Indonesia must get infrastructure financing model right

A SECOND political mandate for President Joko Widodo (Jokowi) will usher a fresh wave of big-ticket infrastructure projects, including new airports, seaports, road and rail links and a possible new capital city to replace the over-populated and gridlocked Jakarta.

After setting an infrastructure budget of US$350 billion in his first term, his advisers are touting a fresh US$412 billion for the second term. The ambitious plan - one of the biggest building programmes in Asia - is noble: lift economic growth, eradicate poverty and propel the nation of 260 million people to developed status before 2050, when the population is expected to cross 320 million.

With the poverty level below 10 per cent in 2018, Indonesia's economic narrative has shifted from survival and subsistence to infrastructure. The country needs connectivity to link the vast archipelago, so that people, goods and services can be transported easily and at affordable rates. The growing middle class is also restless to travel more and seek new economic opportunities, which are currently inhibited by numerous bottlenecks.

But two critical questions must first be addressed to fulfil even part of this ambitious plan.

First, how will the plan be funded, when Indonesia's external debt is already at a new all-time high? Second, has Indonesia forgotten the painful lessons of the 1997 Asian financial crisis, which made the country infamous as Asia's leading centre for distressed debt?

Failure to tackle these issues could have an impact on sovereign ratings, weaken the rupiah and curb the ambition of a nation which has so much growth potential. Worse, it could revive a vicious cycle experienced 20 years ago - this time, with potentially more serious consequences.

THE QUESTION OF FUNDING

According to recent comments to the media by Indonesia's Planning Ministry, the country intends to spend US$412 billion for the 2020 to 2024 period on infrastructure, mostly for transportation-related projects including 25 new airports. Up to 65 per cent will be funded by government or state-owned enterprises (SOEs) with the rest going to the private sector.

However, Indonesia's external debt has now reached a new high of US$387 billion, as at the end of Q1 2019. This makes it challenging for the national treasury or SOEs to shoulder the indicative burden of infrastructure expenditure. Discipline in managing expenditure will be critical. Further, seeking alternative funding route via China's Belt and Road initiative may not be viable, given the recent experiences by Asian countries participating in such projects.

The private sector will have to play a more important role than previously. This leads to the next question: Will the international capital market, previously stung by bad debts 20 years ago, have the same risk appetite this time?

In the aftermath of the Asian financial crisis, I was deeply involved in restructuring distressed Indonesian companies. Most of them had borrowed in US dollars and suffered badly when the rupiah sharply depreciated. I was involved in restructuring Steady Safe, Bimantara, Indobuildco, Japfa Comfeed and Citra Marga Nusaphala Persada, a highway operator which, in 1995, was awarded the concession of the Intra Urban Tollway System, the most lucrative in Indonesia at that time. All were facing the threat of liquidation.

The nights were long and the negotiations intense. Hard decisions had to be made, not just for "haircuts" to the borrowings, but in making changes to the management and operations. New financing structures had to be put in place.

Reflecting on the lessons learned, while assessing the current infrastructure wave, there are three factors critical to success.

First, the debris in the aftermath of the crisis showed that many infrastructure financing models were poorly conceived. Risk was not appropriately priced and assumptions of toll-revenue growth were not realistic. As a result, the economic interests of both borrowers and lenders were not aligned.

The changing global financial landscape has also led to traditional lenders being more risk-averse. Hence, lending premiums will continue to remain high. But there is a bright side - private equity as an asset class has grown exponentially, with new financing models that can separate risk at the construction phase, the cashflow from the operating phase, and new potential revenue stream related to each infrastructure project.

Second, operators of infrastructure projects need to embed appropriate incentives to improve operational efficiency.

Third, stakeholders, including regulators and operators, must commit to honour the agreements with their financial backers. All parties need to build a culture of trust.

Only with trust and commitment, anchored by better planning and pricing mechanisms on the one hand, and sustained operational improvement on the other, can Indonesia usher in a new wave of infrastructure development that can withstand the test of time.