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Infrastructure policy in Indonesia: Where will the money come from? Forum Kajian Pembangun – Presentasi di LIPI, 14 Maret 2012, Peter McCawley, SEADI Project 1

Outline -(1) What is infrastructure? -- And a framework for policy (2) Demand (and need) for infrastructure (3) Supply side challenges (6 to consider)

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(1) What is „infrastructure‟? • Needs some thought … It tends to be: (a) lumpy (and expensive) (b) „basic‟ or „structural‟, often with externalities (c) supports many other economic or social activities … it is a type of „platform‟ (d) often monopolistic (e) sometimes seen as a „basic right‟ (f) expected to be guaranteed by the state

• But there are exceptions to each item… 3

Examples of infrastructure: • Well-known – Physical -- transport (roads, rail, harbours, airports), power (electricity, gas), water (sewerage, sanitation, drainage, irrigation) Social – health, education … maybe housing

• Others – Informal sector in developing countries (water, transport of many kinds, maybe housing, markets) 4

Fig 1: Simple framework of policy issues

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Fig 2: Expanded framework of policy issues

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Fig 3: Overall framework of policy issues

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Difficult policy issues: (1) Given low government capacity, what should the state provide and what should be left to the market? (2) How to handle regulation when regulatory capacity is weak? (3) Who pays? What pricing policies to use? Where will the money come from? If not from consumers, then where? 8

(2) Demand (and need) for infrastructure: • „Stylised‟ fact => the need and demand is clear! • Basic argument – challenges are on the supply side • However, briefly consider some demand-side issues …

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Overall snapshot (= a two track planet) • ADB‟s developing countries overall (2005): -- 37% of hh: no electricity connection -- 23% of rural people: no access to all-season roads -- 73% of people: no fixed line telephone • China and India – about 800 mn do not have electricity at home • Global access to electricity (kWh per capita pa): -- rich countries: around 10,000 -- poor countries: around 500 10

(3) Supply side challenges (6 to consider) (NB: Complex nature of the overall policy package: finance often depends on other factors … “money is not a problem”)

(a) Selection and preparation of projects (b) Finance (c) Pricing (d) Governance and management (e) Policy and regulation (f) Climate change

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(a) Selection & preparation of projects • What is the best target level (the optimal level) of investment in infrastructure? • Which projects should be given priority?

• How can appropriate projects be prepared? … consider each of these …

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Best target level for infrastructure spending? -- cf MP3EI Masterplan (2011-2025 = 15 years) • Total Inv • Per year • Sources of Inv: - Private - Government - SOE - Mix Total

Rp 4,012 trill (about $450 bill) Rp 270 trill (about $30 bill) %

51 10 18 21 100 13

Best target level for infrastructure spending? • Actually … it‟s not very clear ! • Perhaps around 6.5% of GDP as follows: % of GDP

New investment Maintenance Total

4.2 2.3 -------6.5

(= about Rp 500 trill / $ 55 bill pa in Indonesia, or 80% above MP3EI ! => Q: Is MP3EI sufficient for 7% growth?) 14

Which projects should be given priority? • Mainly, C/B (cost/benefit) criteria should be used. • Other approaches („leading sectors‟, showcase national projects) usually lead to trouble. • National debt can build up quickly from bad projects. (But good projects help repay national debt!)

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How to prepare good projects? There seems to be a shortage … While the construction opportunities in India are huge and capital is plentiful, analysts rue there aren’t enough large-scale, quality projects worth financing. There is a paucity of high-quality, or even quality projects that are financeable. Jakarta Post, 21 July 2010

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How to prepare good projects? • Traditionally, MDBs helped a lot. But not so much in recent years. • Planning agencies in Asian developing countries seem to find it difficult to identify good projects. • Risk = projects nominated by promoters. Quality is often doubtful.

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(3) Supply side challenges (6 to consider) (a) Selection and preparation of projects

(b) Finance (c) Pricing (d) Governance and management (e) Policy and regulation (f) Climate change

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(b) Finance • Where will the money come from? Around 7% of GDP is needed. • Target: around $55 bn … • Acute shortage of finance in recent years: Asian crisis (1997-98) did much harm. Recent levels of investment around 3% (except China = 11%).

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Main options for finance are … • Official national budgets (a) domestic financing (subsidies for I) (b) donor funding • Private sector (a) domestic (b) foreign • Self-funding by utilities … consider each of these … 20

Official national budgets … • Traditionally important – up to 80% of funds • But national budgets are now constrained • Much concern about capital “flowing uphill” • Tackling this flow is part of the answer … this involves regional capital markets (a key issue for the region) … but will take time … ... so is private sector the answer? … 21

Donor funding -- ABC News:13 March 2012: PNG to borrow $5 billion to upgrade highways Papua New Guinea government is seeking a $5 billion loan from China to fix its major economic lifeline, the Highlands highway. It runs from the port city of Lae in the Morobe province to the highlands region, which is home to major resource projects like the multi-billion dollar PNG LNG gas project. PNG's Works and Transport Minister Francis Awesa says he will lead a delegation to China soon to negotiate the loan….

Private sector funding … • Difficult … prospects are not really good • Two big problems: (a) history is not good, and (b) current investment climates are not good Louis Wells (on Indonesian experience): If Indonesia can do no better in new arrangements, privatisation is simply too costly. Borrowed funds and state ownership … would be preferable. 23

Self-funding by utilities … • Allow utilities to retain funding (very important in China)

• Encourage utilities to borrow (best by issuing bonds) … But the key issue of pricing underpins both options … Example: funding in the electricity sector (PLN) … see table … 24

PLN: Forecast capital expenditure 2012 Source

Cost (Rp trill)

Cost (US$ bill)

Share (%)

PLN internal budget

33.6

3.7

48

National budget

8.9

1.0

13

Subsidiary loans

9.8

1.1

14

Bank loans

16.7

1.9

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Total

69.0

7.6

100

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(3) Supply side challenges (6 to consider) (a) Selection and preparation of projects (b) Finance

(c) Pricing (d) Governance and management (e) Policy and regulation (f) Climate change

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(c) Pricing • Price suppression in infrastructure is common across Asia. It is a key problem. Worries are: inflation; unfair; inefficiency in suppliers (corruption?); alternatives are better But costs are: national budgets; unfair; misallocation; and limits infrastructure supply

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Access is closely linked to pricing: • Consumers in Asia resent proper pricing partly because the products are unsatisfactory – utilities fail to meet the needs of ordinary people • Two key aspects of access are (a) physical access (“can we get the stuff?”) and (b) minimum prices (often too high) • Infrastructure needs to be made more pro-poor (ie., why should people pay for things that are no use to them?) 28

(3) Supply side challenges (6 to consider) (a) Selection and preparation of projects (b) Finance (c) Pricing

(d) Governance and management (e) Policy and regulation (f) Climate change

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(d) Governance and management • Much formal infrastructure in Asia is supplied by SOEs. Often unresponsive! • Reforms needed: make them more competitive! • Wide range of governance reforms needed – transparency, accountability, different market structures, benchmarking (and pressures on managers to perform!) 30

(3) Supply side challenges (6 to consider)

(a) Selection and preparation of projects (b) Finance (c) Pricing (d) Governance and management

(e) Policy and regulation (f) Climate change

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(e) Policy and regulation • Central idea: healthy competition … and this is a markets issue • All actors need to know the rules of the game – and the rules need to be enforced • Very hard! (Consider GFC) • A strategy is needed: (a) regulatory agencies; (b) civil society; (c) MDBs 32

PLN gambar (1): P fixed and Q fixed

PLN gambar (2): Subsidy = Cost - Pf

PLN gambar (3): Cost fixed and XS Demand

PLN gambar (4): Controls on Pf, Cf, and Qf

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(3) Supply side challenges (6 to consider) (a) Selection and preparation of projects (b) Finance (c) Pricing (d) Governance and management (e) Policy and regulation

(f) Climate change

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(f) Climate change (CC) • Beyond the scope of this talk … but is a central part of infrastructure policy

• Infrastructure is (a) needed to respond to CC challenges, but (b) will greatly exacerbate them • Asia‟s needs for energy are huge … much will be from coal • Rich countries don‟t seem to have any answer to this! (= a two-track planet) 38

Suggestions for policy … (1) Think carefully about the scale of investments needed (2) Consider sources of finance – especially the division between public and private

(3) See financing issues within an overall framework – the overall framework needs to be conducive for private sector investors (4) Policies need to be pro-market – if not, private investors are unlikely to respond well (5) Prepare good projects 39