives of all people in Indonesia – from the tsunami-ravaged areas of Aceh, to the densely-populated cities and rural areas on Java, and the desperately poor areas of Eastern Indonesia. I can assure you that you can rely on all of us in the World Bank Group to play our part.  Thank you.