The best article I've read on Indonesian infrastructure regulation

I'm a little late to it, but Tempo published a great editorial earlier this month entitled Fear of Competition, focusing on network sharing in the telecommunications sector.

Sadly, much journalism on infrastructure in Indonesia is limited to retyping press releases from either government, or private parties, with little, if any critical analysis.

Tempo's editorial is a wonderful departure from that norm. It deals with a pretty complex topic succinctly. It summarises all the key points of the discussion, and brings it all back to what should be the primary concern of government in its participation in the telecommunications sector: the interests of consumers.

I look forward to more such articles in future.

Infrastructure economics job: AIPEG (working with me)

The Australia Indonesia Partnership for Economic Governance (AIPEG) is currently hiring to fill a number of positions, one of which is an infrastructure policy adviser. 

If the things I write on this blog are of interest to you, then you may be interested in applying, because, if you are successful in your application, this is pretty much exactly what you'll be working on. I can say that with some authority, because the successful applicant will report directly to me.

If you are interested, please go to the AIPEG site, download the terms of reference, and apply. Applications are due no later than 9.00am (Jakarta time) on Monday, 15 February 2016.

Please do not contact me for further information about this position. If you have further questions about the opportunity, please direct them to procurement@aipeg.or.id.

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Disclaimer: Please note that this job advertisement is being placed here for general interest of the readership of this blog only. The presence of this ad should not be construed as an endorsement by AIPEG, or any affiliated organisation of any content presented on this blog, or of the existence of the blog at all. This blog is run by me in my personal time, and all opinions are my own.

Belajar dari praktik terbaik di Indonesia: cara memajukan KPS di Indonesia

Indonesia Infrastructure Initiative (IndII) baru saja menerbitkan edisi Prakarsa terbaru. Dalam edisi tersebut ada sebuah karangan dari saya yang menunjukkan apa yang dapat kita pelajari dari PT PLN (Persero) untuk sukseskan agenda kerjasama pemerintah swasta (KPS) di infrastruktur di Indonesia.

Saya lampirkan karangan saya dibawah. Bagi mereka yang ingin membaca edisi Prakarsa secara keseluruhan, yang berfokus kepada keterlibatan sektor swasta dalam infrastruktur di Indonesia, lanjut saja ke situs IndII. Edisi Prakarsa dapat dibaca dalam Bahasa Inggris dan Bahasa Indonesia.

Governments pay when they choose to renegotiate terms

I wrote yesterday about how the Indonesian government were handling a renegotiation of the terms of toll road concession contracts. 

As an example of how this works in countries with more mature regulatory regimes, this article talks about the Victorian government's decision to make trams free in the Melbourne CBD.

The government reported that they did it to help lower the cost of living, and to make it easier for commuters and tourists to use trams in the city. As the operator of the trams would be losing money as a result of this change, the Victorian government had the compensate them for the loss. The cost of the initiative was estimated at around AUD 100 million for the first year of operations.

Reasonable people can differ over whether making trams free is worth the money, or whether AUD 100 million is reasonable compensation for the loss, but the way the Victorian government handled the renegotiation was professional, transparent, and consistent with investor expectations, and good regulatory practice. 

A government like Victoria's knows that it's cheaper to pay AUD 100 million in cash than it is to run the risk of tarnishing their reputation with investors by trying to force the private operator to take the burden of their policy decision. Either way, they'll pay, at least this way they know exactly what it costs them.

All of this contributes to Victoria's perception as a low-risk investment destination, which flows through into cheaper goods and services for Victorian consumers.

Why exactly is Indonesia Air Asia at risk of being shut down?

Reports last week have indicated that AirAsia and 12 other airlines may be forced to shut down their Indonesia operations due to an interpretation of the regulations that says that their license may be revoked if they have negative equity. CNBC quotes Maybank-Kim Eng airline analyst, Mohsin Aziz, as describing it as a "black swan event", further stating the "no country in the world has ever done this."

The airlines affected include: Indonesia Air Asia, Cardig Air, Transwisata Prima Aviation, Eastindo Services, Survai Udara Penas, Air Pasifik Utama, Johnlin Air Transport, Asialink Cargo Airlines, Ersa Eastern Aviation, Tri-MG Intra Airlines, Nusantara Buana Air, Manunggal Air Service, and Batik Air.

The reporting on the matter indicates that the government's concerns with negative equity are safety-related. I don't see the direct link, but perhaps they think that if a company is unprofitable, it may be skimping on safety. Personally, I would rather that the regulator's efforts on enhancing safety are focused on the nuts and bolts, and standard operating procedures of the airlines. Leave the questions of solvency to the airlines' creditors and shareholders.

I'm not that familiar with the aviation law in question. I had quick look through it, but didn't see anything there that specifically dealt with negative equity. It might be some sort of indirect implication that being in negative equity might have. Perhaps something to do with foreign ownership restrictions*, but I'm just speculating here.

Does anyone have any theories as to what article of the law the 13 airlines are supposedly in breach of?

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*Any air transportation business must have at least 51% of shares owned by a local shareholder under Indonesia's Negative Investment List.

The Indonesian government just needlessly cost itself and its citizens a hundred million dollars

The Indonesian government announced last week that they will be cutting toll road tariffs by 25% on private toll roads, and 35% on Jasa Marga run toll roads, effective from the 7th of July until 5 days after Lebaran.

The government instructed toll road operators to make the cut to help out people during their long trip home.

In this post, I’m going to argue that, yes, this does save some of Indonesia's citizens money, but that it is inefficient, poorly targeted, and will cost the government (at least) a hundred million dollars over the next few years.

First off, how much does it save people?

I don’t have numbers on the amount of money this could cost toll road operators (which is the same as the aggregate amount that it saves users), but we can try to estimate a ballpark figure.

The tariff cut is in effect for 16 days, being 16/365 = 4.4% of a year. How much money the companies will lose will depend on the traffic flows. If traffic flows are heavier over that period than over the year as a whole, we’ll lose 25%/35% on more than 4.4% of a year, if they’re light then they will lose less than that.

To me, it seems plausible that they’d be heavy, because a large chunk of the country will be travelling over this period. But then, most toll roads are in Jakarta, and people leave the city during this period, and the flows might be heavy only for a few travelling days, while they’ll be light for a few days in the middle; this could mean that the flows are on average lighter. For this sort of analysis, it’s probably not too far wrong to just assume that traffic flows are, over the whole 16 day period, pretty much in line with the average flows over the year. In that case, we can just multiply the discount by 4.4% of the year, and find that private toll road operators should expect to lose around about 1.1% of their annual revenues over this period, while Jasa Marga will lose 1.5%.

I haven’t got data on the total fare revenue collections on all toll roads in Indonesia, but, in 2014, Jasa Marga’s receipts were around IDR 6.6 trillion and they control a bit under 60% of Indonesia’s toll road network. Assuming revenues roughly split that way too, we can estimate around IDR 4.8 trillion of non-Jasa Marga toll revenues. With a bit of growth and rounding, I’ll assume IDR 7 trillion for Jasa Marga and IDR 5 trillion for non-Jasa Marga toll operators.

So, as a result of this tariff cut, Jasa Marga will lose around IDR 105 billion (USD 8 million), and private companies will lose around IDR 55 billion (USD 4 million) in revenues. Toll road users will be better off by around IDR 160 billion (USD 12 million); the sum of those two amounts.

Just to reiterate again, this is a ballpark figure. It might be twice, it might be half, but it’s probably not 10 times, or 10% of that amount.

And who are the beneficiaries of this transfer?

The beneficiaries of this cut will obviously be the people that use the toll roads. So, who are they, and how much benefit will they actually get each?

Poor people will get some of the transfer, but not much. Poor people either ride motorbikes or the train, so avoid toll roads, or ride buses or “travels”, where their share of the toll is between one fifth and one fiftieth of the fee, depending on the number of people that are in the vehicle. If you have packed full a Toyota Avanza driving from Jakarta to Surabaya, taking every toll road on the way, both ways, your toll fees are about IDR 500,000. So, assuming 5 passengers with bags, the cost per passenger is about IDR 100,000. So, the saving to each poor person is about IDR 30,000 (USD 2.25). If the trip is shorter, or the vehicle is bigger, the savings will be smaller.

Even to a poor person, this is not much. A bus ticket to Surabaya around this time of year is around IDR 500,000, so you might be saving them 6% of their fare. This probably doesn’t even cover their food costs for the journey.

And, this is assuming that bus and travel companies adjust their prices at all. There is a lot of research that says that prices are sticky, so most likely the transportation companies are the ones that will get the windfall profit.

So, other than some poor people and transportation companies that serve them, you’ll have middle-class and rich people, who care even less about a savings of IDR 100,000 on their carload than poor people do about their IDR 30,000.

So, with this policy, the government extracted around USD 12 million from toll road operators, and spread it around a bunch of people that didn't really need it and won't even really notice it.

So why is this such a bad thing?

So, why am I making such a big fuss about this? How does costing toll road operators USD 12 million, most of which is borne by an SOE anyway, cost the government so much money? I’m going to deal with three reasons, as follows:

1. It’s not fair;
2. It’s operationally disruptive; and
3. It sets (or reinforces) terrible regulatory expectations.

It’s not fair

There will be a certain group of people that will scoff at this: “Billion dollar companies can’t afford to give the average citizens a measly tariff cut for a few weeks?”

It’s true, the amounts are relatively small for a billion dollar company, but the point isn’t the amount, the point is that the government made a deal, and signed a contract, now they are unilaterally renegotiating it.

If we imagine a toll road which, in present value terms, will cost USD 1 billion, where the revenues will cover USD 900 million of that. To get it done, the government will have to pay a USD 100 million subsidy and the cashflows will look like the below, in present value terms.

When bidders bid on infrastructure projects in open tenders, they are bidding pretty close to the subsidy (tariff, concession fee, whatever the bid factor/balancing item is) that will exactly cover their costs and no more. They have to work as hard as they can to push down their capital and operational costs, put together the best financing package, convince their lenders to lend at the lowest rate possible, design the best/cheapest systems, and generally do everything they can to bid as cheaply as possible while meeting the minimum service standards. To win, you’re really cutting close to the bone.

So, any tariff cut or unexpected increase in costs, even a small one, means the investors will have lost money.

Imagine you are having lunch with some friends, then the President turns up and says “Surprise! Everyone’s lunch today is free!” then walks out, leaving the restaurants to bear the cost of your free lunch. This is pretty much what is happening here.

The concessionaire agreed to provide a service and bid their tariff according to a particular revenue projection, and all of a sudden, they’re being told that they aren’t allowed to charge what it says they are allowed to in the contract. That’s just not fair.

It’s operationally disruptive

The government has instructed an operator to cut tariffs; how much cash have they got in the bank?

If they have optimised their system, they’ll have as much as they need for that month and not a rupiah more. If they have any excess cash, they should use it to pay off their debts or dividends to their shareholders. All of a sudden, they’re being told that they’re going to lose 25% of their revenues for two weeks with no notice, and the banks are all about to go on holiday.

If a particular toll road operator loses USD 1 million, that means they need to scramble around to find this extra USD 1 million so that they can pay their employees’ salaries and keep the lights on. It’s not a massive amount of money for them, but it’s not easy to mobilise at short notice.

Toll road operators will also need to figure out how to implement a tariff cut with no notice. Tariff adjustments are things that they only expect every 2 years according to a schedule, so they have time to print up new signs, update their computer systems, figure out how much of every denomination of cash they stick in each toll booth, and so on. They, most likely, aren’t set up to change tariffs at a moment’s notice for a 16 day period.

Finding cash and implementing a no-notice tariff cut are not insignificant operational disruptions. Dealing with them will take significant time from the senior management, and probably the lenders as well. The cost of these disruptions is not included in the USD 12 million figure I estimated above.

It sets (or reinforces) terrible regulatory precedent

By cutting tariffs like this for one year in Lebaran, Indonesia has now created an expectation on the part of bidders that they will do the same in future. In Indonesia, for the next couple of years, faced with the same projections of cost and revenues, bidders will bid, discounting their revenues by 1.1%, accounting for the expectation that the government will force them to cut their revenues. For our billion dollar toll road above, going forward in Indonesia, the cashflows in present value terms will now look like the below.

The government will have to pay another USD 10 million in subsidy to cover the cost of the expectation that they created by cutting tariffs like this.

So how much will this cost the government in the long-run?

The government has 5 toll road projects in the “prospective” category of BAPPENAS’s priority project list, with capital costs as follows:

Manado – Bitung – USD 353 million

Tanjung Priok Access – USD 612.50 million

Balikpapan – Samarinda – USD 1.2 billion

Cileunyi – Sumedang – Dawuan – USD 1015.8 million

Pandaan – Malang – USD 420 million

The total capital cost of these toll roads is USD 3.6 billion. Assuming a capex/opex split of 60/40 and that land acquisition cost will be borne by the government, the total net present cost of these toll roads to the private sector will be on the order of USD 6 billion. Assuming no VGF, 1.1% of revenues needed to cover these toll roads represents USD 66 million.

So, future bidders in the toll road sector will “price in” the expectation that the government will force them to cut their tariffs during Lebaran. This price will be passed through to government through requesting a higher subsidy, or paying a lower concession fee; or through to users by charging a higher tariff.

In addition to the USD 66 million, investors will look at a government that is willing to surprise them with multi-million dollar losses not envisioned in their contracts, and expect that there will be a few more surprises as well. To cover this expectation, they will need to build an even larger margin of safety. It is eminently plausible that the margin the investors will assign to this uncertainty will be on the order of USD 100 million dollars.

The broader impacts

The expectation of regulatory intervention applies outside the toll-road sector as well. A government that is happy to force toll road companies to cut their tariffs might force private water operators to freeze their tariffs, apply arcane leverage constraints to airlines, or dramatically change the venues through which they can sell their product.

A government that acts erratically in its regulation is a significant driver of the country risk premium that investors and lenders will apply when deciding how to value their products in Indonesia. This flows through to the cost of finance, which is a component of almost every good in the country pushing up costs to all consumers, and harming the competitiveness of Indonesia's firms, relative to those in countries where the government does not take actions like this.

So, what can they do?

The damage isn’t necessarily completely done. If the government compensates the toll road operators for the gap between the tariff they normally charge and the one they’re being forced to charge, that would mitigate a lot of the impact of the expectations of regulatory meddling.

Even if they don’t do that, they can still mitigate some of the poor expectations by the way they design their concession agreements going forward. All they need to do is build in the right to cut tariffs whenever they want, but make it clear that they must give reasonable notice, and that the government will meet the gap between their agreed tariff, and the tariff that the government may choose to impose.

It will be interesting to see how the next round of tenders proceeds following this announcement.

How Indonesia can deliver rural toll roads

Earlier this week, BAPPENAS launched its priority list of PPP projects for 2015, including 5 prospective toll road projects and 1 potential toll road project. Following the tradition, they have included Manado – Bitung in their list of projects in the pipeline.

I wanted to write about this project because it illustrates a few problems with Indonesia’s approach to PPPs in the toll road sector, and one thing they’re (hopefully about to be) doing right.

History of the Manado – Bitung toll road project

The Manado – Bitung toll road is a 38km road planned to link the coastal cities of Manado and Bitung to support their integration into a unified metropolitan area across the province of North Sulawesi. In the 2013 PPP book, the investment cost was estimated at USD 353 million. I’ve never been to either of the cities, but I understand that this is a longer-term plan, and that the existing traffic flows, while heavy for the existing road, will not remotely cover the cost of construction and operation of the sort of toll road that has been proposed.

In the market soundings I have attended and briefings I have read, people spruiking the project have talked up the potential of the Bitung special economic zone (“SEZ”) and the upgrading of the port to drive traffic growth. There is some information on the SEZ here, and the upgrading of the port here.

The Manado – Bitung toll road has been included in every PPP book ever published by the Indonesian government. It was tendered in 2014, but the tender failed when it emerged that the winning bidder had no experience at all in the road sector and no ability to deliver the project (if I remember correctly, it was also tendered at some point in the late 2000s, but I can’t find a record of it).

Like all toll roads in Indonesia, the Manado – Bitung toll road was tendered with the private party taking full demand risk, getting all of their remuneration via user charges. The existing traffic flows were low, but government asked investors to take into account the potential traffic flows that might arise when the SEZ and upgraded port were finished. Given the uncertainty around the timelines of the development of these two facilities, and the impact they may have had on usage, all of the serious bidders took a conservative view of the traffic flows and realised that there was no way they would cover their costs through user charges alone. As there was no subsidy on offer, the serious bidders elected not to waste their time, leaving only poorly qualified bidders like the one that won.

So, all we need to do is offer a subsidy?

As I noted above, there is a lot of uncertainty surrounding the traffic flows. Private investors will necessarily take a conservative view on the traffic flows, but, with a sufficiently large subsidy, the project should be able to be made financially viable.

If the government wants the project, is that the best thing for them to do?

I would actually tend to think that, no, in fact, that would not be the best thing for government to do.

Excessive risk aversion transfers value to the private sector

The traffic flows for the toll road are highly uncertain. The government thinks that the traffic flows will be great, because they will develop the port and the SEZ, driving traffic, and they will create a conducive policy environment that will spur development along the route, further increasing traffic. Unfortunately for the government, the private sector bidders do not believe this, as the government has no track record of delivering projects like this on time.

The graph below shows, a simple depiction of what the two different scenarios could look like.

In a toll road, you get the vast majority of your revenues from user charges. Assuming you’ve got a single tariff for all cars regardless of distance, your revenues are the number of cars that drive on your road, multiplied by the tariff, as simple as that.

In an infrastructure deal, you’ve got two kinds of cash outflows: capital expenditure (“capex”), and operational expenditure (“opex”). Put very simply, capex is the investment you make upfront, which is fixed, and opex is the cost you bear over time, which changes depending on your traffic. If more people drive on your road, you have to spend more on maintenance. It’s a bit more complicated than that in the real world, but this will do for now.

The government looks at the projected costs and multiplies their traffic flows by the tariff; the difference between the two is the subsidy they think will cover the cost of service. The private sector party uses the same cost estimate, but with a more conservative estimate of traffic flows, calculate that they will need a relatively larger subsidy. In present value terms, the graph below shows how that arithmetic works with some simplified numbers.

In my simplified example, the government think they’ll need a USD 75 million subsidy, and the private party think they’ll need a USD 150 million subsidy.

Unfortunately for the government, what they think doesn’t matter. They run a tender with the minimum subsidy as the bid factor, so all the bidders get together and try and figure out ways to lower their costs, and raise their revenues, eventually arriving at the minimum subsidy they think they can get the job done for. Whoever bids the lowest subsidy wins, so the winning bidder’s expectation of the costs and traffic flows is what determines the subsidy, not the government’s. And, that’s the way it should be.

Through running a tender process, the government is trying to get to what economists call “efficiency.” The efficient subsidy will be an optimisation of the lowest costs capable of meeting the service standards and the best guess at the traffic flows. Each bidder will bid a subsidy that covers their costs, including a reasonable return on their investment, and no more. If they bid more, they would run the risk of being undercut by the other bidders. If the tender process is free and fair, you should come pretty close to the minimum subsidy possible to get the job done.

But, what happens if, in fact, the government exceeds the winning bidder’s expectation and delivers the port and the SEZ, and develops the area around the toll road in such a way that the government’s projection of the traffic flows were realised. The private party already got their subsidy, so the high traffic volumes just mean that the private sector makes a whole lot more money. They got a high subsidy, representing the conservative traffic forecast, then the high revenues from the actual high traffic volumes. The graph below shows what the cashflows could look like in present value terms.

In this simple example, the private party ends up making an economic profit of USD 45 million in present value terms. This means, they ended up covering their costs, including a return on their capital, plus a nice return over and above that.

How can a tender process result in economic profits?

But how can this happen? I said earlier that the subsidy was “efficient”, and efficiency means you just cover your costs, no economic profits. How can a free and fair tender process end up resulting in such a large economic profit?

For starters, in a project like this, someone will always make an economic profit or loss, because you will never predict exactly how many cars are going to drive on your road. If you get only one more car travelling on your road than you expected over the thirty year concession, the tariff paid by that additional car represents your economic profit, if you get one less, that’s your economic loss. In an uncertain world, efficiency means making the best possible guess with the best possible information available at any given time.

The winning bidder bid on the basis of the best information available at the time. They could not have known that the traffic flows would materialise in the way that they did. So, while, looking back, we can say they made a large economic profit, at the time of bid, the expected value of that profit was zero. Unfortunately for decision makers faced with uncertainty, as we live in the present, we’ll just have to live with the swings.

When something like this happens and a private party is making a whole lot of money, governments sometimes try to renegotiate the contract, to claw back some of the economic profit that the private sector is making. In the world of risk, that’s what we like to call a “heads I win, tails you lose” situation. Let’s say I offer to bet you USD 100 on a coin flip, if I win, I take your money, but if I lose, I try and renegotiate and say that I didn’t know it was going to turn out this way. This is analogous to what government is trying to do in some instances when they try and renegotiate contracts to claw back profits when things go well. If the private sector party over-estimated the traffic forecasts and was making an economic loss, the government would not (or, at least, should not) have stepped in to let them increase their tariff or to pay them extra subsidy, but when it is going well for the private party, they step in and try to renegotiate.*

What other options do we have?

At the other end of the demand risk allocation spectrum, you have what is called an availability payment, where the private party actually can have no exposure to traffic flows at all. As a simple example of an availability payment PPP, imagine a private party with a fixed monthly payment that they get as long as the road is in the minimum specified condition. This payment is set during the bid process to exactly cover their capex over a 30 year period. If they let the road condition slip either by building it shoddily in the first place, or by maintaining it poorly, they won’t get their initial investment back. On top of that, they have a separate payment that they get per car which is designed to cover their opex and no more. Revenue collection may be handled by the private party, but that goes straight into a government account.

The graph below shows a simple example of the cashflows in PV terms:

The biggest thing you may note is that the costs and revenues are different. This is because an availability PPP is seen as much lower risk to the private party than a full demand-risk PPP, so private parties can raise equity and borrow from banks at much lower cost, meaning they don’t need to ask for as much money to cover their debt service and repay their equity holders. But, on the other hand, as the government is bearing the risk, they should also discount the revenues they expect to receive to reflect the fact that they are bearing more risk.

I’m calling the subsidy an “effective subsidy” here because it’s not a payment in the same way that the subsidy for a demand risk subsidy is. The payments are the fixed and variable payments, the subsidy is just the residual between those payments and the revenues, whatever they may be.

As I mentioned earlier, this puts demand risk on the government. If the revenues are less than expected, the effective subsidy will be larger than expected, and the government will have to find more cash to pay the private party’s payments than it thought it would. If the revenues are higher than expected, the government takes the whole gain.

So, which is better?

In one case, the private party takes the risk, in the other, the government takes the risk. How do we decide which option is right for us?

True efficiency also means efficient risk allocation

The most basic principle of risk allocation is that you allocate the risk to the party best able to manage it**. If neither party has any control over the risk, then it doesn’t really matter which party you allocate the risk to. In a mature city, for example, there may not be much the government can do to influence traffic flows.

In this particular case, however, there are significant public actions that will need to be taken in the next few years, the government has much more control over the policy levers that will drive the traffic, while the private party will have almost no ability to influence demand. Further, the government has no track record of delivering the port, SEZ and surrounding infrastructure. Indonesia has over-promised and under-delivered in infrastructure for decades. No investor is going to bet hundreds of millions of dollars that the government will suddenly spring into action and deliver faster than it has ever delivered before.

Too many investors, and would-be investors have been burned trying to invest in Indonesian infrastructure, so private sector traffic projections for a toll road like this will always be conservative. If the government truly believes that it can deliver the work program, and it wants to get the value of the traffic flows associated with the delivery of that work program, then they must take on demand risk themselves. 

Government officials here are very risk averse (for good reason), so when you offer them a choice between bearing a risk themselves, or allocating it to the private sector, the initial reaction is almost always to dump it on the private sector party. But, if the risk is one that they are truly the best party to manage, they will end up paying more, and maybe even transferring value to the private party by forcing the issue. To me, that's a worse kerugian keuangan negara (state financial loss), than any loss government might make by taking on demand risk themselves.

Note: I am simplifying it a bit by just saying “government.” In fact, the contracting agency for toll roads is BPJT, the party responsible for building the port is Pelindo IV, the party responsible for building the SEZ is the provincial government of North Sulawesi, and the parties responsible for developing Manado and Bitung are the respective city governments. So, the Indonesian government as a whole has the control, but coordinating all of the parties will be a big job. BPJT alone won’t have the authority to knock heads together, but they’ll have a lot more access to the people that do than a private party. If you hire someone to build a road, get them to build a road, don't ask them to build a road, and coordinate 5 different government entities. That's government's job.

What is the Indonesian government doing to rectify this?

Earlier this year, the government issued Presidential Regulation 38/2015 concerning government cooperation with business entities in the provision of infrastructure. This replaces an earlier piece of legislation, and the new regulation explicitly incorporates language providing greater flexibility for the government to undertake availability-based PPPs.

So, will we see an availability payment being applied for Manado – Bitung?

It’s too early to say. I hope so. I suspect it’s probably appropriate for a toll road like Balikpapan – Samarinda as well.

There has been talk about the use of performance-based annuity schemes (“PBAS”, which is just a fancy name for an availability payment) for the construction of non-tolled roads, but I haven’t yet seen any statement from BPJT on whether they intend to use this model for tolled roads as well. I guess we’ll see what they think when BAPPENAS finally publishes the PPP book with more information.

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*Note that the proscription on renegotiating does not apply where projects were not competitively awarded. This happens a lot in resource projects in developing countries either due to information asymmetries, or straight out corruption (the New Yorker has an example of one here). Renegotiation or even termination could be the efficient outcome there.

**If you want to know more, a good treatment of this is in Tim Irwin’s book Government Guarantees, available in PDF here. Aside from the discussion of risk, it’s a fantastic resource for people in the infrastructure business.

Should you give resettled people equity in toll roads as compensation?

An official in BAPPENAS, Indonesia’s planning ministry, was quoted in a few different papers last week saying that the Indonesian government wants to promote what they call public private people partnership (P4), by giving people that are resettled ownership in the toll roads replacing some portion of their cash compensation. Is this policy a good idea?

In short: no. It is a truly, truly terrible idea.

It doesn’t solve the core dispute

Land acquisition is slow in Indonesia because people either don’t want to move at all, or they don’t like the price being offered for their land. Let’s say you’ve got some guy, Mas Joko, that you have offered IDR 100 million for his land, which he has rejected. “OK”, you say, “how about we offer you shares instead?”

Of course Mas Joko’s first question is going to be “what’s the value of the shares?”

If your valuation of the land is IDR 100 million, then that’s the value of the shares you’re going to offer him. In which case, why should he view the offer any differently?

If you decide that you can pay him more in shares than you can in cash, say, IDR 150 million, then if that is indeed the true value of those shares, you are actually paying him IDR 150 million in cash because you could have just sold the shares on the market yourself, then paid him IDR 150 million in cash. If you couldn’t have sold those shares on the market for Rp. 150 million, then that isn’t the value of them and you’re trying to scam Mas Joko.

Paying people in equity doesn’t make the process of negotiating the value the land any easier; which is the core problem.

Poor people will not be able to (and should not) use it

The risk and cashflow profile of equity in a toll-road is dramatically different from cash.

Let’s try and help Mas Joko try to choose between IDR 100 million in cash and IDR 100 million in equity in the toll road company. He’s not a rich man. He’s got a small plot of land that he inherited from his father, with a house that he lives in with his wife and two kids. Whatever he accepts, he’s going to need to find suitable housing for his family pretty much immediately.

With IDR 100 million in cash, he can go any buy another place straight away and, hopefully, live his life much as he was living it before he got resettled. Let’s look at how his life might be different if he were to take the equity.

The first thing you need to know about equity is it only pays out money if the company pays dividends, which only happens if the company is making a profit, which can only come when the company starts operating and everything is going smoothly.

So, lets look at the cashflow profile first. If he takes the equity, Mas Joko will need to wait until the rest of the land acquisition is done, then for the construction to be completed and the road to start operating before he has any chance of getting any cash at all. Looking at the Cikampek-Palimanan toll road that just started operating last week, land acquisition took 6 years (which is unusually long), while construction took 2.5 years (which is about right). Even assuming land acquisition will now be a breeze with their genius new policy, Mas Joko will need to wait at least 2.5 years until he has a chance of getting any money.

What is he meant to do in the meantime? Where will his family live? They haven’t got the capital to buy a new house because it’s all tied up in shares, so they’ll need to rent somewhere. Do they have the income to afford to rent? Previously, their housing was “free” (zero marginal cost) because they already owned their house, so the entire family income was available for non-housing consumption and savings. Now they have to find enough room for rent in that family income, so—assuming they can even afford it—either their consumption or their savings will suffer.

Equity is also dramatically different to cash in its risk profile. Cash is pretty close to zero risk. As long as it doesn’t get stolen and your bank doesn’t go belly-up, it goes straight to your bank account and stays there, accruing interest until you find something to do with it. Equity in a greenfield toll road is a completely different ballgame.

The BAPPENAS official was quoted by Kompas as saying “every big project that involves the private sector is usually always profitable.” This is patently untrue. Toll roads with demand risk, in particular, have been performing very badly over the past few years. So many were going bankrupt (meaning the equity holders lost part or all of their money) that the Australian government asked the Productivity Commission to conduct an inquiry into the financing of infrastructure to see what needed to be changed in the industry. Closer to home, the MNC group don’t sound like they are very happy with their investments in the toll road sector. By taking an equity position, you are taking on the risk that the cashflows you might get from the project will be delayed, or may even not materialise at all.

One of the ways in which poor people are fundamentally different to non-poor people is that they’re much closer to the bankruptcy line at any given point; they’re severely constrained in their liquidity. A single shock, like a family illness/injury, or a drop in income can be disastrous. As a result, they become incredibly wary of anything that harms their liquidity or increases their risk exposure. In fact, this proposal to give people equity instead of cash both harms their liquidity and increases their risk exposure! No poor person would (or should) take equity over cash.

Calling this a P4 and talking up the benefits for the people is a joke. The only people that would even remotely consider taking this up would be the richest of the rich, big companies, or government entities. No poor person would take it up, let alone be guaranteed to benefit from this.

Implementation would be a nightmare

I have already dealt with the problem of valuation above. Even assuming you get everyone’s land valued appropriately and converted into equity, they now become part-owners of the project. How do you integrate their rights and responsibilities as minority shareholders into the project going forward? How do they make sure that the project is distributing dividends in the way that they want? How do they make sure that the board, that is responsible to them, acts in the way they want? How do they make sure they don’t get forced out, diluted, or otherwise screwed by the dramatically larger shareholders?

Indonesia does have minority shareholder protections built into law, but in practice, they’re very hard to enforce, and doing so costs a lot of money in legal fees. Will the people that take this equity have the time, money and understanding to mount a legal defence if they feel like they are being mistreated?

Then, if you are protecting the minority shareholders, how do you make sure that the company can still operate? Indonesia’s banking penetration is currently around 20% to 30%, depending on who you believe. Most likely these minority shareholders aren’t going to be the most financially savvy investors ever. It’s not fair to expect them to provide meaningful oversight, and it’s not fair to the company to feel like they have to explain every decision to hundreds or thousands of people that have most likely never heard of the concept of corporate governance.

Also, part of the benefit of getting the private sector involved is that they bear the risk if they go bankrupt. If the toll road were to be in trouble, would the government let it go bust, taking away the savings of the poor minority shareholders with it, or would they bail them (and the private company, whose incompetence led to the problems) out?

This sort of thing is immensely complex, and if there’s one thing the government of Indonesia doesn’t need in its infrastructure agenda it’s more complexity. Let’s do some simple projects first before trying to solve something as complex as the protection of minority interests.

In summary

This proposal will not solve the problem. Land acquisition is hard, but the solution is not to come up with ever more complicated schemes and try and give them catchy names that sound like they are benefiting the poor. The solution is to deal with people fairly and firmly, and the existing regulations, while not perfect, are adequate for that purpose. Indonesia is facing an infrastructure crisis, and the government’s endless tweaking of regulations and a lack of focus on actually delivering projects is a key part of why.

All of the quotes about this policy seem to have been from a single event, hopefully it was just an off-the-cuff comment that will not actually see implementation. I am certainly hoping so, and looking forward to seeing more progress on real projects.

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Note: This post has been edited for clarity. 15:08, 24 June 2015, WIB.

Why energy prices are a test of government leadership

I have been enjoying Matt Rennie's LinkedIn posts about various topics relating to the energy sector. Matt is a former colleague of mine at Ernst and Young, and their Global Leader for Utility Market Reform and Unbundling.

His latest post talks about topics I have covered in this blog so far about trying to balance economic efficiency with equity and access. From his post:

For governments, the challenge is to create an environment conducive to reform while managing social equity. A fine balance must be struck between:

• Obtaining the economic growth benefits of long-term movements towards cost reflective retail tariffs by segment, caused by more accurate price signaling
• Ensuring that vulnerable segments of the community — particularly susceptible to impacts in tariff changes — are protected against hardship

Source: Why energy prices are a test of government leadership, Matt Rennie

When Matt says that energy prices are a test of government leadership, he is underlining the fact that politics is an integral part of determining the optimal tariff structure. A government with a strong mandate from its citizens will have a much easier time convincing those citizens that its balance of cost-recovery and equity is the right one, than a government that is distrusted by its citizens. A good adviser will know how to run the numbers, but also be able to help governments think through ways to take into account their political context to make the right decision.

If you are interested in reading more about these issues, I recommend following Matt on LinkedIn.

What is the government's job in infrastructure?

The government’s job in infrastructure is to ensure the right infrastructure is delivered by the right party at the lowest cost.

I chose each of the underlined words quite carefully, so in the rest of the article I'm going to explain what I mean by each. 

The right infrastructure

The right infrastructure means that it is the right stuff in the right places and built to the right design standards. By right, I don’t mean some sort of “international best practice” right, I mean right according to the society that the government represents. 

If the society wants a road, and they want it enough to forgo the other things that they might otherwise spend the money on, then the government should give them a road that meets their needs (subject to their budget constraint).

While the road should meet society’s needs, it’s also important that it’s not over-engineered, or “gold plated.” In Australia that might mean the seats on a bus will be padded, and wide enough for an average Australian rear end, while in Indonesia, it might mean they are hard plastic and wide enough for an average Indonesian rear end. Giving everyone first-class aeroplane seats on a commuter bus might be comfortable for the passengers, but it most likely wouldn’t represent the best use of society’s resources.

A waste of money for commuter buses

Image source: News.com

Societies are made of up people with different preferences, and some might want fancy chairs, while others would prefer a cheaper solution and are happy for everyone to ride on hard wooden benches to get it. Picking a level of service is always going to upset someone, but generally, when governments do it, they are trying to achieve some sort of middle ground that makes the least number of people (or the least number of people they care about) unhappy*. That’s generally as close as you can get to the ideal of the right infrastructure.

The right party

In a modern, open economy, people get their services through a range of delivery modalities, including:

• fully government, in which the government is wholly responsible for the delivery of the service. Imagine a government building a road with equipment and materials it owns directly using its own employees. A more common example would be the core functions of the military.
• government contracted, in which the government contracts for the delivery of the services. This could be a government hiring a contractor to improve a road on a 6 month contract (a common type is an EPC contract), or one to build, operate then transfer a port as part of a PPP on a 50 year concession.
• government regulated, in which the government doesn’t own or contract anything directly, but generally oversees the provider, or providers of the service. This encompasses a huge range of models. Some examples are below:
  • Heavily regulated: A fairly closely regulated example is in the New Zealand power sector where the Electricity Authority creates the market rules, enforces them, and monitors performance. 
  • Loosely regulated: Businesses like management consulting firms are generally quite loosely regulated. They still need to comply with laws and regulations surrounding the general practice of business, hiring, firing, workplace health and safety, taxes and so on, but there aren’t many specific regulations targeting the industry. Note that this can vary depending on the kind of advice being provided, for example, tax and financial advisers have more stringent guidelines than strategy advisors (or economists).
  • (almost) no regulation: Businesses like kaki lima (roaming street food vendors) in countries like Indonesia. In Indonesia, technically they’re meant to have licenses issued by the local Camat, but many don’t. Even if they do get licenses, they’re still exempt from many other regulations by virtue of their size. And, even if they’re not exempt, in practice, no one is going to check whether a kaki lima vendor is paying her employees properly**. Even so, it's not strictly accurate to say that they are not regulated.

A lightly regulated industry

Image source: Wikimedia

These delivery mechanisms are not mutually exclusive. There are plenty of industries where the government uses all three delivery mechanisms. In Australia, local councils own childcare centres, contract private parties to deliver childcare services, and oversee compliance with regulations for fully private providers. In Indonesia the government owns and operates hotels, and regulates private providers within the hotel industry.

What I’m getting at by describing all of these delivery mechanisms is that, in most cases, it shouldn’t matter who it is that provides the service, as long as it gets provided well. Governments should look at all the pros and cons of all of the different delivery models for the service they need and make a choice on that basis.

The lowest cost

By “the lowest cost” I mean that I don’t want to pay any more than I absolutely have to for my right infrastructure***. When I talk about paying, I mean either directly through user charges, or indirectly through government spending money that they might spend on other things that I want for society.

If the government is operating a water network and the private sector could do it to the same or better standards at a lower cost, then I want government to either match that cost, beat it, or hand the project on to the private sector and act as regulator.

Similarly, if a private operator of an airport is abusing their market power to charge exorbitant parking fees, then I want the government to step in to penalise them for it.

When contemplating engaging the private sector in the delivery of infrastructure services, it’s generally considered good practice to develop what’s called a public sector comparator (PSC). A PSC compares the cost of public provision with the cost of private provision, taking into account the upfront and ongoing direct financial costs, economic costs or benefits, risks that could be transferred or retained, and competitive neutrality (which I’ll come back to in a later post). If a private option is cheaper than the government provision, then you go ahead with the private option, if not, stick with government.

Conclusion

So, the governments job is to give us the right services, cheaply, by whatever means creates the most value to society. 

The process that governments go through to determine that they are ensuring the delivery of the right infrastructure at the lowest cost is not a linear one. You can’t just go through and try to answer the question of who should be delivering in isolation of the design and cost, and vice versa. In the delivery of a major project, there are typically years of work going through multiple cost estimates, evaluating different delivery mechanisms and engineering solutions, all feeding in to the coordination process that, ideally, produces an outcome in line with what we want from our governments.

An interesting approach to making the process of delivering infrastructure is more transparent has been pioneered by the Department of Treasury and Finance in the State of Victoria, Australia and is called the Investment Management Standard. If you’re interested, you can read about it more here.

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*Considerations of access are an example where it's generally considered good practice to not weight all individuals' preferences equally. Ensuring wheelchair accessibility for things like public transport is a significant additional cost and is only required by a tiny minority of the population. However, as societies get richer, they increasingly feel like this is an appropriate cost burden for society to carry for the sake of this minority.

**It’s not all good by any means. The lack of regulation is accompanied by a lack of protections as well. Informal sector actors have little recourse if they are shaken down by local criminals (or government representatives), or if they get hit by a car, etc.

***My desire for low costs is, of course, in direct conflict with my desire for good services. The best outcome will be an optimisation of both. 

If you're making a real financial model, don't make this simple mistake...

This is the first  of what will probably be a series of pretty technical posts dealing with some of the nuts and bolts of infrastructure finance and economics. I don't want to do too many of these, but there are a few things that I figured out that took me a lot of blood, sweat and tears that I'd like to save some others if I can. If you're not in the business of making or using financial models on a regular basis, please feel free to skip this one!

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When you build a financial model, there are two ways you can manage your numbers: real, and nominal. In real models, you pick a base year, and do all your calculations using constant real dollars, rupiah or whatever currency you’re working in. In nominal models, you need to adjust all of your numbers by the relevant inflation figure.

Whether you use real or nominal is largely a matter of personal taste. They are (or, at least, should be) mathematically equivalent. It’s more a matter of presentation. I have always been a bit of a nominal model man. The first professional model I ever took over from someone was a nominal model, and I guess that shaped how I think about these things, but, at least theoretically, I don’t mind much which flavour you want to use.

I said “at least theoretically”, because in practice, I have had lots of problems with real models. In fact, a significant number of the real models I have come across in my professional career have had the same glaring mistake. Take a look at the simple models below and see if you can see what it was.

Let’s imagine you work for the government and your boss wants you to analyse an infrastructure project to find out how much a private party will charge users to provide the service.

The project will operate at full capacity for a 10-year period providing a service for which it charges a tariff and incurs operating expenses that both increase with inflation. The business is pretty capex heavy and the capex is all incurred in the first year of operations, then depreciated on a straight-line basis over the 10 year operating period. You’ve got some cost estimates, and a pretty good idea of what the weighted-average cost of capital is for businesses in this industry, so you put all the costs in and run a goalseek to get your full-cost-recovery tariff.

First you make a real model (but unknowingly, make a mistake in its design). See below:

 Then you make a nominal model to check your work (which doesn’t have the equivalent mistake). All you need to do is adjust the WACC, your revenues and your opex by inflation; everything else flows on from those.

 You are alarmed to see that your full-cost recovery tariff is different between the two models that should be mathematically equivalent. What have you done wrong?

 Have you found the mistake? Last chance…

….

….

….

The mistake is in the depreciation. In the real model (and in a significant proportion of real models I have seen in the real world) depreciation has been assumed to be constant. In fact, straight-line depreciation is constant in nominal terms, and decreases in real terms. The 50 units of your year 1 capex that you depreciate in year 10 is worth a lot less in real terms than the 50 units of the capex that you depreciate in year 10. This doesn’t affect your pre-tax cashflows, but, if you keep the depreciation constant, the tax shield impact of your depreciation is overstated.

Here’s the real model with deflated depreciation that results in the correct full-cost-recovery tariff.

 This effect of this mistake is not always very large, it’s only so large here because I used an example that was particularly capex heavy, but it can have a significant impact on decision-making in businesses like infrastructure where profit margins are very slim.

People think that in a real model, they don’t need to assume inflation. This is true if it’s a pre-tax model, but in a post-tax, or vanilla model, you still need to assume an inflation rate to calculate your depreciation correctly (and amortisation, etc.). So, I said earlier that it was largely a matter of taste what sort of model you make. That’s true, but if you’re building a real model, which is anything other than pre-tax, I might question your taste… Having to assume an inflation rate for a real model, to me, should make you question why you are using a real model in the first place.

So, now you know. Next time you see a real model, have a look at the depreciation, and let me know if you find the same mistake. The ones I have found have been made by very successful, multi-billion dollar companies, so the people making these mistakes aren’t in bad company, at least…

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New course on PPPs in developing countries

The World Bank is about to launch a new course to help explain how public private partnerships (PPPs) can help bridge the infrastructure gap and fight poverty.

You can register for the course for free here through Coursera. It runs for 4 weeks, starting from 1 June. 

Gender and infrastructure

In my previous post I delved into the thorny issue of gender and infrastructure. It's something I have been thinking about a lot recently, both personally and professionally. 

It's the kind of area can sound a little odd. I mean, let's be honest here, the gender impacts of the alignment of a power transmission line aren't really immediately obvious. That said, in certain cases, like public transport policy, there can be some really significant positive or negative gender impacts.

In my experience, gender in infrastructure has been viewed through a sort of a safeguards lens, where you plan your project, then check afterwards if there are any negative gender impacts. If so, depending on how much they cost, you might do something about them. I'm interested in whether that is in fact the best way to do things, or if there's some other way. And, if there is some other way, how we can build systems that incorporate these issues from the ground up.

In Indonesia, pretty much the only people I know that are looking at the practice of this sort of thing are the Indonesia Infrastructure Initiative (IndII), an Australian government-funded program*. They have some great materials on gender and disability and are actively incorporate these issues into their program design.

I have also been lucky enough to have a chance to discuss this topic with Dr. Lisa Cameron of Monash University in Melbourne, whose work on Indonesia I have loved for a long time and highly recommend. I'm hoping she sees fit to add to the academic literature on this sort of thing...

Outside of this, and what I have found with a bit of a google, I'm not that aware of many good resources on the topic. If anyone knows of any good research or interesting researchers looking at this field, please let me know in the comments.

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*Full disclosure: I worked for AusAID on the design of IndII (I even came up with the name), and collaborate a lot with IndII on a day to day basis in my day job.

Do we need gender-segregated public transport?

It's not uncommon for societies to make the decision that providing women's only spaces on public transport is a good thing. I'm most familiar with it on Jakarta's Busways, but I remember seeing it on commuter trains in Mumbai, and during the rush hour in Tokyo. It has even been discussed in Australia and the UK at various points.

The most common justification provided by proponents of the policy is that it creates a safe space for women so that they can be free of harassment. This can be a really important reform in places where a significant population of women would choose not to use public transport because they feel unsafe. Women that feel unsafe will either be pushed towards private transport at higher personal cost (taxi fares, or running costs, depreciation for a private car) and social cost (traffic), or choose not to travel at all. Choosing not to travel  can have big negative impacts on women's workforce participation, or if they wouldn't otherwise work, mean that they have to shop at the expensive minimart near their house rather than the cheaper market further away, or force their husband/son/male family member/friend to take more time out of their day to run errands.

So, that can be a big positive, but in policy, we need to weigh the positives against the negatives and the potential positives of all other options to see what the right decision is.

One thing I personally hate about gender segregation is that it puts the onus on women to act to not be sexually harassed. This sort of thing can give rise to statements like "well, if she didn't want to be harassed, she should have been sitting in the women's section." As the harasser is the being anti-social, ideally they would be the one required to go out of their way to stop this happening. Sadly, that's not practical. 

Gender segregation also decreases the efficiency of the public transport system, by decreasing the fungibility of the seating. If you've got capacity for 50 people on a bus, how do you split it? If you ridership is 60% men and 40% women, let's assume for simplicity that you allocate your seating 30:20 men:women. Through random chance and due to differing travel patterns, you're sometimes going to have times when one section will be full and the other section will have capacity, meaning that, at the margin, you need a bigger fleet (or longer waiting times) to handle peak demand. You can (as all services I have seen do) make the "women's" section a "mixed" section, and adjust the split to account for the fact that some women will be indifferent or may choose to sit in the mixed section, but you'll still run the risk of the mixed section reaching capacity and men waiting longer, or the women's section reaching capacity and women that don't feel comfortable riding in the mixed section waiting longer.

So, how do we balance the positives and negatives? Is gender segregation a good thing? 

To me, the clear answer is: it depends. And, no, I'm not being facetious...

I have never been to Saudi Arabia, but I understand that women aren't allowed to ride the most common forms of intra-city buses there, and aren't allowed to drive. So if women in Saudi Arabia want to get around "by themselves", they have to hire private drivers. In a context like that, I could imagine that women-only sections or whole buses could be a great thing for their society. But, I think I would be a bit disappointed if we had to do this in Melbourne, Australia (where I'm from).

I hate the term "international best practice." It is used a lot in development policy (I'll write a bit about the term and its problems more in a future post), and it sort of implies that there's a single solution that is going to be the "best" solution in every situation in every society. Or, if not that, it implies that some "expert" (usually and "international expert" in development) can come in, look at some some numbers and design some solution that is the "best" outcome for that society. This is almost never the case.

I don't think quantitative analysis is useless in these sorts of discussions--it's important to know how many women ride the buses, how long waits are likely to be, see how many women ride in the mixed sections, and how these things change over time--but, to me, the quantitative analysis is an input into the qualitative discussion about what value the society puts on the positives and the negatives.

Someone always gets screwed whenever you bring in a few policy (or, at least, benefits less than someone else). Gender segregation directly benefits a proportion of women that use, or would like to use public transport, and directly harms all men that use public transport (there may be second order-benefits, but they definitely bear a cost). So how do you balance the costs and benefits not just to society, but between individuals? There's not some best practice formula that says women's time is worth this much and men's time is worth that much and this is how you trade them off. This is where politics comes in. 

Politics is often a dirty word in policy. People say "oh, the other side were playing politics" with a sneer. But, to me, in a well-functioning democracy, we vote for people that we think have some approximation of our values. The politicians, for better or for worse, are as close as we get to a representative sample of the democratic unit. My job as an analyst is to get as much data together as possible about who bears the costs and gets the benefits, and how big these costs and benefits are, then the politicians get to decide how to allocate them, based on their understanding of the values of their electorate. If they do it wrong too often, they (hopefully) get voted out and someone else gets to have a go. I have my own values, and they do affect how I present my analysis, but at the end of the day, it's the politicians that have to face up to their citizens, not me.

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Quantitative geek that I am, I love seeing data like the graph in my header showing what improvements men and women want to see in transportation in Dhaka, Bangladesh.  I find it fascinating that there's such a big gender gap in the proportions of men and women that want separate buses for women. I do wonder how big gaps like that impact upon how controversial policies end up being. I have no idea what the best policy solution is here, but that gap indicates that you'll probably have to do a lot of work building consensus around a solution.

What I talk about when I talk about infrastructure

"Infra-"  means "below" and "-structure" means "structure". So when people talk about infrastructure, they are usually talking about the structures that allow things to operate.

Confusingly, people use the word "infrastructure" for all sorts of purposes. IT infrastructure refers to the "combined set of hardware, software, networks, facilities, etc. (including all of the information technology), in order to develop, test, deliver, monitor, control or support IT services". The World Bank has a project where they talk about "judicial infrastructure" being both the physical buildings like courts and offices where the justice system operates, but also the institutions, policies and procedures that allow it to operate. Some people even talk about "emotional infrastructure" of a family or organisation being the systems that allow people to make their feelings known and have them validated. 

When I (and lots of other people) just say "infrastructure" without further clarifying, we are generally talking about the structures that underly the real economy, and allow it to operate smoothly. This sort of infrastructure is usually differentiated along two different axes: hard to soft, and economic to social.

"Hard" infrastructure usually refers to the "crunchy stuff", roads, buildings, physical assets. While "soft" infrastructure refers to institutions, regulations and systems. "Economic*" infrastructure usually refers to things like roads, power systems, ports, while "social" infrastructure refers to schools and education systems, healthcare, sporting facilities, museums and so on.

Below I have sketched out a table showing a very subjective and not-intended-to-be-perfect categorisation of different kinds of infrastructure according to where they sit on the two continua.

Hard vs. soft, and economic vs. social infrastructure

So, technically, you can call all of this stuff infrastructure. But, this isn't what most people (including me) mean when they say it. When most people talk about infrastructure, they're talking about the upper-left quadrant of my table above; the water and sanitation, power, transportation and telecommunications systems of a country. In general, the further you get away from hard economic infrastructure, the less likely people are to call it infrastructure.

The next table shows what most people mean when they talk about infrastructure, with darker shading denoting the fact that you're likely to get more strange looks if you call it infrastructure.

What most people mean when they talk about infrastructure

This blog will follow these conventions in most cases, I'll generally talk more about harder economic infrastructure. This is definitely not because I think hard economic infrastructure is more important than other kinds of infrastructure. It's partly because my experience is mostly in these areas, but it's also because sorts of economic tools and techniques I typically use are more easily and less controversially applied to this sort of infrastructure. I'll talk about the difficulty and controversy in future posts, because it's very interesting!

So, that's what I (and lots of other people) talk about when we talk about infrastructure. I hope you find it interesting! 

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* The term "economic infrastructure", as opposed to "social infrastructure" is not universally agreed on. Some people refer to power, water, telecoms and transportation systems just as "infrastructure", while schools et al get bundled into "social infrastructure". Some people also use "economic infrastructure" to refer to the economic systems of a country; the central bank, the banking system, etc. Confusing, no?

Do the MNC Group not understand the infrastructure business, or do they understand it too well?

The MNC Group is one of Indonesia's largest media conglomerates. In 2013, they moved into infrastructure by, among other things, purchasing a few toll roads from the Bakrie Group. Over the past few weeks they seem to have been getting in trouble with their Kanci - Pejagan toll roads, and the comments they have been making in the media have been more than a little worrying for people that work in the field of infrastructure regulation.

The week before last, Detik Finance published two articles titled "Bakrie and MNC have been in default on the Kanci-Pejagan Toll Road" and "MNC: The Kanci-Pejagan Toll Road has been broken since we bought it from the Bakries."

The first article claims they are not meeting the minimum service standards and that they need to fix the toll road at their own cost, or try and sell it to someone who will. According to the head of Indonesia's Toll Road Regulatory Authority (BPJT), Achmad Gani Ghazali, they've got 90 days to rectify, of which about half has elapsed.

In the second article, the President Director of the operating company, PT Semesta Marga Raya, Irmawanto Soekamto, is quoted as saying "The tollway was in really bad condition when we received it. From the beginning, the tollway has had continual repair work conducted on it", and "we have been asking ourselves, the construction of this road should last decades, but why, as soon as we receive it, is it in such bad condition?"

In addition to blaming the Bakries, Detik's article also notes that Indonesian state-owned contractor PT Adhi Karya (Persero) constructed the road and that it was opened by former President Susilo Bambang Yudhoyono.

The article further notes that the concessionaire asks for forbearance from their users and that they are pursuing legal action to determine the cause of the poor road condition. It closes with a quote from Irmawanto: "I am certain, truth will come out. We all know that this toll road was heavily damaged from the start. So we just need to wait and see who is truly responsible for all of this damage."

I don't know who was responsible for the damage that has led to the current poor quality of the road, but I can tell you who is responsible for fixing it now: the MNC group as current concessionaire.

A CA, like any agreement, governs rights and responsibilities of the parties. In toll roads, the government concedes to allow a private party to charge a toll for the use of the road, but in return, they must build and maintain the road such that it meets the specified minimum standards. In Indonesia, there are only two parties to a toll road CA, the government and the concessionaire. As such, the only two parties with any rights or responsibilities under the CA are the government and the concessionaire.

As the MNC group currently own the operating company, then even if Adhi Karya built a poor quality road, and the Bakries maintained it badly, the users and the government should not care. As the current concessionaire, the MNC group alone have the responsibility to ensure the road is in good order and they alone must bear the cost of doing so.

It is possible that the MNC group can sue either the Bakries or Adhi Karya to recover or defray some of the cost of repairing the road and, if so, I wish them the best of luck in their endeavour, but I have never seen a clause in an Indonesian CA that allows the concessionaire to breach its minimum service standards while it has a fight with some other party. In fact, most CAs in all jurisdictions specifically note that the concessionaire is solely responsible sub-contractor non-performance, and that any change in ownership must be conducted in such a way as to ensure the continued fulfillment of the minimum service standards.

When MNC bought the toll road, they would have run a financial model projecting out all of the revenues they expect to get over the remaining life of the concession, and the costs they would incur in keeping their asset in the required condition to figure out how much they would be willing to pay for the asset. Their projected costs should have included, of course, any rehabilitation required to bring the road up to the required minimum standard.

If MNC did not accurately project the costs or rehabilitation or ongoing maintenance, or didn't read the CA to understand their minimum standards, then, quite frankly, they should lose money... They're a serious company paying serious money taking on some serious obligations. If they're not going to take it seriously, then they shouldn't be in this business.

This idea that a sub-contractor or previous owner non-performance is not the government's problem is not some arcane point of theory, this is beginner stuff. In giving an interview like the one Irmawanto gave to Detik, it seems like one of two scenarios is possible:

1. MNC don't understand the simplest things about infrastructure investing
2. MNC think that the government does not understand the simplest things about infrastructure regulation.

Unfortunately, private businesses making money by betting on the second scenario has some precedent, not just in Indonesia, but all over the world. When we get private contractors to invest in and operate our infrastructure, we want them to innovate on lowering cost, or raising revenue, but sometimes they choose to innovate in trying to renegotiate contracts or otherwise weasel out of their obligations. 

The reality is, especially in developing countries, regulators often don't understand contracts that well, and private companies can usually afford much more expensive and intimidating lawyers than the government can, so even a really well-designed contract* can result in a bad outcome.

CAs often have a clause that allows for the concessionaire to get compensation in the event that the government asks them to do something that might cause them to incur extra costs. Examples of reasonable requests a government might make that a concessionaire could reasonably request compensation for might include widening a road, changing the weight limit of a bridge, installing flood mitigation measures following a new national standard and so on. The concessionaire's compensation for the government's request could be cash, relief of paying a concession fee, an increase in tariff, an extension of the concession period, or something similar. MNC may be hoping that they can convince the government that this rehabilitation expense should be considered a government request that causes them to incur extra costs, rather than something that arose as a result of their own negligence.

In my experience, I have found BPJT to be staffed with pretty professional operators that wouldn't fall for things like this, but then, MNC have a reasonable track record of success in investments that indicate that they know what they are doing.

I don't know which of my scenarios accurately describes MNC's thinking, but I hope they're spending more on maintenance and rehabilitation than they are on their legal fight... Either way, they've only got half of their 90 day rectification period left, so we'll find out soon enough...

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Note: all quotes are translated by the author, for the original wording, please refer to the linked articles.

*The regulatory capacity of the government is a critical thing to take into account when designing a contract, and aligning the regulatory responsibility with their capacity decreases your chances of getting a bad outcome.