In Race to Attract Investment, Indonesia Needs Rule of Law

By webadmin on 03:34 pm Apr 20, 2012
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Andrew White

As a representative of US business interests in Indonesia, I am often asked about the most important criteria for any investor. I respond with three words: rule of law.

Of course rule of law means many things to different people. For companies looking to invest millions or perhaps even billions of dollars, it means equal, fair treatment under a legal system that is transparent. Prevailing laws and regulations cannot be applied arbitrarily. Above all, rule of law means that contracts are sacrosanct. Investors will think twice if there are serious doubts that contracts will be honored and agreed legal frameworks will be observed.

Having just returned to Indonesia from a period living abroad, I am staggered by the incredible progress that Indonesia has made in just a few short years. From cementing democratic principles and institutions to freeing up its economy to capture investment, and the economic growth and jobs that go with it, Indonesia has made remarkable strides.

A large portion of my time is increasingly spent meeting with companies and investors, many of whom are looking seriously at Indonesia for the first time as a place to expand their business or invest their money. These investors are attracted by Indonesia’s wealth of natural resources, its young and growing population, steady economic growth and its recent debt upgrade by rating agencies. The government’s master plan to accelerate and expand the economy, which has created a road map for continued growth, along with anticipated reforms in the banking and financial sectors, are also encouraging.

Indeed, the Heritage Foundation, a leading think tank based in Washington, DC, recently published its annual Index of Economic Freedom. That report praised Indonesia for its wide-ranging reforms to address structural weaknesses in the economy and to improve competitiveness, enabling annual growth of over 5 percent for the past five years. However, the report goes on to say that “despite the progress in economic restructuring, pervasive corruption and a weak judicial system add uncertainty and risk, particularly to new economic endeavors.”

An issue of troubling concern to investors is the lack of proper enforcement of contracts. This concern is echoed by the World Bank, which, in its Ease of Doing Business Index, ranks Indonesia 156 out of 183 countries in the area of contract enforcement.

Harvard Kennedy School’s Ash Center closely examines the rule of law in Indonesia in its report “From Reformasi to Institutional Transformation: A Strategic Assessment of Indonesia’s Prospects for Growth, Equity and Democratic Governance.” The report concludes “that local business interests have routinely used corrupt courts to extract concessions from foreign companies,” and it goes on to state that “the legal system — courts, prosecutors, police, lawyers — must uphold the law and the rights of citizens without bias.”

The current investigation by the Attorney General’s Office into Chevron Pacific Indonesia’s bioremediation project in Sumatra is a case in point. Leaving aside that the allegations appear contradictory (can a project be both fake and too expensive?) and are denied by all parties, there is a larger issue that has gone unnoticed. The investigation is itself an arbitrary action and without precedent. The AGO investigation falls outside the due process contained within the legal framework of production sharing contracts in the oil and gas sector.

The oil and gas sector is the most tightly regulated business sector in Indonesia and with good reason, given that oil and gas revenues provide around 30 percent of the state’s revenue. Under the current agreed PSC legal framework, any dispute over projects and costs is resolved by government auditors and there exists an established arbitration process. If there is a genuine case to answer here, why is the established regulatory and legal framework being bypassed arbitrarily?

In another move that has raised eyebrows in the investment community, operators in the mining and energy sector in Indonesia are also now facing the prospect of unilateral and arbitrary moves to rewrite their contract terms, previously agreed in good faith. As investors we respect the sovereign right of the government to make the laws and regulations. However, contracts allow for the changing of terms under mutual agreement and it is often the case that solutions can be found to accommodate the goals of the host country and the investor through dialogue and mediation.

Indonesia is in a global competition for investment. Legal and judicial uncertainty is a key risk factor in determining where capital investment will go. If Indonesia is serious about attracting foreign investment to continue its remarkable growth story it cannot ignore these challenges.

Andrew White is the managing director of the American Chamber of Commerce (AmCham) in Indonesia.