Indonesia lives dangerously with $355bn infrastructure drive

JAKARTA -- Indonesia's state-owned enterprises minister had a joke ready when she arrived late to an infrastructure conference in September. "The traffic jams are getting worse because we are building so many projects," Rini Soemarno told the audience.

The truth is often spoken in jest, and as many of Jakarta's 10 million residents will tell you, the city known for the world's worst traffic has become even more clogged. Dati Wijayanti, who works in central Jakarta, said she has to leave her home in Bogor, on the outskirts of the capital, before dawn if she wants to make it to her office in less than two and a half hours. "We are trapped whichever way we go," she said, due to the construction of underpasses, overpasses and rail transit networks.

Construction sites are invading road lanes, sidewalks and building entrances as President Joko Widodo's administration pushes its ambitious infrastructure development agenda. But if Widodo's critics are right, worsening gridlock is the least of the worries. They argue the government is doing too much too soon, without securing sufficient state or private-sector funding. This means state-owned enterprises are shouldering much of the risk.

Rini Soemarno serves as Indonesia's minister of state-owned enterprises.   © Reuters

Soemarno is undaunted. "Infrastructure development in Indonesia has been neglected in the past," she said. The sudden flurry of construction amounts to painful but necessary surgery to ensure that "Indonesia can have growth of 6-7% for the next 10 years." The projects are seen as essential for solving problems like sky-high logistics costs and urban-rural inequality.

Heavy lifting

Shortly after taking office in October 2014, Widodo launched a campaign to build 1,000km of toll roads, more than 3,000km of railways, 24 seaports, 35,000 megawatts worth of power plants and more during his five-year term. These projects are expected to cost a total of 4,800 trillion rupiah ($355 billion).

Widodo's efforts to cut red tape and boost government spending have produced some meaningful results, but not nearly as quickly as planned. In the meantime, the state enterprises under Soemarno's purview have been doing most of the heavy lifting.

Only about a fifth of infrastructure investment is being carried out by the private sector, according to the Ministry of Public Works and Housing.

"Jokowi's style is 'just do it' ... [and] if something goes wrong we can make corrections," said Faisal Basri, an economics lecturer at the University of Indonesia, using the president's nickname. "No one is checking. It is becoming uncontrollable."

Critics sounding the alarm over state enterprise debts point to companies like contractor Waskita Karya.

"Stalled for 21 years," Widodo said in a recent speech delivered in the middle of a new toll road in East Jakarta. The project was revived after Waskita bought the concession from private investors in late 2014. The road, which has partially opened, will eventually stretch more than 20km east to the industrial region of Bekasi -- a blessing for manufacturers.

Rather than limiting itself to construction work, Waskita has snapped up more than a dozen toll road concessions. As a result, the company's debt stood at 65.7 trillion rupiah as of September, double the figure a year earlier. Analysts wonder whether it will complete the projects fast enough to generate the cash it needs to repay its growing list of lenders.

Waskita is just one example of a state company that has taken on more risk during the Widodo era. Debt at seven listed infrastructure-related SOEs -- four in construction, two in cement and one toll road operator -- hit about 200 trillion rupiah in September, triple the sum seen three years ago. In the past year alone, the amount has surged by 60%.

It was not supposed to be this way: Widodo's original game plan did not rely on SOEs. Early in his presidency, he slashed gasoline subsidies and freed up tens of billions of dollars in the state budget. This meant the government could fund land acquisitions and award projects that would be attractive to investors. In 2015, government spending on infrastructure surged 67% to 256.3 trillion rupiah, while subsidies fell by more than half, according to data from the finance ministry.

Lately, however, tax revenue shortfalls have been squeezing the budget. The government also feels the need to strengthen fiscal discipline to brace for monetary tightening in the U.S. and Europe.

Widodo has invited private investors to fund around 60% of the country's 247 priority projects. The president has clinched a few victories, including a $4 billion coal-fired power plant in Central Java, where construction has started after years of land acquisition delays. But deal-making with overseas investors has been far slower than Widodo anticipated.

The administration pinned its hopes on public-private partnerships, in which private companies enter into long-term contracts for public projects. Yet many local governments, which are responsible for issuing key permits and licenses, lack the experience and funding they need to design the projects.

The PPP model "is not easy to conduct because there are so many stakeholders involved," said Edwin Syahruzad, financing and investment director at Sarana Multi Infrastruktur. "Local governments are quite familiar with traditional procurement. But if you are talking about selecting new investors, under the current democratic regime, somebody can be accused of corruption. ... It is very sensitive."

"Acrobatics"

With Widodo committed to the infrastructure push, his administration is seeking ways to keep the construction going without hurting the budget -- moves Basri called "acrobatics." The main approach is to use SOEs to fund the projects, and have healthier SOEs fund cash-strapped ones.

A Waskita subsidiary, for example, received a 3.5 trillion rupiah equity injection from Taspen, a pension fund for public servants, and Sarana Multi Infrastruktur, a state-owned infrastructure financing company specialized in debt financing.

Another example concerns a 27 trillion rupiah commuter rail line in Greater Jakarta. In May, the government had state-owned railway operator Kereta Api Indonesia inject capital into the project. This raised the need to rewrite the contract while construction was ongoing -- an unusual development.

The alarm bells grew louder in September, when Finance Minister Sri Mulyani Indrawati fired off a blunt warning to Soemarno and her colleagues. The message focused on state utility PLN and its plan to add 35,000MW of capacity by 2019.

"Considering the inability of PLN to fulfill the investment funding from operating cash flow, high outlook debt maturity profile, and government policies," Mulyani wrote in a letter leaked to the local media, "we believe that it is necessary to adjust the investment completion targets."

Indonesian Finance Minister Sri Mulyani Indrawati

Soemarno immediately pushed back. "We know what we are doing, we know where we are," she said a day after the content of the letter was revealed.

Warning signs

The stocks of most listed SOEs have been lagging the benchmark index, but investors have brushed off concerns that the risks might spill over. Foreign players have poured billions of dollars into Indonesian government bonds since S&P Global Ratings upgraded the country's credit rating to investment grade in May. The currency exchange market has been stable, prompting the central bank to make surprise interest rate cuts in August and September.

Still, there are signs the pressure could build. Some analysts see government subsidies rising in 2018, due to higher crude oil prices and an upcoming presidential election in 2019, when Widodo is expected to seek a second term. This could cut deeper into infrastructure spending.

"The government cannot risk fuel prices going up," said Ricky Ho, an analyst at Bahana Securities. "So there is some downside to the budget."

Some fear that SOEs, scrambling to shore up their finances, will try to wring profits out of the private sector. In September, shares of coal miners temporarily tanked following reports that PLN had asked them to lower the price of coal supplied to its power plants. The arrangement was quickly scrapped, but it left the industry in shock. "Why do we have to subsidize PLN?" one businessman complained. "We are the private sector."

With so many SOEs lining up to raise capital, it is unclear whether enough investors will bite. In a possible sign of things to come, the yields on Kereta Api Indonesia's first corporate bonds were recently priced near the upper end of the target range, indicating weak demand.

Indonesian President Joko Widodo on a new toll road (Reuters / Antara Foto)

"We cannot do this alone," Soemarno said. Her exit strategy is for SOEs to eventually recover their investments by selling off completed projects. "We have to pioneer, but we have to pioneer wisely because we have to ensure that SOEs survive 100, 200 years from now ... which means that when we have projects that are already profitable, we should invite other investors so we can use the money for doing new things."

The viability of this approach is likely to be tested next year, when a string of toll roads in Java will be bundled into a company and sold, possibly through an initial public offering. Until then, investors may want to brace themselves for a rocky ride.

Nikkei staff writer Erwida Maulia contributed to this report.