With additional reporting by Randy Fabi, Rieka Rahadiana, Wilda Asmarini, Fergus Jensen and Jonathan Thatcher of Reuters

Say what you will about the Indonesian authorities, but one thing they can’t be accused of is not having enough on their plate. Late last month, Reuters reported on how Indonesia was racing to speed up construction of gas-fired power projects in Java as it stared at a power supply crisis in some years’ time.

Power demand is growing at more than 7 percent a year in Southeast Asia’s largest economy, which plans to add 60 gigawatts of power capacity to its existing grid by 2022 to meet the burgeoning needs of its increasingly affluent economy. But as with many other initiatives in Indonesia, progress is slow on the back of bureaucratic hurdles, a lack of investment and land disputes. As a result, for example, the planned largest coal-fired power station in Central Java – the first public-private partnership in Indonesia – is yet to be completed, despite being initially due to reach financial closing in 2012.

The approaching power supply crisis illustrates one of several headwinds facing Indonesia despite a spate of surprisingly strong economic data dating back to the end of last year. The country is not only confronting a mining crisis (as chronicled in detail in the April issue of ALB), but also the delayed effects of the central bank’s aggressive monetary tightening, political uncertainty in an election year, a slowdown in China, and the tapering of U.S. monetary stimulus. Data released in early March showed that Indonesia’s trade balance tipped into deficit in January as the mineral ore ban hit exports, rekindling concerns over its large current-account deficit just when it has started to narrow. The trade shortfall came after three consecutive months of surpluses, and is likely to renew pressure on the rupiah. “In the mining industry, we have seen some slowdown due to a variety of government regulations that have made doing business in the resources sector increasingly difficult,” says Widjojo Budiarto, principal at Budiarto Law Partnership in Jakarta.

Confusion over the new rules have caused monthly ore and concentrate shipments worth around $500 million a month to grind to a halt. “The most worrying is if the mining firms do not make any shipments at all, there will be no profits (and) GDP will also slow down,” says David Sumual, an economist at PT Bank Central Asia.

And yet, no one is expecting an economic crash since mining only represented 7 percent of the 2013 gross domestic product, but it is one of several looming factors that analysts believe will force a further slowdown in growth this year, and hurt Indonesia’s image as an attractive destination for investment.

Signs of moderating demand are already starting to trickle down through the economy, with industries ranging from hotels, restaurants, airlines and construction companies adjusting their growth targets. “It seems that inconsistent regulations, poor existing infrastructure, rigid labor laws, and corruption continue to be significant concerns for foreign investors,” says Budiarto.

However, as Budiarto points out, it is not all gloomy, as economic data in recent months has been fairly impressive. According to the Indonesia Investment Coordinating Board (BKPM), a total of $41.6 was invested in the country in 2013, up from $34.8 billion in 2012. “This continues the upward trend since 2009 and shows that Indonesia remains an attractive investment destination despite the negativies. This may be due to the growing middle class, strong domestic demand and a stable political situation, as shown in this April’s legislative election,” he says.

Johannes C. Sahetapy-Engel, managing partner of AKSET Law in Jakarta, believes that in general, investment in Indonesia continues to be attractive to foreign investors, but the outcome of the election this year will be crucial.

“The legislative election is certainly one primary factor for foreign investors to come in, particularly for those who are not here yet,” he says. “Moving forward, the presidential election will also play a major role in determining whether new investors will come in to Indonesia or not. For foreign investors who are already in Indonesia, it appears that they are on hold with regard to any expansion plans that they may have.”
Additionally, he says, increases in costs of operating in Indonesia remain another important factor for investors. “After the substantial increase of minimum wage, the Government increased the electricity tariff recently,” says Sahetapy-Engel. “Certain companies in various industries, such as textiles and garment companies and steel manufacturers, have raised concerns over these electricity price increases.”
Last month, the Indonesian government announced that it would be terminating its Bilateral Investment Treaty (BIT) with the Netherlands, facing, as it does, a rising number of treaty-based investment cases, with transnational companies claiming hundreds of millions of dollars in damages. This has led to debate about whether Indonesia should be canceling some or all of its 66 other existing BITs. “It has been made known that they will do the same thing with other countries, and that is a situation we are studying very closely,” says Theodoor Bakker, foreign counsel at ABNR in Jakarta. “We are looking at the effects of the non-extension of the bilateral investment treaty as compared with the protection that foreign investors have and the existing Indonesian investment law.”

Legal developments

Aside from the mining regulations, two of the most important laws introduced in Indonesia in the past few months have been the New Industry Law (Law No. 3 of 2014) and the Trade Law (Law No. 7 of 2014). According to Sahetapy-Engel, the New Industry Law applies to all manufacturing companies in general and companies that engage in developing and managing industrial estates, while the Trade Law applies to all companies that trade goods and services. “These laws are important as they introduce certain enhanced protection to domestic players, such as the introduction of future incentives for small-and medium-sized companies; emphasis on adding value, including the processing and refining, of natural resources, and restriction/ limitation on export of natural resources,” he says.

Among the notable new laws and regulations that Budiarto cites are the BKPM regulations related to direct investment licence and non-licence guidelines and procedures. “The BKPM investment regulations are more comprehensive on investment guidance in Indonesia, including how to set-up a company in Indonesia and the procedures for licensing,” he says. “Although some improvements still need to be made, by issuing more comprehensive regulations, the Government shows that they are paying more attention to the investment climate by giving more legal certainty to investors.”

The new laws and regulations are of utmost concern for in-house counsel, in particular on how they will impact business, according to Budiarto. “For example, when the new BKPM regulation No. 5 of 2013 was issued, most of the questions raised were related to the interpretation of such regulations,” he says.

“Most foreign investors raised questions on how this regulation impacted on their business. A lot of similar questions were raised when the Minister of Energy and Mineral Resources issued an  implementing regulation regarding the obligation to refine and process mined minerals in Indonesia and also the regulation concerning divestment obligations. They were not only limited to the interpretation of newly issued regulations that were required by in-house counsel; the proposed regulation, such as the proposed revision of the negative investment list, also became one of their paramount concerns.

Furthermore, he adds, for new investors, how these laws are being implemented in practice is important. “Their queries are mostly related to technical matters, such as how to apply for a business licence and an investment permit, how long does it take to apply for a licence, how much it costs to apply for a licence and what the impact upon them is if they do not have such a licence,” says Budiarto. “Sometimes but not always, they also ask about law enforcement in Indonesia, so that they can estimate the risks to their investment in Indonesia. Unfortunately, in practice, it is not uncommon that the implementation differs with what is written in the regulations.”

Budiarto notes that because 2014 is a “political” year, instructions in the capital market space have tended to be lower than in previous years. “Although the ‘election effect’ is not that significant, the political year has indeed impacted on investment in Indonesia,” he says. “Investors are likely to wait and see the development of the market situation.

However, there are certain economies, like Germany, as a case in point, and Japan, which have shown a long-term and steady interest in conducting trade in and with Indonesia, and such economies are unlikely to be deterred by periodical and temporary setbacks. In the past 12 months, however, the legal work we have done for our clients has been mostly related to internal mergers and acquisitions.”

Sahetapy-Engel’s experience has been similar. “Mergers and acquisitions and FDI has continued to be the majority of our work in the last 12 months,” he says. “The transactions primarily have been in the mining and energy sector, such as coal mining and electricity.”

According to Bakker, one of the issues that continue to interest his firm is the language requirements for contracts between Indonesians and foreigners. “This has a great impact on the way foreigners must document their contracts, especially in very large projects where contracts run into thousands of pages and have very technical, specialised language,” he says. “It is a concern for foreign investors that these will have to be translated but there has been a decision from the West Java Court last year which, while still subject to appeal, appears to indicate that this law is there and it must be observed by parties that do cross-border transactions.”

Legal sector

With Indonesia’s legal sector remaining closed to foreign entrants, the last year has continued to see foreign law firms form alliances with local entities in order to get access to the burgeoning amount of legal work coming out of Indonesia. White & Case tied up with MD & Partners, which was set up by a former partner of Hadiputranto, Hadinoto & Partners; DLA Piper partnered with Ivan Almaida Baely & Firmansyah; Singapore’s Rajah & Tann entered into an alliance with Assegaf Hamzah & Partners; Squire Sanders established a relationship with Melli Darsa & Co; Clifford Chance tied up with Linda Widyati & Partners; and Taylor Wessing partnered with Hanafiah Ponggawa & Partners.

“In line with the brisk economy that we’re in now, we’ve seen continued growth in the interest of foreign law firms in being part of the Indonesian legal scene,” says Bakker. “There are restrictions under the applicable regulations, but nevertheless, new foreign firms have set up alliances with Indonesian firms. We see that as a healthy trend. Of course it increases competition for the existing players, but we welcome that as long as they observe the rules.”

Bakker adds that the competition will strengthen the industry overall. “It will separate the stronger firms from the weaker firms,” he says. “That, combined with the expertise on global legal issues and the service levels provided by Wall Street or Magic Circle firms will hopefully further raise standards within the industry and set examples that Indonesian law firms can learn from.”

Sahetapy-Engel says that the industry is seeing a lot of new law firms being established as a result of breakups of existing law firms, and this is a trend that is likely to continue. Another important matter for lawyers practising in Indonesia, Sahetapy-Engel adds, is the pending bill on advocates that will amend the current Advocates Law. “One of the important features of this bill on advocates is it contemplates a multibar approach for admission of Indonesian lawyers,” he says.

Lawyers interviewed agree that the legal sector will continue to grow. “Furthermore, the diversification in investment sectors will create a new challenge for lawyers in Indonesia,” says Budiarto. “Therefore, we expect that the high number of foreign law firms will give positive propulsion to young lawyers in Indonesia. The obligation of foreign lawyers practising in Indonesia to transfer their knowledge will, in addition, help Indonesia in preparing its future lawyers to face global competition.”

The elections

An unexpectedly weak election result for the party behind the frontrunner to be Indonesia’s next president hurt stocks and the currency, with concern Southeast Asia’s biggest economy could be heading into a period of political confusion. Last month’s parliamentary election showed that the Indonesian Democratic Party-Struggle (PDI-P) will have no choice but to cut a deal with other parties to nominate its hugely popular candidate for president in a July 9 poll.

Investor enthusiasm for Indonesia had been on the rise on the belief that Jakarta governor Joko Widodo might even win enough votes to avoid having to go to a run-off in three months time. “At the very least, expectations on the duration of the presidential election is likely to move from one to two rounds, which increases the period of uncertainty,” Trimegah Securities wrote in its research note. It now looks very likely that Widodo, popularly known as Jokowi, will be forced into some form of power sharing with other parties if he is to move into the presidential palace. The rupiah, Asia’s strongest currency this year after being its weakest in 2013, also slipped, although it is still around its highest levels since last November while the main share index is also at its strongest level since September.

“Although there is a change in the government position, we are of the view that – as most analysts and investors believe – the market situation will soon recover after the elections,” says Budiarto. “We are optimistic that the new parliament and president will ensure that the investment climate only improves.

Nevertheless, we still need to await the event and the result of the presidential election. The new president may have his/her own policy that will impact upon the investment climate in Indonesia.”

As for the incoming government, Budiarto says that the first priority is bureaucracy and clean governance. “To attract more investors and make Indonesia an investor friendly country, the next president must focus on tackling corruption, simplifying procedures for licence applications and strengthening law enforcement,” he says. “Good quality public services and the creation of a clean government devoid of corruption will, of course, make Indonesia more attractive for global investors.”

He adds that infrastructure also plays an important role in investment development. “Indonesia is an archipelago and a very wide country,” says Budiarto. “Good infrastructure not only spreads development evenly, but it may also create better opportunities in the development of potential new investments. Roads and electricity supply will play a major role in investment development.”

Meanwhile, Sahetapy-Engel says that he hopes to see the continuation of what the current leadership has achieved thus far. “It will be better if the government is a little more flexible on certain domestic protection, such as with regard to the mandatory divestment of shares by foreign companies operating mines,” he says. “One area of improvement is to ensure consistency of rules and regulations issued by regional governments with those of the central government. We need to eliminate, or least reduce, any contradiction between regional laws and central laws and regulations.”

With Indonesia’s legal sector remaining closed to foreign entrants, the last year has continued to see foreign law firms form alliances with local entities in order to get access to the burgeoning amount of legal work