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Airport development in Indonesia: the prospects and the obstacles (Part II)

Posted by on 07 September 2018
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Part two of a series. Read part one here.

Julian Smith, Director at PT PricewaterhouseCoopers Indonesia Advisory, summarises the current status and plans for Indonesia’s airports and identifies the actions the Government needs to take to secure significant foreign investment to upgrade the facilities in line with the needs of the economy. Part two focuses on the obstacles to airport investments in Indonesia.

There are many reasons why Indonesia has been slow to bring private funding into the airport sector:

1. The current concession structure

The current structure was designed to enable the corporatisation of airport operations by transferring them from the MOT to API and APII. It does not facilitate the next step towards private operation, e.g. it is not possible to grant a sub-concession. The passenger tariff, which is the main source of revenue, must be paid to the concessionaire, not to a private operator. Regulatory change is a slow process in Indonesia, even if the need for change is universally agreed, which is not yet the case here. The structure is also complicated, with a variety of licences being required in addition to the main concession.

 2. Airport licensing

Similarly, there is no precedent yet for private sector operators to be awarded an airport operating licence (“BUBU”) and therefore most investors might need to work with AP I or AP II which already hold these licences. In other countries that have done airport PPPs, there is no such requirement to form a partnership with a SOE, especially if that SOE does not have funds to invest in the equity.

3. The “Negative Investment List”

This regulation limits foreign investment in many sectors. For airport and airline operations, the maximum foreign ownership is 49%. Many sectors, such as toll roads and power plants, have been liberalised in recent years, but liberalisation would be difficult in aviation because there is also a separate similar requirement enshrined in primary legislation (the Aviation Law - No1/2009) which is unlikely to be changed.

4. Tariff increases

Airport concessions in other countries often provide for an automatic annual increase in tariffs to enable operators to cover inflationary increases in operating costs. In Indonesia, the existing regulatory regime does not give such certainty as tariff increases must be approved by the Government. Toll road concessions offer a useful precedent as the concessionaires are entitled to an inflationary increase every two years as long as they are in compliance with their performance obligations under the concession. Without such a commitment, private investors are likely to regard Indonesian airport investments as too high risk, because it will be some years before the revenue from retail and other non-aeronautical sources can compensate for any shortfall in the revenue from passenger and aircraft tariffs.

5. Liberalisation of air routes

Despite congestion in the major hub airports of Jakarta and Denpasar, most regional/local airports in Indonesia are still not open for direct flights to/from other ASEAN countries, even though ASEAN governments have agreed in principle to implement the ASEAN Single Aviation Market (ASEAN-SAM), which in theory allows such flights without needing permission from the Government. Indonesia has not yet ratified this in respect of secondary airports. For example, if you want to fly between Eastern Indonesia and most cities in the Philippines, you generally have to transfer in a major hub such as Kuala Lumpur or Singapore, many kilometres to the West. Local economies including tourism investment could be stimulated and the congestion in the hubs relieved if these restrictions were relaxed. The potential for shorter flights is indicated by the small number of routes operated by MAS Wings between Indonesian and Malaysian parts of Borneo as part of ASEAN regional integration initiatives. The sector would benefit from liberalisation of the process for approving new routes more generally.

6. New airlines

Aviation Law 1/2009 requires all new airlines to have a minimum of ten aircraft in order to obtain an operating licence. This is a major obstacle for entrepreneurs in more remote provinces who might be interested to start up an airline to serve their local market. Proper safety regulation is essential, but the number of aircraft is not a direct determinant of safety. In practice the law (combined with the slow implementation of Open Skies) has the effect of reducing the number of flights which serve remote airports, thus undermining their profitability and attractiveness to investors. Whilst major airlines such as state-owned Garuda and private sector Lion Air do a great job of launching pioneer services, sometimes with government subsidy, they are bound to prioritise more lucrative established routes.

As an example, in India where aviation is more liberalised, Zoom Air, an Indian airline which operates only five aircraft focusing on under-served destinations has been able to provide good services to its passengers with a low number of complaints, delays, and flight cancellations and a good safety record.

What needs to be done to facilitate private investment in Indonesia’s airports?

There is no shortage of international interest in investing in Indonesia’s airports and since there are no experienced local private sector airport operators, most investment must come from overseas. The record in other sectors such as power and toll roads shows that Indonesia’s infrastructure is attractive to foreign investors. Indonesia’s economy is forecast to be among the Top 5 globally by 2030, and unlike other infrastructure sectors, which depend on government payments, airports give access to Indonesia’s burgeoning consumer market. So all that is needed is to simplify and reduce the burden of regulation so that the deals can be done. A typical international standard PPP or concession agreement gives ample protection to the national interest – for example there is no obstacle to military use of the airport in time of crisis, and the PPP can be terminated if the private operator does not perform well (though normally the investors and banks will step in to fix the problem before the Government needs to).

The existing PPP legislation, and the new LCS both offer workable models. The main step that is required is to adjust the existing concession law, or even disapply it from an airport where investment is targeted, since it mainly duplicates the PPP/LCS provisions, and then tenders could be launched and agreements signed within twelve months. It is however an essential pre-requisite to carry out a thorough feasibility study to define the investment needs for each airport, and then allow some flexibility in the concession/PPP for the private investor to optimise the investments to suit the market. It is also essential to implement a reasonable and fair mechanism for annual tariff increases. Changes to the other regulations such as Open Skies and the Negative Investment List may take longer.

In conclusion, if the Indonesian government is serious about attracting private investment in airports, it may need to set up a task force to simplify the regulatory issues and bring some deals to the market.

Join Julian at GAD Asia 2018 and learn more about the prospects for airport PPPs in Indonesia on 25th September >>

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