How much does extending a toll road concession period lower tariffs? (Spoiler: not much)

About three weeks ago, the Minister of Public Works and People’s Housing Basuki Hadimuljono reported that his ministry was looking into extending the concessions of toll roads in an effort to reduce toll road tariffs. Katadata reports that this was in response to an order from President Joko Widodo to reduce toll road tariffs this year, as he had received many complaints from the public that they were too expensive.

This obviously begs the question: how much does extending a toll road concession period lower tariffs? (Spoiler for those who want to skip ahead: comfortably less than 2%).

OK, so we need to build a financial model and collect a bunch of data?

Actually, we don’t need to build a financial model, and don’t need to collect much data at all.

If all we need to know is the percentage change in tariff, we can get in the right ballpark with just the following data:

  • The current length of the toll road concession in question
    • Concession lengths that range from 31 to 50 years with an average all toll roads of 39.3 years (BPJT), so let’s say 40 years.
  • The desired length of the concession
  • The weighted average cost of capital (“WACC”) for Indonesian toll roads
  • The share of capital expenditure in total project cash outflows
    • Capex usually accounts for about two-thirds of cash outflows over the life of a toll road project, in present value terms

We can do this by using the PMT() function in Excel, and just modelling all of the cashflows as an amortising loan payment using the tenor of the loan as the number of periods, and the WACC as the interest rate.

table.png

So as you can see in the table above, even if we set the WACC at an unrealistically low figure of 9%, and extend the concessions all the way out to 60 years, on average, the impact on the tariff is going to be less than 2%. More than likely, it’s going to be less than 0.5%.

(Nerd note: in fact, it’s going to be even smaller than that, because amortising loan payments are constant in nominal terms, while toll road tariffs in Indonesia grow roughly at inflation, so will be backloaded; hence, further discounted. And it’s not like you can get debt on a 60 year tenor either, so you’re still going to be front-loading debt payments, and back-loading dividends, whether it’s a 20 year or a 60 year concession. In any case, the impact is comfortably less than 2%)

Why is the impact so small?

It can be counterintuitive that adding 20 years to a 40-year concession has such a small impact on the tariff; after all, there’s another 20 years’ worth of traffic to spread the capital costs over. The problem is that, 40 years in the future, those cashflows aren’t worth that much in today’s money.

Even at a 9% discount rate, one dollar in 40 years is only worth 3 cents in today’s money, so the many millions of dollars of revenue that a toll road might earn in years 41 to 60 really don’t do a lot to lower the tariff required to cover the project costs projected in today’s money.

Is lowering toll road tariffs even desirable?

The purported aim of this policy is to reduce logistics costs incurred by Indonesia’s businesses while transporting goods on roads. This is a laudable aim, after all, Indonesia’s logistics costs are among the highest in the world as a share of GDP; accounting for 26% of GDP in 2016, compared to 14% in Malaysia, and 8% in Singapore.

However, the main drivers of roads logistics costs are not toll road tariffs, but rather congestion, and wear and tear on cars due to poor quality roads. If you did lower toll roads tariffs a significant amount, you could conceivably increase traffic on the roads, making traffic worse, and increasing the logistics costs overall.

Floating policies like this drives investor perception of risk

Any infrastructure developer knows that an extra 20 years on their concession will have a negligible amount on tariffs, so the government looks unprofessional when they go public with policies like this. In a developer’s eyes, it looks like the government is politicising toll road tariffs, increasing regulatory uncertainty; the impacts of which they are very familiar with.

As I said in my article in the Lowy Institute’s Interpreter blog in August last year “The government’s propensity to undertake post-bid renegotiations is part of the reason that cost of capital for utilities developers in Indonesia is closer to the neighbourhood of its lower-income ASEAN neighbours Vietnam, and Cambodia, rather than its lower-middle-income peers of the Philippines and Thailand.” (Check out that post for the accompanying graph).

Summing up

Extending toll road concessions is not an idea that is worth the attention that has been paid to it over the past few weeks. It won’t lower tariffs by a significant amount, and it’s not clear that lowering tariffs is a sensible policy aim anyway. By promoting this policy, the government stoking investors’ perceptions of regulatory uncertainty, keeping the cost of capital high.

Looking back at the table above, it strikes me that the tariff is dramatically more sensitive to changes in WACC than it is to changes in the length of the concession period. It could be that announcing this policy has already had an impact on future toll road tariffs, but not in the direction that the government was hoping.

When is borrowing at a low interest rate a bad thing for governments?

I was pleased to write an article for the Lowy Institute's great blog, The Interpreter, on Indonesia's regulation of toll roads entitled Indonesia's unorthodox toll road debt. 

From the article:

In 2016 Indonesia’s Ministry of Public Works dramatically underestimated the funds it needed to acquire land for toll road development. To try to keep development on schedule, the government leaned on toll road developers to lend them the difference at well-below-commercial rates. 

In the article, I try to set out how borrowing from the toll road developers at low interest rates may end up costing them more in the long run. To read more, head on over and have a read.

Pre-qualification for Bandar Lampung Bulk Water Supply project is open

I'm not sure how I missed this (or how the English, and Indonesian language media also seems to have entirely missed it at time of writing), but the Bandar Lampung Bulk Water Supply public private partnership ("PPP") project pre-qualification has been open since 30 March, and is open until 30 May 2017.

Source: PDAM Way Rilau

Source: PDAM Way Rilau

 

It's odd that this isn't bigger news because, as far as I am aware, this is the first PPP project to be tendered since the Palapa Ring projects were tendered in late 2015

This is the second time this project has been tendered, and the previous go-around was quite a big deal.

What happened last time

The previous tender process was launched in 2012, and attracted substantial interest from domestic and foreign bidders, with 10 consortia submitting bids. Shortlisting happened fairly quickly, with Water Consortium (Hyundai Engineering and Construction, Itochu Corporation and PT Potum Mundi Infranusantara); Abeima and PT Wijaya Karya Persero Tbk; Acuatico and Mitsubishi Corporation; and Manila Water and Great Giant Pineaple Co forming the final four.

Yet, disagreements over the project costs; the allocation of those costs between the users, central government, and city government; and the project structure meant that the final request for proposal was substantially delayed.

The issue of the project costs was arguably the most critical issue, with widely diverging capital costs proposed by different parties within government. The Ministry of Finance allocated a maximum subsidy based on the lower estimate of the capital costs--allocating a maximum subsidy of IDR 350 billion--and the project went to tender in September 2015.

The Ministry of Finance's estimate of the required subsidy proved to be excessively conservative, and none of the bidders ended up submitting conforming bids, resulting in a failed tender.

Why did no one submit a conforming bid?

Indonesia's main way to provide subsidies to infrastructure projects is through what they call Viability Gap Funding ("VGF"). The aim of this VGF is to bridge the financial "viability gap", allowing government to engage the private sector to deliver a project that they otherwise wouldn't be interested in. (Note: there's a lot more to say about VGF, and why, and when it should be offered, but that's a for separate blog post sometime.)

Indonesia's VGF guidelines are interpreted to mean that VGF is not allowed to exceed a maximum of 49% of the capital cost of a project. This means we that, based on the announced IDR 350 billion VGF, the government was assuming the capital costs for the project were IDR 700 billion (with a little rounding).

The graph below illustrates how the tender failed.

In this project, the revenues from PDAM are fixed*, the bid factor becomes the minimum VGF required to deliver a project that can fulfill the technical specifications. Whichever bidder gets the optimisation of the lowest capital, operating, and finance costs, should be able to offer the lowest required VGF to do the project, and win.

The Owner’s Estimate column showing project costs of IDR 1.4 trillion is present value terms, and equivalent revenues shows a simplified version of the project cashflows that illustrates how the government arrived at the IDR 350 billion VGF number. For this simple illustration, I’m assuming that the total operating expenditure over the life of the project is the same as the capital expenditure. If someone feels like giving me a copy of the government’s owner’s estimate financial model, I’ll happily update the figures, but it doesn’t really matter for the illustration.

The Government’s Ideal Scenario shows what the government was hoping for, where some party ideally was able to get the project done for less than they estimated, and would bid with a VGF of less than IDR 350 billion.

The Actual Lowest Bid shows what actually happened. The bidders would have been working their hardest to get the lowest capital, operating and finance costs to decrease the VGF required to meet their costs, and get under the government’s cap, but none of the four was able to do it. So, the tender failed.

Failed tenders are really expensive

The failure of the Bandar Lampung Bulk Water Supply Project destroyed a lot value in the Indonesian economy; for the government, for the bidders, but--most importantly--for the citizens of Bandar Lampung.

On the government's side, they had multiple rounds of advisers, including top-shelf (and quite expensive) commercial, legal, and technical advisers, both for the preparation of the transaction, and for the appraisal of that transaction. In aggregate, the fees paid to these advisers would be well into the millions of dollars, and I'd be surprised if it were below USD 10 million. Beyond the fees, there is the wasted time of all of the civil servants, all the way up to the minister level, in multiple ministries and agencies, who had to participate in meetings, and produce their own analysis and recommendations.

For the bidders, participating in tender processes is also expensive. Preparing a pre-qualification submission can easily run into the multiple hundreds of thousands of dollars each in staff time and advisers' fees to make sure they can do the project, and to prepare the documents in the format required. Then, the shortlisted parties easily blow another couple of million dollars to prepare a conforming bid, including their preliminary designs. With 10 pre-qualification submissions, an extended pre-bid process, then four short-listed bidders, there would easily be another USD 10 million dollars of value wasted there.

Finally, and most importantly, the citizens of Bandar Lampung have had to go another five years without adequate water supply as a result of these delays, wasting money buying water from eceran, wasting time boiling water and otherwise creating plans to make sure they can access potable water as and when they need it, and bearing health and lost productivity costs due to the poor quality water.

Source: Statistik Kesejahteraan Rakyat Kota Bandar Lampung 2016, table 6.6, page 100

Source: Statistik Kesejahteraan Rakyat Kota Bandar Lampung 2016, table 6.6, page 100

As it is, only around 20% of Bandar Lampung's 1.2 million citizens have access to piped water for cooking, or washing, and pretty much all other potential sources are worse than PDAM supply by some metric; either more expensive (private wells with jetpumps), take a lot more time (wells), or are much lower quality (unprotected wells). Although, on the other hand, most of them are more reliable. 

The estimation of economic benefits of infrastructure projects is always hazy, with lots of uncertainties, but we can come up with a ballpark figure using some simple arithmetic.

The original project was for a 500 litres-per-second facility, aimed at serving 44,000 households. This is far less than the 960,000 people currently without service in Bandar Lampung, so we can assume 100% take-up pretty quickly. So, 44,000 households went with poor quality water for 5 years. If we assume the costs of the poor quality water are a dollar a day per household (counting all the wasted time, purchasing of bottled water, health impacts, etc. etc. that's certainly too low), that's already USD 80 million.

So, just as a conservative ballpark estimate of the cost of the delay, we can get to USD 100 million pretty quickly. Suffice to say that the costs of inaction are really high, and orders of magnitude higher than a couple of millions of dollars of VGF.

What has changed this time?

The word on the street is that the project has been rescoped, and redesigned to make it deliverable under Indonesia's current PPP framework. Just from the details available in the Request for Pre-qualification document on the PDAM Way Rilau website, we can see that there have been some changes made.

The raw water intake is now 825 litres-per-second, and the water treatment plant is 750 litres-per-second, up from the 500 litres-per-second of the last go around. The extra volumes mean that there are potentially more revenues to go around, to decrease the required VGF.

However, the capital costs of the project still seem to be estimated at IDR 700 billion. I'm not entirely sure how the plant capacity increases, and the capital costs (that were already proven to be too conservative) stay the same, but I'm no engineer, so what do I know? It's possible that they have found efficiencies in other areas, or are trading off capex for opex.

If you want in, you'd better hurry up

The pre-qualification process is open for another two weeks from today, so if you are planning on bidding, you'd better get on it!

* Technically not correct, but effectively the same. There was a fixed payment to cover the capital costs, and a variable payment to cover the variable costs of operation. This aims to ensure there is no economic profit (or loss) coming from the operation of the facility if the contractor performs satisfactorily.

Event: Meeting Indonesia's infrastructure investment challenge

I'll be giving a talk on Indonesia infrastructure investment challenges at the Indonesian chapter of the Institution of Civil Engineers' monthly technical meeting tomorrow night, Thursday 24 November.

The synopsis of the talk is as follows:

Inadequate infrastructure is constraining growth in Indonesia. Yet despite infrastructure investment numbers growing from one National Medium Term Development Plan (RPJMN) to another, the infrastructure capital stock continues to decline. One suggestion may be to focus on attaining infrastructure investment levels that would at least stop this decline in infrastructure capital stock.

But how much is needed for this? And is it achievable? Is it realistic to go beyond this and expect higher levels of investment to get the infrastructure capital stock rising again?

To discuss these and other issues, please join this presentation where John Cheong-Holdaway will present the preliminary findings and recommendations of his research on the infrastructure investment needed between 2015-2019 to arrest the continuing decline in the capital stock and to meet the ambitious targets of RPJMN.

The flyer is embedded below:

If you're interested, then please come down, and I'll see you there.

Disclosure: This seminar is for educational purposes only. I am receiving no compensation for the event. Any opinions expressed at this event are my own.

Event: Jakarta at 30 million. Where does the city go next?

The Guardian Cities project is visiting Jakarta next week and are collaborating with the Rujak Centre for Urban Studies to put on an event on Monday entitled Jakarta at 30 million: where does the city go next? 

The write-up for the event is as follows:

Guardian Cities kicks off its Jakarta Week series by joining the Rujak Centre for Urban Studies to get under the skin of south-east Asia's great megacity. From mobility and water to creativity and inequality, a special panel of top urbanists, architects and cultural experts will be in conversation about Jakarta's biggest challenges, its rapid push to modernise – and how to stop people getting left behind.

The event is being hosted at Goethehaus, in Menteng on Monday the 21st of November, so if this is of interest, make sure you get along.

You can register and find more information at their Eventbrite page here.

As part of this visit, the Guardian is also asking people for their stories about how Jakarta is currently changing. If you’d like to contribute, you can find more information here.

NB: Kartika Jahja from Tika and the Dissidents will be on the panel too!

Disclaimer: This post is for general information of readers only. I have no relevant affiliations and am receiving no compensation for this post.

Event: Tusk Infrastructure Knowledge Series - Delivering Major Programs & Projects

Tusk Advisory are putting on a talk on delivering major projects in Indonesia on the 17th of November at the Pullman Hotel, presented by Dr. Atif Ansar, from the Said Business School at the University of Oxford.

The event is open to the public, and is free for government officers, and Oxford and Cambridge graduates; others will have to pay IDR 500,000. 

The flyer is embedded below:

If this is of interest to you, then head along and maybe I'll see you there.

Disclaimer: This post is for general information of readers only. I have no relevant affiliations and am receiving no compensation for this post.

What's wrong with directly appointing infrastructure projects to SOEs?

This post has been adapted from my article, Learning from Indonesian Best Practice: A Way Forward for Public Private Partnerships in Indonesia, first published in the October 2015 edition of IndII’s Prakarsa journal. In the context of the large budget cuts being made to stay under the deficit limit of 3% of GDP, the government is increasingly looking to other non-budgetary sources of finance. A key decision for policy-makers around Indonesia is between delivery by SOE, or by private parties. I hope this article provides some useful context for this decision.

I have written rather a lot about the need for PPP in Indonesia. While I do think PPP has a potential to create value for Indonesian society, I’m far from an ideologue on this matter. PPP is just one of a variety of modalities that government contracting agencies (GCAs) can choose from between when they need to deliver infrastructure services.

One modality that has historically seen a lot of action in Indonesia is direct assignment of projects to state-owned enterprises (SOEs); most notably with the Trans Sumatera Highway, Kalibaru Port, and the Jawa 5 power station. In this post, I want to talk about some of the pros and cons of directly assigning projects to SOEs, that I hope will provide a useful framework for thinking about how projects should be delivered going forward.

Pros

  • Speed of mobilisation: By being able to skip the tender process, which can take six months to a year (at least) the SOE may be able to get to work earlier than a private contractor.
  • Higher degree of Government control: If Government decides that it needs to renegotiate some aspect of the contract, perhaps to change the tariff or request a variation in design, these negotiations are typically easier to conclude with an SOE than with a purely private party as both parties view them as keluar kantong kiri, masuk kantong kanan* to some extent.
  • Track record of delivery: Indonesia has yet to deliver a single project through its PPP framework all the way to operation (though due to recent progress some are now close). SOEs, by contrast have been delivering toll roads, airport expansions, ports, water services, and a range of other infrastructure. Indonesia’s citizens, and their representatives in the GCAs want infrastructure. For a GCA, a bet on an SOE is much more of a known quantity, than a PPP process.

Cons

  • Lower confidence in efficiency of costs: Subjecting the eventual contractor to a transparent, open tender process provides the GCA with a high degree of certainty that the proposed costs are as close to efficient as possible. The SOE may indeed be the party that can deliver the project at lowest cost, and may well be willing to reveal this cost to a GCA, but without a tender process, a GCA cannot be certain of this.
  • Retained risk: When an SOE undertakes a project, it assumes various risks, including construction and operation risks. If these costs end up much higher than anticipated, historically Government has had to bail the SOE out through cash injections or tariff increases. If a private party inaccurately projects the costs of construction or operation, the private party and its lenders should be the only ones that lose money.
  • Delays in development of a large-scale project pipeline: Indonesia needs a replicable model that can deliver dozens of projects per year transparently and efficiently, rather than the handful that are being delivered by SOEs each year at present. PPP provides that model through its transparent tender processes and clear legal framework. Yet the model must be proven, both to private parties that would invest in projects, and GCAs that would propose them, before a pipeline of the magnitude that Indonesia needs can start to form. Appointing every potential project to an SOE may deliver that individual project faster, but delays the whole program from starting.

Summing up

There is a time and a place to award projects directly to SOEs, but SOE balance sheets are limited, and there is only so long that they can be the infrastructure providers of last resort. GCAs and those responsible for the delivery of infrastructure services to all of Indonesia’s citizens should consider carefully the pros and cons before awarding projects directly to SOEs in future.

*In English this roughly translates as “it goes out of the right pocket, and ends up back in the left pocket”, describing the fact that value transfers between SOEs and Government are viewed as shuffling money around under the same umbrella.

Mandatory CSR only makes sense where government is completely incompetent (and, even then, not really)

The Indonesian parliament is currently considering issuing a new law on Corporate Social Responsibility ("CSR"). I haven't seen a draft, but I understand that parliament is considering an article making CSR spending mandatory under law. 

Berita Satu quoted Komisi VII member Hamka Haq saying "There's not yet a decision, everything is still tentative. Some have said 2%, 3%, up to 10%" (translation mine). It wasn't specified in the article, but I understand the 2-10% figures mentioned refer to a percentage of revenues.

There are a range of competitiveness, and business arguments against mandatory CSR, which largely relate to the fact that it's a new tax, and new taxes harm Indonesian businesses and business-owners. My aim in writing this article isn't to take a view as to whether it harms businesses or competitiveness, but rather I'm aiming to explain whether it actually achieves a public development objective. (Hint: it doesn't).

Mandatory CSR effectively functions as a tax, with services delivered by a private party

As I noted above, forcing companies to spend on CSR activities, effectively functions as a tax. The idea is that the private companies take a proportion of their cashflows, and spend them on something that is good for society. This is also the philosophy behind taxation in general, except it's government spending on things that are good for society, rather than a private company.

You can see a simple calculation of profit and taxation in the table below:

Note that the effective tax rate with a mandatory CSR rate as a proportion of revenues changes depending on the profit margin.

Note that the effective tax rate with a mandatory CSR rate as a proportion of revenues changes depending on the profit margin.

As you can see, in Scenario 1, with no mandatory CSR, the government applies a tax rate of 25%, collects tax of 12.5. In Scenario 2, they decide to keep the impact of total mandatory "public interest" payments constant, with a 10% mandatory CSR rate, which creates a tax rate of 6.3%. This keeps the total transfers as 12.5 in total, but now 80% of that is delivered by the private sector, rather than the public sector. 

Another way to impose mandatory CSR is on top of existing taxes, where it now functions as an additional tax, modeled in Scenario 3, where the 10% mandatory CSR payment creates an effective tax rate of 40%, with "public interest" spending delivered equally by the public and private sectors. The equivalence to a scenario where government just imposes a tax rate of 40% is illustrated in Scenario 4.

So, as we can see, in a very simple model, mandatory CSR has identical impacts to taxes on returns to shareholders, and in spending on "public interest" purposes. But then, of course, the question arises: is private spending on public interest purposes equivalent to public spending?

Spending in the public interest is the government's job

One of the core jobs of government is to levy taxes on their citizenry and businesses, decide how to allocate those taxes, then actually spend them. Throughout that process, they are subject to a range of checks and balances, which can include auditors, parliamentary approvals, publication of governmental accounts, and so on. In a democracy, if a government does this incompetently--maybe by spending inefficiently, or on the wrong things--at the end of the day, it is likely to get voted out.

When a private company spends on CSR, it gets to decide what it wants to spend on, and doesn't have anywhere near the same level of scrutiny on its spending. Furthermore, private companies can't (and shouldn't be allowed to) spend on the delivery of major public-interest projects, like infrastructure, or defense, through their CSR. So, in imposing mandatory CSR, the government is taking money out of its consolidated revenue, and allowing private companies to decide to spend that money however they choose, say, on orchestras, or museums named after their major shareholders.

I'm not saying companies shouldn't be allowed to spend on orchestras or dubiously-named museums, but I don't want them to do so to the detriment of the government's ability to spend on infrastructure. Indeed, concerns about the efficiency of CSR spending mean that most developed countries put limits on exactly the types of CSR spending that is tax deductible at all.

The only way in which this sort of mandatory CSR policy is actually in the public interest is where the private sector better understands the needs of the public as a whole than the government, is better at spending than the government, and can address large-scale market failures and collective action problems better than the government. Given private companies can't (and shouldn't be allowed to) plan and spend on things like infrastructure, and defense through their CSR, mandatory CSR only actually creates value for the public where governments are massively incompetent.

But then, if the governments are so incompetent at governing that they can't deliver roads better than a private company can through their CSR, then they probably can't effectively monitor the CSR spending by the companies either. In such a case, you're even more likely to see this CSR spending on vanity projects, or more likely again, in transfers to directly-owned foundations that just transfer the profits back to the owners.

The Indonesian government is not that bad

The Indonesian public sector has its problems, like all governments, but I cannot believe that it is so incompetent that mandatory CSR makes sense. I hope this policy doesn't go much further than the wacana stage...

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.

Is Indonesian an easy language?

Last year, a bunch of talented and motivated young Indonesians and Australians formed an organisation named the National Australia Indonesia Language Awards (NAILA) to foster the development of Indonesian language learning in Australia through running an annual speech competition.

I entered the Executive category of the first ever NAILA speech competition last year, and was honoured to be chosen as the winner. You can see my rerecorded speech below, kindly recorded and edited by Klirkom*. 

I was very impressed by the NAILA team, and their creativity and dedication to put together an initiative like this. I also enjoyed meeting the team, and the winners of the other categories. I was particularly impressed by the fact that most of the other winners had never even been to Indonesia, yet had the diligence to learn to quite a high level. I have only ever successfully learnt languages to any degree of competence when I was surrounded by native speakers!

Entries are now open for NAILA 2016, and they have a range of categories from primary school, to executive, room for creativity, and even a new category for native speakers. If you want to test yourself, I would encourage you to apply; or pass it on to others who might. All of the information you need to apply is available at their website: www.naila.org.

As to the question posed in the title to this blog post: Is Indonesian an easy language? Well, you'll have to watch the video to find out what I think!

* If you're thinking of applying, please don't be put off by the fact that it's professionally shot! My very poorly lit winning entry was shot in my bedroom, with my daughter crashing around in the next room!

If Australian consumers can't get what they pay for, what does that mean for Indonesians?

Back in December, I posed the question: what's worse than paying peanuts and getting monkeys?

You can feel free to read the post, but the the tl;dr version is: paying good money, and still getting monkeys. I used this English saying to illustrate the gap in Indonesia's institutions that hold Indonesia's producers and retailers to account for delivering products as advertised. I contrasted Indonesia's institutions with Australia's, and made the claim that Australia's institutions were more credible than Indonesia's, meaning Australians were more likely to get better products at the right price than Indonesians.

The other day, a friend shared the following picture on Facebook, put out by CHOICE, an Australian, independent consumer organisation.

You can read CHOICE's full write-up here. In short, inspired by a similar test conducted in the United Kingdom, CHOICE decided to test 12 different packets of oregano from supplier that, in aggregate, make up more than 80% of the brand value of the herbs and spices market in Australia. Of those 12, only five were 100% oregano. The 7 that were not are pictured above.

While CHOICE has no authority to leverage fines, or impose direct penalties, the brand damage that can result from revelations like this can be severe. 

I wanted to use this to illustrate that the presence of Australia's institutions like CHOICE, the ACCC, and so on alone does not mean that unscrupulous retailers and suppliers won't try to misrepresent the contents or quality of their goods, but it increases the chance of detection, and the threat of bad publicity, fines, or even criminal charges if they are caught doing so.

So, while revelations like this are embarrassing, and you don't want to see them too often, they are evidence that the system works, and a good warning to people throughout the supply chain that they'd better be sure they're selling what they claim to be selling.

My other favourite example of this from a developing country was the New York Times's expose of sellers of herbal supplements in New York. They reported that  the New York State Attorney General's Office had "run tests on popular store brands of herbal supplements at the retailers — Walmart, Walgreens, Target and GNC — which showed that roughly four out of five of the products contained none of the herbs listed on their labels. In many cases, the authorities said, the supplements contained little more than cheap fillers like rice and house plants, or substances that could be hazardous to people with food allergies." [emphasis mine]

So, if things like this can happen in Australia and the United States, where there is the credible threat of exposure, and massive bad publicity, imagine what it must be like in Indonesia, where no such credible threat exists!

As always, caveat emptor!

What the hell is going on in Nias between PLN and APR?

Last week APR Energy, a US-owned provider of electricity generation published the following open letter, indicating that they are intending to shutter their Nias plant, and pull out of the Indonesian market.

Source: APR Energy

Source: APR Energy

My (unofficial) translation of the letter follows:

Open Letter to the People of Nias

Dear citizens and business owners of Nias;

Since 2013, APR Energy has worked to give You electricity supply that can be relied upon.

Unfortunately, PLN has not yet paid our invoices. That company has not respected its contract with us. But PLN continues to collect money from the people of Nias for the electricity that they use.

As a result of PLN’s actions, we cannot continue our operation in Nias—or anywhere in Indonesia. At the end of May, we will permanently close our generator with total capacity of 20 MW.

Although we will leave, we would like to protect the people of Nias and ensure that you can still get electricity. Because of that, we have offered to sell our generator in Nias to PLN.

Unfortunately, PLN has not yet responded to our offer.

Please understand that our decision to leave Nias has not been easily undertaken. We regret the consequences that will occur with the closing of our generator. But we are also a business that has employees that work so that they can support their families. If we are not paid, we cannot pay our employees, and they are our most important responsibility.

Because PLN has refused to pay our invoice and to respect their obligations under their contract with us, APR Energy has no choice but to leave Nias at the end of May.

Our regards,

John Campion
Head and Chief Executive Officer

It is difficult to get a straight chronology of the dispute from the media, but all sources agree that it started with a dispute between PLN and APR Energy over their diesel generation facilities serving the city of Medan. The gossip around the market is that PLN requested a significant discount on its existing contract, and APR Energy refused to provide it, so PLN stopped paying them. Following this, APR Energy pulled their generators out of Medan, and warned PLN that they would do the same in Nias if their invoices were not paid by 31 March 2016.

Despite the warnings, by the deadline, PLN had not paid. So, at midnight on Friday 1 April 2016, APR Energy stopped generating, and the island of Nias--home to almost 800,000 people--went black. The estimates of the outage vary, Kompas reports that it was total blackout for at least 2 days after which time, they mobilised 17 separate generators, which would only meet 26 percent of the estimated peak load. Some other sites put the timeline at 12  or 13 days! I want to repeat again that this is an island home to 800,000 people!

Finally, the dispute was resolved, and PLN paid APR Energy’s bill after a mediation process where the US Ambassador was reported as getting involved. Although, according to the letter, which is undated, but which I first saw circulating on Whatsapp, then in Indonesian language media on the 18th of May, APR Energy is still pulling out of the Indonesian market.

Why this matters

The Indonesian government is currently making a big effort to improve its investment climate, vowing to improve Indonesia’s ranking in the World Bank’s Doing Business Index from 109 out of 189, to number 40 by 2017.

I have previously given PLN kudos for, among other things, their track record as a reasonable contractual counterpart. Looking from the outside, it difficult to assign fault in the dispute, but contractual disputes resulting in 800,000 people spending days in the dark, then the company packing up and leaving the market in frustration aren’t something you see when things are going smoothly. At the very least, the process was exceptionally poorly managed by PLN.

Whatever precipitated this, I hope the President’s office, Ministry of Trade, and PLN management take a good look at this case study to make sure that we don’t see too many more stories like this.

Palapa Ring: Indonesia signs two PPP concessions in a week, which is good, but not great news

Indonesia's Ministry of Telecommunications and Information Technology has now signed both the West and Central packets of the Palapa Ring, worth IDR 1.7 trillion and IDR 4 trillion in present value terms respectively.

As I have previously written, the quick progression of these projects is good news for Indonesian PPP, which is in sore need of it. I say "good" here, rather than "great" because, while it's definitely not bad news, there is one key aspect of the deal that limits the demonstration effect.

What we know about the deal structure

The concession agreements have not been made public (though, I think there are good reasons to do so), but some details are emerging about the structure of the deal. Various sources have reconfirmed that it is indeed an availability-payment PPP, meaning the government bears full demand risk (which I think is appropriate for lots of Indonesia's projects, more here and here).

This is the availability payment that you've heard so much about, provided for by Presidential Regulation 38/2015 (despite the fact that PLN had been doing availability payments for decades), but these two projects' availability payments differ from what was envisioned by the drafters of Perpres 38/2015 in one key way: the funds don't come from the Ministry's budget directly, but from Universal Service Obligation fees collected from Indonesia's telecommunications operators.

Indonesia's Universal Service Obligation

Indonesia's Ministry of Telecommunications and Information Technology levy a fee on telecommunications service providers. This is called the Universal Service Obligation (USO) fee, and is charged as 1.25% of gross revenues of all operators. In 2015, the number was expected to be IDR 1.3 trillion.

The funds collected through this channel are funneled into a government body under the Ministry known as the Balai Penyedia dan Pengelola Telekomunikasi dan Informatika (Body for Provision and Management of Telecommunications and Information Technology, or BPPTI). The idea is that these funds are used to enhance telecommunications access to customers for whom providing service is uneconomic.

What is the difference between paying availability payments from the USO and from the budget?

As far as I understand it (please comment and correct me if you know better), the USO funds are paid directy to BPPTI, and can then be used by the Ministry for approved purposes without prior approval from the Ministry of Finance.

This differs from the normal budgetary process, where the Ministry needs to submit a request, substantiated by particular activities, that are included in the draft budget by the Ministry of Finance. This draft budget forms a draft budget law, which becomes the national budget law if and when it is approved by the parliament. If you want to see an example, check out 2016's budget law UU 14/2015 here.

Indonesia's annual budget cycle means that, in theory, a ministry has no legal standing to sign contracts that stretch over multiple years because their budget in that year is subject to approval by parliament. A ministry signing any sort of multi-year contract oversteps their authority, and preempts the parliamentary process.

I bolded "in theory" above, because, in practice, this is nuts.

In practice, Indonesia is going to have something resembling a Ministry of Telecommunications and Information Technology, or Ministry of Transportation, or a Ministry of Public Works and People's Housing for a very long time; much longer than the 30 year maximum length of PPP contracts in Indonesia. In practice, while the value of hypothetical PPP payments can be large in absolute terms, they represent tiny fractions of the ministries' overall budgets.

To say that committing a tiny fraction of a ministry's annual budget decreases Indonesia's budget flexibility going forward is drawing an extremely long bow. Yes, it is theoretically true, but the impact is negligible, and far, far outweighed by the increased value that can be created by using contracts that actually create incentives for the contractor to deliver on time, on cost, with good quality, and with the  lowest life-cycle costs.

The other bizarre thing about this challenge to PPP projects is that it doesn't seem to be insurmountable for other kinds of multi-year contracts. The Ministry of Public Works and People's Housing have been constructing infrastructure like dams and bridges (which sometimes need more than 12 months construction, and you can't just stop in the middle of to retender), through multi-year contracts for years*. 

Taking availability payments from the USO fund limits the demonstration effect

One of the keys reasons I think delivering a PPP project is so critical for Indonesia is because of the demonstration effect. Indonesia desperately needs to demonstrate to both private investors and government contracting agencies that PPP is a model that can work (I wrote more about this  in my first post on the Palapa Ring project).

The first few test-cases of a new policy framework will always be pathfinders, to some degree. It is expected that they will run into problems. When they do, policymakers need to try to understand why to see if the policy framework is working as intended. 

The Ministry of Telecommunications and Information Technology's relatively large source of non-national budget funds is fairly unique in Indonesian infrastructure. This means that, for example, the Ministry of Public Works and People's Housing can't use this project model in trying to convince the Ministry of Finance that it should be allowed to use the availability payment scheme for the delivery of road projects. 

This is still definitely good news

Despite my reservations about the demonstration effect for those government contracting agencies that want to do availability-based PPPs, this is still definitely good news. These projects have proceeded from pre-qualification to award within an appropriate timeframe, and had a wide range of national private, state-owned enterprises, and international bidders. 

Even if the demonstration effect for availability payment projects is minimal, it's still the best news in Indonesian PPP for a long time!

Bonus appendix: Taking funds from the USO is probably sensible anyway

I really shouldn't complain about the fact that the availability payments aren't coming from the national budget, because it may actually be the case that it's most appropriate for payments to come from the USO.

I haven't read the USO regulations in enough detail, but from what I can see, paying for availability payments like this seems consistent with the intentions set out for the pool of funds. Please do correct me here if you know more.

As I wrote in an early blog post about the idea of "user pays": as far as is productive, we should generally seek to impose the costs of a service on the users of that service. Taking funds from the USO, rather than general budget funds, does put the cost of maintaining the backbone fibre optic network on the users, which is consistent with the idea that the user pays.

So, those responsible for delivering the Palapa Ring projects shouldn't let me rain on their parade too much!

*Multi-year contracts have their own major challenges, and need to be drastically scaled up, but this is slightly to big a topic for a footnote.

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.

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.

PLN's pipeline of deals continues to flow

IJ Global is reporting that the Request for Proposal has been issued to bidders on PLN's Jawa 1 2x800MW gas-fired, combined-cycle power project. 

The procurement process was launched in May 2015 and, while, I understand, the issuance of the RFP was postponed, reaching issuance of RFP within 8 months isn't bad for a project of this magnitude.

IJ Global are also reporting that China Oceanwide, PJB and Shanghai Electric consortium is rumoured to be the preferred bidder for the Jawa 5 2x1000MW coal-fired project. 

According to this presentation on BKPM's website, tendered 7,600MW of capacity in 2015, and anticipates completing procurement for 37 projects, representing 14,887MW of capacity in 2016. 

PLN IPP Procurement division, Market Sounding: IPP Procurement in 2016 presentation. 8 December 2015. Presentation available here

PLN IPP Procurement division, Market Sounding: IPP Procurement in 2016 presentation. 8 December 2015. Presentation available here

As I wrote in my article in Prakarsa, Learning From Indonesian Best Practice: A Way Forward for Public Private Partnerships in Indonesia, PLN has figured out a model that can deliver a significant pipeline of projects that are attractive to private sector investors, delivered via transparent tender processes that maximise value for money.

Another critical thing that PLN has demonstrated is that this model is scalable. When pressed by Jokowi to deliver the 35,000MW program, PLN has shown an ability to dramatically accelerate their pipeline of projects being delivered to market.

When I worked in private advisory, I would typically have 2-3 meetings a month with people wanting a briefing on infrastructure investment opportunities in Indonesia. Usually these people had heard of the government's ambitious targets to get hundreds of billions of dollars of investment over short time periods. The meetings weren't usually very long, because there were literally no opportunities, other than trying to buy assets on the secondary market, or as service providers to SOEs, or infrastructure delivery ministries that were the only ones delivering projects!

Now, the message is very clear: go to PLN.

As I said in my Prakarsa paper, those proposing projects in other sectors are now in direct competition with PLN for investors' money. If they want to pull investors away from PLN, they should try to emulate their model, as it's clearly working.

I wonder how long it will be until our PPP pipeline looks like this*.

*Or even like the Philippines'.

Here's the full letter banning Gojek, Uber, and others

Indonesian social media has exploded this morning with the news that Gojek, Uber, Grab Bike, Grab Car and all other app-based transportation services have been banned by order of the Minister of Transportation.

The implement of the supposed ban is surat pemberitahuan, or circular letter No. UM.3012/1/21/Phb/2015 sent to the head of the National Police, and copied to the Coordinating Minister for Politics, Law and Defence, the Coordinating Minister for Economic Affairs, all Governors of Indonesia, all regional heads of police, the head of the traffic corps of the National Police, the Director General for Land Transportation, and the Chairperson of ORGANDA.

Aktualita thoughtfully posted the full text, which I am reproducing here:

If you can't read Indonesian, in short, it says that the services named in paragraph one (Uber Taxi, Go-Jek, Go-Box, Grab Bike, Grab Car, Blu-Jek, Lady-Jek) are not in line with various laws and regulations governing traffic and road transportation. The letter asks the police to take steps in accordance with the laws.

Predictably, in the face of massive popular protest, and even personal intervention by the President, the Minister of Transport has clarified that all named services can keep operating, as reported by Detik.com. 

So, after one ill-conceived policy, Jakarta has had a morning full of sound and fury, ultimately signifying nothing. 

These sort of extreme policy backflips are regrettable, and don't do a lot to help build Indonesia's reputation as a stable place to do business... Hopefully we see less of these going forward.

If regulation of taxis and public transport interests you, I previously wrote about it here.

Consumer protection job: AIPEG/SMEC

If my previous post was interesting to you, you will be pleased to know that SMEC, via the Australia Indonesia Partnership for Economic Governance (AIPEG), are currently looking to hire a Consumer Protection Strategy Adviser to advise the Indonesian government on exactly those sorts of issues. You can see the job ad here.

They're looking for an experienced hire, so if anything in my blog post was news to you, the job probably isn't for you. If you're experienced in this field, give it a go!

Disclosure: I am currently employed by SMEC, to work for AIPEG, but I work in a different team, and have no role in the procurement, or evaluation of any candidates. I am linking to the job advertisement in my private capacity as a blogger, and for the general interest of my readers only. Please do not contact me for more information about this job.

What’s worse than paying peanuts and getting monkeys?

I’m currently in the market for a motorbike helmet. I was shopping around the various options in Jakarta and was frustrated by the lack of reliable information about safety standards available to me to inform my purchase.

The frustration I felt is by no means unique to me, nor to the problem of buying motorcycle helmets. In fact, it’s an example of something that is quite the hot topic in development economics these days, so I thought I’d write about it.

Lack of reliable information for consumers harms the economy as a whole

I’m not the sort of guy that places a high premium on brands, and I try not to buy into the idea of conspicuous consumption. I generally try and go for the cheapest product that meets my needs. In the case of a helmet, that means providing an adequate degree of protection to the contents of my skull, in the event that I were ever to need it while riding my motorbike.

When I was looking for my helmet, I noticed a huge range of prices available. People were selling helmets that, to my very untrained eye, looked very similar for prices ranging from IDR 3-4 million, to less than IDR 100,000.

Some of these things are not like the others

Some of these things are not like the others

In English, we have a saying: if you pay peanuts, you get monkeys. A similar one is: if you buy cheap, you get cheap. In short, it means, if something is cheap, there’s probably a reason for it, and that reason may be that the quality is poor. In Indonesian a similar distinction is made between murah meriah (cheap and cheery), and murahan (cheap and nasty).

The problem is, the converse is not always true. High price doesn’t necessarily denote high quality. The only thing worse than paying peanuts and getting monkeys, is paying real money, and still getting monkeys! There are plenty of examples of this, including bottled water in places where tap water is perfectly drinkable, or where people drink expensive wine at all.

So, when I was looking at the helmets I wanted to buy a quality one, I was wondering: would I be paying for true quality, or for the illusion of quality?

Government regulation to the rescue!

Helping consumers get what they pay for is one of the things that almost everyone can agree is the job of government. Even the nuttiest of small-government libertarians accept that we need a government to protect against fraud. Well, maybe not the nuttiest ones...

In the absence of a government holding people to account for misrepresenting the quality of motorcycle helmets, you have to expect that there will be unscrupulous firms misrepresenting the quality of their helmets, if there is a dollar to be made doing it.

In a world were fraud is unprosecuted, the money transferred to fraudsters, and the time and money spent by individuals trying to verify quality for themselves with only the tools and knowledge available to them as an individual represents a market failure. It is cheaper and more effective for some sort of centralised body to set, test, and enforce standards. The centralised body doesn’t necessarily have to be a government, there are cases where industry associations perform this function adequately, but in many cases, people are sceptical of an industry’s ability to regulate itself and government oversight is required.

My lack of certainty in the Indonesian motorcycle helmet industry’s ability to deliver me a quality helmet at the right price is due to my lack of confidence in what development economists call Indonesia’s instutions.

Institutions have been arguably the hottest topic in development economics for the past decade or so. This paper by Acemoglu (one of the key proponents of the idea), Johnson and Robinson gives a comprehensive treatment, while this one from the World Bank, also by Acemoglu and Robinson, gives a slightly updated view. Ha Joon Chang takes a slightly more sceptical view here, but his scepticism is more about the policy recommendations of people like Acemoglu than the idea that institutions are important.

The big idea of instutional economics is that poor countries aren’t poor because they haven’t got any money (or, at least, it’s not just that), a large part of why they are poor is because their institutions don’t let them use what resources they do have efficiently.

In Australia, I wouldn’t have such a big problem, because we have a range of institutions in place that set standards for motorcycle helmets (Standards Australia, here), and test them (the delightfully named Consumer Rating and Assessment of Safety Helmets, or CRASH), and punishes companies that either sell or manufacture helmets that don’t meet standards (the Australian Competition and Consumer Commission, or the ACCC, here). They’re not perfect, but they have been doing it long enough and competently enough that retailers and manufacturers of motorcycle helmets (and other providers of goods and services) have a reasonable degree of certainty that they will get in trouble if they fundamentally misrepresent the quality of their product.

In Australia, relatively secure in my trust in our institutions, I’d just buy the cheapest helmet that met the standards, and be on my bike. From what I can see, it seems like the cheapest ones in Australia retail for about AUD 100, or around IDR 1 million.

In Indonesia, some of these institutions exist, such as the Badan Standardisasi Nasional, and the Yayasan Lembaga Konsumen Indonesia, and the Komisi Pengawas Persaingan Usaha, but I don’t think it’s too unfair to say that your average seller of cheap helmets on Tokopedia doesn't worry too much about the wrath of any of those institutions.

In Indonesia, standards do exist for helmets set by the Badan Standardisasi Nasional and, in theory, all that meet those standards should have an SNI stamp on them. Despite this, there are plenty of helmets for sale on Tokopedia, and through plenty of other retailers including major hardware stores and grocery stores that claim to have SNI helmets for sale for IDR 100,000 (AUD $10), or less.

SNI for IDR 80,000? Really?

SNI for IDR 80,000? Really?

When development economists use the word “institutions” they don’t just mean BSN, YLKI, and KPPU, they mean every single piece of Indonesia’s economy that contributes to the delivery of helmets to consumers, and governs the use of those helmets by consumers. This includes everything from the institutions I mentioned, to plastics manufacturers, to trucking companies, to the traffic police that are meant to check that motorcyclists’ helmets meet standards, to the court system that is meant to prosecute people that put fake stickers on helmets, to the individual consumers themselves who don’t demand or even expect helmets with legitimate SNI stickers, and so on, and so on.

The fact that I can see a helmet for sale on Tokopedia for IDR 80,000 makes me question the ability of the entire network of institutions that make up Indonesia’s motorcycle helmet industry to deliver me accurate product quality information.

So, what can we do?

One of the lessons that we have learnt in development economics over the past few decades is that solving the problem is not as simple as just saying “oh, it’s the institutions", and walking away. Given the complexity of the networks of institutions that are involved in delivering goods and services to consumers, it’s naïve to think that a single policy change, or the establishment or reform of a new institution will magically turn the Indonesian motorcycle helmet industry into the Australian motorcycle helmet industry.

Sometimes it is the case that a particular regulation, policy, or institution is acting as a key constraint, so reforming it can make a material change. But the biggest thing that creates change, and development in institutions is time. Over time, each of these individual small reforms, and the actions of the regulators, contribute to changes in the expectations of consumers and producers, which will eventually lead to consumers being delivered better quality helmets at more appropriate prices.

People can often forget that societies like Australia are built off a set of institutions that have been under development under a relatively stable system for over 200 years; and even those institutions are based off developments in the UK for going-on 500 years. By contrast, Indonesia’s institutions have undergone at least four major periods of upheaval and fundamental redesign in the last 70 years; the latest of which was less than 20 years ago!

Despite this upheaval, Indonesia does have the institutions in place that should, eventually, deliver a market for motorcycle helmets that is functionally equivalent to Australia’s. And, given where Indonesia have come from, they’re doing about how you’d expect. They could be better, but they could definitely be worse!

While I’m waiting for the institutions to change, I’ll try and do my part as a consumer by communicating my desire for good quality at an appropriate price… I ended up going through a small, but reputable company, and I bought a helmet that cost IDR 1 million: about what one that meets Australian standards costs in Australia. I don’t have any guarantee that it does meet Australian standards, but at that price, at least there’s a chance that it does!