Mining Indonesia's risk and reward

Indonesia holds sizeable rewards for Western investors but those chasing success must also navigate significant risk, as Nat Rothschild's Bumi strategy shows.

Lowy Interpreter

Over the past year or so, the success of the Indonesian economy has been applauded by foreign commentators and business people (and, belatedly, by the credit rating agencies). Foreign investment has doubled over the past couple of years and Vice-President Boediono has a good story to tell. But it's still a hard place for Western firms to do business, as Nat Rothschild, scion of the famous banking family, is finding.

Actually, the Indonesian economy has done pretty well over the whole of the past decade, sailing through the 2008 global crash with just a tiny slowing in growth. It is now growing at 6.5 per cent, returning to the pace of development delivered by the Soeharto regime for three decades prior to the Asian crisis in 1997. Having been ignored by the business press until recently, it's now the subject of frequent glowing analyses.

There are big rewards for getting Indonesian investment right (or being lucky). If you had put $US100 into the Jakarta stockmarket in 2001, it would now be worth $US1000. Why don't we all pile in to a market which seems to offer such rewards? The one-word answer is 'risk'.

Some of this risk is intrinsic: mining, for example, is going to be a chancy business anywhere. But some of the risk is man-made: it reflects the uncertain framework of laws, unfamiliar business practices and a simple lack of basic information. If only the fabled wealth of Indonesia could be linked up to the sort of transparency, impartially-enforced rules and good governance that we like to think applies in developed countries, foreign investors would flood in.

It's easier said than done, but one answer might be to shift the governance to a country with strong laws and impartial courts, 'unlocking' the risk premium. Hence the Rothschild idea: take a profitable established Indonesian company, give it strong foreign oversight and have it listed in the London Stock Exchange. Investors will happily put in their money if there are some good British chaps at the helm. Everyone would make a nice profit; Rothschild suggested that foreign investors might double or treble their money.

The target was Bumi Resources, a company with rich coal leases. The major owner was Aburizal Bakrie, Indonesia's most successful indigenous entrepreneur, former co-coordinating minister, chairman of a major political party and likely presidential candidate in 2014. He is superbly connected to the government and has a habit of getting his way. But his huge and diverse empire has been over-leveraged. Thus he was ready to give up some ownership in return for the cash to pay down his creditors (he was paying almost 20 per cent interest on his borrowing from a Chinese financier).

There must have been some differences of views about how this arrangement would work. Rothschild went public, criticising his partners with a very un-Javanese frankness. One of Bakrie's confidants then bought a large share and moved to remove Rothschild from the board. The dust has not yet settled, but it seems pretty clear that this arrangement has not delivered best-practice London-style governance to Bumi.

None of this is very new, or very surprising. Some will recall the rip-roaring case of the BRE-X gold mine in Kalimantan. BRE-X was a Canadian company, listed on the Toronto stock exchange, and the gold was not actually in the mine: it was added afterwards to the assay samples. Then there was the case of Asia Pulp and Paper' Indonesia's largest defaults in the 1997 crisis were the debts of Asia Pulp and Paper, listed in Singapore.

These stories are certainly not unique to Indonesia. There is a big literature of ex-China investors with a common theme: how they lost their money. Australian miners venturing into Africa are learning that when they have a successful mine, there is a fair chance that the host government will rewrite the terms.

By the standards of emerging countries, Indonesia probably rates quite well. A large number of foreign companies are working there successfully under favourable rules. For example, Indonesia allows fully-foreign-owned banks (both the Commonwealth Bank and the ANZ Bank are there, apparently doing well). Foreign investors in Indonesian government bonds are sufficiently confident that they have bid down the yield so that it is not far above that on Australia's AAA government debt (5 per cent compared with 4 per cent). But investing with the Indonesian government is not the same as taking a stake in an Indonesian mining company, even if it is part-owned by a potential president.

One basic problem in cases like Bumi is that the assets which embody this fabulous wealth are not in the foreign country applying the governance rules. If things turn sour and you want to seize some tangible assets, you have to venture into courts that may not understand your way of doing business, and not have much sympathy for foreigners. It's not just about corruption and embryonic standards of corporate governance. Indonesia had a long colonial history of making the foreigners wealthy while the bulk of the population stayed poor. If things go wrong, there may not be much public sympathy for the neo-colonial foreigners.

It will take decades to bring Indonesia's legal and governance systems up to the level of developed countries (and even that clearly doesn't offer investors much in the way of firm guarantees). Foreigner investors have to accept and work within the host country's laws and ways of doing business, while hopefully setting a standard of rectitude and business ethics that will be an example to others.

Originally published by The Lowy Institute publication The Interpreter. Reproduced with permission.

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