Is Suharto Backtracking?

Business wonders as he wavers on free trade and reform

For foreign investors, the news from Irian Jaya was anything but reassuring. At a huge gold mine and mill operated by Freeport McMoRan Copper & Gold Inc., thousands of local tribespeople rioted in March, accusing the New Orleans company of stealing their ancestral land, leveling mountains, and polluting rivers. In a week of unrest, Indonesian troops killed at least six people and arrested 89 others. The government was able to limit the damage to Freeport, the country's largest outside investor, which denies any allegations of wrongdoing.

But Jakarta has had worse luck in reassuring foreigners worried more broadly about Indonesia's erratic economic policies. In a reversal, foreigners and some Indonesians are questioning President Suharto's ability to deliver on economic reforms. "It's going to be very difficult to expect a broad-based, consistent deregulation measure for quite some time," says Juwono Sudarsono, vice-governor of the Indonesian military's National Resilience Institute. Even the World Bank, which normally refrains from criticizing Indonesia, since it accounts for 11% of the agency's loan portfolio, is warning of a need for more consistent and transparent policies.

FAMILY MATTERS. In recent months, nearly every step the government has taken in the name of deregulation looks more like a leap backward. Suharto has stunned foreign auto makers by granting tariff breaks to a local company--run by one of the President's sons--that is teaming up with South Korea's Kia Motors Corp. The government has bestowed similar favors on well-connected companies in the petrochemical industry. And Jakarta has pushed ahead with a huge commitment to building a protected aerospace industry. All this has taken place while the sizable business role of Suharto's family and friends has grown. Executives of companies run by Suharto's children deny that they receive any special favors.

At the same time, an official crackdown on bribery has barely gotten off the ground, foreign executives say. Payment of bribes to get permits and move merchandise is said to make up more than 10% of the operating costs of any company in Indonesia.

Until recently, Suharto presented himself as a pioneer of free trade. In 1994, he issued a deregulation package that slashed tariffs across the board and allowed foreigners to own 100% of Indonesian-registered companies. As host of the 1994 Asia-Pacific Economic Cooperation (APEC) summit, he promised to eradicate barriers to investment and trade with the 17 other APEC states by 2020. He made the same promise to the Association of Southeast Asian Nations (ASEAN) by 2003.

It's still possible he will follow through over the long haul. But his auto industry machinations suggest otherwise. In late February, the government granted special duty-free status to Kia, allowing it to sell sedans for less than half the price of a $30,000 Toyota Corolla, which leads the market. Following government policy to localize production, Toyota Motor Corp. has been in Indonesia for more than 20 years in an alliance with PT Astra International, a local auto maker.

But Kia has some valuable connections: The Indonesian subsidiary is run by Suharto's youngest son, Hutomo Mandala Putra, 33. Hutomo is also chairman of Italian-based sports-car maker Automobili Lamborghini, in which he has a 60% stake. Hutomo and Indonesian partners bought the company from Chrysler Corp. in 1994 for a reported $40 million.

Unlike Kia, established auto makers are still bound by rules that gradually decrease tariffs as local content increases. General Motors Corp., for instance, has invested more than $100 million since 1994, when it opened an assembly plant for Blazers and Opel Vectras. Officials of Astra, which also assembles BMW, Daihatsu, Isuzu, Nissan, and Peugeot cars, say they are still studying the new rules. But they may find it harder to sell the home office on the Indonesian market. As local consumers wait for the cheaper Kias to roll in, the local market is expected to drop 30%, to 300,000 cars, this year.

Kia plans to build up local content over three years as part of a pact to maintain its special status. But that means car parts could become scarce if suppliers decide to work for Kia, warns Herman Latif, vice-president-director of PT Krama Yudha Tiga Berlian Motors, which assembles and distributes Mitsubishi cars in Indonesia.

Another decision affecting trade is proving just as difficult to justify. While the government ruled out protection for the petrochemical industry last year, in February it slapped tariffs of 25% on imports of propylene and ethylene, which are produced by the $1.7 billion Chandra Asri plant in West Java. The facility is owned by Prajogo Pangestu, a local tycoon close to the Suhartos.

Aside from the protectionist tariff policies, economists are also worried by two companies that Suharto has formed to fund controversial state projects. The first is a $100 million foundation formed last year by Suharto's second son, Bambang Trihatmodjo, to feed the impoverished Muslim majority. A government decree requires about 10,000 of the country's biggest taxpayers--mostly ethnic Chinese--to "donate" 2% of their after-tax profits to Bambang's fund.

DISPLEASURE. A second company, chaired by Suharto himself, is charged with developing a $2 billion jet plane for the state aircraft manufacturer IPTN--using more funds contributed by the same tycoons, led by Pangestu. These companies "represent a different sort of intervention in the economy," warns Dennis De Tray, director of the World Bank's Jakarta office. They "may not send clear signals either to the business community or to investors."

Some foreign investors and insurance underwriters are registering their displeasure with Indonesia. Last year, the U.S. Overseas Private Investment Corp. canceled a $100 million political-risk insurance policy for Freeport McMoRan. That decision is being appealed in Washington. The World Bank may cancel a similar $50 million policy, leaving Freeport to depend more on protection from the Indonesian government, which holds a 9% stake in the local Freeport subsidiary. Chrysler Corp., which assembles Jeep Cherokees locally and is considering an expansion estimated at $100 million, says it is "very concerned" about Jakarta's auto policies.

Even so, no foreign companies have threatened to pull out. Aware that Suharto's leadership style is characterized by pendulum-like swings, most hope that he will put his reform program back on track. "That is pretty much the way these things always work--some steps forward, some steps backward," says James Castle, head of consultants Business Advisory Strategies. Indeed, Siemens has just wrapped up financing for a $1.7 billion power plant. The German company's partner: Suharto's son Bambang. For foreign investors, there's nothing like working with a Suharto family member to ease concerns about ever-shifting Indonesian policy.

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