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A Jump Start For Jakarta
Carlton Delfeld; Chartwell Advisor, 09.21.05, 6:00 AM ET
There are two types of political leaders: pie cutters and pie bakers. Pie cutters attain and maintain power by slicing the economic pie to placate opponents and reward friends. Pie bakers focus on making the economic pie larger so that the whole country moves forward.
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Indonesia's President Susilo Bambang Yudhoyono, a combination of general, intellectual and bureaucrat, has been both a baker and a cutter during his first 11 months in office. But with the economic crisis caused by a weakening rupiah, a stock market swoon, and budget-busting petro subsidies, he needs to plant himself in the pie-baking category fast.
Many would categorize Indonesia as a relatively poor country, but I beg to differ. I have toured Indonesia from tip to tip, and it is a country with many assets, great promise and it is strategically positioned to benefit from Asian growth. Three times the size of Texas with the world's fourth largest population, it is rich in natural resources and has a talented and young population. As a relatively young democracy with a developing economy, it lacks two important ingredients for economic growth: capital and a fiscal system to allocate it wisely.
Let's focus on just one important aspect of Indonesia's natural wealth that could dramatically jump-start its economy and stock market while unleashing resources for badly needed education, health and infrastructure: oil and natural gas. There has been much in the press about the staggering burden of the fuel subsidies--$7 billion in 2004 and about $14 billion expected by 2005. A bargain must be struck quickly--sharply reduce the fuel subsidies and in turn, increase spending on education and urgent health projects such as polio immunization programs.
But perhaps a more important issue than the fuel subsidies is that Indonesian energy production is far below its potential.
The way that oil production has been handled over the past few years is worse than a blunder and is close to a crime. Indonesia has 10 billion barrels of proven and potential oil reserves and 180 trillion cubic feet of proven and potential reserves. Nevertheless, Indonesia, Asia's only member of OPEC, became a net importer of oil in 2004.
This production shortfall is primarily due to insufficient investment and delays in awarding exploration and production contracts. Let's look at one example, ExxonMobil's Cepu block project. ExxonMobil (nyse: XOM - news - people ), in various corporate incarnations dating back to the reign of John D. Rockefeller, has operated in Indonesia for a century and invested $17 billion in the country. It agreed to explore the dormant Cepu area years ago and by using advanced technology, found proven oil reserves of 600 million barrels and 1.7 trillion cubic feet of gas.
Prepared to invest $3 billion to develop the project, ExxonMobil has been waiting for two years to move forward, while Indonesia's state-owned energy company Pertamina has been haggling over problems such as the government's insistence on a $400 million up-front signing bonus. That's right, it wants $400 million from ExxonMobil before it risks $3 billion of shareholder capital to develop the Cepu block. Meanwhile, Indonesia's oil production levels have fallen to less than 900,000 barrels a day.
At peak production, Cepu would provide Indonesia's government about $2 million per day in revenue, add 180,000 barrels a day in production and eliminate gas shortages in East Java. There are other projects that could be moved forward and in total could lead to baking an economic pie that could help lift all of the Indonesian people. Moving ahead with these projects would jump-start the economy and bolster the confidence of foreign investors and capital markets. This is certainly a better option than sharply raising interest rates, which chokes economic growth and makes badly needed capital even more expensive.
Due to financial pressures on the Indonesian Government, a 30-year production sharing agreement with ExxonMobil was signed this weekend. This is a big step forward in solving Indonesia's energy shortfall and reassuring international investors of the government's commitment to market reform.
The closed-end Indonesian Fund (nyse: IF - news - people ) is the best vehicle to invest in Indonesia. It is managed by Credit Suisse Asset Management and has come down from a March 2005 price of $6.99 and a premium of 8% to net asset value a current price of $5.76 and a discount of 2% to net asset value. The Indonesia stock market was up 47% in 2004 and is now trading at about 11 times earnings, which is in line with the MSCI Emerging Markets Index.
Indonesia has taken the brave step of opening its financial-services sector to majority investment by international investors; let's also open other areas such as infrastructure and power. The most important reform to make Indonesia more attractive to international capital is to set up a clear approval process to cut red tape and corruption. Then Jakarta needs to reinvigorate a previously announced plan to privatize some of the country's 145 largest state-owned companies to increase their profitability and raise more government revenue. Finally, why not follow ten other countries by putting in place a flat tax to rein in bureaucracy, stymie corruption and stimulate growth and productivity?
Cutting fuel subsidies, addressing pressing social needs, increasing oil production and privatizing state-owned companies will put Indonesia back on the track of prosperity and progress.
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