China and Japan have been engaged in competition over infrastructure lending in East Asia for a number of decades, with particular intensity since the launch of China’s Belt and Road Initiative (BRI) and Japan’s Partnership for Quality Infrastructure in the 2010s. Most discussions in policy circles have been about the geopolitical roots of this competition. Less discussed are the political-economic effects it has on the domestic context of the smaller Asian countries Beijing and Tokyo seek to woo.
While Asia’s infrastructure needs are real, the tendency towards bad borrowing remains strong given the region’s persistent accountability problems. In this context, the “easy money” generated by the two countries’ competition is a double edged sword. On the one hand, creditor competition can generate a ‘windfall effect’ that benefits the host country, giving greater access to financial resources. On the other, easy access to financing can motivate political opportunism as decision-makers in host countries use foreign sponsored projects to enhance their political positions rather than making sound policy choices.
Competition between China and Japan over the Jakarta-Bandung high-speed rail (HSR) project, which has been plagued by complications and troubles since its groundbreaking, is a useful case study through which to examine this issue. The history of the project shows how push factors (easy money from Beijing and Tokyo) and pull factors (Jakarta’s desire to exploit easy money for political gain) interacted to advance this troubled project at the cost of Indonesia’s fiscal discipline and government accountability.
In search of infrastructure modernity (or easy money?)
Since recovering from the Asian financial crisis in 1997, Indonesia has been a rising economy and is currently the world’s 16th largest economy, with prospects to be the 7th largest by 2030. However, due to a dearth of public investment throughout the 2000s, infrastructure development in Indonesia lags behind the country’s growth pace and increasingly threatens to undermine its economic potential. Since the 2010s, infrastructure development has become a priority to Indonesia’s economic policy. It also, however, has become an area of political opportunism, which helps explain how the Jakarta-Bandung HSR, an unlikely project which requires costly greenfield development and risks high socio-environmental impacts, became the first of Joko ‘Jokowi’ Widodo’s big infrastructure push plan.
The project has a convoluted history which is worth diving into. During the Susilo Bambang Yudhoyono (SBY) government, the project was on the sidelines of several development plans drawn up in collaboration between Jakarta and the Japan International Cooperation Agency (JICA). It was merely considered as an alternative route for a larger HSR plan between Jakarta and Surabaya and, because of Japanese ministries’ mixed assessments over the project’s financial viability and the SBY government’s fiscal caution, the project never gained political traction.
The scene began to change following Shinzo Abe’s ascendancy to Prime Minister in late 2012 and the subsequent prioritization of HSR infrastructure in his foreign policy. By January 2014, JICA had designated the Jakarta-Bandung HSR a new initiative in its Overseas Development Aid (ODA) plan for Indonesia, agreeing to finance it along with a Japanese consortium under Jakarta’s financial guarantee. Then came Jokowi’s 2014 presidential victory. Soon after his inauguration, Jokowi vowed to lift the Indonesian economy through an ambitious infrastructure plan, known as RPJMN 2015-19. With an estimated cost of $470 billion, RPJMN 2015-19 faced widespread skepticism for its massive scale and short timeframe on the one hand, and the Rupiah’s depreciation, Jakarta’s fiscal limit, and a host of institutional problems on the other. When Jokowi slashed fuel subsidies to support infrastructure budgets, soaring gasoline and diesel prices heightened criticism for the policy. Jokowi’s approval rating plummeted, and drove him to seek quick deliverables.
The dynamics shifted again after President Xi’s visit to Jakarta on the 60th anniversary of the Bandung Conference in April 2015. Realising the opportunity posed by Japan and China’s competition over infrastructure investments in the region, Jokowi actively made rounds between China and Japan seeking support for RPJMN 2015-19, including extending an invitation to China to conduct a feasibility study for this project. China’s speedy study not only recommended the project but also offered a lower cost and a shorter timeline compared to JICA’s proposal. In response, Japan pledged a 50 percent reduction of the state guarantee for the HSR project. When Jokowi turned down both offers due to Indonesia’s legalized fiscal debt limit, China waived the state guarantee entirely and proposed a contract between state-owned enterprises (SOEs) of the two countries to help circumvent the debt limit and Jakarta’s non-direct involvement. Indonesia soon awarded China the project under the so-called ‘investment’ contract that would not incur public debt. Jakarta-Bandung HSR then became the first RPJMN 2015-19 project to break ground.
The timing of the construction was important to the Jokowi government as it provided much-needed momentum to his infrastructure big-push promised in his 2015 election manifesto and just months before the following election in April 2019. The project was instrumental to Jokowi’s electoral odds. When announced, the project gained strong support from Bandung, the capital of West Java, the country’s most-populous province and where Jokowi lost hugely to his election contender Prabowo Subianto. Local political watchers commonly saw Jokowi’s push for the HSR project, along with more than 30 other infrastructure projects in West Java, as an electoral strategy.
Jokowi’s play between Japan and China paid off. Through 2015-16 Jakarta succeeded in locking in Japanese and Chinese funding for major projects in Metro Jakarta and less affluent areas outside Java Island (both Jokowi’s political strongholds), including JICA’s support for Jakarta Mass Rapid Transit Project and the China Development Bank’s support for Adipala power plants in Central Java. By the end of 2016 his approval rating had rebounded to the high levels seen at the time of his inauguration. However, chasing after easy money did not justify the merits of Jakarta-Bandung HSR itself and instead created many accountability issues.
Repercussions of chasing after easy money
Issues with the Jakarta-Bandung HSR surfaced as early as JICA’s original feasibility study in November 2012. But skeptics within Japanese ministries diminished after Prime Minister Abe publicly backed the project. When announcing the deal, the Jokowi government encountered similar concerns from home, including some from his own cabinet. Jokowi’s office nevertheless defended the project’s value for the local economy, while at the same time pressing ahead with permit approvals to clear the way for it.
Obvious flaws lay in this rushed process. For example, Jakarta approved China’s feasibility study completed in only three months and its environmental impact assessment completed in just seven days! The inadequate preparation manifested itself in the suspension of the project shortly after groundbreaking, due to a multitude of financial and technical challenges, as well as opposition from stakeholders over land acquisition and environmental concerns. The project developer was forced to make major rerouting of the rail terminus, which, along with other changes, raised the project budget from $5.5 billion to $6.1 billion— similar to Japan’s original offer— and more than doubled the proposed ticket fares to absorb cost overruns.
After three years of suspension, project construction resumed earlier this year following Jokowi’s 2019 reelection. It was again stalled after the outbreak of COVID-19. Considering its worsened financial outlook, the Jokowi government in June asked Japan to join the project and integrate it into the JICA-led Jakarta-Surabaya rail project, claiming that this was the only ‘economically viable’ option.
Beyond just the HSR project, Indonesia has borrowed heavily and accumulated a rising amount of foreign debt over the last ten years. As World Bank International Debt Statistics illustrates (see Figure 1), compared to its neighbors, Indonesia saw the highest growth in terms of external debts-to-gross domestic product ratios since 2008, due mainly to surging government spending. More importantly, the fact that a high proportion of its government debt is held by foreign creditors (See Figure 2) is a cause for concern, particularly in times of economic uncertainty.
Though the HSR project itself is not significant in contributing to these debt figures, it nonetheless represents Jakarta’s ever-expanding infrastructure spending, which would not have taken place without Japan and China’s rapid credit expansion under competitive pressure. In addition, as illustrated by the HSR project, large infrastructure initiatives are often prone to accountability problems and inadequate project management, exacerbating fiscal risks.
The project also indicates another risk facing Indonesia: excessive lending via off-public-balance-sheet contracts. Like other emerging economies, Indonesia has recently sought ways to control public debt while continuing to tap foreign capital for megaprojects through new financial schemes such as public private partnerships (PPP). Under competitive pressure, Beijing and Tokyo have increasingly channeled credit to such contracts in order to help their business actors expand overseas. While PPP contracts may help with Indonesia’s financial leverage, they also create indirect fiscal impacts. Indonesia’s debt-ridden SOEs, the key developer of many PPP projects, are emblematic of such risks. These SOEs have recently incurred enormous debt by frontloading the cost of infrastructure contracts. Financial distress was one of the main factors that halted construction of the Jakarta-Bandung HSR in late 2017 and led Jokowi to float the possibility of letting China assume up to a 90 percent stake in the project, a suggestion that quickly garnered widespread criticism. In turn, Indonesian SOEs, including the lead developer of Jakarta-Bandung HSR, issued junk bonds to foreign investors, mainly from China, to keep themselves afloat.
The COVID-19 crisis and the subsequent falling value of the Rupiah has exacerbated Indonesian SOEs’ debt problems so severely that Indonesia’s credit rating was downgraded by Fitch in June, intensifying the bailout pressure on Jakarta. Both episodes prove the profound risk of Indonesia’s reliance on foreign capital to boost its infrastructure. All the problems here show that Japan and China’s easy money fails to improve, if not perpetuates, the institutional and accountability problems that most likely caused Indonesia’s infrastructure capital gap in the first place.
The fact that lending competition in the Asia region is often carried out amidst lax lending conditions and accountability problems of borrowing government make many infrastructure projects susceptible to decision-makers’ political calculations, increasing the chance a project will fail to realize its desired goals and fail to generate enough revenues and economic benefits to recover incurred debts. While in recent years, international organizations have made greater efforts to ensure international creditors’ risk assessments, more funding in itself does not address the issue of project bankability. Rather, it increases the likelihood of reckless projects being financed.
This has important implications amid the ongoing uncertainties within the global economy and sudden credit crunch caused by the COVID outbreak. Many heavily indebted developing countries have begun showing signs of over-leveraging as their governments scrambled to manage heavy debt burdens. In Indonesia, many ongoing Chinese and Japanese-financed infrastructure projects have been suspended or delayed due to cash flow problems. How serious their debt problem will become, how the involved borrower and creditor countries would cope with insolvencies, and whether it may lead to financial crisis are now very real questions as we head into 2021.
This blog is based on a recently published paper in Contemporary Politics: Jessica C. Liao & Saori N. Katada (2020): Geoeconomics, easy money, and political opportunism: the Perils under China and Japan’s high-Speed rail competition, Contemporary Politics, DOI: 10.1080/13569775.2020.1816626
Dr. Jessica C. Liao is an assistant professor of political science at North Carolina State University. She received her PhD in international relations from the University of Southern California. Her research focuses on Chinese foreign policy and East Asian politics. Her current project is about China’s resource and infrastructure development in Southeast Asia.