Indonesia: Investment Climate  2003

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Table of Contents

Overview

Introduction:  

The administration of President Megawati Soekarnoputri made important strides in its second year in maintaining domestic political stability, improving the economy, and routing out domestic terrorists. These developments encouraged greater confidence in the economy during the first half of 2003, with both the rupiah and Jakarta Stock Exchange performing strongly, up over 9 percent and 20 percent respectively. Foreign investors express concern about the rupiah's rapid appreciation and its potential for volatility.

The Megawati Administration, however, made much less progress in improving Indonesia's troubled investment climate. Existing and potential investors cite a number of concerns with respect to Indonesia's investment climate: security, the lack of legal certainty, prolonged contract negotiations, confusion over regional autonomy policies and fiscal decentralization, and tax and labor issues.

Security: Security remains a major concern for investors, particularly following the terrorist attack in Bali in October 2002 and renewed military operations in Aceh. The Megawati administration aggressively pursued those responsible for the Bali bombing, arresting some 40 people. However, the investigation revealed a significant presence of al-Queda-linked terrorists capable of carrying out further attacks. Following the declaration of martial law on 19 May 2003, the military resumed operations in Aceh. Separatism and communal violence continue to challenge national unity in Papua. Prior communal and sectarian conflicts in Maluku, Sulawesi, and Kalimantan have subsided but those areas remain tense. Investors in plantation and extractive industries, particularly on the islands of Sumatra and Kalimantan, continue to be troubled by looters, squatters, protection rackets and illegal miners. These events reflect opportunism by local interests as well as ineffective law enforcement. A perceived breakdown in law and order undermines the government's guarantees regarding the security of foreign and domestic investments.

Legal Certainty: Foreign investors have major concerns about the lack of legal certainty; the difficulties of negotiating and enforcing contracts, arbitration and award judgments; and unequal treatment of domestic and foreign companies. We have received reports of Indonesian companies petitioning Indonesian courts to invalidate legal contracts entered into with foreign parties. Indonesian courts have repeatedly issued rulings ignoring binding arbitration clauses in contracts. Indonesia's Bankruptcy Law, amended in 1998 to establish a separate Commercial Court, has proved a disappointment to creditors. In a serious abuse of the bankruptcy law in 2002, the Commercial Court declared bankrupt a local subsidiary of the Canadian insurance firm Manulife Financial, even though the Ministry of Finance declared the subsidiary solvent. Manulife successfully appealed to the Supreme Court; however, few observers rule out the occurrence of similar cases in the future. In addition, government enforcement of Intellectual Property Rights is weak.

Decentralization: The process of devolving administrative authority to the regions, as outlined under laws 22 and 25 began on January 1, 2001, proved popular and enhanced national unity. Local leaders have greater authority, but many of these leaders singled out investors and levied fees and duties impeding commerce. Foreign companies, particularly in lesser-developed areas, frequently come under pressure to provide facilities and services usually provided by of government. Local communities often seek additional gains by promoting extra-contractual concessions and monopoly arrangements between foreign and local firms. The central government seldom uses its explicit authority to overturn local actions that violate national laws. Although provinces, districts and cities can approve foreign investment applications, a Presidential decree will clarify their role in approving foreign investments.

Economic reform: The government's conservative fiscal policy shaved public debt to 70 percent of GDP in 2003 from 100 percent in just two years. Budget deficits in 2003 have fallen to just over 1 percent of GDP from 5 percent of GDP in 2000, and inflation reduced to 7 - 8 percent from 10 percent annually in 2001 and 2002. The Government of Indonesia announced Indonesia would not renew its five-year IMF program after it ends in December 2003. This announcement reflects the government's growing confidence in the economy and its desire to remove a politically sensitive issue prior to the 2004 elections.

Tax and Labor Issues: In April 2002, the Indonesian Parliament (DPR) enacted a new law creating a tax tribunal to replace the Tax Disputes Settlement Board (BPSP), a special government institution. The tax tribunal holds public hearings on tax disputes and has performed well, according to foreign investors. Labor unrest has increased since 1997 after decades of government neglect. The government tried to define worker rights better, but most business observers believe the officials failed to consider the competitiveness concerns of business. Business claims most legislation since 1997 has favored labor over business. In February 2003, the DPR passed a controversial labor law, scaling-back some of labor's recent benefits, such as severance packages.

Note: The following discussion summarizes the legal, regulatory, and de facto investment framework as of mid-2003. Following the terrorist bombing in Bali, the government set the target value for the rupiah (Rp) in the FY 2003 budget between Rp 8,500 to Rp 9,500/USD. Due to the fluctuating value of the rupiah, it is not always possible to know the precise exchange rate. In some places in this report the exchange rate will reflect a government-calculated rate, while in others a Rp 8,100/USD rate will be used--the prevailing rate in early June 2003.

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