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Interview

with James Castle, Director, CastleAsia

23.01.2008 / Energyboardroom

With over 30 years experience in Indonesia, you are in a unique position to assess the country. Will you please give us an overview of the current domestic economic situation?

In 2008, Indonesia has finally moved beyond the 1998 financial crisis, although even 10 years later, Indonesians constantly refer to the economy as pre- or post-crisis. It remains a watershed and traumatic event in the country’s history, but 2007 saw the highest growth rate since 1996, and the first time over 6% since the financial crisis. The economy is now looking forward, with only a few residual problems remaining.

With the Indonesian economy’s current strong momentum, the country is finding more uncertainty globally, rather than domestically, from issues such as the US credit crisis. Growth in 2007 was between 6.3-6.5%, and prior to the poor outlook in the US, projections for 2008 were even stronger. Despite a potential global economic slowdown, forecasts still call for domestic growth of at least 6%, a good year by any standard. Indonesia is in a good situation, and is helped by the strong global commodities cycle, as an exporter in many different commodities from agricultural to mineral, not just oil and gas. In oil and gas, Indonesia is a smaller player in the global scene, compared to its status as a major player in exports of palm oil, copper, gold, and coal. Nevertheless, its exploration potential remains high for traditional fuels and it offers excellent prospects for coal bed methane. Hot sectors for Indonesia in 2008 and beyond include infrastructure, oil and gas exploration, and coal, the latter being an especially robust sector.

Despite this optimism, if you compare Indonesia to its neighbours in terms of foreign investment, it still lags behind. What is the source of this disappointing reality?

It’s a case of looking at the glass as half empty or half full. There are a variety of reasons for this apparent lag, but the bottom line is that if growth is over 6% when investment is lagging, when levels of investment finally do increase, growth will be even higher. With one hand tied behind its back, Indonesia is achieving 6% GDP growth. And when there is higher foreign investment there will be growth rates of 8-9% like China and India. In many ways it’s frustrating to not be at these levels currently, but much of the lag is attributable to a new governmental system and interest groups, whose interests and influences take time to absorb. The country is headed in the right direction, and it is worth some delay for the long-term benefit of the new democratic political system. Tensions are low, and there is virtually no violence during elections when compared to other Asian countries like Thailand or the Philippines. This is quite an achievement. Stability is something to be grateful for, and shows something positive about the national state of mind. Indonesians are focused on getting ahead and improving their economic standing and generally agree that their government is moving in the right direction, even it development is slower than most would want.

Looking beyond this agreement, some people complain that the introduction of democracy makes everything more complex for business.

Yes there are those who complain, and often these are the same people who were angry in the last 10 years of Suharto’s regime when he was giving big government contracts to his children. Such people tend to have selective memories. In the old days, projects were parceled out based on connections, so even incompetent players – as long as they were well-connected – did fine. Now, this group is suffering because there is no single, powerful figure or agency to award projects in the transparent manner that democracy demands. However, their current difficulties are due to their failure to develop competence during their privileged period and few people have sympathy, because they missed their chance when it was time to reform. Other companies like Medco and EMP who did well in the Soeharto era are also doing well now. They developed competencies to augment their political strength. Among the losers who were the beneficiaries in the old days but did not develop technical competence, there are still important people who complain, but again, there is little sympathy.

What is the main factor holding Indonesia back from realizing its potential?

Largely, Indonesia’s bottleneck is infrastructure. The country does not seem able to create the right regulatory framework to attract private sector money. There is real interest from the private sector, and every infrastructure conference is filled with investors who want to write cheques, but the government is not offering terms and conditions that are financeable. This results in an overall lack of investment in infrastructure, from both the private and public sectors. Government infrastructure investment, which was running pre-crisis at 6-7% of GDP, dropped down below 2% of GDP post-crisis, and it was only 2005 or 2006 when the figure again rose above 4%, which is the figure considered at the bottom end of satisfactory investment for a developing economy. If we look at other Asian countries such as China and Vietnam, they spend much more, and Indonesia could easily reach those levels and beyond if there is a more attractive financial environment for private investment.

You mention China, which is part of the rising BRIC countries that are redefining the world economy. If we look at Indonesia in terms of size, population, and resources, it has all the necessary elements for success, yet nobody associates the country with these other emerging economies. What will it take to put Indonesia in the spotlight?

Indonesian opportunities have often been undervalued, and the country consistently ranks lower as a good investment destination than it deserves. Indonesia‘s grew 6-7% per year for 25 years prior to the Asian Crisis, sustained period of growth that the BRIC countries — China, India, Brazil and Russia — have yet to achieve, although each may be on its way. There are several reasons Indonesia has been kept out of the spotlight. In Europe, for instance, the Suharto government was a political pariah for several decades, and the East Timor issue was very contentious around the world. To compete with the BRIC countries, what Indonesia needs is foreign investment. US investors have a strong presence in oil and gas, financial services, and banking, but that’s all. Only Japan has consistently taken advantage of the broad range of opportunities Indonesia offers. In one way, this is logical because Indonesia is in Japan’s backyard, much the way that Mexico and Canada are related to the US. Korean and Taiwanese firms are also serious manufacturing investors here. Again, it is their backyard too. And much more investment from India and China can be expected in the next decade.

After years of instability, Indonesia still has image problems despite currently having good fundamentals. Can you comment on foreigners’ perceptions of the country?

Indonesia can be a difficult country for newcomers because its regulatory environment is less transparent than some its neighbors. But with familiarity comes understanding. There are difficulties with the government, for example, which has contradictory regulations in some areas. As a result, Indonesia has more Asian investors, as they come from complex regulatory environments, as opposed to American or European investors who may be intimidated because they are used to much more legal clarity than Indonesia currently provides.

Indian companies, example, may be more comfortable doing business here than those from some other countries because they have already mastered the own complex bureaucratic and regulatory environment. Companies from mainland China are also starting to invest abroad, including in Indonesia. Their focus, however, tends to be in resource exploitation and major projects, rather than manufacturing. And the Chinese investors tend to be large state-owned companies as private companies from the PRC have not yet started to go abroad in a significant way. And Chinese state-owned companies are very similar to there brethren elsewhere, in that they tend to mover more slowly and sometimes have political and strategic considerations beyond the usual profit motive that drives private companies.

Is the skyrocketing price of oil and gas a positive thing for Indonesia? Minister Purnomo claims that the windfall is positive, because although the subsidies are more expensive, there is benefit from higher export prices.

The minister is correct in saying that the numbers are net positive, but this balancing act comes at a huge cost because of large subsidies for domestic fuels. The subsidies are fiscally sustainable at current prices but not wise, and tremendously distortive. They are one of the key reasons the sector has not grown domestically. Twenty-five years ago, Pertamina was far ahead of Petronas. That is no longer the case. Technically and financially Pertamina has fallen behind. This is because of the more negative elements that frequently burden SOEs, a heavy subsidy burden, and the multiple roles Pertamina is required to play. Pertamina’s current President, Ari Soemarno, is trying very hard to make Pertamina work like a company and get it ready for a partial public listing, but it’s a difficult job.

The issue of subsidies is complicated by the fact that the national government pays 100% of the subsidy but keeps only about 80% of the revenues. This is because some of the revenues are distributed, by law, to regional governments. Higher prices cause higher subsidies and therefore a higher burden to central government finances. The Megawati government missed a big chance in 2003 by ending indexed gasoline prices, and the current government missed an opportunity in 2005 when it raised prices, but kept them at a fixed level, rather than returning to indexing. Subsidies are always a problem because they benefit the wrong people, miss targets, and create economic distortions and inefficiencies. Politically, it’s a drug that is difficult to quit, and there will not be any change until after the presidential election in 2009.

As a consultant to many companies, CastleAsia is a barometer for new foreign interests in the oil and gas industry. Have you seen an increased demand for market-entry strategies in recent years?

Yes, and the interest is very real. Most oil companies, even those without current contracts, are watching the market closely. Marathon returned to Indonesia two years ago, and Murphy Oil has set up an office to bid on PSCs. Companies are often frustrated by the slow pace at which the government offers new blocks for bids and delays in getting work plans approved. These kinds of problems keep Indonesia a rung or two lower on the new investor’s ladder than would otherwise be the case. Despite all this, companies are very interested in Indonesia, and current oil prices make the offshore fields look much more attractive.

When a company is interested in coming to Indonesia, what kind of services do they request from CastleAsia?

It depends on the industry, because oil and gas is a very different sector with different rules when compared with manufacturing or financial services, for example. Many big oil companies are already quite knowledgeable about Indonesia, and may have employees who are familiar with the market or with previous work experience here, Indonesia is well-known in the industry. Large manufacturing companies, on the other hand, may have nobody who has ever worked in Indonesia.

So oil and gas companies tend to be quite savvy, but feel CastleAsia can help them better understand and monitor current political and economic considerations, and provide valuable contacts through our CEO program, where top executives of over 100 major companies, including most of the major oil and gas companies operating in here are members. CastleAsia also provides a fortnightly five-page business highlights a monthly alert on Indonesian politics and the oil and gas market, and semi-annual macroeconomic forecasts. We also provide customized reports and briefings and help companies develop and implement action plans.

CastleAsia wants to position itself as a point of reference in Indonesia. What do you offer in order to achieve this goal?

CastleAsia has changed its business model significantly over the past decade as a result of the Asian Crisis. The company once did a lot of industrial research, which went from 60% to 0% of business in the three years after the crisis. Now, we are focused on services for companies that are already here, primarily the CEO program, which is called the “Indonesia Country Program.” CastleAsia makes it relevant to a broad range of companies rather than specific sectors. Our special niche is understanding and interpreting the political economy and the regulatory environment. As I have personally worked on a number of national commissions, we have a good understanding of the regulatory environment and how the processes work. This gives us a unique perspective of local developments that we can transfer to members of our CEO program and other clients.

You have very good relations with international companies, but how are your relations with the government?

Basically, the bottom line is longevity. There are many bureaucrats that CastleAsia has known for ten or twenty years. Over time, many have risen to very senior positions. Because they have known the company for a long time, they know that we operate above board and have the best interests of the country and investors at heart. One reason CastleAsia is active in the chamber of commerce and other international business organizations is that our participation raises the company’s profile and demonstrates our commitment to economic growth and reform. The Indonesian Chamber of Commerce (KADIN) has become a much more dynamic and important organization over the past decade. The American Chamber of Commerce (Amcham) and the International Business Chamber (IBC) have built strong links with KADIN. As past president of Amcham and the founding chairman of the IBC, I have been privileged to play a role in developing this cooperation. It has also allowed me to demonstrate our commitment not just to corporate profitability, but to the long term development of the country and its institutions.

What is your final message to oil and gas investors who are interested in entering Indonesia?

It’s almost a cliché: Indonesia offers tremendous opportunities, but it takes patience to realize them. Indonesia is not for everybody because many companies don’t have resources to be patient. But in the oil and gas industry, it’s a necessary place to have an informed view about. Over the next decade terrific opportunities are going to present themselves, and it’s important to be able to make informed decisions when opportunities arise. This is a country where it’s worthwhile to take small positions as a market entry tool, to build a network that will help you recognize and respond to bigger opportunities when they arise.

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