With former businessman Joko Widodo, or Jokowi as he is popularly known, at the helm of Indonesia after election results were announced on July 22, investors can finally breathe a sigh of relief. Jokowi has touted the need to continue to protect Indonesia’s banking industry and upgrade the country’s place in the natural resource value chain, but he is nowhere near the hardliner that his opponent, former military general Prabowo Subianto, would have been. While existing regulations for mining exports and banking will most likely stay in place, Jokowi’s commitments to fight corruption, resume negotiations with natural resource companies, and invest in infrastructure, may provide a promising outlook for the 2015 investment climate in Indonesia - provided that he can gather enough support in parliament.

“Jokowi recognizes the importance of investment, and has told companies he will seek ways to promote investment in Indonesia, but he faces a bureaucracy which is somewhat independent minded,” says Murray Hiebert, the Deputy Director for Southeast Asia at the US- based Center for International and Strategic Studies (CSIS).

Having won only 53 percent of the vote, Jokowi also has a problem in that his party the Partai Demokrasi Indonesia Perjuangan (which translates as Indonesian Democratic Party of Struggle), managed a minority in the nation’s parliament in April elections.

For this reason, he will be most likely forced to cobble together a messy coalition; his slim victory also means Prabowo could contest the results and drag them out. Finding a way to push through reforms within the first one hundred days will be key, according to Hiebert.

One thing is certain: If Jokowi can build a majority through defections - or coalitions put together based on the promise of specific legislation - and strengthen ties with provincial authorities, he will undoubtedly be much more effective in creating greater transparency and stability for foreign companies looking for access to Indonesia’s some 240 million strong and growing consumer market.

“There may even be improvements in some administrative systems, as Jokowi is very focused on leaner government and systemization of government processes,” says Mellli Darsa, founder of Melli Darsa & Co.

Reforms will build on pro-business legislation passed between 2011 and 2014, including amendments making it easier to acquire electricity as a start-up business, gaining access to information on obtaining credit, and applying for the license to trade and register a business. With a growing middle class - estimated to be at least 141 million by 2020 - foreign multinationals and companies looking to invest in Southeast Asia cannot ignore the benefits entry into the Indonesian market brings.If Jokowi’s pledges are followed up on in his typical blukusan (hands-on) management style, the mechanisms necessary to assist foreign companies to overcome traditional hurdles to investment in Indonesia will be established.

By reigning in provincial power, building the transportation infrastructure necessary to support Jakarta-based companies, and investing in human capital (namely education), to increase local capacity for business, in the long run the fulfillment of Jokowi’s bottom-up vision may even eventually lessen the need for protectionist measures in Indonesia by naturally levelling the playing field for local entrepreneurs.

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Regulatory restrictions

Many of the market-protecting measures put in place by Indonesia are an attempt to bolster the  country’s readiness to join the ASEAN Economic Community (AEC) in 2015, as well as address rising inequalities between rich and poor, which have increased by more than 30 percent since 2003, according to the Gini Coefficient.

While the unemployment rate in Indonesia has been slowly decreasing— from 6.17 percent in late 2013 to 5.7 percent in 2014, according to Statistics Indonesia, economic growth must remain considerably higher than 5 percent to avoid jeopardizing current employment levels, according to the World Bank in their 2014 Development Policy Review.

Jokowi is keenly aware of this — and his commitments to assisting small and medium enterprises (SMEs) using reciprocal banking policies and the Trade and Industry Laws which came into force in January and February 2014, respectively, combine with the previous administration’s mineral export ban and negative lists (Daftar Negatif Investasi) as an attempt to keep profits inside the country while stimulating domestic industries and creating more jobs.
“We could expect more development in Eastern Indonesia, and infrastructure building under Jokowi. Thus there will be more work for contractors and service providers,” says Darsa.

While the mineral export ban and subsequent infrastructure development for smelters may be controversial, it presents opportunities for investors to bring technical knowledge and expertise as the country seeks to move up the value chain, according to industry watchers.

The Indonesian mining industry currently operates under a dual framework: legacy Contracts of Work (CoW) and post-2009 mining licenses (IUP). The CoWs are contracts between a mining company and the Republic of Indonesia, and contain all the key terms of the mining rights that have been granted. In the Prabowo-Jokowi election tussle, discussions centred on CoWs, with Prabowo taking a hardline stance which insisted that the contracts were disadvantageous to Indonesia, and the government would rescind them.

While Jokowi similarly adopted a protectionist approach, he has said that the government would re-analyze contracts but not break or re-negotiate them until the term came to a close. While it is yet to be seen how he will implement this, negotiations are an opportunity for Indonesia to restrategize how to live up to its commitments made to the G-20 at the 2011 Cannes Summit to support a multilateral trading system.

Exporters in other industries can also expect to be affected when Article 54 of the Industry Law is implemented more strictly in the upcoming year. The law stipulates that exporters are obligated to apply Indonesian national standards (SNIs) to products or risk facing suspension, making the testing process more costly and time consuming by having to deal with domestic controls.

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Tackling corruption

Indonesia ranks at 114 out of 177 on Transparency International’s corruption index, tied with Egypt for the 63rd most corrupt country in the world after Ethiopia, Kosovo, and Tanzania.

Despite continued economic growth in the past decade, with a rate above 6 percent since 2011, endemic corruption continues to dissuade many foreign investors. The international business community has also witnessed a number of cases brought to trial against the government by companies who claim to have been swindled by authorities who granted overlapping permits to land, such as Churchill Mining, which is now claiming more than $1 billion in reparations from the Indonesian government with the International Centre for Settlement of Investment Disputes (ICSID) alongside Newmont.

“There are success stories, but for every success story there is absolute cries of corruption and foul play by other companies who are seeking the full relief owed to them under provisions of bilateral trade agreements,” says a UK-based legal advisor formerly associated with the Churchill Mining case, who asks to remain anonymous.

It is not a surprise, then, that corruption remains a factor in the decision to invest or not. Most companies face hefty fines back home for illegal activities overseas. For example, US-based companies can be charged with up to $5 million in fines and 20 years of jail time for violating the 1977 Foreign Corrupt Practices Act (FCPA), according to the Criminal Division of the US Department of Justice.

While “big multinationals [not in the natural resource sector] have said they do not face this issue very much, it clearly has a dampening effect for all,” says Hiebert, who explains that decentralized power hubs often operate with impunity and do not always respect the central government’s guarantees to foreign investors.

“Regional autonomy has had a significant impact on foreign investment for companies investing outside of Jakarta in the provinces,” says Peter Church, a special counsel with Stephenson Harwood.

What Jokowi has promised to provide, and lived up to during his time as mayor of the 520,000 resident strong Solo, formally known as Surakarta city, where he successfully organized with local authorities to decrease corruption, are increased collaboration between authorities — a factor crucial for reforming the arcane bureaucracy ousting bribery.

For the government to create more guarantees, “a lot depends on to what extent Jakarta can reign in the provincial officials and leaders,” says Church, explaining that the success of Jokowi’s anti-corruption campaign will depend heavily on which ministers he decides to appoint in his cabinet, the date of which is yet to be announced.

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Indonesia in context

Yet when compared to her ASEAN neighbours in the second half of 2014, Indonesia’s relative political stability causes it to rank higher in attractiveness for foreign investment - even despite a regulatory environment that is constantly in flux.

Since May 2014, Thailand has sunk into military rule with exoduses of more than 160,000 Cambodian factory workers due to immigration crackdowns. While the junta has since then approved a number of investment applications, there are no indications that anti-military social movements by pro-Thaksin supporters will abet, and tensions are expected to explode in August when ousted Prime Minister Yingluck Shinawatra is expected to return.

Across the border in Myanmar, political stability is shadowed by uncertainty whether Aung Sung Suu Kyi will be eligible to participate in the 2015 elections, and conflict between Muslims and Buddhists continues cause social unrest. In Vietnam, the torching of dozens of Chinese-owned factories over oil drilling in the South China sea in May 2014 may have seemed to calm down, but the riots of more than 20,000 enraged workers demonstrates the local dissatisfaction with foreign investment and potential for future flair ups.

While money lost to bureaucracy, corruption, and traffic congestion are not as newsworthy or revolutionary as those occupying Indonesia’s ASEAN neighbours, they create surprising losses. Indonesia loses $1.43 billion per year due to productivity wasted in traffic, according to a 2010 report by the Presidential Work Unit for Development Monitoring and Control.

Jokowi has promised to resume work on the stalled monorail and mass rapid transit system to connect airports and the outskirts of the city with the centre, following up on the previous administration’s plan to partner with the private sector to invest $140 billion in investment over the next five years, notes the Canadian Trade Commissioner Service.

“He understands the importance of infrastructure. Moving workers and goods constantly jammed up in traffic takes a big bite out of the GDP and productivity,” says Hiebert.

“At the end of the day ... businesses need to steer the economic partnership to the next level, aware of but not hamstrung by the difficulties involved,” reports the Center for Strategic and International  Studies (CSIS) outlook for US- Indonesia relations in 2020.

 

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The impasse continues

Even with Jokowi’s new government, Newmont Mining’s next move in its dispute with Indonesia is still up in the air

While hotly disputed Indonesian election results continue to inject uncertainty into the new government and its subsequent domestic policies for foreign and international business and trade, mining and coal industry experts say the outcome will not change the course of the Newmont case – a potentially multi-million dollar lawsuit hanging over the Indonesian government over a mineral export ban and tax implemented in mid-January this year.

Newmont, a Colorado-headquartered company which has mined on Indonesian soil for copper and gold concentrate for more than two decades - first at the Minahasa Raya mine in north Sulawesi until 2003, and from 2000 at Batu Hijau in Sumbawa island - shut down its operations in June following disputes over escalating export taxes for unprocessed minerals, a complete ban on nickel ore and bauxite exports, and demands for in-house smelting to increase the value of Indonesian minerals and benefits from natural resource exploitation.

“In recent years the government has introduced a number of dysfunctional laws and regulations with respect to the mining sector. It has also tried to cajole and persuade those mining companies which have long term mining contracts with the Government to amend them to comply with the new laws and regulations,” says Peter Church, special counsel to Stephenson Harwood.

In an attempt to hone in on higher value chain activities related to mineral processing, the government’s 2009 Mining Law has backfired, as reported in these pages earlier.

Industry specialists now say the government’s policies, and Newmont’s lawsuit, have the potential to sabotage the $6 billion per year extractive industry, which accounts for 12 percent of national GDP, and employs tens of thousands of Indonesian workers.

Regulations that demand mining companies process minerals inside Indonesia is sub-economic for companies such as Newmont, according to Bill Sullivan, a foreign legal counsel with Christian Teo Purwono & Partners. Meanwhile high taxes on unprocessed exports may exacerbate corruption and lead to losses in government revenue, leaving few winners under the new restrictions.

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Newmont likely to win court case

The tax on unprocessed exports, which will reach 60 percent of a shipments’ total value in late 2016, is considered exorbitantly high by mining companies, who see the government-enforced contractual amendments as a breach of the Contract of Work (CoW) signed in the 1980s.

“The agreements were drafted as a model for the whole of the developing world because they provided certainty that foreign investors needed in the mining sector,” says Church, explaining that the arrangements are meant to be legally binding from the cradle (commencement of prospecting) to the grave (completion of mining). “It was never intended or expected that the Government would seek to interfere with the contractual rights,” he adds.

Newmont, which previously exported thousands of tons of copper and gold each month, has already lost millions of dollars since freezing exports in January when its domestic storage facilities reached full capacity and laws preventing export forced its shipments to come to a grinding halt.

“From Newmont’s analysis, they had to stop production, have no cash flow... [and] nothing will happen until 2015 when the new government is in place. It’s simply intolerable [for a business] to have no cash flow for 12 months,” says Sullivan, explaining why the mining company invoked force majeure against the Indonesian government in early June 2014 after working in the country for more than two decades.

Newmont, which was founded in 1921 and is well regarded in the industry, signed a four-generation contract with the Indonesian government in 1986 to export copper from Batu Hijau mine. The company currently exports the unrefined copper to China and Korea for processing, and numerous studies show it is uneconomic to build smelters in Indonesia, as it would cost billions of dollars and require at least three to five years to build, according to Reuters.

“We have taken numerous steps to help resolve the export issue and support the government’s desire to increase in-country smelting. However, despite our best efforts, we have not been able to export copper concentrate since January, and we still do not have an export permit,” said Martiono Hadianto, President Director of Newmont in Indonesia in a statement released in early June.

The case will be heard by the International Centre for Settlement of Investment Disputes (ICSID) in Washington. While the case will take at least a couple of years to be resolved, “unless there is something we are not aware of, there is a very strong likelihood that Newmont will win. The government is preventing them from exporting under the benefits pursuant to the contract of work,” says Sullivan.

Newmont Mining is not the only party that the Indonesian government is battling at the ICSID. In 2012, the UK’s Churchill Mining filed a request for arbitration against the Indonesian government, alleging that Indonesia had breached its obligations under the UK-Indonesia Bilateral Investment Treaty when its licenses on a coal site in East Kalimantan were revoked. The tribunal ruled earlier this week that it rejected the Indonesian government’s attempt to challenge the ICSID’s authority to adjudicate the Churchill lawsuit. This will enable the company to pursue its claims worth up to $1.05 billion for compensation of the revoked permits.

If Jokowi’s administration loses the trial, it will have no choice but to shell out for the financial losses incurred by Newmont as a result of foregone mineral exports, which could range anywhere from hundreds of millions to billions of dollars, according to Sullivan. And as party to the UN Convention on Investment and Foreign Arbitration Awards since 1982, the government will have no choice but to comply.

But in the meantime, Newmont may face high risks of internal retribution from authorities, which isn’t expected to change under the new administration, according to Sullivan. The risks include the possibility that its foreign staff will have their work permits revoked and tax orders will be demanded, as was the case in the Churchill mining dispute. “They [the central government] tend to play hard ball in these matters,” he says Sullivan.

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Resource nationalism

While it isn’t the Indonesian government’s first time to take on big business in international arbitration, it also isn’t Newmont’s first head-on court collision with government officials.

In 2005, Newmont was accused of dumping two thousand tonnes of mercury and arsenic tailings from Minahasa Raya gold mine into Buyat Bay per day, leading to health problems in villagers living nearby, according to Cultural Survival, an international advocacy NGO for indigenous communities.

The case was eventually thrown out in 2007, absolving Richard Ness, the Director of Newmont’s Indonesian subsidiary at the time, of any wrongdoing, but the case is just one example of the terse relationship that the state has with the natural resource industry when trying to protect national interests, and Newmont in particular.

Friction between local communities and the mining industry first gained momentum in Indonesia with the increasingly autonomy of regions under Jusuf Habibie in 1999 and early 2000, according to Church. As power became increasingly decentralized with the introduction of elections for local mayors in 2005, the amplification of regional voices coupled with corruption, creating the advent of problems for the mining industry, say analysts, as reported by local news sources.

Nationalism is always a possibility when “governments [either provincial or central] want a bigger piece of the pie,” says the vice-president of a Canadian-owned global gold mining company, who prefers not to be named.

“The nationalist rhetoric often increases during Indonesia’s election cycles. In this election cycle it has been the resource sector which has in particular been targeted,” says Church. And while Jokowi has taken a less hardline approach against the mineral extraction industries in Indonesia than his defeated counterpart Prabowo Subianto, and a senior party official said in mid-July that negotiation would resume, on 24 July the government rejected Newmont’s plea to ICSID to speed up arbitration, signalling further lack of agreement on how to proceed.

In spite of being the number one exporter globally for nickel ore, refined tin, and thermal coal, since 2013 Indonesia has ranked lower than Democratic Republic of Congo (DRC), Kyrgyzstan, and Zimbabwe as one of the least attractive countries for mining investors due to an uncertain and risky operating environment, according to Fraser Institute’s most recent Global Mining Survey.

Meanwhile Freeport-McMoRan, the current owner of the Grasberg mine who together with Newmont excavate 97 percent of Indonesia’s copper, may resume production shortly after prolonged negotiations with the government - an entirely different response to the new mining regulations that that adopted by Newmont, according to a recent news report by Reuters.

“Freeport has a longer investment horizon than Newmont. Newmont’s copper and gold deposit will be exhausted in a few years when gold resources depleted,” says Sullivan, explaining that Freeport stands to lose much more than Newmont if they push back aggressively against new export regulations.

Freeport plans to invest further in excavation in Papua to reach the estimated remaining 31 billion pounds of copper and 30.9 million ounces of gold below ground. The American-owned company, which has been operating since 1991, hopes to renew its contract for another twenty years after it expires in 2021.

“We are encouraged by our discussions with the Indonesian government toward reaching a near-term agreement to enable resumption of PT Freeport Indonesia’s copper concentrate exports,” said James R. Moffet, Chairman of the Board for Freeport in a statement released on 23 July 2014.

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Illegal metal exports

Meanwhile companies who opt to stay will have to grapple with the restrictions placed on the mineral and oil resources industry, leaving them with few legitimate choices if they wish to stay in business and remain economic, according to Sullivan.

“The government is becoming increasingly worried about the scale of Indonesia’s illegal mineral and coal exports and the loss of government revenue these illegal mineral and coal exports represent,” he says.

Up to 60 million tonnes of coal ship out from Indonesia illegally per year (12 to 15 percent of the industry) on carriers more than twice the size of soccer fields, raising questions about transparency among those meant to be monitoring outflow.

While in the past year, the government has introduced stricter controls on sea transportation, given the number of authorities involved at provincial, regional, and central levels, “it must be seriously questioned whether these measures stand much chance of success,” Sullivan added.

If the coal industry is anything to compare it to, the scale of lost revenue from mineral companies who decide to go the same route could be significant.
Newmont has paid almost 9 trillion IDR in taxes - more than $774.86 million - in taxes, dividends, wages, and other fees to the Indonesian authorities, not including corporate social responsibility activities to build up communities, according to the company.

“Historically post the election the nationalist rhetoric has faded away. Hopefully this will be the case again. If not, and without an overhaul of mining law and policy the future is bleak for the mining sector,” says Church.

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