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Envelopes of Cash Show Indonesia Graft Rivaling Suharto Era

Indonesia's President Susilo Bambang Yudhoyono
Susilo Bambang Yudhoyono, Indonesia's president. Photographer: Toshiyuki Aizawa/Bloomberg

Indonesian anticorruption officers watched Wafid Muharam for five hours before raiding his office to seize envelopes stuffed with $151,550, sparking a scandal that’s roiling President Susilo Bambang Yudhoyono’s party.

“The envelopes contained rupiah, U.S. dollars, Australian dollars and euros,” said Johan Budi, a spokesman for the Corruption Eradication Commission, or KPK, in Jakarta. “We caught the official, a secretary in the youth and sport ministry, red-handed” in the April operation, he said.

With the cash were checks worth 3.2 billion rupiah ($350,000), part of a bribery trail that led to Muhammad Nazaruddin, treasurer of Yudhoyono’s Democrat Party, who was arrested four months later by Interpol in Colombia after fleeing the country, Budi said. The scandal has undermined Yudhoyono’s election pledge to tackle graft, sending his popularity to a record low and hampering efforts to match investment levels in rival Asian nations.

Investing in Southeast Asia’s biggest economy is now more complex than in the 1980s and 1990s, during the rule of former President Suharto, according to Hal Hill, a professor of Southeast Asian economies at Australian National University in Canberra who advises the World Bank and Asian Development Bank. Suharto allegedly embezzled $15 billion to $35 billion, Transparency International said in a 2004 report.

‘Who to Pay’

“Under the old regime, corruption was highly organized and predictable, and now it’s highly disorganized and unpredictable,” said Hill. “You knew who to pay, how much and what the payoff would be. Now, none of those are clear.”

Corruption is discouraging spending on roads and plants that HSBC Holdings Plc says the country needs to catch up with the region’s fastest-growing economies. Foreign direct investment in Indonesia, the world’s fourth-most populous nation, fell to 1.9 percent of gross domestic product last year from 2.9 percent in 2005, World Bank data show.

Gross investment isn’t yet a key driver of the nation’s economic growth, DBS Group Holdings Ltd. said in a June note. Gross fixed capital formation was 24 percent of GDP in 2010, below China’s 46 percent, Vietnam’s 41 percent and the 35 percent in India, the bank estimated.

After the arrest of Muharam, Nazaruddin made his own corruption allegations to Indonesian media while on the run. He was brought back to Indonesia in a chartered Gulfstream jet, surrounded by a retinue of officers from Interpol, KPK, the Indonesian police force and immigration officials, said Budi.

Trial Looms

Nazaruddin was sacked by the Democrat Party and faces trial over alleged bribes for building projects for this month’s Southeast Asian Games. He has connections to businesses worth at least 6 trillion rupiah, the KPK said.

Hotman Paris Hutapea, a lawyer for Nazaruddin, declined to comment on whether his client is guilty of the charges, saying in a Nov. 18 telephone interview that the investigation into the case is “legally flawed.” Erman Umar, a lawyer for Muharam, who is currently on trial in Jakarta, denied his client was involved in bribery when reached by telephone Nov. 17.

As news of the arrests broke, Yudhoyono’s popularity slumped. A poll by Indonesian Survey Circle published Oct. 16, the most recently released, showed 46.2 percent approved of his performance, down from 63.1 percent in January 2010.

The president, 62, said after Nazaruddin’s arrest that he hoped the case would be handled transparently, objectively and with accountability. Yudhoyono told parliament on Aug. 16 that “efforts to weaken the anti-graft body should be prevented.”

Yudhoyono’s spokesman, Teuku Faizasyah, said the president isn’t available for further comment as he’s preparing for his son’s wedding.

Agency’s Record

The KPK has received more than 50,000 complaints from the public since 2004, Budi said. The agency says it’s recovered 157.3 trillion rupiah in cash and assets since 2005 and convicted more than 100 officials.

Graft has become more complex since the end of Suharto’s 32-year reign in 1998 because of involvement of lower-level officials, according to Jakob Friis Sorensen, Jakarta-based president director of PT Maersk Indonesia, a unit of A.P. Moeller-Maersk A/S, owner of the world’s biggest container shipping line.

“The complication now is with more power being transferred to the provinces, obviously you will see a decentralization of people trying to get a piece of that cake,” Sorensen said in a Nov. 8 telephone interview. “Domestic and overseas investors are increasingly confused and frustrated about this environment.”

Decentralization is part of Indonesia’s democratic transformation, an evolution that will still take a long time to get right, he said.

Maersk Concern

Maersk’s only investment in Indonesia, made in the 1980s and 1990s, is a $20 million warehouse in Cakung, south of Jakarta’s Tanjung Priok port, Sorensen said. The company would have invested more if it weren’t for corruption, said Sorensen, who worked for Maersk in Indonesia in Suharto’s era and returned in 2006.

“Worldwide data tells us that corruption is a significant ‘tax’ on domestic and foreign investors,” said Daniel Kaufmann, a senior fellow at the Brookings Institution in Washington and former World Bank Institute director of global governance and anti-corruption. If Indonesia reduced graft to the level of Taiwan, per capita income could rise about 300 percent, he said.

Indonesia’s gross domestic product per person this year is $3,469, while Taiwan’s is $21,592, International Monetary Fund estimates show.

Increased investment in Indonesia would help lift growth to more than 8 percent by 2020, HSBC analysts estimated in July. By comparison, the nation’s annual average expansion rate in the decade through 2010 was 5.2 percent.

Going Elsewhere

Businesses from Espoo, Finland-based Nokia Oyj, the biggest mobile-phone maker by volume, to Santa Clara, California-based Intel Corp., the largest chipmaker, are building plants elsewhere in Southeast Asia.

Intel began operations at a $1 billion assembly and testing plant in Vietnam’s Ho Chi Minh City in June 2010, similar to its plants in Malaysia and China. Nokia, which also has plants in China, India and South Korea, plans to open a factory for low-end handsets near Vietnam’s capital, Hanoi, in 2012. Stuttgart, Germany-based Robert Bosch GmbH said in June it plans to invest 520 million euros ($700 million) in a solar cell plant in Malaysia.

Malaysia’s infrastructure, reliable power supply and workforce quality attracted Bosch, said spokeswoman Martina Horton. The company never gives reasons why investment isn’t made in a competing country, she said.

Vietnam’s Appeal

Vietnam offered proximity to end customers, “good prospects for a solid talent pipeline” and government incentives, said Nick Jacobs, a regional spokesman for Intel. Nokia declined to comment on whether it plans to manufacture products in Indonesia, spokeswoman Mona Kokkonen said.

“Foreign companies don’t have the stomach for this,” said Mohamad Ikhsan, a special adviser to Indonesian Vice President Boediono, referring to Indonesia’s pattern of corruption. “For investors who don’t know how to handle and solve it, they prefer to avoid the country.”

Revelations of graft pose a risk for equity investors as well. PT Perusahaan Gas Negara, Indonesia’s biggest distributor of the fuel, tumbled 7.1 percent on May 25 last year after the Jakarta-based company said it had suspended a director who’d been named as a suspect in a graft case by the KPK. The benchmark Jakarta Composite Index declined 3.7 percent that day.

Nazaruddin, the arrested former treasurer of Yudhoyono’s Democrat Party, accused PT Wijaya Karya, a building company, and PT Adhi Karya, a construction business, of offering bribes to win contracts, the official Antara newswire reported on July 25. Both Jakarta-based enterprises denied involvement in graft.

Impact on Stocks

Shares in Wijaya Karya have slumped 27.3 percent since the start of July, while Adhi Karya’s stock price has tumbled 42.5 percent. That’s more than the 5.6 percent fall in the Jakarta Composite Index in the same period.

For companies such as Freeport-McMoRan Copper & Gold Inc., the largest publicly traded copper producer, and Greenwood Village, Colorado-based Newmont Mining Corp., the biggest U.S. gold producer, potential returns from Indonesia’s deposits of oil, coal, copper and gold, outweigh the risks.

The district around Phoenix-based Freeport’s Grasberg mine in Mimika, Papua province, about 1,940 miles (3,122 kilometers) east of Jakarta, contains the world’s largest recoverable reserve of copper and the biggest gold reserve, according to the company’s website.

Newmont’s local unit said in June it had agreed on a $600 million loan with banks to expand its gold and copper mine in West Nusa Tenggara province.

Middle Class

Other foreign investors are looking to tap an expanding middle class in the nation of 237 million people. Toyota Motor Corp., Asia’s biggest carmaker, said in September it plans to build a second factory in Indonesia at a cost of 26.3 billion yen ($342 million).

The revival of corruption scandals comes after foreign direct investment jumped almost 173 percent to $13.3 billion in 2010 from a four-year low of $4.9 billion in the previous year, according to United Nations data. Fiscal stability under Yudhoyono has put the economy on the verge of its first investment-grade credit rating since the 1990s.

Sorensen said he’s optimistic Maersk can invest more in Indonesia without being involved in graft by refusing to tolerate it. He banned so-called “facilitation payments” of up to $50 and said the company will take major problems it encounters to senior government officials if necessary or walk away from a project.

Eschewing Payments

“It’s often implied by tax auditors that they will go away if you pay them to do so,” said Sorensen. “We don’t do that. We give them a place to sit. We give them all the documents they want. We will actually inundate them in papers until they simply realize there is nothing here to come for and they go away.”

Even when projects proceed, a culture of corruption can lead to poor quality execution, said Richard Messick, a senior operations specialist at the World Bank. In one case, an Indonesian road was 40 percent thinner than specified and had 13 percent less asphalt than required because of fraudulent construction, the World Bank said in a June report.

Such concerns threaten to undermine Yudhoyono’s plans to tap private investment in doubling spending on roads, ports and airports to $140 billion by the end of his term in 2014.

“Corruption within the Democrat Party is an important political issue for Yudhoyono, which could damage the image of the party in the next election,” said Maswadi Rauf, professor of political science at Universitas Indonesia in Jakarta. “If corruption is proven in the court later, it would be very detrimental. The party needs to take steps to clean up.”

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