FOREWORD

Over the past decade there have been progressive reforms in support of foreign investment in Indonesia. Moving into a new era, Indonesia is now going through exciting and historic political and economic reforms. Over the medium term, the move to democracy and civil society will have a positive impact on business ethics and the investment climate although there may be rough periods along the way. While Indonesia is not an investment destination for everyone, it does present real opportunities for many Canadian investors.

This booklet provides basic information on the foreign investment environment in Indonesia and a brief overview of related rules and regulations. It is not meant to be a comprehensive treatment of the topic covered, but to provide a snapshot view of foreign investment rules, issues and policies with which Canadian investors should be familiar when making investments and conducting business in Indonesia.

The Canada Indonesia Business Development Office (CIBDO) is a project of the Alliance of Manufacturers and Exporters Canada and is funded by the Canadian International Development Agency, Industrial Cooperation Program. CIBDO is ready to help prospective Canadian investors by providing them with specific information and assistance in the development of their business ventures in Indonesia. Please see the contact information at the end of the booklet.

                      Executive Director
Canada Indonesia Business Development Office

Deborah Turnbull

A REVIEW OF THE INVESTMENT ENVIRONMENT IN INDONESIA

I.Overview

A. Indonesian Government's Attitude toward Foreign Investment

B. Foreign Exchange Convertibility

C. Expropriation and Nationalization

D. Dispute Settlement

E. Fiscal Incentives

F. Protection of Contract and Property Rights

G. The Implementation of Laws and Regulations

H. Banking, Capital Markets and Portfolio Investment

II. Corruption

III. Bilateral Investment Agreements

IV. Labour and Education

V. Free Trade Zones/Free Ports

VI. Foreign Direct Investment Statistics VII. VII.Canadian Assistance Programs

I. Overview

The Canada Indonesia Business Development Office (CIBDO) is a project of the Alliance of Manufacturers and Exporters Canada and is funded by the Canadian International Development Agency, Industrial Cooperation Program. CIBDO's mandate is to facilitate and assist Canadian investments in Indonesia. We strive to ensure that all partnerships will result in positive developmental impacts. Reducing poverty and inequality is a humanitarian priority, which also promotes economic growth and good governance. The CIBDO project aims to identify and assist commercial linkages between Canadian and Indonesian private sector companies, which will have these long-term sustainable impacts on Indonesia.

Whilst the main objective of CIBDO is to increase Canadian investment in Indonesia, we always endeavour to provide a balanced view of the overall investment climate. The opinions provided herein are those of CIBDO and have been formulated based on experience in the Indonesian marketplace.

Indonesia is slowly emerging from a severe economic and political crisis sparked by the regional currency collapse that began in mid- 1997. The economic downturn coincided with a prolonged political crisis, which culminated in widespread disturbances and leading to the resignation of President Soeharto, Indonesia's leader for 32 years. In May 1998, then-Vice President, B. J. Habibie, replaced Soeharto as Indonesia's president. In June 1999, the country held its most democratic parliamentary elections in over forty years. The People's Consultative Assembly, consisting of 500 newly elected members of Parliament and supplemented by 200 appointees, met on October 20th and 21st, 1999 to select Indonesia's new President, Abdurrahman Wahid and Vice-President, Megawati Sukarnoputri.

The Government of Indonesia (GOI) asked the International Monetary Fund in October 1997 for assistance in surmounting its many economic difficulties which included a substantial depreciation of the Indonesian rupiah, rising inflation, and a collapsing banking system.

The program, under the administrationsof Soeharto, Habibie, and now Wahid, has undergone several revisions, and includes major structural reforms that will ultimately result in an improved investment climate. The main issue in the June 1999 election campaign was reform, interpreted broadly to include institution of the rule of law, rejection of corruption, decentralization of authority, and greater government transparency and accountability. The latest Letter of Intent to the IMF signed by the GOI on May 171 2000 again confirms Indonesia's commitment to major economic and legal reforms. Implementation of these reforms will continue to enhance the incentives to invest in Indonesia.

Over the past year, the GOI has succeeded in stabilizing the exchange rate, reducing. inflation, and establishing the legal framework for addressing banking sector recapitalization and corporate debt restructuring. In 1999, Parliament approved laws that transfer greater political autonomy to the regions and established principles of fiscal decentralization. The Rupiah strengthened and the Jakarta Stock Exchange Index rose following a largely peaceful campaign and election, which were monitored by domestic and foreign observers.

Economic policy challenges still facing the GOI include: increasing budget revenues, including privatization of state-owned enterprises; completing the bank recapitalization program, including asset recovery to reduce the budgetary burden; promoting debt restructuring between Indonesia's corporate debtors and their foreign and domestic creditors; refining the fiscal relationship between the central, provincial, and regional governments through the implementation of the new autonomy laws; improving transparency and accountability of social safety programs to permit on-going donor financing; and attracting domestic and foreign investment.

The new government has stated that it intends to work closely with the IMF and other international institutions to improve Indonesia's economic stabilization and reform program. President Wahid has strongly endorsed Indonesia's participation in the global economy and has stated that Indonesia will maintain an open door to foreign and has stated that Indonesia will maintain an open door to foreign investment. With the right policy framework, Indonesia will be able to capitalize on its strengths --large domestic and regional markets and a correspondingly large workforce, abundant natural resources, modern telecommunications and other infrastructure, and substantial experience with market-based economics and the international trading system.

Indonesia is preparing itself for an era of regional free trade when the ASEAN Free Trade Agreement comes into effect in 2003 which opens up a market of 500 million people. This market will not only be available to Indonesia but also to foreign investors in Indonesia.

A. Indonesian Government's Attitude to Foreign Investment

The GOI is very open to foreign investment. Virtually all sectors allow foreign participation except those of specific national interest for Indonesia. In 1998 and 1999, the Government issued several new regulations to ease the entry of foreign firms and capital into Indonesia. The Foreign Capital Investment Law of 1967, which provides the basic framework for foreign investment, is under revision in order to consolidate it with the Domestic Investment Law. This will create a level playing field for both foreign and domestic investors.

The Board of Investment & State-Owned Enterprises ("BPM- PBUMN") plays a key role in promoting foreign investment and approving investment project applications. The relevant technical government departments handle investments in the oil and gas, mining, banking, finance and insurance industries. All other foreign investment must be approved by BPM-BPUMN, which also approves domestic investments when the owners seek investment incentives. Approval by BPM-PBUMN takes between seven and twenty days following submission of a completed application form and required attachments. Depending on the size and complexity of investment, at times it can take a considerable amount of time before the application meets BPM-PBUMN's requirements for submission. While BPM-PBUMN aims to function as a one-stop investor service, investors are sometimes required to work closely with relevant technical government departments, such as the Departments of Manpower, Land Affairs, and Law & Legislation, as well as regional and local authorities. Recent reforms have freed investors from some of the cumbersome documentary requirements resulting from the need to work with other departments and local governments.

The new decentralization and autonomy laws will ultimately move the process of foreign investment approval away from the central government and into the regional governments. BPM-PBUMN and the new Ministry of Regional Autonomy are currently formulating an effective framework for the transition process of both investment authority and operations.

Over the past two years the GOI also made changes to simplify the approval process. For example, approvals for foreign investment up to US$100 million no longer have to be approved by the President of Indonesia, but can now be approved by the Chairman of BPM-PBUMN. On the domestic side, approval of investments up to Rp 10 billion (approximately CDN$2 million) may be issued by the Chairman of the Regional Capital Investment Coordinating Board ("BKPMD") rather than by headquarters in Jakarta. A recent Ministerial decree gave authority to Indonesian embassies and consulates abroad to accept applications for foreign investment, which would then be forwarded to BPM-PBUMN for approval. Other deregulation is being considered to liberalize the procedures even further. The Canada Indonesia Business Development Office (CIBDO) and the Indonesia Canada Chamber of Commerce (ICCC) have been actively involved in lobbying the Indonesian Government for various deregulation measures that would result in a decrease in bureaucratic procedures.

Private entities and individuals, both foreign and domestic, may establish, acquire, and dispose of interests in business enterprises. Current regulations permit foreign firms and individuals to acquire domestic firms in sectors open for foreign investment after receiving the initial approval to proceed from BPM-PBUMN.

When reviewing applications from foreign firms seeking to acquire locally established firms, BPM-PBUMN, for certain sectors, requires the buyer to reserve a small stake for a local buyer or the original owner. In cases where the local firm is being "rescued" by a foreign buyer, BPM-PBUMN requires them to inject capital, not just provide management expertise, technology or assume outstanding loans. In every case, the purchase of domestic firms is limited to sectors open to foreign investment. A mandate of the Jakarta Initiative, launched in the fall of 1998, is to eliminate obstacles to corporate debt restructuring. The Jakarta Initiative has been moderately successful and works with many of the firms taken over by the Indonesian Bank Restructuring Agency (IBRA). IBRA is the government agency set up to help local banks and the private sector settle their debts and the liquidity crisis, after these became a major factor related to the depreciation of the Rupiah in 1997.

Indonesia promotes the participation of small and medium-sized indigenous firms in certain sectors of the economy, such as handicrafts, various agricultural activities, and retail/wholesale. This approach was promoted under the general concept of a "people's economy" endorsed by the November 1998 special session of the People's Consultative Assembly. Foreign investors in designated sectors are required to partner with small businesses or cooperatives before investment applications are approved. Presidential Decree No.99 of 1999 identifies the sectors open only to small businesses and those open to medium and large-scale companies in partnership with smaller firms.

Some sectors are closed to all private or foreign investment. A negative list published by BPM-PBUMN outlines sectors closed to investment. The most recent list, published in July 1998, significantly reduced the number of closed industries. Sectors that remain closed to foreign investment include freshwater fishing, forestry, public transportation, broadcasting and film, and medical clinics. Copies of the negative list are available from CIBDO.

Harbors, electricity generation, telecommunications, shipping, airlines, railways, and water supply are among the sectors which have been opened to varying degrees of foreign investment since 1994/1995. However, foreign investment opportunities in many other services remain restricted. The government is continuing to develop policies on the private provision of infrastructure through build-own-operate, build-operate-transfer and concession schemes, particularly for electric power, telecommunications, water supply and roads. Full foreign ownership is not permitted in these sectors. Local partners are required to own a minimum of five percent of these investments. Presidential Decree No.7 of 1998 and its implementing regulation outline the rules relating to private-public cooperation in infrastructure projects. The legal significance of those promulgations, however, is likely to be eroded as regional autonomy begins to take root throughout Indonesia.

Also, in June 1998, Indonesia lifted many restrictions on foreign participation in domestic distribution services. Under the present regulations, foreign companies manufacturing in Indonesia may distribute their locally produced goods at the wholesale level and may apply for permits to import and distribute other products as well. Companies engaging in wholesale distribution may not conduct retail operations directly, but must form a separate retail company.

In June 1998, the GOI eliminated many. restrictions on foreign investment retail operations. Foreign firms are now allowed to operate retail outlets in most major urban areas although restrictions remain in rural areas. In addition, many foreign firms use franchising, licensing, and technical service agreements to distribute their goods and services in Indonesia. In general, such arrangements do not fall within the jurisdiction of BPM-PBUMN.

Oil and gas: The Indonesian government maintains ownership of all oil and gas resources through the state oil and gas company, Per1amina. Oil companies (mainly foreign) operate under production sharing contracts (PSCs) and variations of PSCs, and are granted the right to explore and produce hydrocarbons from a contract area. The contractor provides the capital to explore and develop the oil and gas resources. If, in fact, commercial production is not achieved, then the contractor can not recover its sunken costs. On the other hand, if production is achieved, capital investment is partially repaid through the PSC cost-recovery mechanism after the start of production. The contractors have rights to split actual production profits with Pertamina

An oil and gas bill submitted to Parliament in early 1999 shifts management of PSC contractors from Pertamina to the central government and gradually phases out Pertamina's responsibility for PSCs. The draft law also calls for an end to Pertamina's monopoly over downstream oil distribution and marketing of fuel products.

While this bill was taken off the agenda at the end of Habibie's leadership, it is expected to be reintroduced, with some modifications, by the current government.

Mining: Foreign investors operate under general mining contracts of work (COW) and coal contracts of work (CCOW). The contractor conducts all stages of exploration, development and operation, and assumes all financial and operational risks. The government's latest, eighth-generation COW and fourth-generation CCOW, which are still in draft stage, contain significant new provisions regarding the empowerment of regional governments, royalties and tax sharing, and community development obligations for stakeholders.

Banking, Securities and Insurance: A 1988 deregulation package opened the banking, securities and insurance industries to foreign investment; all entrants had to be in the form of joint ventures, and foreign insurance and securities firms were subject to discriminatory capital requirements. Such restrictions have since been relaxed or eliminated. In 19971 the government lifted restrictions on foreign ownership of non-bank firms listed on Indonesian stock exchanges. Amendments to the 1992 Banking Law enacted in 1998 eased restrictions on foreign investment in the banking sector. The Department of Finance licenses new securities and insurance ventures; Bank Indonesia, the central bank, licenses banks and regulates banking activity.

Privatization

To enhance the efficiency of state-owned enterprises and as part of the Indonesia's ongoing IMF program, the government set an ambitious timetable to divest majority ownership in seven major state-owed companies, including state-owned steel, plantation, telecommunications, mining, and cement firms. International investment houses were appointed to assist the government in evaluating and packaging these firms and foreign investors have been sought. The process has been delayed, however, due to difficulties establishing the valuation of the state-owned firms, domestic resistance to selling national assets, and the challenge of attracting buyers with the uncertain political and economic environment. The new government is under pressure to accelerate the privatization process to raise revenue. The new Minister of Investment & State-Owned Enterprises, who came into office in November 1999, is fully committed to privatizing state firms and is making it his priority for the year 2000. With a new government, leadership, and commitment, it is expected that a number of state companies will be privatized by the end of the year.

B.Foreign Exchange Convertibility

In August 1997, Indonesia abandoned its currency. controls and allowed the Rupiah to float freely. The Rupiah depreciated sharply from 2500 to the US Dollar to as low as 17 ,000 in January 1998. From the 3rd quarter of 1998 to the 2nd quarter of 1999, the Rupiah remained in the range of Rp 8000 to the US dollar but has strengthened to approximately 7300 since the election of the new President and Vice-President in October 1999.

In 1999, Indonesia enacted a Foreign Exchange Law that continues the long-standing policy of free currency convertibility. The law institutes a system of more rigorous monitoring of foreign exchange flows. The Indonesian Rupiah is still freely convertible and is traded in the Jakarta interbank market.

Indonesia maintains no capital controls and foreign exchange may flow freely in and out of the country, subject only to the new reporting requirements. No prior permits are necessary to transfer foreign exchange. Foreign investors have the right to repatriate capital and profits at the prevailing rate of exchange. The government does not place restrictions on outward direct investment.

C.Expropriation and Compensation

Article 21 of the 1967 Foreign Capital Investment Law stipulates that the government shall not initiate nationalization of foreign investments except by law and when such action is necessary in the interest of the state. According to BPM-PBUMN, no foreign investment has been expropriated since the passage of the 1967 law. There has been some speculation that a new government may nationalize some projects or abrogate contracts awarded to firms connected to the family of former President Soeharto. However, Indonesian government officials have stressed that foreign firms' interests will not be expropriated during the possible dismantling of the business empires of former first family members. As of January 2000, the new government has held to this promise despite pressures from various groups to cancel contracts labeled as "KKN contracts" or those drawn up under corrupt practices of previous administrations. KKN is the Indonesian acronym for corruption, collusion and nepotism.

D.Dispute Settlement

The new Arbitration and Alternative Dispute Resolution Law became effective in August 1999. It recognizes the right of contracting parties to submit commercial disputes to final and binding arbitration, describes arbitration procedures, and provides for the enforcement of domestic and international arbitration awards. An Indonesian arbitration board, BANI, is available when both parties to a dispute agree to submit to arbitration in Indonesia. The law also permits ad hoc arbitration procedures to be used. Indonesia is also party to the 1958 New York Convention on Recognition and Enforcement of Foreign Arbitral Awards.

The Indonesian court system does not provide effective recourse for solving commercial disputes. Serious questions exist as to the competency and integrity of the judiciary , and allegations of external influences are commonly reported. Judgments of foreign courts are not enforceable in Indonesia. The GOI has recognized that the legal system must be generally revamped and modernized. Legal and judicial reform is at the core of Indonesia's economic reform program. Amendments to the Bankruptcy Law entered into effect in August 1998. In 1999, Indonesia enacted laws on consumer protection, chattel mortgages, alternative dispute resolution, anti-corruption, and fair business competition. Other bills in various stages of preparation cover, foreign investment, oil and gas, electricity, and telecommunications.

E.Fiscal Incentives

Various fiscal incentives are available to both foreign and domestic investors. A company producing for the domestic market may apply for import duty exemptions on all required machinery and equipment as well as on raw and supporting materials needed during the first two years of commercial production. A company exporting 65% of its production is offered additional incentives. It may apply for restitution of import duties paid on imported components and raw materials, which are subsequently re-exported in finished form. Special investment incentives in the form of income tax, value-added tax, and luxury tax facilities are made available on a case-by-case basis by BPM-PBUMN.

The GOI re-introduced basic tax holidays with Government Regulation No.45 of 1996. Investments in specific sectors, including capital goods manufacturing, agribusiness, infrastructure, sea and air transport, engineering, and professional personnel training may be eligible. Presidential Decree No.7 of 1999 laid out evaluation criteria for new tax facilities for new investors entering designated "pioneer" industries.

The basic incentive period is three years, with an additional two years for investments outside of Java and Bali. The incentive period can be extended for investments that employ more than 2000 Indonesian workers, are at least 20 percent held by an Indonesian cooperative, and/or whose total investment is CDN$290 million or more excluding land and buildings. Tax exemption for qualifying investments begins at the start of commercial operations or after the project is licensed, whichever comes first. Time beyond five years to achieve startup will be deducted from the period of the tax incentives.

Indonesia does not have rules of general application requiring that investors purchase from local sources or export a certain percentage of output. Rules that encouraged investors to locate in industrial estates were eased in June 1998. Foreign firms are not required to disclose proprietary information to the government as a requirement to invest.

Indonesia now has a relatively open foreign investment regime and looks to foreign investment to help the country out of the current economic crisis. The government expects foreign investors to contribute to the training and development of Indonesian nationals, allowing the transfer of skills and technology required for their effective participation in the management and operations of foreign companies. As a general rule, a company can hire foreigners only for positions that the government has deemed open to non-lndonesians. Employers must have manpower-training programs aimed at replacing foreign workers with Indonesians.

F.Protection of Contract and Property Rights

Since the economic crisis began, Indonesia has suspended many private infrastructure projects for economic and political reasons. Although Canadian companies have not been directly affected by these suspensions, CIBDO, the Canadian Embassy and the Indonesia-Canada Chamber of Commerce have vigorously emphasized to the Indonesian government the importance of honoring internationally binding contracts and conducting project reviews in a rule-based, consistent, objective, and transparent manner. Most government officials recognize the importance of honoring contracts.

Mortgages (known as "hak tanggungan") may be registered on title to real property. Security interests in both tangible and intangible personal property are also recognized and a law establishing a registration system for such security interests was finally enacted in 1999. Implementation of this registration system is slated for 2000. At least in the past, enforcement of secured interests was problematic.

Although it rernains on international watch lists, Indonesia has made considerable progress in improving regulatory protection for intellectual property rights. The 1987 Law on Copyrights carries a penalty of seven years imprisonment and/or a Rp 100 million fine for copyright violations, although enforcement remains a problem. Indonesia is a member of the World Intellectual Property Organization and a party to the Paris Convention for the Protection of Intellectual Property. In March 1997 I the Parliament passed amendments to Indonesia's patent, copyright and trademark laws designed to bring them into compliance with the Trade Related Aspects of Intellectual Property Rights (TRIPS) agreement of the Uruguay Round. In 1997, Indonesia also ratified to the Berne Convention and the Trademark Law Treaty. Other international agreements to which Indonesia is party include the Nice Agreement for the International Classification of Unclassified Goods and Services, the Strasbourg Agreement Concerning International Patent Classification, and the Budapest Treaty on the International Recognition of the Deposit of Microorganisms. New laws are being drafted to protect industrial design, trade secrets, and integrated circuits.

 Patents: Indonesia's first patent law came into effect on August 1, 1991. The law and its implementing regulations outline patent application procedures, application fees, registration of patent consultants, and patent announcements: Products and production processes are in principle patentable subject to certain requirements for a period of 14 years commencing from filing of the patent application

The duration of a patent may be extended for an additional two years. In addition to this relatively short term of patent protection, the law also contains certain compulsory licensing provisions. Pharmaceuticals are singled out for even less advantageous treatment. The law permits importation of 50 specific pharmaceutical products by non-patent holders, and patent protection is granted only to pharmaceutical products manufactured in Indonesia.

Trademarks: The current trademark law took effect on April 1, 1993. This act states that trademark rights are determined on a first-to-file basis rather than on a first-use basis. After registration, the mark must actually be used in commerce. The law offers protection for service marks and collective marks as well. Procedures for challenging registrations are also provided. In principle, the law also provides "well-known" mark protection, although procedures for registering trademarks as "well-known" have not been fully developed, and could be to the detriment of some companies. Cancellation actions must be lodged within five years of the trademark registration date.

Copyright: Parliament passed amendments to the 1982 copyright law in 1987 and again in March 1997. The amended law affords protection to foreign works, expands the scope of coverage and raises the terms of protection to international standards. In May 1997, Indonesia ratified the Berne Convention on Copyright Protection.

G.Transparency Regulations of the Implementation of Laws and Regulations

Indonesia has a complex regulatory and legal environment where, in the past, many firms -both foreign and domestic -have attempted to circumvent applicable legal and regulatory obligations. Laws and regulations are often vague or ambiguous allowing government officials wide latitude in their interpretation and enforcement, thereby leading to a lack of business certainty.

Deregulation has been successful in removing barriers, creating more transparent trade and investment regimes, and alleviating, but not eliminating, red tape. Lack of transparency and bureaucratic delays are routinely cited by Canadian businesses as factors hindering their operations in Indonesia.

Canadian and other foreign investors overwhelmingly welcome the new Indonesian Government's commitment to increased transparency, reduction of corruption and non-essential bureaucratic procedures, and even-handed enforcement of laws through a strengthened judicial system.

H.Banking, Capital Markets and Portfolio Investment

Banking: Problems in Indonesia's banking sector were at the core of the severity of the economic crisis. In response, major efforts to restructure the sector began in June 1998. .The economic crisis that swept through Southeast Asia starting in July 1997 I paralyzed Indonesia's financial sector and caused severe disruptions in the banking system. Most bank loans were not being serviced; banks were in turn unable to service their debts; and the collapse in bank credibility had all but shut off the flow of interbank credit. Bank restructuring, together with private debt restructuring, remain two of the most urgent priorities of the government.

After a decade of banking sector liberalization, the Government of Indonesia found itself forced to play an increasing role in banking as the economic crisis deepened. Bank Indonesia first provided a substantial amount of liquidity credits to banks --in effect becoming the part owner of many troubled banks. As the extent of banking sector weakness became clear, the Government established the Indonesian Bank Restructuring Agency (IBRA), charged with reducing the number of banks and with supervising and eventually recapitalizing the remaining ailing banks. The Government also issued a sweeping guarantee on bank deposits and other liabilities.

Capital Markets: Indonesia's capital market expanded rapidly over the last decade, led by growth of the equity market. Trading on the Jakarta Stock Exchange -the dominant securities market in the country -increased from only 27,000 shares per day in 1988 to 254 million shares per day in mid-1998. Like the banking sector, however, the stock market was hit hard by the economic crisis that struck Indonesia. Market capitalization declined by 30 percent in Rupiah terms from May 1997 to May 1998.

The lack of a well-developed bond market had been a limiting factor for Indonesia's financial sector, and contributed to the financial and economic crisis. Lacking a deep domestic market for bond financing, and facing relatively high domestic interest rates for bank loans, many rapidly expanding Indonesian companies borrowed abroad during the early 19905, running up private offshore debts of about CDN$115 billion by 1997. These loans were largely unhedged, because companies counted on the Rupiah's continuing depreciation at a slow and predictable rate against the U.S. Dollar. The loans were also largely short-term, but it was common practice for lenders to rollover the principal on a yearly basis.

Because of the overall weakness of the commercial and banking sector, very little credit is available on t