The January Surprise

On January 12, Indonesia’s mineral export ban came into effect with an unexpected kicker: an export tax on copper concentrates.   As predicted, a last minute compromise allowed them to be exported but soon after it was revealed that the Finance Ministry contradicted the thrust of the exemptions by imposing a graduated export tax that goes from 25% to 60% within 2 years.  Ignored by the senior leaders is that these processed products retain 95% of the metal’s production value compared to the 100% of a smelter.  The US companies that produce them employ upwards of 40,000 people in the least developed regions of the country generating over 2% of GDP, paying billions in corporate taxes (at 35% not the new 25% rate) and royalties. Many other benefits could be listed.  The point is many thought cooler heads had prevailed until the surprise tax was announced.   No one had anticipated the move as it was not mandated by the law or the implementing regulations. Whatever compromise had reportedly been worked out with the President  turned out not to have been one. Finance Minister Chatib Basri said: “This is a fiscal instrument to force companies to build smelters — it isn’t a policy to increase tax revenue, not at all”.   Last week mining CEO’s scurried to Indonesia for consultations and so far have come up empty ended.  The concentrate shipments are now pretty much dead in the water along with those of raw minerals and according to the Trade Ministry the government has processed no export requests.  Existing copper concentrate shipments are going to Indonesia’s sole smelter in Gresik, East Java.

If Indonesia does not walk back some of these policies the mining industry will eventually grind to a halt and companies with early generation Contracts of Work such as Freeport and Newmont may be headed to international arbitration, something that should be in everyone’s interest to avoid at all costs.  Its been pointed out by numerous experts as well as the head of Indosmelt (a local company trying to build a new smelter) that smelters are currently operating on a thin profit margin with existing supply and bringing more on stream would be deemed financially unfeasible without government incentives. The current government obviously believes the mining industry is bluffing and somehow sees huge benefits from insisting on holding on to  the minerals ban for dear life.  But the strangled victim may turn out to be the Indonesian economy.   Bans tend to have unintended consequences.  The sawn timber and rattan export ban of the 80’s never led to the amount of furniture and plywood factories the government had anticipated.  Other possible side effects: social unrest in Papua, where a small independence movement has existed for decades; erosion of confidence in Indonesia’s business climate and in the sanctity of contracts; and $billions in loan defaults in the mining industry.  One can take heart in KADIN’s recent efforts to engage the Parliament and the Finance Ministry and get the law overturned or the tax rolled back (see story below). This is an evolving story whose ending may not come until a new government is elected later this year.  Business does not like surprises; but in Indonesia one learns to take them in stride.