Openness to Foreign Investment
After two years of prolonged debate, the Parliament finally approved the new Investment Law on March 29, 2007, with the intention of making the Indonesian economy more attractive to foreign investment. Compared to the 1967 Foreign Investment Law the new legislation is friendlier to foreign investors, addressing key issues such as land rights. A presidential decree updated Indonesia’s negative investment list in December 2007. This decree closed 23 types of business to both foreign and domestic investment (particularly those relating to weapon, ammunition, and explosives), reserved 43 sectors for small and medium-sized enterprises (SME), 33 sectors for partnership, and opened 98 sectors to foreign investment. In total, 11 sectors became more restrictive such as telecommunications and insurance. Foreign ownership in telecommunication companies is now restricted to 65 percent for mobile services and 49 percent for fixed network, and the insurance industry is restricted to 80 percent. Other sectors, however, are more open to foreign ownership, including oil and gas exploration, pharmaceuticals and construction services. Some sectors, previously partially or wholly closed, are now opened to foreign investment, including health and education. The Investment Coordinating Board (BKPM) wants to reduce the procedures to approve new investments by promoting better coordination between the various government institutions, providing tax incentives to make the returns to investments attractive and by persuading major players to capitalize on the 'large' domestic consumer market.
Coal: Under Indonesia's Coal Contracts of Work (CCOW) foreign shareholders are required to divest up to 51 percent under a fixed timetable. The regulations, however, lack specific guidance on share transfer. Academic experts and industry representatives have cited the government's tax policy on coal as a major disincentive for investment in the sector. Corporate tax rates, royalty payments and value added taxes (VAT) are among the highest in the world. According to an industry survey, first generation contract coal companies pay a combined royalty and income tax rate (excluding other taxes) of 58%, which is 65% higher than in China, 69% higher than in Australia, and 80% higher than in South Africa. The Parliament had yet to pass a new mining law, though one is reportedly under consideration. Indonesia is on track to produce 198 million metric tons (MT) of coal in 2007 and has produced 143.5 MT valued at $4.6 billion during the first three quarters. Indonesia produced 192 MT in 2006, according to GOI statistics, and became the world's largest thermal coal exporter in late 2006/early 2007. It has estimated reserves of around 40 billion tons. The GOI is seeking to build 35 new coal-fired power plants generating 10,000 MW of electricity by 2010, which will require state electricity firm PLN to double its coal demand to 70 MT per year.
In December 2005 the Coordinating Ministry for the Economy agreed to implement Ministry of Finance Decree No.95/2005 to impose a coal export tax of 5 percent to secure supply for domestic needs. The export tax was implemented in combination with an accelerated VAT reimbursement program. Nonetheless, the Finance Ministry removed the export tax following an August 22, 2006 Supreme Court ruling that declared it illegal. The Ministry repealed the tax on Oct. 20, 2006, effective retroactively to Sept. 13, 2006. Finance Ministry intended to impose a new tax that complied with the high court’s ruling, but have yet to announce any detailed plans.
Petroleum: Indonesia became a net oil importer in 2004, a trend which continued until now. State revenue from the oil and gas sectors was Rp 185.1 trillion in 2007, a light increase of 0.7 percent from Rp 183.8 trillion in 2006, according to the state budget. It was due to higher global prices since Indonesia continued to suffer declining production. According to the GOI, Indonesia produced 1.01million barrels per day (bpd) in 2006, below 2005’s production level of 1.06 million barrels bpd. Crude oil production has steadily declined over the last 11 years as new production failed to offset declining output from aging fields. The average crude oil price in Dec 2006 was $60.2/barrels, an increase of 10 percent from $54.6/barrels in 2005. Moreover, the domestic sales per 2006 are 42.1 million kiloliters, bellow 2005’s domestic sales of 64.7 million kiloliters.
Natural gas production remained steady in 2006 with daily production of 8.10 billion standard cubic feet per day. Although the government took some positive steps to reform the industry, the general oil and gas investment climate remained below potential in 2005 and 2006, due to problems with contract sanctity, regulatory issues, tax policies, and uncompetitive terms and conditions. Nonetheless, high global prices have spurred several international energy firms to announce multi-billion investment programs for 2007 and beyond.
After a three-year wait, the government issued new implementing regulations to the 2001 Oil and Gas Law at the end of 2004. The private sector called the new implementing regulations a "good first step," but expressed a desire for additional clarity on some important issues, such as government procedures for applying the domestic market obligation (DMO) for gas, as well as assurances that the requirement to offer participating interest to regional and national companies will follow standard business practices. As of the end of 2007 the mining law is still under procession on the parliament and it predicts to be finished at the end of the year.
Tax policy, particularly Value Added Tax (VAT) reimbursement, continues to be an important concern within the industry. The Indonesian Petroleum Association (IPA) reported that as of the end of 2006, implementation of VAT and import duties reimbursements for old production sharing contracts (PSCs) were largely resolved except for those cases still in court. VAT reimbursements for PSCs signed after 2001 remain largely unresolved. In December 2003, the Ministry of Finance (MOF) issued a decree terminating the ability of PSC contractors to collect VAT on purchases they made from vendors. Instead, the MOF was required to verify that vendors were paying VAT to the State Treasury before reimbursing the contractors. Although normal VAT reimbursement should not take longer than 120 days, the revised system caused severe delays. The MoF replaced the 2003 decree in January 2005 with a new decree that reinstates PSC contractors as VAT collectors. In August 2006 the MoF issued a regulation on tax refunds that states that VAT should be refunded within two months from the receipt of each claim. The latest Investment Climate Monitoring surveys conducted by University of Indonesia's Institute for Economic and Social Research in June – August 2007 indicates that VAT refund time is getting shorter and the percentage of the initial claim refunded has increased.
As required under Oil and Gas Law 22/2001, the Indonesian government created two new bodies to take over state oil and gas company Pertamina's upstream and downstream regulatory functions. In July 2002, the government formed the Implementing Body for Oil and Gas Upstream Activities (BPMIGAS). This nominally independent body reports directly to the President and is principally responsible for managing the PSCs. The government established the downstream regulatory authority, BPHMIGAS, in December 2002. Like its upstream counterpart, BPHMIGAS is an independent body responsible for regulating the supply and distribution of oil fuel and natural gas, as well as setting tariffs for natural gas pipelines. According to the law, both authorities are termed "state legal entities" and therefore not government bodies.
Holders of PSCs laud BPMIGAS's success in streamlining the natural gas marketing mechanism, which has helped increase the number of gas sales agreements over the last three years. However, other companies are concerned over the lack of a coordinated LNG marketing mechanism, following the transfer of that responsibility from Pertamina to BPMIGAS in 2002. New downstream regulator BPHMIGAS has only begun its activities. In October 2004, the government issued implementing regulations for the downstream sector clarifying the procedures for engaging in downstream business activities. Since then, BPHMIGAS has begun issuing licenses to local and foreign companies in the gas retail and sales markets as well as for gas pipeline construction.
The Oil and Gas Law 22/2001 ordered the liberalization of the downstream sector by November 2005, ending Pertamina's monopoly and creating new refining, distribution and retail opportunities for private investors. As also required by the Oil and Gas Law, the GOI changed Pertamina into a limited liability company through a presidential decree issued in June 2003. Shell became the first private company to open retail fuel stations in November 2005, followed by Malaysian Petroleum Nasional (Petronas) in 2006. The government extended Pertamina's monopoly over downstream fuel distribution and its public service obligation (PSO) to deliver fuel throughout the archipelago through 2006 and then again through 2007, until BPH MIGAS finds a suitable entity to carry out the PSO through a direct appointment or regular tender process. A number of other private companies also (including ChevronTexaco, BP, Total, and Petronas) have expressed a desire to participate in segments of the downstream sector.
Infrastructure and Transportation: The GOI said it plans to accelerate transportation infrastructure through the passage of four new bills in the transportation sector, establishment of a National Transportation Safety Board, and provision of institutional guidelines for mass rapid transit (MRT) management in Jakarta. Parliament passed railway legislation in May 2007 and the Ministry of Transportation (MoT) plans to get other bills passed on maritime, aviation, and land transportation. Earlier legislation in the four sectors dates back to 1992 and does not provide for an effective mechanism for private investments in the transportation sector or regional transportation planning after decentralization. Transportation projects have attracted few investors and the GOI has failed to provide tender documents for its model transportation projects. In step with the ongoing decentralization process, many regional governments have implemented transportation projects, but they have done so in a piecemeal fashion with little consideration for capacity, other infrastructure links, or transportation projects in neighboring districts. New legislation will focus on increasing opportunities for outside investment in the sector and streamlining the procedure to do so. The new bills also target better strategic planning and coordination for transportation links and infrastructure at the regional (provincial) level.
Jakarta's choking traffic lowers both quality of life and economic growth. To remedy these twin maladies, the GOI infrastructure acceleration plan calls for the creation of an institution for Mass Rapid Transit (MRT) in Jakarta. The GOI hopes that this institution will also serve as a role model for MRT development authorities in other large cities. The MRT authority’s primary function will be to manage the controversial Jakarta monorail project, which is being built primarily by companies associated with Vice President Jusuf Kalla. The on-again-off-again monorail project is now underway again after a government regulation (No. 103/2006) granting minimum ridership guarantees to the monorail project. The monorail project is scheduled for completion in 2010. The local Jakarta administration will be responsible for establishing this authority.
Conversion and Transfer Policies
The rupiah, the local currency, remains freely convertible. Currently, banks must report all foreign exchange transactions and foreign obligations to BI. With respect to the physical movement of currency, Article 16 of Law No. 15/2002 contains a reporting requirement for any person taking cash into or out of Indonesia in the amount of Rp 100 million ($11,000) or more, or the equivalent in another currency, which must be reported to the Director General of Customs and Excise (DGCE). BI regulation 3/18/PBI/2001 and the DGCE Decree No.01/BC/2005 concerning the Reporting Procedure of Cross Border Cash Carrying, launched on January 2005, contain the requirements and procedures of inspection, prohibition, deposit of Indonesia Rupiah into or out of Indonesia. The Decree provides implementing guidance for Ministry of Finance Regulation No.624/PMK.04/2004 of December 31, 2004, which requires individuals who import or export more than rupiah 50 to 100 million in cash (approximately $5,500-$11,000) to report such transactions to Customs.
In 2005 Bank Indonesia issued certain prohibitions and restrictions in conducting foreign exchange transactions with foreign counterparts. The regulation lowered the limit on transaction amounts for commercial banks engaging in derivative transactions with foreign counterparts from $3 million to $1 million. This limit covers all types of transactions involving foreign exchange selling and purchasing against the rupiah. However, the restrictions will not apply if the derivative transactions are conducted for hedging purposes within the framework of an investment in Indonesia that will last for at least three months. The regulation also requires foreign or domestic currency lending to foreign counterparts to be conducted in the form of a syndicated loan that engages a prime bank (commercial banks with a certain investment rating from a well know rating agency) as lead bank for the purpose of project financing in the real estate sector in Indonesia. The regulation fines a flat rate of 10% of the amount of the violating transaction. This is more stringent than under the previous regulation, which provided a fluctuating rate. These financial penalties, however, should not be more than Rp 27 billion ($2.7 million). Bank Indonesia hopes that the regulation will reduce foreign exchange movement that is not related to a genuine underlying purpose.
Under the new 2007 investment law, GOI gives assurance to investors relating to the transfer and repatriation of funds, in foreign currency, on capital, profit, interest, dividend and other income, funds required for (i) purchasing raw material, intermediate goods or final goods, and (ii) replacing capital goods for continuation of business operations, additional funds required for investment project, funds for debt payment, royalties, income of foreign individual working on the invested project, earnings from selling or liquidation of invested company, compensation for losses, and compensation for expropriation.
Expropriation and Compensation
Article 21 of the 1967 Foreign Capital Investment Law stipulates that the Government shall not initiate nationalization of foreign investments except by law and when such action is necessary in the interest of the state. The new 2007 investment law, which replaces both Foreign and Domestic Investment Laws, in broad terms opens up major part of the economy with the guarantee that the government will not enforce nationalization. Foreign firms will be protected against nationalization by the government, except where corporate crime is involved.
According to BKPM, Indonesia respects a company's right to compensation if expropriated; however, the government has not expropriated any foreign investment since the passage of the 1967 law. In 1999, however, the Overseas Private Investment Corporation (OPIC) paid a claim by a US investor after the Government failed to honor an arbitration award. Indonesia subsequently agreed to repay OPIC. The Government also paid USD 15 million compensation to the Multilateral Investment Guarantee Agency (MIGA) for its insurance payment to a power project.
The requirement of gradual divestment has been abolished. Investment assurances such as the right to appoint foreign management and the prohibition to effect nationalization without indemnification (now against market value) have been retained. The same goes for repatriation rights. However, repatriation may now be suspended by a court for as long as the investor has not fulfilled its responsibilities under the Law.
Dispute Settlement
Indonesia is a signatory to the Convention On The Settlement Of Investment Disputes Between States And Nationals Of Other States (ICSID). The new investment law ensures that disputes between the government and investors can now be arbitrated using international laws. It also retains the submission of disputes to ICSID arbitration. The Indonesian court system remained to be seen as weak, lacking in transparency and corrupt by foreign investors. In an attempt to ease the backlog of cases, parties are required to undertake mediation before litigation, although courts do not necessarily fully enforce this rule. As a result, most law firms advise clients not to attempt litigation in the country, with arbitration in another jurisdiction being the preferred method of resolving disputes.
Although the Yudhoyono Administration had made judicial reform and anti-corruption top priorities, the court system does not provide effective recourse for resolving commercial disputes. The judiciary is nominally independent under the law, and legal practitioners say irregular payments and other collusive practices often influence case preparation and the judicial ruling. GOI recognizes the need for judicial reform, but has not yet taken significant action. In several instances, the local courts accepted jurisdiction over commercial disputes despite contractual arbitration clauses calling for adjudication in foreign venues. In addition, criminal laws and penalties may be applied in cases that appear to be covered under civil laws and procedures.
In August 2006 the Constitutional Court stripped the Judicial Commission of its oversight role, questioning its authority to monitor the Supreme Court and Constitutional Court and sent the matter to Parliament and the President to clarify. The Parliament is expected to make simultaneous amendments to three laws, Supreme Court Law, the Constitutional Court Law and the Judicial Commission Law, to restore the authority of the now-powerless Judicial Commission. An Indonesian Supreme Court ruling to uphold a lower court’s decision to nullify $500 million of secured bonds sold in 1994 by Inda Kiat Pulp and Paper (a subsidiary of Asia Pulp and Paper), was also harmful to investor confidence. Since some foreign investors held these bonds, the ruling created additional uncertainty about Indonesia’s legal and judicial environment for foreign investors. While Indonesia is a Civil Law jurisdiction and the decision does not set a binding precedent, The domestic and international press has widely publicized recent cases where those awards have not been enforced. The Supreme Court in October 2006 upheld a lower court decisions that over US$ 1 billion in bonds issued by Asia Pulp and Paper were illegal and did not have to be repaid. The bonds in question follow a common format for international debt and has been used in several other Indonesian investments. A civil review of the Supreme Court ruling is now underway, and its result could profoundly affect investor confidence in Indonesia.
So far, only one US investment company has brought a case to the ICSID, which ruled in its favor. Indonesia's Arbitration Law recognizes the right of parties to apply any rules of arbitration procedure they may mutually agree upon, and provides default procedural rules that apply if no other rules have been designated. An Indonesian commercial arbitration board, BANI, is available if both parties agree. Companies have resorted to ad hoc arbitrations in Indonesia using the United Nations Commission on International Trade Laws (UNCITRAL) arbitration rules, as well as others. Other companies in Indonesia have used ICC arbitrations.
Performance Requirements and Incentives
The Government notified the WTO of its compliance with Trade-Related Investment Measures (TRIMS) on August 26, 1998. The Government issued on January 1, 2007 a regulation providing investment tax incentives to 15 industries: textiles, chemicals, pulp and paper board, pharmaceutical, products that use rubber as raw materials, iron and steelmaking, electronics, and component products for land transportation. The regulation allows qualifying investors to deduct up to 30 percent of their realized investment from gross taxable income (five percent of the realized investment per annum for the first six years of the project); carry forward losses for up to 10 years; utilize an expedited depreciation schedule; and reduce from 15 to 10 percent the income tax rate on dividends paid outside Indonesia. The Incentives will apply to both domestic and foreign direct investors, either for new investment or expansion of existing plants.
The new 2007 investment law offers incentives to new investors and investors expanding their investment in Indonesia, provided that the investment projects satisfy at least one of the conditions listed in the law: create employment for a large number of workers; relate to the infrastructure sector; involve the transfer of technology; classify as a pioneer industry (the Government will define “pioneer industry” in subsequent regulation); located in isolated areas, in areas bordering other countries likes Malaysia in West/North Kalimantan, or in developing areas; provide sustainable environmental development; involve research and development; involve partnership with micro-, small- or medium-sized enterprises; use capital goods, machinery or equipment produced domestically.
Types of incentives that may be offered: reduction of income payable by five percent of capital investment annually for six years; import duty exemption or tax relief for importation of capital goods, machinery or equipment not produced domestically; import duty exemption or tax relief for importation of raw materials or supporting materials within a certain period of time; exemption or suspension of imposition of value-added tax on imported capital goods, machinery or equipment not produced domestically within a certain period of time; acceleration of amortization; reduction of land-building tax rates for certain sectors; and others.
Indonesia expects foreign investors to contribute to the training and development of Indonesian nationals, allowing the transfer of skills and technology required for their effective participation in the management of foreign companies. Under Ministry of Manpower regulations, any expatriate who holds a work and residence permit must contribute USD 1,200 per year to a fund for local manpower training at regional manpower offices. As a general rule, a company can hire foreigners only for positions that the Government has deemed open to non-Indonesians. Employers must have manpower-training programs aimed at replacing foreign workers with Indonesians.
At present, Indonesia does not have formal regulations granting national treatment to U.S. and other foreign firms' participating in Government-financed and/or subsidized research and development programs. The State Ministry for Research and Technology handles applications on a case-by-case basis. However, the Ministry is currently drafting regulations to enable interested parties to participate in research and development programs in certain circumstances.
Indonesia does not require investors to purchase from local sources or export a certain percentage of output. The Government eased rules in June 1998 that encouraged investors to locate in industrial estates. Foreign firms are not required to disclose proprietary information to the government before investing.
Right to Private Ownership and Establishment
Indonesia recognizes the right to private ownership and establishment and relies on the private sector (albeit often protected), as a principal engine of economic growth. At the same time, State-owned Enterprises (SOEs) play a dominant role in many sectors, including oil & gas, electric power generation & transmission, infrastructure, banking, fertilizer production and wholesale distribution.
In recent years, Indonesia has promoted competition in some sectors and has decreased the privileges enjoyed by SOEs. The Parliament formed the State Ministry for SOEs in 1998; privatization is an important part of its mandate, but political opposition has effectively hindered attempts to privatize. Some provincial governments have improved management and transparency of provincially owned firms (BMD's) to stem losses and prepare them for possible privatization.
Protection of Property Rights
The U.S. Government improved Indonesia’s standing on the Special 301 Watch List after completion of an “Out-of-Cycle” review (OCR) in November 2006. The OCR concluded that throughout 2006, Indonesia bolstered implementation of its regulations designed to stop illegal production of pirated optical discs (ODs) such as CDs and DVDs by controlling the licensing of factories and conducting raids against pirate optical disc production facilities. Indonesia’s authorities conducted numerous raids on retail outlets selling pirated goods. During this period, the Indonesian Government activated its minister-level National Intellectual Property Task Force and its working groups to coordinate IPR enforcement strategy among agencies as well as to conduct public awareness campaigns. Indonesia also passed a new Customs Law no. 17/2006 in November 2006 that clarifies the authority for Customs officers to seize goods that infringe on IPR. However, the Ministry of Finance Directorate General of Customs and Excise are still working on the implementing regulation and expected that they will have customs IPR enforcement in full swing by end of 2008. The Indonesian government (GOI) has steadily improved the regulatory and legal framework for the protection of IPR. While the GOI has recently improved its enforcement, more effort in this area is needed to create an effective deterrent. U.S industry maintains that 90 percent of all CDs (audio, video, and software) sold in Indonesia are pirated. An increasing number of local factories produce most pirated CDs and DVDs, raising concerns that regional piracy syndicates are moving export-oriented production operations to Indonesia, and that Indonesia could soon become a major supplier of pirated ODs globally. The International Intellectual Property Alliance (IIPA) claims that piracy in Indonesia caused US$ 191.6 million in losses in the film, music, software and publishing industries in 2004. Pharmaceutical companies claim imports of counterfeit and grey market drugs control up to 30 percent of the local market.
Indonesia's copyright law (Law 19/2002) took effect on July 29, 2003. The law increases fines up to Rp 500 million (USD 51,266) and provides for prison terms of up to five years for dealers of pirated materials. The law requires the commercial courts to try cases of alleged copyright violations and render judgments within 90 days. As part of the law's implementation, the Ministry of Industry and Trade issued optical disc regulations (ODR) in October 2004 which came into effective in April 2005. Under the ODRs the Ministry of Industry has created and trained an optical disc factory monitoring team. At the end of 2006, this team had registered and begun random unannounced inspections of all 28 known OD factories.
Transparency of Regulatory System
Indonesia has a tangled regulatory and legal environment that causes many firms, both foreign and domestic, to avoid the justice system. Laws and regulations are often vague and require substantial interpretation by implementing offices, leading to business uncertainty and rent seeking opportunities. Deregulation has been somewhat successful in reducing barriers, creating more transparent trade and investment regimes, and has alleviated, but not eliminated, red tape. Still, U.S. businesses routinely cite transparency problems and red tape as factors hindering operations.
Efficient Capital Markets and Portfolio Investment
Stock Market: Year 2007 is a historical year for Indonesia’s Capital Market due to the merger between Surabaya Stock Exchange (SSX) and Jakarta Stock Exchange (JSX) to become Indonesia Stock Exchange (IDX). In 2007, IDX had shown a remarkable performance through the significant increases of all its trading indicators, such as its transaction activities, indices movement, and the number of foreign investors who invest in Indonesia’s capital market. Observers believe that the merger will set the stage for development of better derivatives markets, although there will be some rough patches during the transition period. Previously the SSX, which specialized in bond trading, wanted to explore derivatives (futures, options, real-estate investment trusts) but the underlying asset was often traded on the larger, more liquid JSX. Trading related securities on different exchanges creates problems in coordinating market surveillance to guard against market manipulation. As soon as the merged entity is stable, it is predicted that the bond futures will be rolled out in 2008. The SSX was already in the advanced stages of developing a financial futures contract for government bonds.
Indonesia's stock market was the second-best performing market in Asia after China in 2007, and the third best performing stock exchange in the world after China and Russia in 2006. Securities trading on the JSX, the dominant exchange, is measured by the Jakarta Composite Index (JCI). (See www.jsx.co.id for more information.) On December 11, JSX has hit an all-time high of 2,811. At the end of 2007, the composite index was closed at 2,740, a 52% increase from its closing level in 2006, compared to 55% in 2006, 16% in 2005 and 45% in 2004. Stock market capitalization at the end of 2007 increased 59% from 2006, amounted to Rp 1,249 trillion. There were 22 new listings in 2007. By the merger of SSX, 25 more issuers, which used to be single listed in SSX, are added. By this addition and a number of IPOs in 2007, IDX now has 383 listed companies. Prior to merger, JSX recently launched Kompas 100 Index, a cooperation between JSX and Kompas Daily, as a guideline to make a selection of investment in the capital market, which in the end will improve the liquidity of transactions in Indonesia Stock Exchange. The 100 stocks are chosen based on their transaction frequency, transaction value, market capitalization and fundamental performance. The index will be reviewed twice a year, on every January and July.
GOI has made significant progress in building a strong foundation for its government bonds market. As of end 2007, the government of Indonesia had Rp 543.7 trillion of tradable, domestic, rupiah-denominated and US$5.5 billion of international, dollar-denominated sovereign bonds outstanding. In July 2006 Indonesia launched its first 3-year retail bonds (ORI), where individual investors can place minimum orders of Rp 5 million (US$ 545). ORI can now be purchased via subscription through a variety of banks nationwide, making them more available. The MOF implemented a primary dealer system for government securities in the first quarter of 2007, as per GOI’s July 2006 Financial Sector reform package recommendation. .The DMO held the first of several T-Bill auctions in May 2007. A withholding tax was applied to the T-Bills, which caused problems for a number of investors, but the auctions continue to be over-subscribed. The Ministry of Finance is aware that it currently lacks a rational and consistent approach for tax treatment of securities, and plans to address this in 2008.
Corporate Bonds: Throughout 2007, the activities of corporate bonds reached Rp 68.22 trillion or underwent an increase of 114 % from IDR 32 trillion in 2006. The frequency of transaction also increased 79%, and the daily average transaction increased 114.2%. Majority of issuers are financial institutions (banks and finance companies). Total nominal of listed bonds was Rp 84.9 trillion, up 25% from December 2006.. Domestic mutual funds and pension funds hold major part of corporate bonds. The secondary market is thin and plagued by shortages of investors and issuers. There is not yet any widely available pricing system for Indonesia's corporate bonds. A few corporate bonds from Indonesia's largest companies are dollar denominated (Medco Energy, Indosat, etc.)
Rating Agencies: The Capital Markets Supervisory Agency (BAPEPAM) and Bank Indonesia established Pefindo, Indonesia's largest rating agency, in 1994. Pefindo is a private limited liability company owned by 100 domestic shareholders including pension funds, banks, insurers, securities companies and the Jakarta and Surabaya Exchanges. Pefindo is an affiliate of Standard and Poor's and adapts Standard and Poor's methodology in its rating process. About 60 percent of its business is rating domestic investment grade corporate bonds, and it also publishes credit opinions on corporate bond issuers. Pefindo has begun to incorporate good governance as a sub- element of its rating methodology. Kasnic Credit Rating Indonesia, incorporated in 1998, is affiliated with Fitch Ratings through its shareholder Duff and Phelps. Fitch Ratings opened an office in Jakarta in mid-2006 and is publishing assessments of credit quality on a variety of Indonesian institutions.
Foreign firms generally enjoy good access to the Indonesian securities market. A deregulation package in 1988 opened banking, securities and insurance to foreign investment. In line with its commitments under the WTO's Financial Services Agreement, the government equalized the capital requirements for domestic and foreign insurers. It amended the banking law in 1998 and removed restrictions on foreign bank branches outside Jakarta. In 1997, Ministry of Finance lifted the 49% restriction on foreign purchases of shares in non-bank listed firms. In 1998, Ministry of Finance removed discriminatory capital requirements on foreign securities. Bank Indonesia, the central bank, licenses banks and regulates banking activity. The Capital Market and Financial Institutions Supervisory Agency (Bapepam-LK) licenses new securities and insurance ventures, and regulates mutual funds and capital markets.
Bank Indonesia issued a ruling in 1999 allowing 99% foreign ownership of local banks. Such banks are allowed to designate foreigners as members of the board of directors and commissioners, but at least one member of the executive board must be Indonesian. In subsequent years, foreign investors bought large domestic banks such as Bank Central Asia and Bank Danamon. In addition, foreign banks may now open branches in Indonesia, but the government extends this privilege only to the world's 200 largest banks (in terms of assets) with minimum credit ratings of A from either US based credit rating agencies Standard & Poor's or Moody's. At the end of 2006, 48 of Indonesia's 130 banks were under the ownership of foreign investors, representing an overall 48% stake in the banking industry.
An October 2006 BI regulation requires "controlling" shareholders of more than one bank (defined as ownership of 25% or above, or if below 25% where there is direct or indirect control in the bank operations) to comply with a “single presence policy,” via merger, divestment or through the use of an Indonesian financial holding company. BI requires affected shareholders to submit an action plan by December 2007, to be implemented by December 2010. The policy is not applicable to locally incorporated foreign-owned banks, or to JV banks, or to shareholders having a stakes at two banks where one is Syariah-based. BI will give leniency for "complex" situations, apparently aimed at state-owned banks, if it is done in a way that is "objective, transparent, and acceptable for stakeholders".
Political Violence
Public reaction, including anti-U.S. demonstrations to events in Middle East continues to be limited to sporadic protests, mostly nonviolent. President Yudhoyono has demonstrated a strong commitment to combating terrorism. There have been some successful police investigations (e.g. regarding 2005 bombing in Bali), and the discovery of evidence linking terrorist activities to radical Islamic beliefs have had a constructive effect in turning general public opinion against terrorism. Many leading members of Jemaah Islamiyah, however, are still at liberty and they have a number of supporters.
The Department of State warns citizens to evaluate carefully the risks of travel to Indonesia. There is potential for violence and unrest; both can erupt without warning. There are threats, including the possibility of terrorist activity, throughout Indonesia. Sectarian, ethnic, communal and separatist strife, and violence are ongoing threats to personal safety and security in various areas, including Central and South Sulawesi, Papua and Maluku. The Department of State encourages American citizens considering travel to Indonesia to review carefully the information available in the State Department's Travel Warning and Consular information sheet (CIS for Indonesia), at http://travel.state.gov/indonesia.html, which are available at any US Embassy or Consulate abroad and on the Department of State, Bureau of Consular Affairs' web site http://travel.state.gov.
U.S. citizens involved in commercial or property matters should be aware that the business environment is complex, and dispute settlement mechanisms are not highly developed. Local and foreign businesses often cite corruption and ineffective courts as serious problems. Business and regulatory disputes, which would be generally considered administrative or civil matters in the U.S., may be treated as criminal cases in Indonesia. It is often difficult to resolve trade disputes. C
Corruption
President Yudhoyono’s anti-corruption campaign, the most significant since Indonesia’s independence, made clear progress against corruption in 2006 with numerous of high-profile investigations and prosecutions of current and former Government of Indonesia (GOI) officials. The Anti-Corruption Commission (KPK) and other GOI anti-corruption bodies continue to increase their capacity and receive budget increases in 2007. The KPK in particular is growing increasing staff, training new investigators, and receiving robust technical assistance from donors. Regional prosecutors are busy with new corruption cases. Corruption watchdogs at the national and local level are proliferating: there are now 20-30 national groups and 200-400 local groups monitoring the police, the government, and the judiciary. Indonesia’s media also energetically report on corruption cases. While corruption remains a difficult problem in Indonesia, numerous sources report the atmosphere in the bureaucracy has changed with officials at all levels reluctant to take actions that could appear improper and land them in jail. Indonesia signed the United Nations (UN) Convention Against Corruption in December 2003 and ratified it in March 2006 via Law 7/2006. This will give Indonesia access to UN resources to assist it in improving its efforts against corruption including establishing codes of conduct for public officials.
Bilateral Investment Agreements
Indonesia has signed investment protection agreements with 60 countries, including: Algeria, Argentina, Australia, Bangladesh, Belgium, Bulgaria, Cambodia, Chile, Croatia, Cuba, Czech Republic, Denmark, Egypt, Finland, France, Germany, Hungary, India, Iran, Italy, Jamaica, Jordan, Kyrgyzstan, Laos, Malaysia, Mauritius, Mongolia, Morocco, Mozambique, North Korea, Norway, Pakistan, People's Republic of China, Peru, Philippines, Poland, Qatar, Romania, Saudi Arabia, Singapore, Slovak Republic, South Korea, Spain, Sri Lanka, Sudan, Suriname, Syria, Sweden, Switzerland, Thailand, The Netherlands, Tunisia, Turkey, Turkmenistan, Ukraine, United Kingdom, Uzbekistan, Vietnam, Yemen, and Zimbabwe.
OPIC and Other Investment Insurance Programs
The Overseas Private Investment Corporation (OPIC) has been the key U.S. Government agency encouraging American private business investment in developing countries, newly emerging democracies, and fledgling free market economies. OPIC has had some difficulty operating effectively in Indonesia for several years due to the lack of an updated bilateral agreement. Progress on a new agreement has been slow. Investors are urged to contact OPIC directly for up-to-date information concerning availability of OPIC services in Indonesia. See www.opic.gov.
Indonesia has joined the Multilateral Investment Guarantee Agency (MIGA). MIGA, a part of World Bank Group, is an investment guarantee agency help investors and lenders deal with political risks that may accompany an investment in emerging markets, by insuring eligible projects against losses relating to currency transfer restrictions, expropriation, war and civil disturbance, and breach of contract.
Labor
Indonesian labor is relatively cheap by world standards, but the country's under-funded education system and overly rigid labor laws combine to make Indonesia's competitiveness lag behind other Asian competitors. Investors frequently cite high severance payments to dismissed employees, restrictions on outsourcing and contract workers, and rules on expatriate workers, as significant obstacles to new investment in Indonesia. Lack of education is especially problematic among unskilled and semi-skilled workers. Labor contracts are relatively straightforward to negotiate but are subject to renegotiation, despite the existence of a written agreement. Local courts are likely to ignore written contracts and side with locals in labor disputes. On the other hand, some socially responsible foreign investors view Indonesia’s labor regulatory framework and respect for freedom of association and the right unionize as an advantage to investing in the country. The GOI established in January 2006 a new Labor Court as part of a broader labor dispute resolution system. Expert local human resources advice is essential for American companies doing business in Indonesia, even those only opening representative offices.
Industrial relations at the factory level have improved in recent years and frequency of strikes declined. Following the October 2005 fuel price increases, unions demanded annual minimum wage increases (regional, district, or industrial sector) as high as 50 percent, but most settled for increases closer to 10 percent. Although demonstrations surrounding these negotiations were vocal, they were not perceived as a significant threat to civil order. Draft revisions to the labor law -- particularly reductions in severance payments and removal of restrictions on outsourcing and contract employment -- led to labor protests in 2006 that prompted the GOI to suspend efforts to amend the law, and to instead formulate regulations aimed at changing severance pay to ease the burden on employers while providing cushion to those unemployed. Since that time, industrial relations at the national level have remained chilled.Foreign-Trade Zones/Free Ports
The Indonesian Government offers incentives to foreign and domestic industrial companies that locate in any of Indonesia's seven designated bonded zones. The largest bonded zone is on the island of Batam, located just south of Singapore. Investors in bonded zones are not required to apply for additional implementation licenses (location, construction, and nuisance act permits and land titles), and foreign companies are allowed 100 percent ownership. These companies do not pay import duty, income tax, value-added tax (VAT), and sales tax on imported capital goods, equipment, and raw materials until the portion of production destined for the domestic market is "exported" to Indonesia, in which case fees are owed only on that portion.
Companies operating in bonded zones may lend machinery and equipment to subcontractors located outside of the bonded zone for a maximum two-year period. The companies have also enjoyed exemption from VAT and sales tax on luxury goods on the delivery of products to subcontractors for further processing outside of bonded zones. The Free Trade Agreement between the United States and Singapore, signed on May 6, 2003, allows special tax treatment for certain Singaporean exports made with components sourced Indonesia.
In an effort to accelerate the pace of investment climate reform, the GOI announced in 2006 plans to develop seven special economic zones (SEZ) or regulatory “islands of excellence.” The GOI plans to establish these SEZs in strategic areas with existing supporting infrastructure, a cluster of supporting industries, and access to inputs of production such as skilled labor. Indonesia and Singapore in July formed a Joint Steering Committee to create the first SEZ on the islands of Batam, Bintan and Karimun.
Foreign Direct Investment Statistics
In an effort to provide more accurate and transparent investment figures for Indonesia, starting in 2006 the Indonesian Investment Coordinating Board (BKPM) switched from reporting data on investment approvals to data on realized investments. BPKM data does not include investments in the following sectors: oil and gas, finance, banking, non-bank finance, insurance, and leasing. BKPM reports should be treated with caution, the agency has only just begun monitoring of investment project implementation, and some investors may inflate the value of their investments to maximize government incentives.
Table 1. Foreign Realized Investment
| Year | Total Projects |
FDI Realizations (US$ Billions) |
| 2007 (Jan-Oct) | 842 | 9.1 |
| 2006 | 867 | 6.0 |
| 2005 | 909 | 8.9 |
| 2004 | 546 | 4.6 |
| 2003 | 571 | 5.5 |
| 2002 | 444 | 3.1 |
| 2001 | 454 | 3.5 |
Table 2. Foreign Realized Investment By
Top Ten Sectors, 2007 (Jan-Oct)
| Sector | Projects | Total Value (US$ millions) |
| 1. Transport, Storage, Communication | 3 | 3,295.7 |
| 2. Chemical and Pharmaceutical | 29 | 1,610.4 |
| 3. Food Industry | 47 | 579.8 |
| 4. Trade & Repair | 254 | 435.5 |
| 5. Paper and Printing | 9 | 428.0 |
| 6. Motor Vehicles | 35 | 379.2 |
| 7. Construction | 15 | 373.1 |
| 8. Metal & Electronic Industry | 89 | 335.2 |
| 9. Mining | 29 | 301.8 |
| 10. Food Crops & Plantation | 13 | 165.7 |
| Sub-totals (as a percent of all sectors) |
544(65) | 7,738.7(85) |
Table 3. Foreign Realized Investment
by Region Year 2007 (Jan-Oct)
| Region | Total Investment (US$ millions) |
% of Total |
| Java | 7,684.4 | 84.6 |
| Sumatra | 1,048.7 | 11.6 |
| Kalimantan | 213. | 9 2.3 |
| Sulawesi | 78.6 | 0.0 |
| Maluku/Papua | 2.4 | 0.0 |
| Bali | 46.3 | 0.0 |
| Nusa Tenggara | 5.3 | 0.0 |
| TOTAL | 9,079.6 |
Table 4. Foreign Investment Approvals By
Top Five Leading Countries, 2007 (Jan-Oct)
| Rank Country | Number of project | Total Investment (US$ millions) |
| 1. Singapore | 100 | 3,453.6 |
| 2. United Kingdom | 59 | 1,669.2 |
| 3. Japan | 96 | 562.1 |
| 4. Taiwan | 29 | 466.0 |
| 5. South Korea | 147 | 270.0 |
Table 5. Investment as Percentage of GDP
| Year | % of GDP |
| 2007 (H1) | 23.8 |
| 2006 | 24.0 |
| 2005 | 22.0 |
| 2004 | 21.7 |
| 2003 | 19.3 |
| 2002 | 19.0 |
| 2001 | 19.2 |
(source: Bank Indonesia)
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