Indonesia: Doing Business In Indonesia - The Road to Reform: Achievements to Date, Challenges Ahead

The impact of the regional monetary crisis in 1997–1998 included a high inflation rate, devaluation of the Indonesian rupiah, a fall in foreign investment, capital flight and a high unemployment rate. All this in turn created political as well as economic instability in the country. Three changes in government over the succeeding five years added to such problems. These various developmentshave had long-term impacts on Indonesia’s political, social and economic structure. The Government has made progress in connection with its reform efforts to deal with these problems. Examples of its achievements are discussed in greater detail below.

As a result of the regional monetary crisis in Asia, on October 31, 1997 the Government of Indonesia entered into a three-year stand-by programme with the International Monetary Fund (IMF) under which various reforms were required to be carried out according to certain deadlines. This was then followed by a series of extensions and renewals of the programme as well as a series of Letters of Intent between the Government and the IMF.

This chapter focuses on the challenges faced by the legal sector in assisting the Indonesian Government in achieving its overall reform objectives.

In August 2003 the Government decided to conclude its cooperation program with the IMF. In preparation for this, the Government prepared a "White Paper" containing policies to be implemented in connection with the overall reform of Indonesia’s economy. The intention of the White Paper was to replace the IMF programme, although the Government decided to participate in the IMF’s Post-Programme Monitoring. The White Paper, like the IMF programme that came before it, includes various targets for the Government to achieve in reforming the legal sector.

The IMF cooperation programme was eventually concluded at the end of 2003, when Indonesia stopped receiving IMF funding and the rescheduling facility for its Paris Club debts. The IMF continues to monitor Indonesia’s reforms through its Post-Programme Monitoring and Article IV reviews, which are used for all IMF members when they complete a cooperation programme. The first Article IV review on Indonesia’s reforms after the conclusion of the programme was on May 9, 2004.

The White Paper

The Government issued Presidential Instruction No. 5 of 2003 dated September 15, 2003 Regarding the Package of Economic Policies Pre- and Post-Cooperation Programme with the International Monetary Fund. This Instruction contained the Government’s White Paper. Under the Presidential Instruction, the aims of the Government’s policies for 2003 and 2004 are to (i) maintain and improve macro-economic stability, (ii) continue the restructuring and reform of the financial sector, (iii) increase investment and exports and (iv) create employment opportunities.

The White Paper contains various measures to be implemented by the Government in a timely manner (in some cases the measures are still in process) to recover from the 1997–1998 economic crisis. A summary follows of the policies outlined in the White Paper in connection with legal reforms and specific steps that are envisioned to realize these policies.

• Legal Reform Policies

1. Corruption Eradication

a. Establishment of the Commission for Eradication of Corruption (KPK) and appointment of its members.

b. Improvement of the knowledge of public prosecutors and judges in handling corruption cases through training sessions and other means.

c. Blueprint on the Corruption Court.

d. Deliberation of a Judicial Commission Bill.

e. Deliberation of amendments to Law No. 5 of 1991 dated July 22, 1991 Regarding public prosecutors.

f. Deliberation of the Freedom of Information Bill

2. Improvement of the Commercial Court

a. Deliberation of Amendments to the Law on Bankruptcy and Suspension of Payments.

b. Renewal of the blueprint on the Commercial Court.

3. Harmonization of Regional Regulations

4. Improvement of Legal Enforcement Capacity.

a. Training for judges and public prosecutors.

b. Improvement of the curricula for legal enforcers.

In order to ensure the proper implementation of White Paper policies, a Monitoring Team was set up under the auspices of the Coordinating Minister for the Economy. This Team holds monthly meetings to discuss developments concerning the measures contained in the White Paper.

Reform Achievements Under the IMF Programme and Otherwise

• In General: Indonesia’s economic recovery under the IMF programme has been satisfactory. At the end of 2003, the IMF indicated that it expected Indonesia’s GDP to be in the range of 3.5% to 4%, inflation to be 6%, and the real effective exchange rate to remain broadly stable in 2003. The IMF declared that "Indonesia has made significant progress in strengthening macroeconomic policies and implementing key areas of structural reform agenda…."

The international financial community has demonstrated its confidence in Indonesia through the overwhelmingly positive response to the issuance of sovereign bonds in late 2003, its first for more than seven years. Several private bond issues have also been very successful.

Another indication of recent achievements is that Standard & Poor’s and the Japan Credit Rating Agency have improved Indonesia’s sovereign debt ranking.

Successful privatization of a number of state-owned enterprises, including P.T. Bank Mandiri (Persero) Tbk., P.T. Bank Rakyat Indonesia (Persero), P.T. Pembangunan Perumahan (Persero) and P.T. Adhi Karya Tbk. (Persero), has also occurred.

• Legal Reforms: In the legal sector, notable achievements under the programme with the IMF are as follows:

• The establishment of the Commercial Court and the amendment to the bankruptcy law inherited from the Dutch colonial period.

• Promulgation of the Arbitration Law.

• Promulgation of the New Anti-Corruption Law, and amendments to further improve it.

• Appointment of non-career judges to the Supreme Court.

• Greater independence for the judicial system, achieved by the transfer of administrative control from the Department of Justice and Human Rights to the Supreme Court.

• Establishment of the Advocates Law to govern advocates in Indonesia.

• Promulgation of the Anti-Money Laundering Law, including strengthening amendments in October 2003.

Challenges Ahead

• General: Indonesia continues to face significant challenges. Among these are a low growth rate, the lack of foreign and domestic direct investment, capital flight, depreciation of its currency, inflation and high unemployment and underemployment rates. These challenges arise from and are also a result of the lack of political and economic stability.

An immediate challenge facing the country is the election of the President and Vice- President on July 5, 2004, with a run-off in September, if necessary. The election will be the first direct election of the President and Vice-President in Indonesia’s history.

• Legal Reform Challenges: Despite the achievements in law reform noted briefly above, uncertainty created by Indonesia’s legal system remains a major obstacle to greater foreign and Indonesian direct investment in Indonesia.

Legal reform plays a major role in Indonesia’s overall reform efforts. If Indonesia’s legal system is certain, comprehensive, equitable and reliable, potential new investors will be better able to assess investment risks in Indonesia. The mere ability to assess investment risk is itself a major factor in reducing such risk. If the laws and regulations are comprehensive and certain, and law enforcement is fair, equitable and reliable, investors will be attracted to Indonesia. Such investment will in turn provide employment opportunities and purchasing power, leading to greater economic growth, which is in turn essential to political and economic stability and further reductions in investment risk.

The major challenges to Indonesia’s legal sector and the need for greatest reform are:

• Fair and Equitable Enforcement of Laws and Regulations: Despite the Government’s efforts, inadequate law enforcement and implementation by the Indonesian judicial system continues to be a major problem. Two recent judicial decisions may illustrate this problem.

• P.T. Tri Polyta Indonesia Tbk: Tri Polyta sought a cancellation of its 1996 loan agreement with its creditors. A special purpose and wholly owned subsidiary was established by Tri Polyta in the Netherlands, i.e. Tri Polyta Finance B.V., as the borrower, which took on responsibility for the loan to Tri Polyta. Tri Polyta in turn guaranteed repayment by Tri Polyta Finance.

Tri Polyta alleged that the loan agreement violated Indonesian law because it was a tax avoidance scheme that violated Indonesian tax laws, and the District Court agreed. However, there is no Indonesian legal prohibition on the use of such a structure in general or the use of such a structure to reduce Indonesian taxes.

The District Court also ruled in its provisional decision (which we understand has now been made final) that the loan violated Indonesian law because Tri Polyta was required under the structure to pay twice, once as a borrower to its subsidiary and once as a guarantor to the subsidiary’s lenders. The court thus refused to recognise that Tri Polyta could act in two capacities, as borrower and guarantor, or that Tri Polyta could cause its wholly owned subsidiary to pay its lenders, in which case it would have no liability as guarantor.

As a result of the decision, the loans were invalidated and there is no obligation to repay US$185,000,000 in principal. Also, the lenders were prohibited from foreclosing their security. The case is on appeal.

There appear to be several other cases where the foregoing arguments have been made successfully at the lower court level.

• P.T. Prudential Life Assurance: Another recent example of unreliable court enforcement is the Prudential bankruptcy case. This case arose out of a contract dispute between an agent and the company. Rather then pursue his claim in the District Court, the agent sought to have Prudential declared bankrupt in the Commercial Court.

The Commercial Court declared Prudential bankrupt on the ground that there was a debt due and payable to the agent, even though the claim was disputed. The decision was reversed by the Indonesian Supreme Court because the alleged debt was not capable of simple proof and should have been submitted to the District Court. Prudential thus won the case, but not without major commercial disruption to the company and embarrassment for Indonesia.

Effective legal enforcement also involves the professional bar and the police. As noted above, an important step forward is the recent adoption of the Advocates Law, which may lead to an official, unified bar association. It is hoped that this step will result in greater professionalism among Indonesian attorneys and higher standards of practice.

The police are also involved in civil law enforcement, insofar as they must enforce judicial decisions in the absence of voluntary compliance. Among the reform measures of the post-Soeharto era is the separation of the police and military forces, with the expectation of increased professionalism in the police force in this vital area.

• Harmonization of Laws and Regulations: A significant part of Indonesia’s reform is decentralization and devolvement of political power to the regions from the Central Government. After three decades of authoritarian rule, political power has been dispersed. While the political objectives of regional autonomy are laudable, legal disruptions have occurred as regional governments have adopted regulations that conflict with those of the Central Government. The Monitoring Team reports that the Department of Home Affairs had as of May 2004 reviewed 3,442 regional regulations, 161 of which it revoked and 284 of which it proposed should be revised.

• Corruption: No discussion of legal reform in Indonesia would be complete without a discussion of corruption. Transparency International has ranked Indonesia as one of the most corrupt countries in the world and there is a widespread perception among domestic and foreign investors alike that there is a significant, systemic corruption problem at all levels of government and in all political institutions. Indonesia has very severe anti-corruption laws, including a comprehensive 1999 Anti-Corruption Law. The Government has also established an Anti-Corruption Commission (the KPK) and has given it broad investigative powers. It is too early to determine KPK’s effectiveness.

Indonesia has adopted substantive laws and created institutions to combat corruption, but the true test of the Government’s resolve to eradicate or reduce this societal problem is and will continue to be a litmus test for Indonesia’s young democracy.

Conclusion

Although Indonesia has been independent of colonial rule for almost 60 years, it is in one sense a new country, having just become democratic after decades of authoritarian rule and wasted opportunities. Its recent reform efforts must be measured against this historical backdrop as the country finds it way along the road to democracy. The true test of Indonesia’s commitment to reform and democracy is not in the adoption of new laws but in the exercise of the political will to implement them. As the fourth largest country in the world and one of its youngest democracies, Indonesia both needs and deserves the world’s support and patience in this process.

Originally published in "Doing Business With Indonesia" (Asia Law & Practice, 2004)

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