Business Week article on KPC (Kaltim Prima Coal) in Indonesia

Business Week article on KPC (Kaltim Prima Coal) in Indonesia

Business Week European Edition May 20, 2002

By Michael Shari Sangatta, Indonesia

In the post-Suharto era, everyone wants a piece of the action. Result: An investor nightmare

Noke Kiroyan, chairman of mining giant Rio Tinto's Indonesia operations, seems unnaturally calm as he appears for a hastily rescheduled meeting in a coffee shop at the Jakarta Hilton. Just hours earlier at 12:45 p.m. on March 26, the receptionist at his office on the 28th floor of Jakarta's swank Kadin Tower got a phone call. "I am from Kalimantan," said the male voice. "At 2 pm, the Rio Tinto office will explode." Then he hung up. Kiroyan's staff whisked him down to the lobby as a police bomb squad arrived and office workers fled. The threat turned out to he a hoax.

Kiroyan is used to such disruptions. His life has become a test of nerves since late 2000, when the government of East Kalimantan province, part of the island of Borneo, began a campaign to take a controlling stake in Kaltim Prima Coal (KPC), a mining venture in which London-based Rio Tinto Ltd and BP PLC have invested $1 billion in the past decade. Various provincial officials have taken Indonesia-born Kiroyan to court, summoned him for interrogations, and lambasted him as "unpatriotic" for refusing to sign over control of KPC. Provincial officials say they're doing nothing wrong. "No one in the East Kalimantan government administration is participating in or directing an intimidation campaign" against KPC shareholders, says P. D. D. Dermawan, counsel to the province's governor. Kiroyan suspects otherwise and vows not to yield. "If you're a professional, you don't just jump ship at the slightest problem," shrugs Kiroyan, 56. "I'm not acquiescing to anything I'm uncomfortable with."

Rio Tinto's travails could be dismissed as an unusually nasty episode in a nation struggling to develop a more civil means of mediating business disputes after decades of crony capitalism. After all, Rio Tinto and BP first secured their huge concession in East Kalimantan during the regime of dictator President Suharto. And Western mining companies - Rio Tinto included - have come under fire from environmentalists, human rights activists, and indigenous ethnic groups for a range of alleged past abuses.

But Kiroyan's story fits a pattern that raises new, disturbing questions about Indonesia as a site for foreign investment. In industries from telecom to manufacturing to consumer products, managers of multinationals complain of growing harassment at the hands of officials across the 17,000-island nation of 220 million. The litany: endless demands for bribes, local officials who disregard contracts signed with Jakarta ministries, state corporations that renege on years-old deals, and outright threats by xenophobic nationalists and increasingly powerful Islamic fundamentalists.

Clearly, something has gone badly wrong with Indonesia's transition to democracy since the 1998 downfall of President Suharto. Ill-designed reforms have led to a breakdown of central authority. Indonesia is now a nation of too many bosses-all seemingly determined to advance their own ambitions. Yes, Suharto is gone. But in its attempt to share power, the government, quips an economist who visits Indonesia frequently, has "created 100 Suhartos." The resulting chaos makes it maddeningly difficult to conduct business across the far-flung nation. Increasingly, executives complain there are no impartial courts to enforce the laws or contract terms. Some top officials in Jakarta admit they're virtually powerless to help. "You can't just stop off in Jakarta anymore" to negotiate with power brokers, says Coordinating Minister for Finance & Economy Dorojatun Kuntjor-Jakti. "People in the regions who were so silent in the past now must be listened to, and we are on a learning curve.

Some multinational managers even say they live in fear. Last year, police in the port city of Surabaya threatened to imprison two foreign Cargill Inc. employees in a dispute over a grain shipment. In late 2000, Jakarta police held an Indonesian executive of Canadian insurer Manulife Financial Corp. for 20 days over a dispute with the company's local partner. After complaining about corruption in the Customs Dept., Lee Kang Hyun, a Jakarta-based general manager of Korea's Samsung Electronics Co., says he received death threats over the phone-and fled with his wife to Singapore twice, in 1999 and 2000.

The climate has grown so bad that several multinationals are quitting. Telecom giants such as Cable & Wireless, AT&T Wireless Services, and France Telecom are selling their stakes in big joint-ventures, saying the government and local partners have made it impossible to make a profit. "There's no rule of law and no sanctity of contract here," says Jakarta-based AT&T Wireless Vice-President John G. Vondras. Thiekomunikasi Indonesia says the real reason AT&T and five other partners are leaving is the weak telecom market since the 1998 crisis.

Dealing with local officials has grown so difficult that some multinationals are throwing in the towel.

The biggest cost to Indonesia is the loss of foreign know-how, which the country's floundering economy badly needs. To be sure, some multinationals, especially in consumer goods and retailing, say the climate has dramatically improved since 1998, thanks to lower import barriers and liberalized investment rules. The chief problems, though, are with big-ticket investments, such as mines, oil projects, and utility franchises that involve long-term contracts and agreements with the central government. From 1994 to 1997, Indonesia received $38 billion in direct foreign investment. Since then, more than $50 billion in investment has flowed out of the country, according to Standard & Poor's MMS International.

After decades of systemic corruption and cronyism, nobody expected Indonesia to level the playing field overnight. But investors had hoped reforms enacted since Indonesia's first democratic elections in 2000 would produce a big improvement. Indeed, most foreigners give high marks to the economic team appointed by President Megawati Sukarnoputri when she took power.

"There is no rule of law," says the AT&T Wireless executive, "and no sanctity of contract here"

But in its zeal to undo the dictatorial regime constructed by Suharto, the new government made some big mistakes. One of the biggest was the flawed design of the Regional Autonomy Law. The aim was noble enough: to give local communities more say over how they are governed and more control over the gold, gas, oil, copper; timber; and other resources extracted from thefr lands. Under Suharto, multinationals struck backroom deals in Jakarta to win long-term concessions, splitting the revenue with Suharto family members, cronies, and the military. Indigenous people benefited little while their environments were trashed and were crushed when they protested. ExxonMobil, Newmont Mining, and FreeportMeMoRan Copper & Gold stoked backlashes from Aceh to Irian Jaya. As for Rio Tinto, environmentalists say waste at its Kelian gold mine in East Kalimantan contaminated the drinking water and that mine employees helped the military forcibly evict villagers. Kiroyan denies the charges.

A law giving more power to the provinces may just benefit a new set of insiders, rather than local citizens.

The autonomy law, which took effect in January, 2001, was supposed to end such abuses by giving the country's 26 provincial governments and 300 districts greater control over everything from taxation to public contracts. Each province now is entitled to 15% of oil revenue, 30% of gas revenue, and 80% of the proceeds from mining and forestry on their lands. They also can keep 90% of property taxes collected in their jurisdictions. Some provinces have used their new resources and autonomy well: In the Japanese city of Yogyakarta, for example, foreign investors praise Sultan Hamengku Buwono X for his efforts to fight corruption and speedily approve projects that used to take more than a year to push through Jakarta. "It's my job to make sure things go right," says Buwono. "If I lose a foreign investor, it's a big loss to me as well."

Unfortunately, such regional leaders are an exception. Most of the governors who filled the vacuum left by Jakarta's mandarins are army generals, while most district chiefs lack even high-school educations. Also, political analysts and businessmen who visit the provinces, note there's little sign local officials are spending the new funds on public works or development projects. "Less than 1% of this money is reaching the poor;" contends a Western diplomat. "It's just stolen at various levels along the way." The autonomy law's drafters also didn't factor in the provinces' weak legal systems. "Decentralization is a very positive step," says American Chamber of Commerce in Indonesia President Carol A. Hessler. "But the rules need to be transparent and to be enforced. For any investor out in the provinces, there is concern as to what law prevails - and who is in charge."

Kiroyan's ordeal is a good example. Rio Tinto and BP first signed a contract to develop its open-pit coal mine in the jungles of Borneo in 1982. Thanks to low labor costs, the coal costs $20 per ton to extract, making it one of the most cost-effective mines in the world. The original contract required Rio Tinto and BP to gradually divest 51% of the shares to Indonesian investors over five years, starting in 1996. To keep management control, Rio Tinto didn't want any single investor to acquire the 51%, says Rio Tinto Indonesia President Lex Graefe.

The divestment process never got off the ground. Indonesia's Mines & Energy Ministry had first crack at buying shares in the mine, but it couldn't afford them after the 1997 financial crash. Neither could other local investors. So in April, 2000, KFC offered a 30% stake to the East Kalimantan government. Governor H. Suwarna agreed in writing to pay $175 million. But the next month, when Parliament debated the autonomy law, Suwarna's office told KPC it wanted the entire 51% stake for $300 million. Rio Tinto and BP declined.

Things turned ugly. In April, 2001, Energy & Mineral Resources Minister Purnomo Yusgiantoro supported the province's demand. When Rio Tinto again refused, East Kalimantan sued KPC, claiming $776 million in dividends it projected it would earn through 2010. Then, the South Jakarta District Court froze the mine's equity, keeping Rio Tinto and BP from selling to others. Hardball legal tactics, to be sure. But the pressure grew. On March 12, Kiroyan was summoned to the mining ministry's Jakarta headquarters. He was met by a ministry official, East Kalimantan Assistant Governor Syaiful Teteng, and East Kutai Deputy District Chief Mahyudin. They ordered Kiroyan to sign an amendment to KPC's contract stating that the divestment process would start immediately, "giving priority to the East Kalimantan government." Kiroyan refused to sign. For the next hour, the officials screamed at him, accusing him of having "no sense of nationalism." Both Teteng and Mahyudin say their behavior was justified because Kiroyan, as an Indonesian, should place his country's interests above those of foreigners. East Kalimantan says it deserves the 51% stake because the central government ceded its right of refusal to the province.

A big question is whether the autonomy law in this case is just benefiting a new set of insiders. One disturbing development: The East Kalimantan government apparently intends to cede most of its 51% stake to a local company, Intan Bumi Inti Pradana. A key player in this transaction is David Salim, a cousin of Anthony Salim, whose family controlled Indonesia's best-connected business empire under Suharto. David Salim is an adviser to Intan, says Salim associate Joachim U. Rohn. This deal undercuts the principle behind local autonomy, alleges KPC attorney Mulya Lubis. "They've been saying this is for the people of East Kalimantan," Lubis says, when instead the mine will be controlled by "other parties related to the Salim Group." AnthonySalim denies be wants to take over KPC or that David represents the group.

Other multinationals have their own woes. In the latest run-in with foreign managers, a prosecutor in the city of Bandung on Apr. 17 charged AT&T's Vondras and another company exec with embezzling $7.6 million. Vondras denies the charge, and says he suspects it is revenge for a $1.3 billion claim AT&T brought against Telekomunikasi Indonesia in a Geneva arbitration court relating to the venture's failure. Telkom denies any role in the criminal charge.

As if Indonesia's confusing legal system weren't enough, companies now must cope with Islamic fundamentalism. Since Suharto's fall, Islamists have gained clout. One target is Unilever Group, which is thriving in Indonesia. In December the Religious Affairs Ministry issued a decree that would have required Unilever to put stickers on each package of ice cream, soap, and everything else it sells proving they were prepared in accordance with Islamic principles. Buying billions of stickers from a government printer would have raised prices, and "would certainly have cut into potential sales and impeded our growth," says Unilever Indonesia Chairman Nihal Kaviratne. The measure was delayed after Unilever complained to legislators, but the ministry vows not to back off. But the issue "will come back again," warns Hadi Susastro, director of Jakarta's Center for Strategic & International Studies. "It's a new way of rent-seeking."

Much of the rancor could have been avoided if coherent eccnomic policies had accompanied Indonesia's democratic reforms. President Sukarnoputri's economic team is feverishly drafting new laws to clarify investment rules. But it could take years for the lethargic Parliament to act. "We have 60 laws waiting in Parliament," complains economy minister Dorojatun. "Without these laws, I can't publish policies."

Until Indonesia sets up a real commercial legal system, it likely won't regain its allure for investors. Thus economists don't see Indonesia's economy - now growing at about half its pre-crisis level - taking off anytime soon. Struggles in such places as East Kalimantan are closely watched. Rio Tinto also owns 40% of the Freeport McMoRan gold mine in West Papua; the Jakarta court froze that asset as well. Graefe warns Rio Tinto will reconsider future investments if it loses the coal case. Meanwhile, BP has invested $6 billion in Indonesia's oil and gas industry and plans a $2 billion natural gas project. If provincial bureaucrats think such projects are up for grabs, there soon may be little to grab at all.