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IN THE INDONESIAN PUBUC PORTS

December, 1994

This Paper was prepared by J. Van der Ven. It is based on the report prepared by a team of port experts led by J. Lethbridge following a mission to Indonesia in May 1993. Team members were J. Arnold, G. De Monie, C. Doan, S. Sherer and B. Tang. The draft report was discussed with the Directorate General of Seacommunications in November 1993. D. Hawes and P. Guislain reviewed and commented on drafts of the Paper. PRIVATE SECTOR PARTICIPATION IN THE INDONESIAN PUBLIC PORTS

Drawing on the experience of the expert team with private participation in ports, this Paper examines how the objective of the Indonesian Government to increase the role of the private sector in the public ports can best be achieved given the characteristics of port activities and functions in general, the institutional structure of the Indonesian port sector and the Indonesian legislative context.

In view of the many opportunities for private participation and the varying degrees of complexity possible, the Paper advocates a progressive implementation of the policy starting with the simpler and well tested forms such as the provision of services to the port, following on with schemes for the operation of existing cargo terminals and schemes for the development of the superstructure and operation of new terminals. Because of the risks associated with major schemes involving the development of both the basic infrastructure and superstructure and the operation of new terminals, the Paper advises against pursuing such schemes in the initial stages.

The Paper emphasizes that to secure effective private participation a number of key requirements need to be met, including: competition for or in the market, an enabling regulatory basis, the sharing among all parties of the efficiency gains, and consistency in objectives pursued by all levels of government. Because of the considerable scope for competition in the Indonesian port sector and the recent modernization of the shipping and port legislation, conditions for meeting these objectives are favorable. However, what matters most in the end is how the private sector partners are selected (which determines whether agreements are made with the most capable) and what precisely is entered in the agreements (which determines now the benefits of improved efficiency are shared among the port, the port users and the private sector party). The Paper, therefore, recommends that key components of model agreements and of a competitive selection procedure be developed in parallel with the building up of an institutional capability for preparing and negotiating effective agreements. It also argues that if private sector participation is to proceed on a larger scale, action must be initiated without further delay to bring port tariffs in line with costs, and to modernize port labor policies and practices so as to avoid that tariff and labor issues remain an obstacle when transferring port activities to the private sector. PRIVATE SECTOR PARTICIPATION IN THE INDONESIAN PUBLIC PORTS

TAzL OF CONIN

Page

ExecutiveSanunary ...... i

1 IntroductionandBackgrnd d ...... 1 1.1 TeoIdonesian Ports Sector ...... 1 1.2 IbisPaper ...... 2

2 GOI Policies and Objectives in Relation to Private Sector PartiipatoninPorts ...... 3 2.1 Overall Policles and Objectives of the GOI ...... 3 2.2 Specific Policy Objectives for the Ports Sector ...... 3 2.3 Operational Objectives of the Port Corporaons ...... 4 2.4 The Need to Consider the Objectives and Interests of Other Concerned1Parties ...... 4

3 How much Private Sector Participation ? ...... 5 3.1 Port Functions and Private Sector Partcipation ...... 5 3.2 Opportunities for Private Sector Participation ...... 6

4 Key Requirements and Principles ...... 8 4.1 The Need for Competition and a Competitive Process ...... 8 4.2 TheNee dforaRegulatoryBasis ...... 9 4.3 All Parties ShouldGain ...... 10 4.4 Government Commitment and Clarification of Objectives ...... 11

5 Establishing the lega nd Regulatory Basis ...... 11 5.1 General ...... 11 5.2 Laws and Regulations Directly Related to Ports and Shipping .... 11 5.3 The Port Corporation as a State-Owned Corporation (BUMN) ... 13 5.4 General Rules Regarding Economic Deregulation and Foreign Investment ...... 13 5.5 The Indonesian Commercial Code of Law ...... 14 5.6 Recommended GOIActions ...... 14 Page

6 Structuring and Implementing Agreements with the Private Sector 15 6.1 General ...... 15 6.2 The MAor Components of an Agreement ...... 16 6.3 Types of Agreements ...... 18 6.4 Approach for Evaluating Agreemnents ... n...... 20 6.5 The Competitive Bidding Procedure ...... 22 6.6 Structuring...... Payments.to ...... 23 the Portor 6.7 Structuring Charges to the Port Users ...... 24 6.8 Recommended001 Actions ...... 25

7 The Port Tariff and Private Sector Partipation ...... 26 7.1 General ...... 26 7.2 Alternatae Tariff Adjustment Scenarlos ...... 26 7.3 The Indonesian Port Tariff Structure ...... 27 7.4 RecommendedAction ...... 28

8 Port Labor and Private SectorParticilpation ...... 28 8.1 General ...... 28 8.2 The Need for a Comprehensive Labor Reform Strate ...... 29 8.3 Recommended Action ...... 31

9 Institutional Aspects in Relation to Increased Private Sector Particpation ...... 31 9.1 The Strengths of the Puic Sector and Private Sector ...... 31 9.2 The Respective Roles of the Ministry and the Port Corporations 32 9.3 Developing a Capability for Guiding the Implementation ofthePolicy ...... o...... 33

10 Opportunities for Private Sector Participation in the Indonesian Public Ports ...... 34 10.1 General ...... 34 10.2 Provision of Port Services ...... 35 10.3 o perating of Existing cargo Term s...... 35 10.4 Development of Superstructure and Operation of New Terminals . . 37 10.5 Development of a Systematic Procedure for Expanding Private Sector Participation ...... 39 10.6 Securing Adequate Funds for the Development of the Sector .... 41 PRIVATE SECTOR iARTICIPATION IN THE INDONESIAN PUBLIC PORTS

ExECUrVE SUMMARY

I. INrODUCrON

A. Government's Policies

i Indonesia has assigned a key role to infrastructure towards its goal of sustained economic growth. Three key elements of its strategy for infrastructure services are: (a) providing adequate capacity to ensure that lack of infrastructure will not constrain growth of the productive sectors; (b) dismantling regulations which do not serve a useful purpose; and (c) obtaining private sector participation for the development and operation of facilities. Increased private sector participation is expected to bring greater efficiency and additional investment resources. As ports are a critical link in the trade logistics chain and will require substantial investments in the coming decade, this strategy is particularly relevant to the ports sector. It also represents a logical continuation of past policies in the sector. ii. Since the early eighties, Government has been actively pursuing efficiency improvements in the port sector through a series of policy measures covering successively corporatization, deregulation and commercialization.1/ Overall, these policy initiatives have been successful and performance of the port sector has continued to improve in the past ten years. There is scope, however, for further improvement, in particular through expanded private sector participation. The new maritime law enacted in 1992 and its Implementing Regulations, issued in September 1994, should provide the legal and regulatory basis for greater and effective private sector participation in the port sector. Until now, the role of the private sector in public ports has been limited to stevadoring services, but a pilot scheme to rationalize and expand the role of the stevedores for general cargo terminal operations is already under way [para. viii. (b)]. Also, major schemes for private participation in container terminal development in Tanjung Priok and Tanjung Perak, the largest and second largest ports respectively, were announced recently.

1/ The milestones of governments policies in the port sector are: - In 1983, creation of four state port corporations each responsible for managing on a commercial basis some 25-30 branch ports, * In 1985, deregulation of ports and international shipping through Instruction of the President No 4; - In 1988, deregulation of domestic shipping; * In 1992, transformation of the four port corporations from a Perum (100% state-owned corporation) into a Persero (shae corporation with majority state shareholding); - In 1992, enactment of a new maritime sector law which modernizes the legal basis for maritime transport and ports and provides the legal basis for greater private participation in ports; - In 1994, promulgation of the Government Implementing Regulations for the new maritime sector law, to be followed by implementing Ministerial Decrees. - l- B. Alm and Focus of this apW

lii. Involving the private sector in activities which have hitherto been the domain of the public sector may appear easy, but, as those countries that have pursued this policy have learned, to be successful It requires very careful analysis, planalfg and Implementation. In particular, a process based on competition and the use of performance Incentives In contractual agreements are crucial ingredients for effective private sector participation. The aim of the Paper is, therefore to: Identify opportunities for greater private participation in Indonesian ports; outline approaches for introducing competition and promoting efficiency in areas that have traditionally been public monopolies; highlight the requirements which need to be met and the conditions for success; and analyse aspects of particular Importance such as the appropriate rcturing of agreements, the port tariff and port labor policy issues. To this effect the study team considered the experience with private sector participation in ports in other countries and reviewed examples of typical agreements with private sector companies for a number of different, but typical, port activities.

Iv. The focus of the Paper is on private sector participation in public ports and primarily the 110 commercial ports which come under the responsibility of the four state port corporations. This Executive Summary reviews briefly the opportunities for private sector participation in the Indonesian port sector, the key factors and principles which should guide the policy, and the next steps towards implementatZon of the policy.

I. OPPORTUNITIES FOR PRIVATE SECTOR PARTICIPATION IN THE INDONasIAN PUBLIC PORTS

A. Port Functions v. A wide range of functions and activities are carried out in ports, including:

* Securing the safety of navigation (provision of lights, buoys and beacons; dredging, hydrographic surveys; control of ship movements; pilotage; tUgs); * Loading and unloading of cargo (provision of cargo handling nofrastructure; provision of cargo handling superstructure; cargo handling; warehousing and other ancillary services); * Administrative functions (regulation of activities at port; reception and disposal of ship wastes; industrial safety at port; security); * Charging for port services (dues for basic infrastructure; charges for particular services); * Controls over port development (environmental controls; national port planning). vi. Each of these functions lends Itself to different approaches as to the respective roles of the public and private sector. International experience shows a wide spectrum of private sector participation in port activities, which is largely explained by the different historical backgrounds in these countries. The options for organization of the port sector in terms of public versus private sector involvement range from the situation now obtained in the U.K. following a complete sell-off of the port assets and responsibilities to the private sector to the situation where the private sector is not involved at all, except as users, such as Mombasa nort in Kenya. However, most of the functions related to the safety of navigation, environmental control and port planning are generally performed by the public sector. The greatest diversity in approach is found in the area of cargo handling and from this perspective the range can be typified in a simplified way as follows: * Publicly owned and operated port (Yangon, Mombasa) * Private stevedoring in publicly owned and operated port (Lagos, Tema) ** Private shore cargo handling and stevedoring In publicly owned port (Indonesia) Private operating concession in publicly owned port (Container terminal Kingston, Jamaica; Laem Chebang, Thailand) * *Privately developed (spetcu) and operated termunal using basic public infrastructure (typical USA 'landlord port, Antwerp, Kelang-Malaysia) Privately developed (both ifrastructure and superstructure) and operated terminal (Hong Kong and part of Rotterdam) Complete port, originally publicly owned, sold to private Interests who are responsible for practically all the above listed port functions (UK).

vii. The picture in the Asia region is quite diversified with traditionally a wide range of approaches with regard to public/private participation. In recent years, however, the role of the private sector in ports has been expanded In most Asian countries. In Indonesia's 110 commercial ports, all functions except cargo handling (stevedoring on board ship and some shorehandling) are provided by the public sector, namely through the Directorate General of Sea Communications (DGSC) of the Ministry of Communications (MOC) and the four state port corporations. DGSC's routine functions, in particular in the area of safety of navigation, are exercised by the harbormaster. In addition, Indonesia in 1984 instituted the function of Port Administrator (Adpel) In the major ports to provide for the coordination of MOC's functions with the government functions exercised in ports by other ministries, such as customs, immigration and health. While this institution helped in resolving the swere problems encountered at the time it gave rise to some new problems on account of lack of clarity in their responsibilities for government functio on the one hand and port operational functions on the other.

B. Opportunities In Indonesia

viii. Taking into account the current Indonesian situation, the international experience with private sector participation in ports, tLe fact that public ports occupy scarce waterfront land and provide a public service through common user facilities, the complete transfer to the private sector of all the assets and responsibilities of the ports or of a major part of their assets and responsibilities is not recommended. However, there is considerable scope for expanding the role of the private sector in the Indonesian ports along the lines of some of the alternative forms of private sector participation for cargo handling outlined above and for support services. In the following, possibilities are grouped in four broad categories according to their increasing complexity and the size of the risks involved.

(a) Provision of support services. This would include provision by the private sector of services such as tugs, towing, pilot boat provision, equipment maintenance, navigation aids activities, etc. The Paper discusses how such services could be procured, contracted and priced. In many instances considerable costs saving plus increased quality of service can be achieved while it would also reduce the burden on port management of day-to-day operations;

(b) Operation of existing cargo terminals. This would include, for example, improvement and extension of the Terminal Operating System (STO) introduced experimentally in Tanjung Priok in April 1993 for general cargo. The Paper outlines how the system should be expanded and improved. Private sector management of existing container terminals would be another possibility. In both cases, the participation could include some investment in equipment andlor minor infrastructure works; .vi-

(c) Development of superstructure and operation of new terminals. To increase the container handling capacity, which will reach critical levels in at least two ports, the private sector can be invited to invest in the superstructure (paving, buildings, utilities, equipment) and to operate and manage new terminals. 7b. principles of a process for successfully involving the private sector in this type of task are outlined using Tanjung Priok as an example. (d) Development of basic lastructureand and operation of new terminals. Under this option the private sector would make major investments, including in such works as navigation channel, breakwater, port basin, land reclamation and quay wall construe1on as well as in the superstructure and would operate the terminal under a BOT type scheme.

ix. Private sector participation under the first category can be Implemented relatively quickly In the existing Indonesian context considering the capabilities of the maritime sector industry and dr.-ving on the many successful examples of such participation in various ports in the world. Schemes under the second category, can also be designed to be relativelyst depending on the amount of private sector investment being sought. Schemes under the third category would require more careful preparation and planning If the efticiency goals are to be achieved and the interests of the users adequately safeguarded. To ask the private sector to invest in both the basic infrastructure and the superstructure and to operate the terminal under a BOT type scheme is a much more complex undertaking. The various iks involved are much greater and more difficult to assess and to manage. As a result such schemes are likely to require time consuming preparation and negotiations as evidenced by the experience with the third container terminal at Tanjung Priok There are as yet few examples of all-inclusive BOT type investments In public ports and experience shows that for such investments to be made attractive to the private sector in a country where this is a new proposition, the public sector will need to provide extensive guarantees to cover the risks Involved. BOT type schem, however, would be very appropriate in the case of special facilities (e.g. for bulk handling) where there is a sole user of the services or the facility. There are many successful examples of such schemes. x. On the part of the private sector there certal s interest for greater involvement in port activities as is evidenced by the wide participation in the bidding for privatization schemes in ports in the region in recent years. Parties that have expressed interest in the specific case of Indonesia are the ship operating groups active in Indonesia (both local and foreign). The emerging international port operating companies are also likely candidates. The local stevedoring companies are also interested but are aware that they would need to associate with modern port operators to be able to offer the required know-how in modern port operations.

II. KEY REQUIREMENS AlD PRINCHMS

A. The Need for Competition and a Competitive Process xi. The evidence of the privatization experience in the world indicates that competition is the most crucial factor in improving efficiency. Also, there are many ways in which competition can be secured or a competitive process organized. Even when a port activity is provided most economically by a single entity-making competition in the market unfeasible-it will often be possible to organize a competitive process for the right to carry out the activity. In countries oi regions where seabound cargo -vii -

is substantial and can sustain several competing port operators, and where infrastructure Is adequate and well developed land transport and intenodal services are available, It is possible to rely on competition. In this situation the role of the government/public sector in cargo handling can be limited to a minimum as cargo owners and shippers have access to alternatives.

xti. When the above competitive conditions are lacking in a particular region, ports have a monopoly power over import and export traffi and serve "captive marketsO. Under such circumstances, *privatizatione of a major activity such as the port's cargo handling operations introduces the potential of abuse of monopoly power. The risk of this outcome can nevertheless be reduced by inviting firms to compite for the right to operate the port's cargo terminal(s) on the basis of leases or concessions which are awarded to the bidder who is evaluated as most efficient. Remaining risks of abuse of monopoly power, should be addressed through careful design of the efficiency incentives included in the agreements and of a formal feedback channel for port users to register complaints of discriminatory behavior and possibly through regulatory controls. For fanctions of lesser scope such as tug or pilot boat services, equipment maintenance and similar activities, it will normally also be possible in such countries/regions to organize a competitive process at the tendering stage.

xiii. In Indonesia, owing to rapidly growing port traffic, combined with the expansion of the port and land transport infrastructure, there is increasing scope for competition between alternative providers of cargo handling services or for a competitive process in awarding service contracts. Also, because of the large number of different ports, there are many different situations, and hence, good opportunities for implementing different forms of private participation mad for a much expanded role of the private sector. (A recent World Bank Discussion Paper I reviews alternative forms of provision of infrastructure services and criteria for choosing among these forms.) Even In the case of smaller ports in isolated areas which are not commercially viable and where it may not be considered desirable to increase tariffs to a level necessary to attract private participation, a competitive process can be organized. For example, the private sector can be invited to bid for service contracts in which the port pays the private sector for the services and continues to charge the port users at rates which are below its costs. The rationale for such an agreement would be that the cost of providing the services would be reduced through the higher efficiency of the private sector. This arrangement would reduce though not necessarily eliminate the need for continuing subsidization of these ports. A variant of this scheme is to award a contract for performing port activities with given performance standards and a given tariff structure to a private operator under a bidding procedure where the lowest subsidy is the principal selection criterion.

B. The Need for a Regulatory Basis

xiv. When the decision is taken to promote greater private sector participation in ports in a country where it is a first time proposition, as is the case in Indonesia, virtually everything that has to be done has no precedent. Experience shows that implementation of the policy will require changes to laws, regulations and guidelines and will involve a painstaking process of resolving one issue after the other. While it may be possible to Implement particular schemes on such an ad-boc basis it is a very inefficient approach, which will invariably involve long delays and create confusion. There is the risk that the commitment and resolve to succeed on the part of both the Government and the private sector will wear out. xv. If private participation is to succeed in Indonesia-with its large number of ports within which many activities are suitable for private sector participation-on a scale which is commensurate with

2/ Institutional Options for the Provision of lefrastrnctur. World Bank Discussion Paper No 212, 1993. - vill - the potential, it is imperative to have in place an appropriate enabling regulatory system. This should provide the legal basis for the various forms of private participation suitable to port activities and lay down the principles and the process to be followed la implementing the policy. It is recognized that such a system can not be established overnight. However, while it is being developed, a minimum requirement for schemes to be successfully Implemented is the ability for the public sector and the private party to enter into clear and enforceable contractualagreements. The refinement of the regulatory system may well benefit from the experience gained from the early cases. The Paper sets out the main steps to implement such a system for the Indonesian port sector. Two recent Bank reports 31 discuss the national economic environment and policy framework and the general issues related to the development of private enterprise and to private participation in the provision of infrastructure services.

C. Al Parties should Gain

xvl. . The private sector involvement should result in a reduction in the overall cost of providing the same or better services. The agreement worked out between the port and the private party will deteimine how this gain is shared. It represents a compromise between the interests of (and the risks faced by) the three parties concerned, the port, the private sector and the port users. In assessing whether an agreement is worthwhile these parties naturally adopt a different perspective. From the private sector's viewpoint, it is necessary that the return on the investment and on entrepreneurship be comparable to that which would be obtained from other business opportunities. The port users-who in most cases are not a contractual party to the agreement but whose Interests should be safeguarded by the public sector-will etpect an Improvement with respect to both level of service and tariffs or as a mianmum an improvement in one of these parameters. From the port's viewpoint, the arrangement should leave the port in at least as good a financial position as it would have been if it had continued to provide itself the same services or invesaents which it proposes to transfer to the private sector. Of course, the pursuit of this objective by the port would not be justified if the port were abusing a position of monopoly power (which is not the case In Indonesia). While the Indonesian p>rt corporations cross- subsidize losi making activities with profitable ones, overall, they are not blatantly inefficient, nor are they making "excessive monopoly profits owing to the tariff constraints Imposed by 001. This cross- subsidization, however, implies that until port tariffs are properly related to costs-which is of high priority (para. xxxi)-the transfer of the most profitable activities to the private sector through agreements which adversely affect the port's financial position would put at risk the port corporation's financial self- sufficiency.

D. Government Commitment and Clarification of Objectives xvil. The experience of other countries indicates that an essential requirement for the successful implementation of effective private participation is a very strong commitment on the part of the Government to proceed with the implementation of carefully selected schemes. In the absence of strong determination on the part of the Cabinet or the responsible ministers, little will be effectively achieved. xviii. The general statements of long term policy and the passage of the New Maritime Law (Law No. 21 of 1992) reflect the governments goals to improve efficiency and reduce the need for public financing of port development. To become operational for the officials in the Ministry and the Port Corporations responsible for policy implementation these general goals need to be translated into more specific objectives. For example, many specific objectives could be pursued such as promoting efficiency through competition, eliminating the need for government financing of major investments, upgrading

I/ Indonesia - Developing Private Enterprise. May 9, 1991; and, Indonesia - A Strategy for Infrast ure Development. June 22, 1992. . ix -

skills of port managers, staff and workers, reducing surplus dock workers, attracting foreign investment, fostering national entrepreneurship, eliminating government monopolies. Promoting efficiency through competition should normally be the guiding principle and if in addition other objectives are considered of particular importance this will need to be clarified to facilitate the task of the officials in charge of policy implementation and to allow them to take these objectives into account in designing the request for.proposals and the award process in general. Also, it will be important to ensure that the objectives and interests of other concerned parties-the port users, the port employees, residents in adjacent communities and other users of the port's shared facilities-are not overlooked.

IV. NErT SIWS TOWARDS fflENMATION OF THE POUCY

A. An Enabling Ports Regulation xix. The legal and regulatory environment necessary for greater private sector participation in ports includes not only laws and regulations directly concerned with ports and shipping, but also those regarding state owned corporations and the general rules regarding economic deregulation and domestic and foreign investment. At present, the general legal framework for a greater private sector role in Indonesian ports is in place and opportunities for foreign investment have also been created. However, some specific regulations and guidelines to facilitate and encourage effective participation (including from foreign investors) have not yet been developed or issued. In view of the rapidly evolving port scene, foreign participation will be important for securing state-of-the-art know-how. xx. A key requirement is that the Government Implementing Regulation on Port Affairs (Kepelabuhanan), which is the primary implementing instrument for the articles of the new Shipping Law No.21 of 1992 concerned with ports, in its section regarding Cooperation/Working Together (Kerjasama) between a port enterprise and the private sector allows all types of agreements which are appropriate in the port context. As a mininmum, the types of agreements should include: (i) management/service contracts; (i) operating agreements; (ii) lease agreements; and (iv) concession agreements.

B. Developing Model Agreements and a Competitive Bidding Procedure xxi. Model Agreements. As already emphasized, the success of a scheme to expand private participation will depend critically on the adequacy of the contractual agreement. Three main types of situations can be distinguished: (a) those where the private sector will provide services to the port; (b) those where the private sector will operate cargo handling or other port activities mainly using existing facilities and/or equipment; and (c) those where the private sector will invest in and operate new facilities and/or equipment. For each situation the content and terms of the agreement should address strategic issues-such as the period of the agreement, to whom services are to be provided, the responsibility for the assets used, the extent of competition, the pricing of the services, the quality of service to be achieved-which will determine how the benefits to be derived from the scheme and the risks associated with it will be shared among the port, the private sector party and the port users. xxii. In practice, the type and content of the agreement will vary according to the particular operation or service being considered but standardization of approach for typical cases is needed. Thus, to facilitate increased private sector participation in the Indonesian ports the four types of agreements mentioned above should be defined in greater detail for port activities in Indonesia through the development of model agrements which would be updated in the light of experience. Because port operations have increasingly become an international business, contracts with private parties have become x-

more standardized. Examples of existing agreements can be used as a starting point for developing such model agreements.

xxiii. A Competitive Bidding Poecedure. Competitive bidding should be the underlying principle for private sector involvement In the Indonesian ports. The process should be transparent and adhere to clear guidelines. For each scheme a bidding dotAment should be developed which specifies the terms and the conditions of the service or the business. In the case of important activities, where international participation is sought, bidders should be pre-qualified based on a demonstrated capability of conducting the particular type of business and on sufficient financial resources to sustain the business. The bidders should provide background information on their line(s) of business along with an indication of their legal structure. The request for bids should be publicizvd for a sufficient period to attract serious bidders.

xxiv. The components of the agreement on which the bidders are expected to compete and the basis for evaluation of their bids can be put together in a number of ways. For example, depending on the nature of the activity and degree of competition for the services to be provided, the bidders could be requested to compete on the basis of the payment offered to the port, or the charges to be levied on port users. While it is possible to have bidders compete on several items, the greater their latitude, the more difficult it will be to compare bids and have an objective and transparent evaluation.

XXV. Again, to achieve effective private sector participation in ports it will be critical to develop standard documents and procedures for requesting and evaluating proposals for the main types of activities being considered for private sector involvement. In their practical application these documents and procedures will, of course, still need to be tailored to the particular activity or business. This Paper provides further suggestions for developing a standard procedure.

C. Developing a Capability for Guiding the Implementation of the Policy xxvi. Without guidance in terms of, for example, standard documents and procedures, implementation of the policy will suffer. With the establishment of the four state port corporations Indonesia adopted a two tier institutional structure for port administration jI and both tiers will have a role to play in implementing the policy. In line with the general principle that policy formulation rests with the Ministry and policy implementation with the port corporations, a cn l capabfty will need to be established wihin the Ministry to guide and direct the policy of expanding private participation. The purview of this central entity would cover, inter alia, to: (1) further develop (and fine-tune as experience is gained) the legal and regulatory framework; (ii) develope (and subsequently fine-tune) model contracts for private participation in the port activities; (iii) develope procedures for the whole process of inviting, evaluating and awarding contracts for private sector participation in ports; (iv) monitor private sector participation schemes; (v) formulate lessons of experience, and provide direct assistance on specialized topics to the port corporations engaged on particular schemes. xxvii. The port corporaions in turn will need to set themselves up to handle their new responsibilities as manager of assets and contracts. Their recently acquired status as a shareholding company (Persero) gives them expanded opportunities to adjust to their evolving role. As a first priority they will need to rapidly strengthen their capabilities in the financial area. Two aspects require particular attention. First, they will need to acquire the range of skills which will enable them to structure the terms

I/ The ministerial level (MOC/DGSC) esponsible for general policy and planning and for operations at the 450 or so smaller ports an the one hand, and the port corporations responsible for policy implementation and operations at the 110 major and secondary ports on the other. of agreements so as to ensure that the port corporation and the port users are better off than they would be without such agreements, or as a minimum, would not be worse off (para. xA). Second, as the use of private capital in the port sector need not be limited to direct investment by providers of port services, the port corporations should explore more aggressively other forms of resource mobilization. In terms of increasing complexity this would consist of project finance from banks (which Is already a source of funds in some cases), investments by institutional investors (e.g., fixed term paper), and equity financing through the capital markets.

xxvill. Furthermore, together with MOC they will need to develop a systematic procedure for expanding private sector participation In their activities. This would cover a series of steps such as defining activities/business units suitable for private participation, determining the potential interest, identifying constraints, developing appropriate strategles for each type of business unit, prioritizing and phasing of the program and finalizing the bidding procedures. When identifying suitable business units the focus should be on activities which require quick response to users' needs. Thus, cargo handling would be a prime candidate.

D. Rationalizing the Port Tariff

xxix. The pricing of the services to be offered by the private sector is one of the key issues to be settled under the agreement between the port and the private sector (para. xxi). One option is that the agreement specifies the amount charged for the services or the basis for determination of these charges and the conditions and procedure for revisions. Alternatively, the private sector may be given total freedom to rt the prices, or to set prices wthin certain limits. Clearly, the ability to use the port tariff as a mechanism or basis for defining these prices will greatly facilitate the process of structuring an appropriate agreement. In other words, the transfer of port activities to the private sector is facilitated when the port tariffs reflect the costs of the individual activities. This does not necessarily mean that tariffs are based strictly on costs, but does require that the revenues generated by the tariff charged for a specific port activity cover the cost of that activity. Under these conditions, it will for example, be possible to transfer the activity with the existing tariff structure without adjustments at the time of transfer. It should be noted that designing the port tariffs so that the charges for individual services produce revenues which are related to the costs of providing these services also has the important merit that port users will be used to paying these prices and will make their business decisions based on sustainable prices which approximate the resource costs to the economy. xxx. The existing Isdnedeas post tffstructure is not well suited to the promotion of private sector participation for several reasons. The practice of applying the same tariff In a number of ports fails to take into account the different cost structures in each port. It also Ignores differences in the markets served by these ports and the demand for specific cargo and vessel related services. Furthermore, individual tariffs are seldom related to the services being provided. This can be seen in the arrangement in Tanjung Priok where the private stevedoring companies collect not only a negotiated handling charge but also a portion of the revenues from the port tariffs for wharfage and storage. Finally, the tariffs for particular services, such as towage for example, may often not cover the costs of these services and consequently would discourage the participation of the private sector in this business. The financial ratios for the different units (container terminal versus other activities) suggest that this may be the case in Tanjung Priok. xxxi. Thus, a rationalization of the port's pricing structure to make it correspond to its individual business activities is an essential part of the implementation of the policy. First, the structure should be revised so that there are specific tariffs for specific businesses. Second, the prices should be set taking - x -

Into account costs and market conditions so as to be able to attract private sector interest in these businesses.

E. Moderising Port Labor Policies and Pracices xxxil. Implementation of particular schemes to expand private participation in ports (or any scheme to improve port efficiency for that matter) may result in a need for extensive streamlining of the labor force or an even more dramatic outcome such as a surplus of port labor. This would be a crucial issue which will need to be satisfactorily resolved to successfully implement the scheme. This suggests that to realze In the medium to longer term the full potential of private sector participation in the port sector an ad-hoc approach to such issues will not be adequate. A forward looking strategy aimed at modernizing and reforming port labor policies and practices will be required. Such port labor reform need to be carefully planned and executed after proper consultation with labor and employees, relevant government agencies, the port corporation management and private sector employers. Failing this, there is a high risk that port laborers and employees will strongly resent any change in working conditions and arrangements, and will likely oppose institutional changes such as *privatization. xxxiii. Effective port labor policies and practices cover a wide range of aspects-such as the arrangements for employment of dock labor, the mix of permanent and casual labor, the adaptation of the skills mix of the workforce, manning levels and multi-skilling, working hours and incentive schemes, negotiating mechanism and dispute procedure, the safeguarding of benefits, and not least manpower development and training. The development and lIplementation of a comprehensive modernization program of port labor policies and practices presents a formidable management task. To deal with this challenge effectively, consideration should be given to the establishment of a commission or other such body representing the various interests for developing the program and overseeing its implementation. Actual implementation should preferably be formulated and implemented on a port by port basis. Such a two tier approach would allow to take into account both national and local priorities. PRIVATE SECTOR PARTICIPATION IN TE INDONESIAN PUBLIC PORTS

1 INTRODUCTION AND BACKGROUND

1.1 The ladonesian Ports Sector

1.1.1 Indonesia has some 560 public ports and in addition, there are reported to be some 720 special industrial ports developed and operated by public or private industrial companies. The Government of Indonesia (GOI) manages the ports sector through: (i) the Ministry of Communications (MOC); (J1) the Directorate General of Sea Communications (DGSC) which comes under the MOC and has direct responsibility for some 450 second level ports; and (I1) the four state Port Corporations which are each responsible for some 110 first level ports (each corporation covering 25-30 ports).

1.1.2 In the past, the GOI has relied heavily on the public sector for the development and operation of its ports system. Where the private sector is allowed to play a role, it is subject to stringent regulation and control. However, this policy is no longer considered by the GOI to be the most effective in meeting the challenges arising from a rapidly expanding economy and the GOI now wishes to encourage a greater participation of the private sector in its port activities. For the next long term planning period, Indonesia has assigned a key role to infrastructure towards its goal of sustained economic growth. Three key elements of its strategy for infrastructure services are: (i) providing adequate capacity to ensure that lack of Infrastructure will not constrain growth of the productive sectors; (11) dismantling regulations which do not serve a useful purpose; and (iii) obtaining private sector participation for the development and operation of facilities. Increased private sector participation is expected to bring greater efficiency and additional investment resources. As ports are a critical link in the trade logistics chain and will require substantial investments in the coming decade, this strategy is particularly relevant to the ports sector. It also represents a logical continuation of past policies in the sector.

1.1.3 Since the early eighties, Government has been actively pursuing efficiency improvements in the port sector through a series of policy measures covering successively corporatization, deregulation and commercialization. The milestones of government's policies in the port sector are:

- In 1983, creation of four state port corporations each responsible for managing on a commercial basis some 25-30 branch ports; - In 1985, deregulation of ports and international shipping through Instruction of the President No 4; - In 1988, deregulation of domestic shipping; - In 1992, transformation of the four port corporations from a Perum (100% state- owned corporation) into a Persero (share corporation with majority state shareholding); .2-

- In 1992, enactment of a new maritime sector law which modernizes the legal basis for maritime transport and provides the legal basis for greater private sector participation in ports; - In 1994, promulgation of the Government Implementing Regulations for the new maritime sector law, to be followed by Implementing Ministerial Decrees.

1.1.4 Overall, these policy initiatives have been successful and performance of the port sector has continued to improve In the past ten years. There is scope, however, for further improvement, in particular through expanded private sector participation. The new maritime law enacted in 1992 and its Implementing Regulations issued in September 1994 providt the legal and regulatory basis for greater and effective private sector participation In the port sector. Until now, the role of the private sector in public ports has been limited to stevedoring services, but a pilot scheme to rationalize and expand the role of the stevedores for general cargo terminal operations is already under way (pan. 9.3.1) and schemes involving major private participation In container terminal development in Taqjung Priok and Tanjung Perak, the country's largest and second largest ports respectively, have been announced.

1.2 This Paper

1.2.1 Involving the private sector in activities which have hitherto been the domain of the public sector may appear easy, but, as those countries that have pursued this policy have learned, to be successful it requires very careful analysis, planning and implementation. In particular, a process based on competition and the use of performance incentives in contractual agreements are crucial ingredients for effective private sector participation. The aim of the Paper is, therefore to: identify opportunities for greater private participation in the Indonesian context; outline approaches for introducing competition and promoting efficiency in areas that have traditionally been public monopolies; highlight the requirements which need to be met and the conditions for success; and analyse aspects of particular importance such as the appropriate structuring of agreements, the port tariff and port labor policy issues.

1.2.2 The Paper is concerned with private sector participation in public ports and primarily the 110 commercial ports which come under the responsibility of the four state port corporations. The objective was practical, I.e. to determine how the rolt. of the private sector could be Increased within the current Indonesian legislative, regulatory and cultural context. Ie Paper does not recommend or suggest that all Indovesian port operations should be 'privatized". It intends to review the Issues and clarify the key requirements that have to be met in the port sector to ensure successful implementation of the policy. To this effect the study team considered the experience with private sector participation in other countries and reviewed examples of typical agreements with private sector companies for a number of different, but typical port activities. General issues related to the development of private enterprise and to private participation in the provision of infrastructure services are discussed in detail in two recent reports./

1/ Indonesia - Developing Private Enterprise. May 9, 1991; and Indonesia - A Strategy for Infrastructure DevelopenaL June 22, 1992. -3-

2 GOI POUCmS AND OtECnVES IN REATON To PRIVATE SEcTR PARnctPAoN I PORnTs

2.1 Overall Policies and Objectives of the GOI

2.1.1 Following its desire to increase the use of the private sector, the overall policy of the GOI, (as set forth in the Broad Guidelines of State Policy (GBHN) of 1993, which covers both the Sixth Five Year Plan (1994-1999) and the Second Long Term Development Period (1994-2019)) is to encourage private sector participation in the economy as a whole. The Economic Sector Objective of the Second Long term Development Period is stated to be *to create an economy that is autonomous/self- sufficient and firm/steady...... which is pushed by strong business partnerships among cooperatives, state enterprises and private sector enterprises....0. In particular, Article 26 of the recently enacted Law No. 21 of 1992 regarding Shipping (Pelayaran), which took effect in September 1994, states:

(1) The management of a public port is done by the Government and its laplementation may be transferred to a State-owned Corporation (BUMN) which is established for the purpose mentioned, based upon existing legal regulations;

(2) Indonesian legal bodies 2/ may participate in the management of a public port, as meant in Section (1), on the basis of working together (kera sama) with a State-owned Corporation (BUMN) which is implementing port activities;

(3) The provision as mentioned in Sections (1) and (2) shall be regulated further by Government Regulations.

2.1.2 The GBHN of 1993 state that the role of the newly formed Port Corporations as state owned enterprises (BUMN) during the upcoming Sixth Five Year Development Plan is for continuous improvement of their efficiency and productivity to better serve the general public in the implementation of the development policy and to assist in financing development through their new structure as autonomous corporations. One method of achieving this is by participation (kerja sama) with the private sector.

2.2 Specific Policy Objectives for the Ports Sector

2.2.1 These general statements of long-term policy and the passage of Law No.21 of 1992 reflect the desire for institutional change and are interpreted to involve the following objectives:

- to make Indonesia's ports more responsive, efficient and cost effective.

/The tenMw Indoneuian legal Body' as defined in Shipping Law No.21 of 1992, is a corpome body owned by either the state, a private party or a cooperative. -4-

- to reduce the need for public financing of port development;

- to reduce the number of civil servants engaged in Indonesian port activities; and

- possibly to generate funds through the disposal of port assets and thereby help reduce the national debt.

2.2.2 More specific objectives of the policy may include, all or at least a significant number of, the following:

(a) Fostering efficiency through competition in the provision of port services and operations; (b) Eliminating the need for government investment except for major projects or special tasks; (c) Upgrading the professional skills of port managers, staff and workers; (d) Promoting private sector involvement in the development of port infrastructure or provision of services; (e) Reducing or eliminating surplus dock workers and restrictive labor practices; (f) Spreading the ownership of the ports; (g) Attracting foreign investment; (h) Importing foreign expertise; and (I) Eliminating government monopolies.

2.3 Operational Objectives of the Port Corporations. At the level of the port corporations, these objectives would be translated into the following operational aims:

(a) Establishing operational targets; (b) Determining the efficient throughput capacities of the various elements of the port; (c) Formulating a comprehensive port development strategy; (d) Identifying the facilities or services in which private sector participation is desirable or should be increased; (e) Assessing the true operating costs of the port to provide a basis for the "privatization exercise; (f) Identifying alternative funding sources, including whether foreign investment is necessary or desirable and the means through which such investment could be attracted to the port; (g) Identifying the areas where new technologies might be introduced; and, (h) Formulating a strategy for rationalizing labor structure and practices.

2.4 The Need to Consider the Objectives and Interests of Other Concerned Parties. When designing strategies for the involvement of the private sector, it is also necessary to take into account the objectives of other interested parties. These parties, all with very different objectives include: -5-

(a) the "port users, e.g., ship operators, shipping lines, shippers (Importers/exporters), land transport services, all of whom require speedy and cost effective services;

(b) port employees who seek stable employment for adequate reward with career opportunides and benefits;

(c) the adjacent community residents who require the port to operate in a mutually satisfactory and environmentally sound manner; and

(d) the users of the port's waterways and other shared facilities. These can Include ferry services, pleasure craft and fishermen who seek to continue their activities without Interruption.

It is imperative that the impact on all of these groups and their objectives and aims are properly considered and defined at the outset of a policy to expand private sector participation in order to provide direction to those who will be closely involved with the process (para. 4.4.2).

3 How MUCH PRiVATE SECTOR PARnCIPAnON?

3.1 Port Functions and Private Sector Participation

3.1.1 When assessing the scope for increased private sector participation in ports it is important to bear in mind that a wide range of functions and activities are carried out in ports, including:

* Securing the safety of navigation (provision of lights, buoys and beacons; dredging, hydrographic surveys; control of ship movements; pilotage; tugs); * Loading and unloading of cargo (provision of cargo handling infrastructure; provision of cargo handling superstructure; cargo handling; warehousing and other ancillary services); * Administrative functions (regulation of activities at port; reception and disposal of ship wastes; industrial safety at port; security); * Charging for port services (dues for basic infrastructure; charges for particular services); * Controls over port development (environmental controls; national port planning).

3.1.2 Each of these functions lends itself to different approaches as to the respective roles of the public and private sector. International experience shows a wide spectrum of private sector participation in port activities largely explained by the different historical background of nations. The options for organization of the port sector in terms of public versus private sector involvement range from the situation now obtained in the U.K. following a complete sell-off of the port assets and responsibilities to the private sector to the situation where the private sector is not involved at all, except as users, such as Mombasa port in Kenya. However, most of the functions related to the safety of navigation, environmental control and port planning are generally performed by the public -6-

sector. The greatest diversity In approach Is found in the area of cargo handling and from this perspective the range can be typified in a simplified way as follows:

* Publicly owned and operated port (Yangon, Mombasa) Private stevedoring in publicly owned and operated port (Lagos, Tema) Private shore cargo handling and stevedoring in publicly owned port (Indonesia) Private operating concession in publicly owned port (Container terminal Kingston, Jamaica) Privately developed (superstructure) and operated terminal using basic public infrastructure (typical USA 'landlord ports, Antwerp, Kelang- Malaysia) Privately developed (both Infrastructure and superstructure) and operated terminal (Hong Kong and part of Rotterdam) Complete port, originally publicly owned, sold to private interests who are responsible for practically all the above listed port functions (UK).

3.1.3 The picture In the Asia region is quite diversified with traditionally a wide range of approaches with regard to public/private participation. In recent years, however, the role of the private sector in ports has been expanded in most Asian countries. In Indonesia's 110 commercial ports, all functions except cargo handling (stevedoring on board ship and some shorehandling) are provided by the public sector, namely through the Directorate General of Sea Communications (DGSC) of the Ministry of Communications (MOC) and the four port corporations. DGSC's routine functions, in particular in the area of safety of navigation, are exercised by the harbormaster. In addition, Indonesia in 1984 instituted the functon of PortAdministrator (Adpel) in the major ports to provide for the coordination of MOC's functions with the government functions exercised in ports by other ministries, such as customs, immigration and health. While this institution helped in resolving the severe problems encountered at the time It gave rise to some new problems on account of lack of clarity in their responsibilities for government functions on the one hand and port operational functions on the other.

3.2 Opportunities for Private Sector Participation

3.2.1 Taking into account the current Indonesian situation, the international experience with private sector participation in ports, the fact that public ports occupy scarce waterfront land and provide a public service through common user facilities, the complete transfer to the private sector of all the assets and responsibilities of the ports or of a major part of the assets and responsibilities is not recommended. However, there is considerable scope for expanding the role of the private sector in the Indonesian ports along the lines of some of the alternative forms of private sector participation for cargo handling outlined above and for support services. In the following, possibilities are grouped in four broad categories according to their increasing complexity and the size of the risks involved.

(a) Provision of support services. This would include provision by the private sector of services such as tugs, towing, pilot boat provision, equipment maintenance, -7-

navigation aids activities, etc. The Paper sets out the range of these services and how the service could be procured, contracted and priced. In many instances considerable costs saving plus increased quality of service can be achieved while it would also reduce the burden of day-to-day operations on port management;

(b) Operation of existing cargo terminals. This would Include, for example, improvement and extension of the Terminal Operating System (STO) introduced experimentally in Tarjung Prlok in April 1993 for general cargo. The Paper outlines how the system should be expanded and improved. Private sector management of existing container terminals would be another possibility. In both cases, the participation could include some investment in equipment and/or minor infrastructure works;

(d) Development of basic infrastructure and superstructure and operation of new terminals. Under this option the private sector would make major investments, including In such works as navigation channel, breakwater, port basin, land reclamation and quay wall construction as well as in the superstructure and would operate the terminal under a BOT type of scheme. A scheme of this type was being pursued unsuccessfully between 1991 and 1994 for the third container terminal in Tanjung Priok.

3.2.2 Private sector participation under the first category can be implemented relatively quickly in the existing Indonesian context considering the capabilities of the maritime sector industry and drawing on the many successful examples of such participation in various ports in the world. Schemes under the second category, can also be designed to be relatively straightforward, depending on the amount of private sector investment being sought Schemes under the third category would require more careful preparation and planning If the efficiency goals are to be achieved and the interests of the users adequately safeguarded. To ask the private sector to invest in both the basic infrastructure and the superstructure and to operate the terminal under a BOT type scheme is a much more complex undertaking. The various risks involved are much greater and more difficult to assess and to manage. As a result such schemes are likely to require time consuming preparation and negotiations as evidenced by the experience with the third container terminal at Tanjung Priok. There are as yet few examples of all-inclusive BOT type investments in public ports and experience shows that for such investments to be made attractive to the private sector in a country where this is a new proposition, the public sector will need to provide extensive guarantees to cover the risks involved. BOT type schemes, however, would be very appropriate in the case of special facilities (e.g., for bulk handling) where there is a sole user of the services or the facility. There are many successful examples of such schemes. -8-

3.2.3 On the part of the private sector there certainly Is interest for greater involvement in port activities as is evidenced by the wide participation in the bidding for privadzation schemes in ports in the region in recent years. Parties that have expressed Interest In the specific case of Indonesia are the ship operating groups active in Indonesia (both local and foreign). The emerging International port operating companies are also likely candidates. In their meetings with the Team, the ship operating groups were excited about the prospects of a policy to expand private sector participation, thought that it was timely and badly needed. They we skeptical on how long it would take to become a reality and how bureaucratic it might become. They were also concerned over the issue that foreign capital would be required and what kind of encouragement and confidence foreign investors would require before making major investments in Indonesian ports. .The meetings with stevedoring and cargo handling companies showed that they are out-of-date with the way modern ports operate. They appeared unsure whether the typical stevedoring company could play a major role In taking the initiative considering that their experience is based mostly on the supply of labor and minor cargo handling equipment.

4 KEY ItEQ- EMMN ATM PMITCIPLES

4.1 The Need for Competition and a Competitive Process

4.1.1 The evidence of the privatization experience in the world indicates that competition is the most crucial factor in improving efficiency. Also, there are many ways in which competition can be secured or a competitive process organized. Even when a port activity is provided most economically by a single entity-making competition in the market unfeasible-it will often be possible to organize a competitive process for the right to carry out the activity. In countries or regions where seabound cargo is substantial and can sustain several competing port operators, and where infrastructure is adequate and well developed land transport and intermodal services are available, it is possible to rely on competition and the role of the government/public sector in cargo handling can be limited to a minimum as cargo owners and shippers have access to alternatives. Generally, under this strategy, the resulting division of roles and responsibilities between the public and private sector is that which is characterlzed as the "landlord port". Under this model the role of the public sector (government/state port corporation) is limited to maritime safety, establishing and enforcing environmental standards, pollution control (e.g., port state responsibility under MARPOL), overall strategic port planning, provision of water access (including maintenance dredging of navigation channels, aids to navigation, and perhaps vessel traffic management), provision of land access (including berth and terminal access roadways with linkages to the urban and national highway networks), information and data services (hydrological, meteorological data and general economic information) and customs/immigration services. Actual execution of most of these responsibilities can of course also be contracted out to the private sector.

4.1.2 When the above competitive conditions are lacking in a particular region, ports serve "captive markets* and have a monopoly power over import and export traffic. Under such circumstances, "privatization" of a mqjor activity such as the port's cargo handling operations introduces the potential of abuse of monopoly power. The risk of this ft9-

outcome can nevertheless be reduced by Inviting firms t compete for the right to operate the port's cargo terminal(s) on the basis of leases or concessions which are awarded to the bidder who is evaluated as most efficient. Remaining risks of abuse of monopoly power, should be addressed through careful design of the efficiency incentives included in the agreements and of a formal feedback channel for port users to registor complaints of discriminatory behavior and possibly through regulatory controls. For functions of lesser scope such as tug or pilot boat services, equipment maintenance and similar activities, it will normally also be possible in such countries to organize a competitive process at the tendering stage.

4.1.3 In Indonesia, owing to rapidly growing port traffic, combined with the expansion of the port and land transport infrastructure, there is increasing scope for competition between alternative providers of cargo handling services or for a competitive process in awarding service contracts. Also, because of the large number of different ports, there are many different situations, and hence, good opportunities for Implementing different forms of private participation and for a much expanded role of the private sector. (A recent World Bank Discussion Paper 3/ reviews alternative forms of provision of infastructure services and criteria for choosing among these forms). Even in the case of smaller ports in isolated areas which are not commercially viable and where it may not be considered desirable to increase tariffs to a level which would make private participation feasible, a competitive process can be organized. For example, the private sector can be invited to bid for service contracts in which the port pays the private sector for the services and continues to charge the port users at rates which are below its costs. The rationale for such an agreement would be that the cost of providing the services would be reduced through the higher efficiency of the private sector. This arrangement would reduce though not necessarily eliminate the need for continuing subsidization of these ports. A variant of this scheme is to award a contract for performing port activities with given performance standards and a given tariff structure to a private operator under a bidding procedure where the lowest subsidy is the principal selection criterion. 4.2 The Need for a Regulatory Basis

4.2.1 - When the decision is taken to promote greater private sector participation in ports in a country where it is a first time proposition, as is the case in Indonesia, virtually everything that has to be done has no precedent. Experience shows that implementation of the policy will require changes to laws, regulations and guidelines and will involve a painstaking process of resolving one issue after the other. While it may be possible to implement particular schemes on such an ad-hoc basis it is a very inefficient approach, which will invariably involve long delays and create confusion. There is the risk that the commitment and resolve to succeed on the part of both the Government and the private sector will wear out.

4.2.2 In the case of Malaysia, where there was a strong commitment to privatization on the part of Government, it is recognized that insufficient effort was exerted

II lastitutional Options for the Provision of lafrasctue. World Bank Discussion Paper No 212, 1993. - 10-

to create the conditions for private sector participation before initiating work on a specific scheme. . For example, the container terminal at Port Kelang was selected for OprivatizationO before Government fully appreciated what legislation was needed to authorize the scheme. Thus, Malaysia had to develop new policies and legislation at each step of the *privatization* process. The enactment of a single legislative package before beginning the exercise would have avoided hasty piecemeal legislative remedies. A better approach, certainly for countries that can learn from that experience, is to ensure that the legal basis is In place before initiating any major scheme the early completion of which will be essential for the capacity of the sector.

4.2.3 If private participation is to succeed in Indonesia-with its large number of ports within which many activities are suitable for private sector participation-on a scale which is commensurate with the potential, it will be imperative to establish the enabling regulatory system. This should provide the legal basis for the various forms of private participation suitable to port activities and lay down the principles and the process to be followed In implementing the policy. It Is recognized that such a system can not be established overnight. However, while it is being developed, a minimum requirement for schemes to be successfully implemented is the ability for the public sector and the private party to enter into clear and enforceable contractual agreements. The refinement of the regulatory system may well benefit from the experience gained from the early cases. The Paper sets out the main steps to implement such a system with regard to the port sector. Two recent Bank reports discuss the national economic environment and policy framework and the general issues related to the development of private enterprise and to private participation In the provision of Infrastructure services (para. 1.2.2).

4.3 All Parties should Gain

4.3.1 The private sector involvement should result in a reduction in the overall cost of providing the same or better services. The agreement worked out between the port and the private party will determine how this gain is shared. It represents a compromise between the Interests of (and the risks faced by) the three parties concerned, the port, the private sector and the port users. In assessing whether an agreement is worthwhile these parties naturally adopt a different perspective. From the private sector's viewpoint, it is necessary that the return on the investment and on entrepreneurship be comparable to that which would be obtained from other business opportunities. The port users-who in most cases are not a contractual party to the agreement but whose interests should be safeguarded by the public sector-will expect an improvement with respect to both level of service and tariffs or as a minimum an improvement in one of these parameters. From the port's viewpoint, the arrangement should leave the port in at least as good a financial position as it would have been If it had continued to provide itself the same services or investments which it proposes to transfer to the private sector. Of course, the pursuit of this objective by the port would not be justified if the port were abusing a position of monopoly power (which is not the case in Indonesia). While the Indonesian port corporations cross-subsidize loss making activities with profitable ones, overall, they are not blatantly inefficient, nor are they making "excessive" monopoly profits owing to the tariff constraints imposed by GOI. This cross-subsidization, however, implies that until port tariffs are properly related to costs-which is of high priority (para. 31)-the transfer - 11 -

of the most profitable activities to the private sector through agreements which adversely affect the port's financial position would put at risk the port corporation's financial self- sufficiency.

4.4 Goverment Commitment and Cladfcation of Objectives

4.4.1 The experience of other countries indicates that an essential requirement for the successful implementation of effective private participation is a very strong commitment on the part of the 3overnment to proceed with the implementation of carefully selected schemes. In the absence of strong determination by the Cabinet or the responsible ministers, little will be effectively achieved.

4.4.2 The general men of long term policy and the passage of the New Maritime Law (Law No. 21 of 1992) reflect the governments goals to Improve efficiency and reduce the need for public financing of port development. To become operational for the officials In the Ministry and the Port Corporations responsible for policy implementation these general goals need to be translated Into more specific objectives. For example, many specific objectives could be pursued such as promoting efficiency through competition, eliminating the need for government funds in major investments, upgrading skills of port managers, staff and workers, reducing surplus dock workers, attracting foreign investment, fostering national entrepreneurship, eliminating government monopolies. Promoting efficiency through competition should normally be the guiding principle and If in addition other objectives are considered of particular importance this will need to be clarified to facilitate the task of the officials in charge of policy Implementation and to allow them to take these objectives into account in designing the request for proposals and the award process in general. Also, it will be important to ensure that the objectives and interests of other concerned parties-the port users, the port employees, residents in adjacent comnumities and other users of the port's shared facilities-are not overlooked.

S E-ALISHG THE LGAL AlND REGLATORY BASIS

5.1 General. The legal and regulatory environment necessary to.facilitate greater private sector participar *sport affairs includes not only laws and regulations directly concerned with ports and shipping but also laws and regulations regarding state-owned corporations (BUMN) and the general rules regarding economic deregulation and the guidelines for domestic and foreign investment. At present, in Indonesia the general legal framework for a greater private sector role in the ports is in place and opportunities for foreign investment have also been created. However, some specific regulations and guidelines to facilitate and encourage effective participation have not yet been developed or issued.

5.2 Laws and Regulations Directly Related to Ports and Shipping

5.2.1 The new Shipping Law No. 21 of 1992, took effect in September 1994, consolidates and modernizes a disparate set of laws, regulations and decrees many of which date back to the Dutch colonial period. It provides a sufficient general legal basis for private sector participation in most port activities, short of complete transfer of a public - 12 -

port to the private sector. Chapter VI of the Law (Articles 21-34) covers port atiars. Under Article 26, the management of a public port must be by the Government itself or be transferred to a state-owned corporation (BUMN) that is established for that purpose, such as the present four Port Corporations. The BUMN may then work together with Indonesian legal bodies to carry out port activities. The explanation to Article 26 notes that such cooperation may not include the port basin/harbor area or navigation safety, but may specifically include activities at a container terminal, stacking areas, tugboats and other services. In addition, under Article 16 of the Law, pilotage which is now a public function may be transferred to a private entity. Article 27 states that port services shall be carried out by Indonesian citizens or legal bodies. Such services include activities to help overall port operational efficiency, including offices, shops and other facilities for the public in the port area.

5.2.2 In addition, Article 32 provides more flexibility with regard to the setting of tariffs. The type, structure and classes of tariffs for port services shall be set by Government Regulation and the Explanation to that Article states that the Port Manager will have significant flexibility to set tariffs within the general structure set by the Government.

5.2.3 Thus the new Shipping Law through the new implementing Government Regulation (PP) on Port Affairs (Kepelabuhanan) and more detailed Decrees still to be issued by the Minister of Transport (KEPMEN) on specific matters can develop a new system of port administration which would effectively encourage private sector participation In the ports. The new %jovernmentRegulation also replaces a number of old Dutch regulations from the 1920s and 1930s regarding various aspects of port affairs, particularly concerning vessel arrival and departure, as well as Government Regulation No. 11 of 1983 on Port Affairs, as amended by Government Regulation No. 23 of 1985, and helps clarify the relationship between the four port corporations and the ADPEL at the major ports.

5.2.4 Specific comments on the Government Regulation on Port Affairs (RPP Tentang Kepelabuhanan - Konsep III) concern the definition of Workng Together (kerama) between the Pon Eaterpdse and the Pdvate Sector. Article 44, Section (2), provides for three types of working together: i) Joint Operations (kerjasama operasi - KSO); ii) Joint Activities (kerjasama usaha - KSU); and, iii) Joint Management (kerjasama manajemen - KSM). However, Decree of the Minister of Finance N.740/KMK.00/1989, dated June 26,1989, defines only 'joint operations* and Omanagement contract (kontrak manajemen - KSM)'. It is not clear, therefore, what 'joint activities" are and this may not even be a necessary category. However, lease and concession agreements are different from operating agreements. Thus, it is critical that lease and concession agreements be provided for as possible forms of private sector participation. The types of working together would then be: (i) management/service contracts; (ii) operating agreements; (iii) lease agreements; and (iv) concession agreements. * 13 -

53 The Port Corporation as a State-Owned Corporation (BUMN)

5.3.1 A second important area is the legal status of the four state-owned Port Corporations (BUMN). Government Regulations Nos. 14, 15, 16 and 17 of 1983 established these enterprises as PERUM (100% state-owned corporations) which must be self-financing but with certain autonomy In hiring employees, setting salaries and in budgeting. Government Regulations No. 56, 57, 58 and 59 of 1991 then changed that legal status to a share corporation (PERSERO), effective December 1, 1992. The change from PERUM to PERSERO does not appear to have caused major differences in thinking of the enterprises themselves in terms of a more commercial attitude. The new status, however, provides the basis for changes in such enterprises which might help in fostering a more commercial outlook, such as the addition of outsiders either in the form of port interests or professional entrepreneurs/managers to the Supervisory Board (Dewan Komisatis).

5.3.2 In addition, as at least 51% state-owned, these corporations are regulated under INPRES No. 5 of 1988 and its implementing Minister of Finance Decree No. 740IKMK.00/1989, dated June 26, 1989. That Decree defines a BUMN and its classes, sets some performance standards for such corporations, defines the process for sale of their shares, and generally defines the terms "joint operations" (kejasama operasi - KSO) and "management contractO (kontrak manajemen) for the working together of a BUMN with a private party. However, no specific guidelines have been issued as to standards for such "Joint operations" both generally in the Indonesian economy and more specifically for the. ports sector. This lack of such guidelines will make it difficult for private enterprises to submit proposals to port corporations for the provision of port services or operations and also for the port corporations to judge and evaluate proposals that it receives from the private sector.

5.4 General Rules Regarding Economic Deregulation and Foreign Investment

5.4.1 The third major type of laws and regulations that affect private sector participation in the ports sector are the rules regarding economic deregulation and the guidelines for domestic and foreign invesonent. INPRES No. 4 of 1985 and the PAKNOV/1988 have gone a significant way towards opening up the shipping sector, including licensing of companies and operations at ports. However, in light of the experience with the trial STO scheme (Section 9.3) and the need for greater rationalization, it may be indicated to review the licensing requirements to be met by port sector companies, such as stevedoring companies, terminal operators and freight-forwarders, to ensure that they meet the minimum capability to provide the service required.

5.4.2 With regard to the guidelines for domestic and foreign investment, ports have not been listed as being excluded from foreign private sector participation. However, absence of an explicit exclusion may not be sufficient to encourage such participation. Large-scale activities, such as container terminal operation and management, require capital and expertise that could be provided by foreign companies within the framework of a consortium with an Indonesian legal body as a lead, under Article 26 of the new . 14-

Shipping Law, or as a shareholder of such a body. More specific encouragement may be needed for such investment to takb place.

5.4.3 The October 23, 1993 deregulation package further liberalized rules regarding foreign investment to permit 100% initial foreign ownership with a minimum capital of US$50 million in all cases. However, in 20 years 51% of the shares must be divested to Indonesian shareholders, commencing ten years after the start of commercial production. Such divestiture may now be by public flotation of shares, thus eliminating the need to find a suitable and capable Indonesian partner. In addition, initially 100% foreign-owned companies may be established with a minimum capital of only US$2 million If the company concerned produces intermediate goods and components for other industries. These changes may make certain types of joint ventures in the ports sector more attractive to foreign investors.

5.4.4 Consideration must also be given to KEPPRES No.39 of 1991 under which a Ministerial Team was established to monitor and control foreign commercial loans for projects related to governmental activities. This Decree does not specifically cover loans to private sector borrowers but would apply to jont activities in which BUMN were in any way Involved. Thus, the regulatory measures taken in recent years may not be sufficient to encourage the necessary Investment from the private sector for port activities. More specific encouragement may be needed for such investment to take place.

5.4.5 Regarding domestic investment, the General Outlines of State Policy (GBHN) 1993 for the Sixth Five Year Plan (1994-1999) and the economic principles for the Second Twenty-Five Year lAng Term Period (1994-2019) state that the economy (including transportation activities) should be pushed by business partnerships between cooperatives, state enterprises and private enterprises. The lack of the technical guidelines for BUMN discussed above is sending mixed signals in practice.

5.5 The Indonesian Commercial Code of Law. Further, the present Indonesian Commercial Code (KUHD) and the Indonesian Civil Code (KUHPerdata) are not yet adequate for international commercial transactions, with particular regard to enforcement of agreements and of securiy interest and in areas such as bankruptcy. Both of these pieces of legislation are left over from the Dutch colonial period. As in other areas of the economy, private investment in the port activities is more likely to occur when this basic legal foundation is strengthened.

5.6 Recommended GOI Actions

5.6.1 Establishing an Enabling Ports Regulation. At present, the general legal framework for a greater private sector role in Indonesian ports is in place and opportunities for foreign investment have also been created. However, some specific regulations and guidelines to facilitate and encourage effective participation (including from foreign investors) have not yet been developed or issued. A key requirement is that the Government Implementing Regulation on Port Affairs (Kepelabuhanan), which is the primary implementing instrument for the articles of the new Shipping Law No.21 of 1992 concerned with ports, in its section regarding Cooperation/Working Together (Kejasama) - 15 -

between a port enterprise and the private sector allows all types of agreements which are appropriate in the port context. As a minimum, the types of agreements should include: (i) management/service contracts; (U) operating agreements; (ii) lease agreements; and (iv) concession agreements.

5.6.2 Clarifying the Role of Foreign Investment. As indicated in Section 2 above, consderationeds to be given as to what is the preferred role of foreign private sector participation. Ports serve an important public function In the economy of an archipelago and thus this issue must be thought through carefully. As recently liberalized in the October 23, 1993 deregulation package, foreign ownership in Indonesian legal bodies may now be 100% for an initial investment of US$50 million or more, but ownership must be reduced to 49% or less after 20 years (para. 4.4.3). This may not be sufficient for the larger projects such as container terminal expansion, especially if the policy of the GOI in seeking such investment is not spelled out in a positive manner. Thus consideration might be given to the issuance of a Presidential Decree similar to Presidential Decree No. 37 of 1992 concerning Private provision of Electric Power. This decree specifically encourages foreign investment in that sector under the existing foreign investment laws. This type of additional policy statement is not necessary legally but would help to clarify the policy of the GOI in this area.

6 STUCTURING AND IMPLEMENTING AGREEMENTS WITH THE PIVATE SECTOR

6.1 General

6.1.1 Contractual arrangements between public ports in various parts of the world and private entities have existed for many years and have multiplied in number and variety in the past ten years. These are now evolving towards fairly standard contractual statements between the two parties. Actual terms and conditions, however, will reflect the particular circumstances of the country, port, cargo, market, facility and/or service under consideration. The lease agreement is one of the most widely used agreements in the port sector and provides a convenient starting point for reviewing the key issues. For this Paper, a carefully selected sample of lease agreements was reviewed and distilled into a *Model Capital Leasew. This compendium of many 'real' leases can be used as a checklist and guide for developing specific agreements.

6.1.2 Each agreement must be developed to fit the particulars of the business to be ccxracted and covering the assets to be used. The following is a checklist of elements to be included in a lease or management contract

(a) Participants

(b) Purpose

(d) Schedule of payments - Amounts - Indexing - 16-

(e) Renegotiation -Scope - Tiing

(f) Permitted use of premises

(g) Rights of Lessee - Franchises - Sub-contracting - Sub-leasing - Scope of charges to users

(h) Performaace Standards - Quality of service - Throughput - Compliance with port's Rules, Regulations and Bye-laws

(i) Allocation of Assets and - Transfer of mobile assets to lessee Labor - Transfer of labor to lessee - Return or disposal of assets at termination

(j) Operational Aspects - Control of berth - Assignment of vessels - Condition of assets at termination

(k) Liabilities of lassee - Damage to equipment and facilities - Security of Cargo and of facility - Insurance - Performance bonds - Environmental damage and restoration

(1) Conditions of Termination - Basis of early term - Penalties for violation of terms - Penalties for early termination

(m) Facility Modification - Planning approval - Construction - Removal or retention

(n) Interpretation and Dispute Settlement

(o) Applicable Law

6.2 The Major Components of an Agreement

6.2.1 In addition to the specifics with regard to the items in the checklist above, the content of the arrangement for private sector participation in the port depends on what is being offered. The agreement document must codify all negotiated elements clearly so -17- that each party may ejoy the relationship and misinterpretations which generate disputes can be avoided. Generally the private sector is granted the right to conduct a business (i) which is as yet not performed but which the private sector intends to perform; or (ii) which the port currently performs or intends to perform, under terms and conditions set out in the agreement. For example, the major components of, say a concession agreement, covering the development of the superstructure and the operation of a new terminal (para. 3.2.1 (c)), could be the following:

1. The right of franchise-which defines the business that Is being transferred to the private party, the markets which are to be served and any limitations on potential competition for these markets;

2. The lease-which transfers the assets used to perform the business from the port to the private operator for a specified period of time and assigns responsibility for the maintenance and renewal of these assets during this period and their disposition at the conclusion of the agreement;

3. The operating agreement-which specifies how the business is to be conducted and the quality of service to be provided;

4. The payment schedule-which indicates the payments to be made by the private sector for the franchise and for any assets transferred to them and the charges which can be levied by the port and by the private sector for the services provided;

5. The investment schedule-which assigns responsibility for investment in new assets either to improve the quality of service over the life of the agreement or to meet the growth in demand.

6.2.2 The components of the agreement address a number of strategic issues which will affect the benefits to be derived by the port, the private sector and the port users. These issues are:

1. The period of the agreement. Is generally limited to the life of the assets to be financed by the private sector. A longer agreement will permit the private party to make major investments and to undertake other efforts to build up the business. A shorter agreement will generally involve less risk and provide the port with the ability to adapt to changes in the market, to allocate its resources to those businesses which are most important to its future, and to choose those private parties which are most effective in conducting these businesses.

2. Who the services are provided to. The port may be the exclusive client of the private party and pay directly for the services provided or the port users may be the client and pay for these services. In the former case, the port is able to directly influence both the quality and the price of the services but in the latter it must rely on regulation or competitive forces. On the other hand, a direct relationship between the private party and the port users allows the former to respond directly to the - 18 -

needs of the users and to introduce new services or additional capacity at the request of the users.

3. Responsibility for the assets used. The assignment of responsibility for allocation, use, maintenance and renewal of port assets which are assigned to the private sector as part of the business will affect not only the quality of the service but the condition and economic life of these assets. The assignment of responsibility for acquiring additional assets to provide a better quality of service and to meet the growth in demand will determine the type and quality of these assets and the time required to obtain them.

4. The extent of competition. The private party may be given an exclusive franchise for this business or may compete directly with the port and/or other private parties in providing the service. This may be an open competition among the participants or the market may be subdivided among them. Competition helps to control both the quality of service offered and the price for these services, but it can also increase the risks of the business as perceived by the private party or discourage investment where a new business is being established.

5. The pricing of the resources and services offered by the private party. The amount charged for the services or the basis for these charges may be determined as well as the conditions under which these charges can be revised over time. The private sector may be allowed to set their own prices, to charge according to the existing port tariff or to set prices according to certain limits. The suitability of the port tariff to serve as a mechanism for defining these prices depends on the, current structure of the tariff and the ability of the port to modify this tariff (Section 7).

6. The quality of service. The private party may be required to meet certain standards of efficiency in performing these services, the level of utilization of the ports assets, the overall demand for the services and/or the benefits derived by the port users from these services. The agreement should specify quantitative standards and indicate what data must be collected to evaluate this performance.

6.3 Types of Agreements

6.3.1 Various forms of agreements are available for establishing the commercial relationship between the port and the private sector. If the private sector participation is to be limited to providing services to the port rather than directly to port users, then a management or services contract can be used. Common examples are contracts with the private sector to provide the maintenance of port equipment or towage services to the port which, in turn, offers them to the port users. If the private sector is to provide services directly to the port users then some form of licensing or operating agreement is used. Ucensing of stevedoring companies is currently used for the handling of general cargo in Indonesia ports. Operating agreements are used to establish privately-operated terminals which serve the operator's own cargo and vessels, specific third party vessels or cargo, or serve all vessels and cargoes as in the case of a common user facility. This type of agreement will be used in the future to govern the activities of the Terminal Operators - 19-

under the STO system (Section 9.3) and would be used in the case of private container terminal operators.

6.3.2 The agreement between the port and the private sector may also provide for the transfer of assets through a hase agreement. For example, the port may lease facilities and equipment to the private sector to be used for providing specific services to the port users or for any activity which the lessee chooses. These transfers can be accomplished through separate capital leases or can be Included as part of the operating agreements between the port and the private sector. When the assets are transferred on a permanent basis a sales/purchase agreement or a lease/purchase agreement would be used. Permanent transfers are generally limited to mobile assets. Existing facilities may be transferred for a period of 5-20 years with the shorter periods being favored. Land to be developed by the lessor Is usually transferred for a period of 15-30 years. Capital leases would be required to formally transfer the general cargo berths to the terminal operators (STOs) and the container berths in Tar#uMg Prlok and Surataya to private operators. While sales/purchase agreements may be used to reduce the port's inventory of mobile equipment following the transfer of cargo-handling operations to the private sector, the larger equipment such as cranes and yard gantries may have a life that extends beyond the period of the agreement and would in such case be included as part of the lease.

6.3.3 When the lease agreement between the port and the private party provides for the latter to finance during the period of the lease specified new investments which will revert to the port at the expiration of the lease, the arrangement is commonly referred to as a concession. A typical example is the case where a private party enters into an agreement with the port to develop the superstructure of a new terminal and to operate this terminal till the end of the concession period. The concession is a typical agreement used by the landlord port. A Buid-Operate-Transfer (BOT) agreement is a form of concession used for major new projects. Under a BOT contract, a private party would agree to finance and construct both the infrastructure and superstructure of a new terminal, and to operate and maintain it for a specified period at the end of which the terminal would be transferred to the port.

6.3.4 If the assets transferred to the private sector are constrained in their use to a specific function or service, then the value of the assets will depend on that function or service, but if they are transferred without restriction, then the value is that associated with the optimum use of the assets. For example, if a mobile crane is transferred to the private sector under a sales/purchase agreement, then its value is equal to the price of the crane in the second-hand market. If the same crane is transferred under a lease agreement for use in terminal operations, then its value is either the marginal savings in operating costs to the terminal operator from having this equipment or, if the equipment is essential, the cost to the terminal operator of providing a similar piece of equipment. .20-

6.3.5 If land is transferred to the private sector A/ without restriction on its use, either through a long-term lease S/ or sales/purchase agreement, then its value Is that which would be obtained from the highest bidder. If the land is leased for use in providing a specific service, then the value to the bidder will be limited by the cost of land elsewhere which would provide a similar function. For both the general cargo berths and the container terminals, it is recommended that the assets transferred be limited in their use to die handling and storage of the cargo from vessels berthing at these facilities.

6.4 Approach for Evaluating Agreements

6.4.1 The transfer of a business, or of the use of facilities, to the private sector should be done through a competitive bidding process. The purpose is to select the qualified bidder who offers the best financial terms. In order to evaluate the financial terms of an agreement, I is necessary to consider the impact of the involvement of the private sector on the port's cash flow and on the port's ability to invest in other facilities and equipment The cash flow analysis requires that the port prepare projections of:

1. The revenues from performing the business under the existing tariff with allowances for periodic tariff increases in line with previous experience;

2. The direct operating costs including costs for repair and maintenance and direct operating overheads; and

3. The costs for investment in new capacity and renewal of existing capacity over the period of the agreement.

With this information and the port's discount rate, the present value of the port's cash flow tom the business can be calculated.

6.4.2 The transfer of the business would modify all three components of the cash flow as follows:

1. The revenues would be reduced by the tariff items that the port would no longer collect or by that part of the revenues which would be passed on to the private sector. The revenues would be increased by the private sector payments to the port under the terms of the agreement. These would include rentals, activity charges and other fees.

4/ As a general principle, a port should never dispose of its valuable waterfront lands except in such cases where the land is no longer useful for port operations but has considerable real estate value. Examples are the very attractive waterfront developments that have taken place in ports such as Boston, Baltimore , Barcelona and London.

I/ In the Indonesian context, there is generally no freehold but land is transferred under lesser rights to land, i.e. a general right to building (hak guna bangunan - HGB) for up to 30 years with possibility for renewal for a similar period. -21 -

2. The costs would be reduced by transferring part or all of the responsibility for operations and maintenance and for the employment of labor to the private sector. These reductions would be partially offset by the cost of indemnization to be paid by the port to the labor which is transferred or terminated.

3. The capital costs for investment and renewal would be reduced to the extent that the private sector would now make these investments. If the assets procured are removed from the port at the termination of the agreement, then the savings would be partially offset by the cost of acquiring replacements at the time of termination.

6.4.3 A comparison is made between the business with and without private sector participation by using the present value of the cash flows involved.f/ If the present value of the port's revised cash flow is greater than the present value without the private sector participation, then the port will be better off financially with more private sector involvement. These calculations require a projection of the business activity or the level of utilization of the assets transferred over the period of the agreement. They also require estimates of the escalation in operating and capital costs due to inflation, the escalation in revenues due to tariff revisions and the reduction in operating costs (and increase in capital costs) due to increases In labor productivity. In addition, the discount rate of the port should be adjusted by a risk factor appropriate to the type of business.

6.4.4 A similar calculation is made by the private sector party in order to determine what it is willing to offer to the port for this business. The value of a business is the net present value of the free cash flow produced by that business. This cash flow depends on the private sector's operating and capital costs, which should be lower than those of the port's for the same business. It also depends on the rates that the private sector is able to charge the port users for the services provided. Presumably these are equal to or less than the current rates. The greater the potential revenues from the users, the more the private sector will be willing to pay the port for the business. If the present value of the payments to the port is equal to the net present value of the free cash flow from the business, then the private sector earns its expected rate of return on investment but no more. In particular, it does not obtain a return on entrepreneurship which for low capital service industries can be more important than the return on investment.

Al Of the three broadly recognized methods to value a business - asset value, price-earnings, and the net present value of the future free cash flows - the latter is the most widely accepted. A value of the net tangible assets of the business at current market value is generally not appropriate unless these assets are to be sold. This value may be used to ensure that the price received for the business is not less than the breakup value of the business, i.e. the price which would be received if the assets were sold separately. It may also be necessary to determine these values in order to adjust the balance sheet and to anticipate any changes in property tax or insurance requirements. The price-to-earnings ratio is commonly used to evaluate the current price of shares in a company. Since it does not look at the future income stream of the business, it is less useful for valuing a business. -22-

6S The Competitive Bidding Procedure

6.5.1 Competitive bidding should be the underlying principle for the involvement of the private sector in the Indonesian ports. The process should be transparent and adhere to clear guidelines. For each scheme a bidding document should be developed which specifies the terms and the conditions of the service or the business. In the case of important activities, where international participation is sought, bidders should be pre- qualified based on a demonstrated capability of conducting the particular type of business and on sufficient financial resources to sustain the business. The request for bids should contain both a description of the bidding document to be submitted and the format of the proposed agreement between the port and the private sector. The bidders should provide background information on their line(s) of business along with an indication of their legal structure. The request for bids should be publicized for a sufficient period to attract serious bidders. The method for publicizing the request and the exent of the coverage will depend on the extent of national and foreign sector participation being sought. This would also affect the period of time given for submission of tenders.

6.5.2 The competitive bidding process is used to identify the most advantageous potential private party for the port business to be privatized. The components of the agreement on which the bidders are expected to compete and the basis for evaluation of their bids can be put together in a number of ways. For example, assuming that the bid document specifies the rights of franchise and the terms of the operating agreement, the competition would focus on the payment and investment schedule. The bidders are asked to propose either the payments to be made to the port or the charges to be levied against the port users. Alternatives include the following:

1. If the charges to the port users have been specified or the process for regulating them has been set out, then the bidders would compete on the basis of the payment to the port, either*

a. the annual rental to be paid to the port b. the unit throughput or activity charge, or c. a combination of both.

2. If the port specifies the rental and throughput charges in the request for bids, then the bidders would compete on the basis of:

d. the schedule of charges to be levied against the port users, or e. the maximum charges to the user

3. Additional criteria for bid evaluation which have been taken into account in particular cases, include:

f. the minimum level of activity over the period of the agreement, and g. the amount of capital investment to be made. -23-

6.5.3 While it is possible to have the bidders compete on several of these issues, the greater their latitude, the more difficult it Is to compare bids and to provide an objective and transparent evaluation. For example, one bidder might propose a much larger investment program than another but this would be balanced by a lower payment to the port or higher charges to the port users. Similarly, one bidder might offer a larger . payment to the port but also charge the port users more. 6.6 Structuring Payments to the Port 6.6.1 A number of alternative mechanisms exist for the private sector to compensate the port for the transfer of a business and the related assets. For the permanent or long-term transfer of assets, with or without restriction on their use, the port may charge a single up- front payment (sales/purchase, freehold or leasehold), an annual rental with periodic adjustments (long-term capital lease) or an annual rental for a fixed period followed by a final balloon payment (lease/purchase). For the temporary transfer of assets, the port may charge an annual or monthly rental and/or a use-related charge. 6.6.2 For the transfer of a business from the port to the private sector on a permanent basis, the port may charge a fixed annual payment (a licensing fee), a fixed payment per unit of activity (royalty), a variable charge per unit of activity (sliding scale), or some combination of the three. The annual payment may be further constrained by establishing a minimum annual payment based on a minimum level of activity and/or by establishing a maximum level beyond which no additional charge is levied.

6.6.3 The basic criterion to be applied when settinglegotiating the financial arrangements between the port and the private sector is that the port should be at least as well off financially as if the transfer had not been made.j/ This is determined by comparing the port's net cash flow with and without transferring the business and associated assets as mentioned above. This calculation should take into account a number of factors including: a. potential increases in traffic and revenues as a result of better quality service provided by the private sector b. reallocation of revenues between the port and the private sector c. likely increase in the tariffs for these services which the port would obtain if it did not transfer these services d. reduction in the ports costs by eliminating responsibilities for operations, procurement, maintenance and renewal of assets, administration of the services to be provided by the private sector and related improvements in management, and

2/ As pointed out in Section 4.3 the pursuit of this objective by the port is justified if the port is not abusing a position of monopoly power. This condition is normally satisfied when the port either is operating in competitive markets or has regulatory (pricing or other) constraints imposed on it (as is currently the case in ndonesi). Whn this is ot the case, there is a risk that the port and not the port users will capture the bulk of the gains resulting from tho greater efficiency of the priv sector. -24-

e. Indemnization costs associated with the reduction In the port's labor force as a result of the transfer

6.7 Stracturing Charges to the Port Users

6.7.1 The transfer of a business to the private sector should be accomplished so that also the port users benefit from the lower operating cosL It Is therefore necessary to consider whether the port user will be better off as a result of the transfer. One way to ensure that there will be a benefit to the port users is to select the pricing mechanism to be used by the private sector when charging for the services provided. 7bis selection must take into account the competitive environment in which the private sector will operate. Ideally, the private party will operate in a competitive market, or one which can be readily contested, which should ensure that the interests of the port users are safeguarded.

6.7.2 If the market is not fully competitive, the following should be guiding principles. If the private sector provides services directly to the port rather than the port user, then the port users will continue to be charged according to the port tariff but receive a comparable or better service. If the private sector provides services directly to the port user and provides the same quality of service, then it should charge not more and preferably less than the existing tariff. If the quality of service is improved, then it may charge more than the existing tariff. However, the increase should be less than the increase in benefits to the port users from the improved service.

6.7.3 There are four basic pricing mechanisms for setting the rates charged by the private sector. The first is to continue using the port's published tariff, but to transfer responsibility for collecting this tariff to the private sector and to allow them to retain all or part of these revenues. The second is for the private sector to publish rates which apply uniformly to all users of their services so as to avoid discrimination other than through explicit volume discounts. The result is that individual user will not be discriminated against. The third mechanism is to allow the private sector to negotiate rates with individual port users. In this situation, it is likely that some users will be charged more than under the port tariff while others would be charged less. The extent of discrimination can be controlled by using the fourth mechanism, the introduction of maximum rates or pricing guidelines. With maximum rates, the private sector has complete freedom to negotiate a lower tariff but is prohibited from charging more than the maximum. With price guidelines, the private sector can negotiate whatever rate it likes but the user has the option to request the port to mediate if the resulting rates exceed the guidelines. Both the guidelines and the maxima can be set equal to the existing port tariff if no improvementin the quality of service is anticipated or at a higher rate if such an improvement is realized.

6.7.4 While the use of the third mechanism allows for greater flexibility, it is economically efficient only where there is significant competition. This occurs where there are multiple suppliers of services competing in the same market and where new suppliers can enter the market without major investments or legallregulatory barriers. This situation is not common but does exist in ports where there are a large number of facilities that can be assigned to several competitors. It can also exist where the port is in competition with -25-

other ports or modes or where competng trades make the cargoes handled through the port extremely sensitive to changes in delivered price.

6.7.5 If the competition is limited, some form of pricing regulation is required. The second mechanism is the mildest form of regulation especially where the published rates are only the maximum charge. The use of pricing guidelines or maxima can act as a mild or strict form of regulation depeding on their detail and complexity. The strongest form of price regulation is to set all prices according to the port tariff. Increasing levels of regulation reduce the ability of the private sector to respond to changes in the market and may discourage their participation in the business. Also, regulation itself has its costs. Nevertheless, some regulation may be necessary to prevent the private sector from charging an excessive amount and/or from using predatory pricing to dominate the market.

6.7.6 The principal difficulty with the first mechanism is the lack of flexibility in adjusting prices to conditions in the market place. The first and fourth mechanism are also difficult to implement because the rates, guidelines and maxima must all be adjusted periodically to account for changes In the costs for providing services due to inflation, investment, etc. This can be an automatic adjustment using an index based on published measures of relative inflation, but it is preferable to allow for a broader review in the form of negotiations between the port and the private sector at regular intervals. The scope of this negotiation can be limited by identifying what information will be considered as justification for an increase in charges or by specifying the method of arbitration should the port and the private sector be unable to reach an agreement.

6.8 Recommended GOI Actions

6.8.1 Developing Model Agreements. As already emphasized, the success of a scheme to expand private participation will depend critically on the adequacy of the contractual agreement. Three main types of situations can be distinguished: (i) those where the private sector will provide services to the port; (i) those where the private sector will operate cargo handling or other port activities mainly using existing facilities and/or equipent; and (iii) those where the private sector will invest in and operate new facilities aWdio equipment. For each situation the content and terms of the agreement should address strategic issues-such as the period of the agreement, to whom services are to be provided, the responsibility for the assets used, the extent of competition, the pricing of the services, the quality of service to be achieved-which will determine how the benefits to be derived from the scheme and the risks associated with it will be shared among the port, the private sector party and the port users.

6.8.2 In practice, the type and content of the agreement will vary according to the particular operadon or service being considered but standardization of approach for typical cases is needed. Thus, to facilitate increased private sector participation in the Indonesian ports the three types of agreemrents mentioned above should be defined in greater detail in the context of port activities in Indonesia through the development of model agreements. Because port operations have increasingly become an international business, contracts with private parties have become more standardized. A carefully selected sample of agreements can help as an initial reference for developing such model agreements. -26-

6.8.3 Developing a Competitive Bidding Procedure. To achieve effective private sector participation in ports it will be critical to develop standard documents and procedures for requesting and evaluating proposals for the main types of activities under consideration for private sector involvement. In their practical application these documents and procedures will, of course, still need to be tailored to the particular activity or business. The suggestions and recommendations contained in this Paper should provide a useful starting point for developing a standard procedure.

7 Ta1 PORT TARF Alm PRIVATE SzCTOR PARTICIPATION

7.1 General. The transfer of port activities to the private sector is facilitated when the port tariffs reflect the costs of the Individual activities whether the market for the services is competitive or not. This does not necessarily men cost based tariffs, but does require that the revenues generated by the charges for a specific port activity cover the cost of that activity. Under these conditions, it will be possible to transfer the activity with the existing tariff structure without adjustments at the time of transfer. Thus, a rationalization of the port's pricing structure to make it correspond to the individual business activities is indicated where the private sector is expected to operate under the rates specified in the port tariff or at levels less than the current tariff. A difficulty with using this mechanism is that the tariffs must be periodically adjusted to reflect changes in operating costs. This adjustment can be relatively complex where the private sector will be deriving its revenues from a number of different tariffs. It is much less difficult when considering a single tariff item.

7.2 Alternative Tariff Adjustment Scenarios

7.2.1 If the prices charged the port users by the private sector are to be based on the port's tariff, then both the structure of the port tariff and the current rates will determine which tariff revenues are transferred to the private sector. Assuming It is possible to revise the structure of the tariff so as to have separate charges for each of the principal businesses of the port and to set these charges according to commercial principles allowing a reasonable rate of return on investment, then a business can be transferred to the private sector together with the tariffs for that business. A numeric example is shown in Line A, Table 6

7.2.2 If the port tariff is not well suited tc the transfer of the business, but the port wishes to use the published tariff as a mechanism for controlling the amount charged the port users, then it is necessary to select one or more tariff items and to define a percentage of the revenues from these tariffs which the private sector will keep in order to cover its direct operating costs and provide a reasonable return on investment (Example B in Table 6)

7.2.3 The opposite situation occurs when the private sector is allowed to set their own rates either in a published tariff or in private negotiations. The port must still modify the port tariff so as to reduce or e.'minate the tariff Items for thtse services to be provided by the private sector. The port must diminish its revenue collections in accordance with the reduction in costs which result from the transfer of the business to the private sector -27-

(Example C, Table 6). Assuming that the tariffs for these service would produce revenues in excess of the amount of costs savings as a result of the transfer, then the port could eiber reduce these charges or eliminate them altogether, but increase other charges to compensate for the shortfall (Example D, Table 6). On the other hand, if the tariffs for that particular service did not produce revenues equal to the costs savings, then other tariffs could be reduced to produce an overall reduction in revenues comparable to the cost savings (Example E, Table 6).

Table 7: ExAMWLs OF TAaMw ADsranro To ACCOMMODATE TRANSFERS TO TlE PRIVATE SECTOR CurrentRevenues from Revenues Retained by Private Sector Private Sector from Revenue Example Cargo- Wharfage Requirement Cargo- Wharfage handling R handling A 3,500,000 2,000,000 2,500,000 tariff revised to 2,500,000 3,000,000 100.0% B 2,000,000 2,000,000 2,500,000 100.0% 25.0% Reduction in Port Charges Savings in Port Costs Cargo- Wharfage handling C 2,500,000 2,000,000 2,500,000 -100.0% D 3,000,000 2,000,000 2,500,000 -83.3% E 2,000,000 2,000,000 2,500,000 -100.0% -25.0%

7.3 The Indonesian Port Tariff Structure

7.3.1 The existing Indonesian port tariff structure is not well suited to the promotion of private sector participation. The practice of applying the same tariff in a number of ports fails to take into account the different cost structures in each port. It also ignores differences in the markets served by these ports and the demand for specific cargo and vessel related services. Furthermore, Individual tariffs are seldom related to the services which are provided. This can be seen in the arrangement in Tanjung Priok where the private stevedoring companies collect not only a negotiated handling charge but also a portion of the port tariffs for wharfage and storage.

7.3.2 In Tanjung Priok, the relatively low working ratio (operating costs less depreciation and interest divided by operating revenues) for the container operations and the higher ratios for other businesses do not necessarily indicate that all the tariffs should be changed, but it is likely that the tariffs for some of the individual services such as towage do not provide sufficient revenues to cover the costs aor these services and thereby discourage the participation of the private sector in this business. -28-

7.3.3 Many of the smaller ports have working ratios exceeding 1.0. Since these ports provide certain life-line services it may not be desirable to increase the tariffs to a level which would make the port commercially viable. However, this need not preclude the participation of the private sector. Rather, It will call for different kinds of agreements. One possibility are service contracts in which the port pays the private sector for the services and continues to charge the port users at rates which are below its costs. The basis for such an agreement would be that the cost of providing the services would be reduced through the participation of the private sector and would therefore decrease the port's working ratio. This arrangement would reduce though not necessarily eliminate the need for continuing subsidization of these ports. A variant of this scheme is to award a contract for performing port activities with given performance standards and a given tariff structure to a private operator under a bidding procedure where the lowest subsidy is the principal selection criterion.

7.4 Recommended Action. Thus, in order to expedite the transfer of port businesses to the private sector, it will be important to rationalize the port tariff. First, the structure should be revised so that there are specific tariffs for specific businesses. Second, the prices should be set so as to be able to attract private sectorinterest in these businesses. These prices should reflect the full costs of the specific business rather than allowing for cross-subsidies from other businesses.I/ The prices could also allow for some differentiation between markets served according to the ability to pay. It should be noted that designing the port tariffs so that the items charged for individual services produce revenues which are related to the costs of providing these services also has the important merit that port users will be used to paying these prices and will make their trading decisions based on sustainable prices.

8 PORT LAWOR AM PRIVATE SECTOR PARTICIPATION

8.1 General. Implementation of particular "privatization* schemes may well result in the need for streamlining of the work force or an even more dramatic outcome such as a surplus in port labor. This would be an important issue which will need to be addressed to successfully implement the scheme. This suggests that to realize in the medium to longer term the full potential of private sector participation in the port sector an ad-hoc approach to such issues will not suffice. A forward looking strategy aimed at modernizing and reforming port labor policies and practices will be required. This will in fact be vital to improve the efficiency of Indonesian ports, irrespective of whether private involvement in ports will be increased or not. Achievement of greater private sector participation will make the need for reforms only more urgent. Such port labor reform need to be carefully planned and executed after proper consultation with labor and employees, relevant government agencies, the port corporation management and private sector employers. Failing this, there is a high risk that port laborers and employees will strongly resent any change in working conditions and arrangements, and will likely oppose institutional changes such as *privatization".

A/ This is not an argument for tariffs based on accounting prices. Quite the contray, the prices used in a business should be set according to market conditions. Only the overall revenues from the business need to be equated with the costs of sustaining that business. -29-

8.2 The Need for a Comprehensive Labor Reform Strategy

8.2.1 Effective port labor policies and practices cover a wide range of aspects which can conveniently be grouped under the following 10 headings:

- Employment of dock labor - Number of employees - Streamlining of the work force - Contractual conditions of employment - Improved working practices - Negotiating mechanism and dispute procedures - Employment safeguards - Personnel and manpower development - Training - Management of the reform program

The way in which each of these aspects is dealt with will to a large extent determine the development and operational efficiency of the Indonesian ports. It will be important, therefore, to formulate and implement appropriate solutions with respect to each of the issues as part of a comprehensive strategy.

8.2.2 Employment arrangements of dock labor. For the modernization and expansion of private participation (in whatever form) In the Indonesian ports to succeed, the arrangements for employment of dock labor from the "Koperasi" will need to be adapted. The present system should ultimately be discontinued and employment (recruitment procedures) modernized, with a substantial number of the labor force becoming permanent staff, either of private sector companies or of the Port Corporations, depending on which organization will be responsible for the cargo handling operations. However, because of the irregular nature of port traffic, it may be necessary to maintain some residual labor in a common pool or some similar arrangement, to meet peak traffic demand.

8.2.3 Number of employees. Private and public port operating companies will have to determine the number of workers and employees they wish to engage on a permanent basis and be given the freedom to recruit them. This may mean that fewer employees will be engaged than presently, although with a growing trade volume it should be possible to maintain or possibly even increase the numbers employed. The main change is therefore likely to be in the required job skills, with a much greater need for technically competent staff. This may result in an excess supply of non-skilled labor.

8.2.4 Streamlining of the composition of the work force. In order to bring the work force to the required strength and at the same time ensure the technical skill levels demanded by modern port operations, a strategy must be formulated to replace, when necessary, workers and employees in an economic and socially responsible manner. If, therefore, retrenchment of certain categories of workers is considered as unavoidable, schemes must be developed that will achieve this without negative effect for those involved. This implies that policies of natural attrition and voluntary redundancy should be given preference. T financial implications of any proposed scheme to streamline the -30-

composition of the work force and enhance its qualifications are likely to be significant and these should be carefully studied and quantified as accurately as possible.

8.2.5 Contractual conditions of employment Private operators must be free to introduce new types of employment contracts, which allow for adjustments of manning levels, salary structures and working hours. Operators (private or public) should be free to negotiate with the work force (or its representatives). New conditions of employment are also required for the residual labor force and for the labor that will continue to be employed by the public sector. These conditions should be based on the needs of modern port operations and the challenge will be to reconcile these objectives with the expectations of labor for proper job remuneration, some measure of job security and manpower development. Needless to say that any new employment contract will need to be consistent with the applicable Indonesian labor legislation.

8.2.6 Improved working practices. Future contracts of employment must contain clauses promoting improved working practices which will lead to multi-skilling, flexibility In the deployment of labor and in the hours worked, elimination of restrictive working practices, revised manning levels in the gangs, removal of job demarcation and improved and transparent incentive schemes.

8.2.7 Negotiating mechanism and dispute procedure. For reform of labor policies and practices to succeed there is a need to establish an effective negotiating machinery between employers and employees. This could be achieved by developing on a port by port basis a form of collective working agreement. A proper framework to deal with any disputes must be drawn up to ensure harmonious Industrial relations.

8.2.8 Employment safeguards. It is essential that the introduction of reforms and the greater involvement of the private sector does not lead to undesirable practices such as those in some countries under the casual system of employment. In order to make the transfer feasible and attractive, consideration may need to be given to the formulation of an appropriate salary and benefit package for those employees transferred to the private sector. The private sector employers may have to give the guarantee that they will offer conditions of employment which are not less attractive than existing schemes.

8.2.9 Personnel management and manpower development. The occasion of implementing labor reforms provides an excellent opportunity to introduce modem personnel management and manpower development schemes, both within the private and public sectors. These should cover recruitment, creation of new required functions, job descriptions, career development, training and other related aspects.

8.2.10 Training. No reform program of the scale described can be successful unless it is supported by the provision of ample training and re-training opportunities. All employees both from public and private port sector companies will need training/retraining, particularly if multi-skilling is introduced and the skill level of workers and other staff is to be upgraded. A firm comnitment to training will foster a more cooperative climate from the labor side during the transition period. Questions that need to be tackled include: who should have the overall responsibility for running the training - 31 -

program, who should pay for the program, and what numbers are involved over, say, the next ten years. Good presentation of the structure and costing of the training effort is not only necessary, but will help to ensure the private sector's required support. There should be strong private sector involvement in the design and implementation of the training program. 8.3 Recommended Action. IT development and implementation of a comprehensive modernization program of port labor policies and practices presents a formidable task. Consideration will need to be given as to how this may best be managed. It is recommended that a commission (or other such body representing the various interests) be established at the national level to be responsible for developing a port labor policy and for overseeing the implementation of the reforms. In practice, actual reforms should preferably be formulated and implemented on a port by port basis. This two tier structure would allow to take into account both national and local priorities. At the same time it would also strengthen the case, if necessary, for a government supported and funded voluntary redundancy scheme.

9 INsTraoNAL Asants iN RELAnON TO INCREASED PRIVATE SBCTOR PARTCIPAON

9.1 Ite Strengths of the Public Sector and Private Sector

9.1.1 In line with several other countries' thinking, the GOI has already taken the step of establishing the four Indonesian port groups as state owned corporations (for example: India, Pakistan and Malaysia and more recently Australia (Sydney), have taken this step). With the establishment of the four state port corporations Indonesia adopted a two tier institutional structure for port administration (the ministerial level (MOC/DGSC) responsible for general policy and planning and for operations of the 450 or so smaller ports on the one hand, and the port corporations responsible for policy implementation and operations at the 110 or so major and secondary ports on the other). Given the size and complexity of the Indonesian port sector this has proven to be an effective approach. Notwithstanding the increased private sector participation anticipated for the future, this institutional structure will remain appropriate for some time to come as the efficient management of the port sector will remain a daunting task requiring all the abilities available in the public sector. Both tiers, however, will need to adjust to their evolving role.

9.1.2 To define the future role of the public sector in the Indonesian port sector it is useful to consider first the abilities of the private sector which is called upon to play a much larger role. A private sector company has many characteristics which allow it to function efficiently and flexibly and which are necessary for successful commercial business activities. Decision making can be almost instantaneous, changes in operations are usually unfettered from lengthy chains of command, financial matters can be managed in a multitude of ways, and allocation of resources to fit changing conditions can be accommodated in the most productive manner. The private sector usually employs only qualified managers and technicians who are effective in providing service with a profit whereas a government entity is subject to political influences and to constraints imposed -32 -

by non-business considerations. In sum, the private sector operator can deploy labor for greater effectiveness, tap various financial resources for capital, create partnerships as appropriate to the business, expand and contract operations when necessary, change equipment and operational techniques to fit the occasion, and develop effective customer relations beyond national boundaries. Bringing such an effective organization more aggressively into the port environment will improve productivity, reduce costs, allow more rapid expansion of business, and conserve public monies. The private sector should, therefore, be regarded as an asset offering a major contribution to the future development of Indonesia's ports and thus its industry and people who are served by them. A potential drawback of private enterprise, however, is that it gives priority to the generation of profit and as a result tends to set prices according to ability to pay, which in the absence of competition, results in monopolistic pricing. Also, because of the greater risks it runs in making investments (relative to the public sector which has a large portfolio of investments), the private sector applies a higher discount rate, and therefore, a shorter payback period, when deciding on investments.2/

9.1.3 Experience demonstrates that the public sector does not display all the above attributes. Even when a government organization is established as a state-owned share corporation It does not automatically adopt all the operational characteristics of a private enterprize company. It is detached with some autonomy from its parent organization and its "independent" status gives it a certain measure of responsibility for its own resources/decisions-financially and administratively-within the enabling regulations. However, the state corporation will not be able to shed all of the bureaucratic constraints associated with governmental agencies. Thus, in principle, the aim should be to achieve as much private sector involvement in ports as is compatible with the need to ensure that the less desirable potential outcomes of the private enterprize profit motive are kept in balance. This implies that some activities will need to be performed by the public sector and that provision should be made for adequate safeguards or controls on other activities carried out by the private sector.

9.2 The Respective Roles of the Ministry and the Port Corporations

9.2.1 The key responsibilities of the public sector will be to establish and implement the policies for the sector, to ensure that the long term development needs of the sector are provided at least cost and that the public interest concerns in relation to port activities and maritime transport are properly taken into account. In view of the size of the Indonesian port sector, comprising some 560 public ports (and a further 720 industrial ports) the increased private sector involvement will not eliminate the need for a VPort Authority" body (which in the Indonesian port context covers functions currently carried out by the Adpel and the port corporation). As businesses, operations and activities are transferred to the private sector, the role of the public sector will become more heavily concentrated on policy and planning at the expense of operations. The two tier structure-comprising the Ministry and the port corporations-provides the possibility for the Ministry to delegate

2/ The public sector, in contrast, is generally limited in thw surplus which it geurates and uses natively little discrimination in prcug. Also it is willing to make longer term investments because of its lower discount rate. - 33 -

much of the responsibility for policy implementation (of private sector participation in particular) to the port corporations. At the level of both the Ministry and the port corporations, action will need to be taken urgently to meet the challenges resulting from this evolving role. 9.2.2 If the private sector involvement In Indonesian ports would proceed along the lines set out In this Paper, the role of Indonesian Port Corporations as an "Operations Port" would be reduced and they would begin to assume a "Landlord Port" type of role. 10/ Instead of acting, in coordination with the Adpol, 11l as the omnipresent and omnipotent body responsible for everything undertaken in the port, a key function of the Indonesian Port Corporations of the future would be to assist in the implementation of Indonesia's port sector policies. Accordingly they would concentrate their effort on the efficient performance of five fundamental functions:

* the financial and commercial aspects of the landlord function - the medium term planning function within their assigned geographical boundaries - the policy implementation and surveillance function - the monitoring and promotion function - the port training function.

9.3 Developing a Capability for Guiding the Implementation of the Policy 9.3.1 In line with the general principle that policy formulation rests with the Ministry and policy Implementation with the port corporations, a cenbl cqablty will need to be established wWdx the Atsy to guide and direct the policy of expanding private sector participation. The responsibilities of this central entity would be, inter alia, to: establish (and fine-tune as experience is gained) the legal and regulatory framework; develope (and

IQ/ It could be argued that there is so need for maintaining at all the Port Corporations as state enterprises given that eventually most operational activities would be caried out by the prvate sector, that the Port Corporations only constitute an additional layer of bureaucracy consuming substantial resources without generating measurable outputs and could well be replaced by a private landlord company driven by the profit motive. This view, however, ignores the unique Indonesian geographic context with its large number of ports, and the still weak institutional setting. In these conditions and for the foreseeable future th two tier port administration system remains an effective and tested formula for administering the geographically diverse port scne. Precisely because all major operational activities would be entrusted to private operators, there is a need for some largely state-owned bodies that would perform the core functions of a "Port Authority".

11/ The term Adpel refers to the position of "Port Administrator". The Draft Government Regulation on Port Affairs, Concept M, Chapter M, Organization, Articles 15 through 18, states that the Minister shall appoint an Official as port Administrator (Adpel) at a commercial public port to implement coordination of the typical O01 functions - namely, safety of navigation; customs and excise duties; immigration; quarantine; security and order - and also the supervision and examination of port operations carried out by public ports and private sector operators within those ports. At the working level of the port, the system can be a valuable asset to the port's general manager who can quickly resolve issues through the Adpel instead of having to approach central government. However, it is important that the Adpel not be directly involved in port commercial operations. .34-

subsequently fine-tune) model contracts for private participation in the port activities; develop guidelines and procedures for the whole process of inviting, evaluah4 and awarding contracts for private sector participation in ports; determine the kinds of constraaints or disincentives to foreign private investment and initiate appropriate action to introduce improvements; bring officials involved in port activities into the policy making process from the outset; monitor privat sector participation schemes; formulate lessons of experience; and provide direct assistance on specialized topics to the port corporations engaged on preparing or negotiating particular schemes. This would include obtaining outside expert assistance in financial, legal, and technical aspects to design, negotiate and implement such schemes.

9.3.2 The port corpoedeas in turn will need to set themselves up to deal with a shift in emphasis of their responsibilities from port operations and service provision to management of assets and contracts. Their recently acquired status as a shareholding company (Persero) gives them expanded opportunities to adjust to their new role. As a first priority they will need to rapidly strengthen their capabilities in the financial area. Two aspects require particular attention. First, they will need to acquire the range of skills which will enable them to structure agreements which will ensure that the port corporation and the port users are better off than they would be without such agreements, or as a minimum, would not be worse off. Second, as the use of private capital in the port sector need not be limited to direct investment by providers of port services, the port corporations should explore other forms of resource mobilization. In terms of increasing complexity this would consist of project finance from banks (which is already a source of funds in some cases), investments by institutional investors (e.g., fixed term paper), and equity financing through the capital markets. The implementation of the recommendations made in this paper-rationalizing the port tariff, modernizing port labor policies and practices and developing the capability to structure agreements with the private sector-would all enhance the chances of the port corporations to tap these new resources.

9.3.3 Finally, if greater private participation in the port sector is to become a reality, the port corporations will need to take a pro-active approach rather than waiting for private parties to express interest in particular port activities. In consultation with MOC, the port corporations will need to develop a systematic procedure for expanding private participation. This would cover such steps as defining business activities/business units suitable for being carried out by the private sector, identifying constraints to private participation developing appropriate strategies for transferring each type of business unit to the private sector, prioritizing and phasing of the program and finalizing the bidding procedures and arrangements (Section 10.5).

10 OPPoRTuNrrIES FOR PRIVATE SECIOR PARTICIPATION IN THE INDONESAN PUBLIC PORTS

10.1 General. In Section 3, the opportunities have been grouped in main categories according to the general level of complexity and the risks involved. While in some particular cases this grouping may appear somewhat arbitrary, in general, the structuring of agreements for service contracts, for the operation of existing terminals and for the development of new terminals can be expected to present increasing levels of complexity -35 -

along with a decreasing number of examples to draw upon. These general cases are discussed In somewhat greater detail In the following.

10.2 Provision of Port Services

10.2.1 As mentioned In Section 3.3 many areas of port activity can be considered for provision by the private sector such as:

* tugs and towing services - pilotage-both pilots and pilot boats - mooring boat and launch services - cruise ship terminal operation (if investments would be involved then this would be a form of private participation similar to that discussed below) - warehousing, including specialized warehousing (i.e. refrigerated warehouses, stripping/consolidation centers) - ship bunkering; fresh water; and garbage, sewage and oily waste services under the MARPOL Convention - equipment maintenance and repair-all categories - navigation aids maintenance - the carrying out of maintenance dredging

10.2.2 A few of these services are already being supplied by the private sector in the smaller ports but there is considerable scope for greatly increased use of the private sector in these services. The advantages are improved availability, better service and reduced costs coupled with significantly reduced day-to-day management problems for the Port Corporations. Forms of agreements, and requests for proposals and tendering documents are discussed in Section 6.

10.2.3 An example is the provision of tug and towing services. Currently, the tugs are owned and operated by the port corporation. Tenders could be invited from the private sector to provide the services required in terms of anticipated daily ship movements and other tug and towing needs carefully specifying the horsepower, propulsion systems, fire fighting and other technical requirements as well as the tasks to be performed and the quality of service expected. The tenderers could be required through the bid document to take over the existing fleet and then It is for the successful tenderer to decide if it can be used, or is to be sold or upgraded. Because the private sector operator can probably use the idle time of the tugs for other tasks his hourly operating costs can often be much lower than those of the port and if he has a large fleet of vessels the maintenance task is made simpler and less costly.

10.3 Operating of Existing Cargo Terminals

10.3.1 The General Cargo Terminal Operating System at Tanjung Priok. On April 1, 1993, the Port of Tanjung Priok introduced, on a trial basis, the *Terminal Operating System' (System Terminal Operasi (STO)), whereby a number of conventional berths have been allocated for exclusive use to each of eleven groups or consortia of stevedoring and cargo handling companies active in the port. Each group or consortium operates a section -36 -

consisting of two or three berths with two or three sheds and the leading company in each consortium signed to this intent a service agreement with Port Corporation II. Additional to these dedicated berth allocations, the Port Corporation 11 has retained two common user berths for operation by any stevedoring company, Including the Corporation's own stevedoring company, on an ad-hoc basis. These berths are predominantly used for bulk cargoes such as scrap iron, or for large consignments of bagged cargoes such as rice.

10.3.2 The stevedores In the STO consortia negotiate directly the stevedoring charges with their shipping line clients, based on the Stevedoring Association's basic tariff rates. The wharfage tariff, which is approved by the Government and applicable for all Indonesian ports, is collected by the stevedores to cover their operational overheads on the landside, but eighty percent of the earned revenue is passed on to Port Corporation II. The Indonesian port storage tariff also applies for the sheds allocated to the various consortia or groups, and similarly eighty percent of the collected revenue Is handed over to Port Corporation H.

10.3.3 If the STO experiment, which is only a first small step towards the expansion of private participation In cargo handling in Indonesia, is considered successful, then it could be consolidated in Tanjung Priok and extended to other major Indonesian ports. A possible scheme for further consolidation and extension of the STO system could be implemented in three phases, namely: Phase 1: Formalizing the present arrangement in Tanjung Priok by signing with the leading company in the STO groups or consortia or with the consortia directly, once these have been established to this intent as new operating companies, afve- year les agreement;

Phase 2: Introduce in the other major Indonesian ports the STO scheme on a one year trial basis, by agreeing service contracts with selected groups or consortia of stevedores and cargo handlers;

Phase 3: After the first five-year lease contract has been completed, the Port Corporations, starting with Port Corporation II, can then either offer the same groups or consortla, after negotiation, a five-year extension of the lease or alternatively, they can open up the allocation procedure by tendering procedures to include other qualified operating companies.

10.3.4 The option of an open tender for the extension should be the preferred one but then the period of the lease should not be less than ten years (but allowing for renegotiation of some terms of the agreement at 5-year intervals) and the contract should only be awarded following a well prepared tendering procedure which uses clear evaluation criteria. These could include, for example:

* the managerial and operational competence of the prospective operator; - the maximum cargo handling tariff levels proposed by the prospective operators, in case GOI would allow them to set their own tariff levels In the future; *37-

- the compensation offered by the prospective operator in case the tariff levels would be a given; - the throughput volume the prospective operator can reasonably expect to handle, based on his present and potential customer base; - the proposed level of additional investments the prospective operator would be willing to make for replacement, renewal, modernization and or expansion of the existing facilities. * the throughput that the prospective operator can expect given his current operating practices and proposed operadng plan and investments.

Such criteria could be weighted to reflect the longer-term objectives of the Port Corporation. The weightings applied would vary from port to port. One could also consider prequalifying the prospective operators based on their business plan and financial strength.

10.3.5 The ultimate purpose of the consolidation and extension of the STO scheme should be to improve the operational efficiency of the conventional cargo facilities, increase berth capacities, reduce the Port Corporation's capital investment requirements, promote greater private sector participation in port Infrastructure, equipment and sivices, and finally increase the operational dimension and offer the port's customers gains from the inherent economies of scale. It can be expected that through a process of rationalization, the number of STO consortiums would be reduced in the future from the current number of eleven to perhaps four or five or even less.

10.3.6 Management/Operation of Existing Container Terminal. Private sector operation could be introduced into the existing Indonesian container terminals in Tanjung Priok, Surabaya, and possibly some other ports, with considerable advantage to the Port Corporations in terms of increased access to new technology, better marketing and, perhaps more important, better availability of the equipment due to improved maintenance management practices. The private sector could be invited through competitive tendering procedures to provide such terminal management. The successful tenderer would be selected following evaluation of the tenders on the basis of, for example, his experience and track record in similar situations and that of the proposed management team, his financial offer as an expected stream of revenues with an implicit risk factor, his business plan for promoting demand for the services of the terminal, his operating plan for ensuring the efficient use of the assets and the labor, the participation of port users in the venture, the ability and willingness to invest to maintain existing capacity or increase capacity.

10.4 Development of Superstructure and Operation of New Terminals

10.4.1 Adequate container terminal capacity is a major concern for the larger Indonesian ports and will become an issue in the secondary ports in the future. The use of the private sector in the development of the superstructure and the operation of these terminals is considered to be the best option. For example, the following would be a suitable scenario for expansion of container terminal facilities by Port Corporation II in Tanjung Priok: - 38 -

- The port corporation to create the land areas, approach channels and berthing areas through dredging, construction of the quay walls, bringing ground areas to near finished working level, providing access roadways and bringing essential services to the site boundary. The port corporation would raise the funding from its own resources, combined with project funding from sources such as international lending agencies or local financial institons and arrange for the works to be carried out through international competitive bidding procedures using consultants and tidrir own engineering staff.

- Through a carefully managed tendering procedure, an Indonesian legal body is selected to finance and complete the infrastructure (paving, gate structure, workshops, etc); to provide the quayside gantry cranes, container stacking and moving equipment; install EDI and other terminal management systems; and, then to manage and operate the terminal through a negotiated agreement with Port Corporation I. The shareholding of this Indonesian legal body (company/ /corporation) could be held by shipping lines and investors, both Indonesian and foreign, as permitted under Indonesian law. The Port Corporation H could also be a share-holder if it wishes. The agreement would probably be for a period of 20 years with certain sections to be re-negotiated at regular intervals.

10.4.2 A number of key issues must be settled prior to inviting the tenders. The more important of these are:

- Lease payment for the site (land areas, quay wall, port basin, navigation channel access, roadway access, services, etc.). The lease payment could be determined by the port based on an adequate return on its investments In basic infrastructure both existing and new (in this case the tenderer would be asked to state the port charges he requires), or the tenderer could be asked to bid for the lease (in this case the port charges would be given); - Port charges and tariffs. The tenderer could be asked to operate using the current tariff as a ceiling or to state the tariff he requires or be given the freedom to negotiate tariffs within certain limits; - Cargo allocation. Will the allocation of vessels or cargoes to the existing two terminals and the new third terminal be by market forces or according to some other procedure; - Arrangements for the transfer of port labor; - The procedures and documentation for requesting proposals, bidding and bid evaluation; - The procedures for continuous monitoring of the design, construction, equipment selection, operation and management.

Since the private sector operator will be in competition with the two existing terminals it is essential to set fair competition levels and yet for the port corporation to recover the costs of the major new investments.

10.4.3 With regard to the question as to how.v comprehensive the private investment should be, it is recommended that in view of the very substantial investments required (and - 39 -

associated risks) for deep-water port development, such Ps those for land reclamation, port basin, quay wall, approach channel and breakwater construction, the private sector not be asked to invest in such major civil engineering infrastructure works under a first experience in involving the private sector in port investment and operation. The various risks involved in basic afrastructure development are much greater and more difficult to assess and to manage. As a result such schemes are likely to require time consuming preparation and negotiations as evidenced by the experience with the development of a third container terminal at TanJung Priok. There are as yet few examples of all-inclusive DOT type investments in public ports and experience shows that for such investments to be made attractive to the private sector in a country where this is a new proposition they will require the public sector to provide extensive guarantees to cover the risks involved. In addition, there are other aspects that are worth considering. First, it will be much easier for the Port Corporation to control the standard of design and construction of the civil works if it undertakes this work itself instead of having to control a private sector entity. Second, It Is also possible that the Port Corporation would have better access to cheaper funds (e.g., from Development Banks) than the private sector. BOT type schemes, however, would be very appropriate In the case of facilities for bulk handling where there Is a sole user of the services or the facility. There are many successful examples of such schemes.

10.5 Development of a Systematic Procedure for Expanding Private Sector Participation

10.5.1 The transfer of selected port activities to the private sector can be accomplished in a gradual, ad hoc, way or through a structured program. The former approach has the advantage that some individual activities can be transferred sooner. The latter has the advantage that more activities can be transferred over a given period of time an in way that takes advantage of the markets receptivity. In the case of Indonesia, it is appropriate to combine these approaches. Some activities have been identified as suitable for rapid transfer, but for most a program has to be developed in a systematic fashion covering the definition of business units, the identification of constraints to transfer, the development of strategies and the prioritization and phasing of the program.

10.5.2 Definition of Business Units. The port activities which are suitable for transfer can be identified by first separating the activities for each port into business units. Each unit should offer a distinct set of services and resources to the port users, possess a distinct set of assets and have clearly defined costs and revenues. Although a separate management structure and set of tariffs are not essential, they will facilitate the process. The process of defining business units can be accomplished within a three months period.

10.5.3 Determinatfon of Potential. Once the port's business units have been identified, it is necessary to determine the characteristics of the markets served and the profitability of each business unit to evaluate the potential interest of the private sector. The value of a business unit to potential investors depends on the expected cash flow which, in turn, depends on the revenues and expenditures which would be transferred. It will also be appropriate to directly assess the private sector interest through surveying the providers -40-

of similar services In other locations, the providers of complementary services within the port and the users of the services provided by the business under consideration.

10.5.4 Identifying Constraints to Private Sector Partcipation. The difficulty of transferring each business unit to the private sector can vary significantly. However, the difficulty also depends on the approach used and it Is, therefore, necessary to identify the factors constraining the transfer of each business unit and to develop effective strategies for minimizing these constraints. Experience worldwide has Indicated a number of common constraints such as the resistance of labor, the size of the initial investment required from the private sector, the concern that a private monopoly will replace the public monopoly, and the size of the business unit. These constaints do not prevent the transfer to the private sector but do affect the method of transfer and the degree of difficulty should determine the order in which the transfer occurs.

10.5.5 Developing Strategies. The outcome of the above analyses ard reviews will be used to develop appropriate strategies for each business unit. The strategies should be selected so as to achieve an acceptable kvel of interest from the private sector while meeting the objectives of the port to increase efficiency and reduce the costs to port users. In addition to the choice of the basic approach for private participation-e.g., ranging from service contract to a terminal concession as discussed in this Paper-the port must decide on a number of strategic Issues such as: which investors will be allowed to compete, the period of the agreement, responsibilities for maintenance of assets, setting of tariffs, liabilities, other financial arrangements, and enforcement mechanism for the agreement.

10.5.6 Prioritizing and Phasing of the Bidding Activity. Once the strategies for transfer of individual business units I'- re been developed, it is necessary to decide on the order in which these units should be brought to the markeL The process could begir with those business units for which there is the greatest level of interest and having the least constraints. From the experience gained in each case it will be easier to proceed to cases having additional constraints.

10.5.7 Derming the Bidding Procedure. The process of obtaining competitive bids from the private sector generally involves a prequalification phase. This may not be necessary if there is well-defined but limited Interest on the part of the private sector. When the level of interest is uncertain, the prequalification can be used to indicate if there is sufficient interest. If there is a large number of interested parties, then the prequalification can be used to reduce the number of bidders to a manageable level. The bids will generally have both a financial proposal and a business plan. The preparation of both the prequalification and bid documents, including the terms of the contract, can be simplified by using model documents

10.5.8 Timing Requirements. For specific business units which have few constraints, a high level of interest and no other complications, the total process starting with the identification of the business units up to completion of a first operation should require between six months and one year. -41 -

10.6 Securing Adequate Funds for the Development of the Sector

10.6.1 The above outlined scenarios for private sector participation in ports should not preclude other forms of resource mobilization for the sector. In particular, the use of private capital need not be limited to direct investment by providers of port services. The port corporations may also be able to obtain investment funds from other sources. In countries with developed capital markets, the option for obtaining equity through share offerings presents a relatively low cost source of capital. Recently Port Kelang has successfully sold part of Its shares in the container terminal on the Kuala Lumpur exchange. The ports of Peninsular Malaysia also have access to various forms of funding including loans and project finance from local banks. An Increasingly important source of relatively low cost capital in both Latin America and Asia is becoming available from pension funds. The relatively large sources of funds which are seeking reasonable rates of return with minimum risk are attracting the attention of utilities and other former government companies which can offer a relatively safe return on their investment.

10.6.2 The sources of funds available to the Indonesian port sector are currently limited by government regulations. However, as the port corporations evolve under their new status as a Persero (para. 4.3.1), they should not only take on some of the new responsibilities outlined above but will also need to manage their financial situation in a more commercial manner and tap an increasingly large potential of investment sources. In this connection, an interesting scheme was recently structured by the Korea Maritime and Port Administration. This involved the leasing of container terminals to the buyers of bonds issued to finance the development. The scheme based on the attraction of having the right to operate the container terminals turned out to be well received by the private sector. Given the variety of potential sources of funds and the complexity of modern financial deals, the ports should obtain outside assistance In assessing the financial implications of alternative investment strategies. This has already been done by many of the larger ports in the Asean region.

10.6.3 An Important source of direct investment In port facilities is capital from overseas. This would be accessed through arrangements whereby the foreign partner in a local company provides funds. The foreign partner is limited to a minority holding but is able to repatriate some of the earnings. Given the relatively high cost of capital for Indonesian investors (and their correspondingly high expectations regarding rate of return) it is likely that foreign investors provided with adequate guarantees would offer a much lower cost source of investment funds. Such funds would be in foreign currency terms with repayment in foreign currencies regardless of Indonesian currency devaluations and this currency risk must be taken fully into account. Supplier credits have been another source of low cost funds, albeit for relatively short periods. ASA REGIOND~SCUSIONPAPErS / (CoMued) Illi AlQil ie mrgiao

IDP74 A Cas Study ofda GdualApemé to B==10 Ran: n VittNan Eiipeinnmcof 1985.8S 2.Drabk Sente 1990 Z. Dbek

IDP85 On atin ginad~quacyofBfsgyIobE Revaled Food Cn~ ~inBuhaviar mus Nutitimnn Norm B.8.MinM ~ Sqnber 1990 ~. Jayanthi

1DP88 Ania~gia Samar äPocy Chnalga inkndia OCtober 1990 C. Chamberl

IDP93 Para ic Populati N ~ctiona d its U=san frPolicy Analysih W, sanumn April 1991 J. P. Tan

1DP96 A Revew of earuas Tad Patn D. M. Iipigb and .Y. Song Marh1991 D. Leipziger

Thermh~"itev n i 7~ugtand Praice R.B. Norard June 1991 F. Johansen

1DP99 Houng Prics Afford.iaity, ad Go~eramet Policyin Korea K.L Kim july 1991 D. Leipziger

DPIO1 La from Experience with Wag Flexibilityin Asia L Nab August 1991 L Nabi

EAS&ASAÅNDPACEZRGIONADE=USIOPAPER

IDP112 Innuia Wom in Deelopm t R.CaIkis April1992 .Cakins A Strategy farContin~ed P ~egnus W. Sruben C. Biapon

DP136 What Drives Interest Rates in indonmia and Are They Too High? D.Hanna February 1994 F. Iqbal

DP139 Foreign Direct lvewnat in East Asia Trends, Determinan and Policy mPliatin 0. Kawaguchi April 1994 V. Thomas

/l Papers are available upon request frumEAPVP(Chief com^inis Office). Mia Seies discontinued followig December 1, 1991 retructing ofthe Region.

叵 ，〕 Public Disclosure Authorized Public Disclosure Authorized ASU G-Wormcc~

叵，〕 Public Disclosure Authorized Public Disclosure Authorized ASU G-Wormcc~