Paper on Climate Change: "Environmental Policies and Economic Growth in Indonesia: Challenges and Opportunities"

8/7/2019 Paper on Climate Change: "Environmental Policies and Economic Growth in Indonesia: Challenges and Opportunities"

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Environmental Policies and Economic Growth in Indonesia: Challenges andOpportunities1

Paper for Friedrich Naumann Stiftung, Jakarta and National Climate Change Council

Indonesia (DNPI)28th of October 2010

IntroductionCombating global climate change has become the dominant agenda in internationaldevelopment. A large developing country such as Indonesia is both a big contributor toglobal greenhouse gas emissions (GHG) and a victim of adverse impacts of climatechange. This requires Indonesian policymakers to balance two objectives. First, there is aneed to achieve high economic growth that safeguards the traditional goals of economic

development: creating wealth, jobs and income. Second, it has to safeguard the quality ofthe environment in order to preserve a sustainable endowment of natural resources.This paper argues that comprehensive environmental policies framed within a low carbon economic growth strategy - is essential to achieve both objectives. The first partexplains the rationale behind a low carbon economic growth policy and how Indonesiasemissions profile and projection scenario determines its mitigation opportunities andchallenges. The second part looks at specific economy-wide and sector benefits and costsif climate mitigation policies were to be implemented in Indonesia. The third part looks atspecific policy challenges arising in specific priority sectors adaptation, forestry andenergy. The last part summarizes the main findings.1. Indonesian development as a move towards a low carbon economyThe fight against global climate change has been put at the forefront of the internationaldevelopment agenda. Virtually all major multilateral development and finance agencieshave now accepted the scientific conclusion of the Intergovernmental Panel on ClimateChange (IPCC) that climate change is happening and that human induced(anthropogenic) emissions are largely responsible. As the IPCC (2007 notes: Warming of the climate system is unequivocal, as is now evident from observations of increases

in global average air and ocean temperatures, widespread melting of snow and ice and rising

global average sea level Most of the global average warming over the past 50 years is

very likely due to anthropogenic GHG increases and it is likely that there is a discernible human-induced warming averaged over each continent (except Antarctica) Anthropogenic

warming over the last three decades has likely had a discernible influence at the global scale on

observed changes in many physical and biological systems.(IPCC, p.72 )

1Kurnya Roesad , RMAP/Crawford School of Economics and Government, ANU


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Recent forecasts of CO2 emissions trajectories indicate that without global collaborativemitigation efforts, the world will face a potentially catastrophic scenario in whichtemperatures would be 5 C warmer than in the pre-industrial era (IPCC 2009). Theconventional wisdom is that global greenhouse gas (GHG) emissions need to be

stabilized at 450 ppm of CO2 equivalent in order to keep global warming at a 2

o

Celsius,the level at which human civilization could adapt to the worst impacts of climate changeat relatively low costs (Stern 2006, World Bank 2010c).The physical consequences of global climate change include changed precipitationpatterns, sea level rise (amplified by storm surges), more intense and perhaps frequentextreme weather events, increased prevalence of vector-borne diseasesand perhapscatastrophic events, such as reversal of the Gulf Stream or melting of the Greenland icesheet.The economic fallout from global warming could be substantial. The Stern Review

(2006) estimates that in a business as usual scenario (BAU) that is if no serious climatemitigation measures are taken the world will need to invest 1 percent of total worldGDP per annum to mitigate the worst effects of climate change. The World Bankestimated that about 75-80 percent of the damage costs inflicted by climate change willbe borne by the developing countries (World Bank 2010c).The economic costs to developing countries will mainly show up as decliningproductivity in the economy. Productivity losses will be especially felt in the agriculturalsector in the form of decreases in fishery production, damages in infrastructure, loss ofproductive areas and settlement due to land inundation, species extinction and decline inecosystem integrity as life support system (Ahmad 2010). Other impacts are increasedstresses on health and water systems, changes in trading patterns and internationalinvestment flows, financial market disruption, and altered migration patterns. All thesefactors will increase the vulnerability of developing countries to sudden adverse shocks.Thus, the costs of global climate change are real and Indonesia faces an internationalenvironment in which major economies have embarked on a low carbon economicgrowth path. Most countries, including the major developing economies, have committedto emissions reduction goals. Despite the failure of the COP 15 in Copenhagen to agreeon a binding climate policy agreement after the Kyoto Protocol will expire in 2012, theinternational community has not abandoned climate change as a major developmentagenda. The Copenhagen consensus has resulted in major developing economiesformulating significant emissions reduction commitments, matching the targets ofdeveloped economies. Most economies have also formulated ambitious renewable energytargets in order to achieve their emissions targets.Table 1 : Emissions and renewable energy targets in selected countries

Emissions reduction targets Renewable energy targets

Australia 5-25% below 2000emissions

20% by 2020 from 8% in2007


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China 40-45% below 2005 inemissions intensity

15% by 2020 from 8% in2006

Indonesia 26-41% below BAU 15% by 2025 (incl. nuclear)

Japan 25 % below 1990 emissions 16TwH by 2014

Korea 30% below BAU 6.08 % by 2020 from 2.7

%in 2009Malaysia Target to be introduced in

2011

Singapore 16% below BAU

Thailand 30% below BAU 20% by 2022

Philippines 100% increase from 2005 to2015

USA 17% below BAU No national targets, about30 states have mandatorytargets

Vietnam 5% by 2020from 3% in2010

Source: Summaries of targets taken from various national documents, from submissions to the UNFCCC,and from Olz and Beerepoot (2010), quoted in World Bank (2010c forthcoming)

However, commitments to emissions reductions need to be backed up by concretepolicies and to achieve these ambitious goals, economies need to adopt a low carbongrowth strategy by making production and consumption less carbon-intensive and pricingenvironmental externalities.The current emissions trends make it clear that this will be a tall order to achieve. Thepoint here is that emissions have to be seen as a corollary of output growth: emissionstrack GDP in most countries (see Table 2). In order to reduce emissions below the BAU

scenarios, economic growth needs to some extent be de-coupled from emissions. For thisto happen, two things need to be tackled. First, production patterns need to be de-carbonized, i.e. energy needs to be used more efficiently and directed toward using moreclean energy sources. Second, consumption behavior needs to be steered towards moresustainable levels.Table 2: GDP, Emissions and Energy Growth (%)

Average annual growth rates1971-90

1990-2000 2000-5

World

Emissions growth 2.1 1.1 2.9

GDP growth 3.4 3.2 3.8

Energy growth 2.4 1.4 2.7

OECD


GDP growth 3.2 2.7 2.1

Energy growth 1.5 1.6 0.8

Non-OECD



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GDP growth 3.8 4 6.2

Energy growth 3.8 1 4.6

Source: Garnaut, Howes, Jotzo, Sheehan (2008)

A countrys low carbon growth strategy depends on its climate mitigation and adaptationopportunities, which in turn depends on its emissions profile.Indonesia is both a victim of and a contributor to climate change. The countrysagricultural sector is still significant, which makes it vulnerable to extreme weatherpatterns. Thus, poverty alleviation efforts will depend heavily on adaptation measures tosecure rural food production systems. On the other hand, Indonesia presides over one ofthe largest remaining tropical rainforests in the world and deforestation activities are amain case for GHG emissions.Emissions trends show thatIndonesia belongs to the top 25emitters, if forest-based emissionsare included. Based on fossil fuelcombustion, Indonesia is among thetop 25 CO2 emitters, or ranked 16

thwhen counting EU as one country.However, if CO2 emissions due todeforestation and land use changeare included, Indonesia then rises toamong the top emitters. 2

Indonesias emissions profile shows that the land use change and land use change fromforestry (LULUCF) accounts for the largest share, followed by peat fires and energy

However, there are uncertainties regarding the emissions from forest-based sources. Recent figures from

the Min istry of Forestry indicate that the rate of deforestation may be only a third of the average rates in

the late 1990s.

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Figure 1: Top 25 Global CO2 Emitters in 2004Source: International Energy Agency (2007) [www.iea.org]


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Figure 2: Sector Emissions, 2005

LUCF.1 % 36

Peat fire

25.7%

Energy

22.5%

Industry

2.1%

Agriculture

4.5%

Waste

9.1%

.

Source: Indonesia Second National Communication to the UNFCCC, 2009.

Indonesias CO2 emissions per capita is relatively low by international comparison,valued at around 2t CO2 per capita.But this also reflects the fact thatIndonesia is still catching up oneconomic growth. In fact,Indonesias economic growth hasbecome more carbon-intensive, withemissions per capita growing fasterthan GDP per capita. The annualgrowth rate of CO2 emissions percapita has risen by 3.3 timesbetween 1980 and 2004. During thesame period, the growth rate ofGDP per capita has increased by 2.3times and energy/person by 2.1 times(Figure 3). This means that thecarbon intensity of energy use hasincreased as well.

A closer look reveals why this is the case. Table 3 shows that the increased carbonintensity of electricity production and consumption is mainly due to rising coal use. Theindustry and electricity sectors account for most of coal-based emissions.

Table 3: CO2 Emissions in Indonesia in 2006 (in million t CO2)

By Fossil Fuel Source

Figure 3: Annual Growth Rates of GDP, Energy Useand Emission per Capita

Source: International Energy Agency (2007) [http://www.iea.org/]


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By Consumption Group Coal Oil GasTotal

Emissions

Share intotal(%)

Emissions growth1990-2006 (%)

Industry 50.73 23.08 22.32 96.13 29 192

Electricity 57.49 23.22 9.12 89.82 27 309

Transport 72.35 0.01 72.36 22 127

Other* 0.06 44.95 31.29 76.3 23 60

of which: Residential 0.06 25.76 0.04 25.86 8 41

Total 86.8 179.6 69.6 334.61 100

Note: * 'Other' includes unallocated auto-producers, other energy industries.

Source: IEA 2008 Annexes

Two main challenges for Indonesia arise from these emissions trends. First, in the short and medium-run, the main challenge is to reduce emissions from LULUCF, including

peat fires. Second, in the long-run mitigation of energy related emissions will becomethe more important issue in the future, with the added twist that the government has tobalance energy supply objectives - which could be achieved by relying on cheaper coal-based fuel and renewable energy targets.Indonesia has committed to a 26 percent reduction in emissions below the BAU scenarioby 2020. Table 4 illustrates the emissions scenarios. Starting from 2005 emissions levels,under the BAU scenario total emissions would increase from 2.12 to 2.95 giga tons (gt)in 2020. A 26 percent reduction from the BAU level in 2020 would mean that the forestrysector would be the biggest contributor in reducing total net emissions, followed by peatland, waste and energy. Another 15 percent in emissions reductions could be achieved, if

substantial international assistance were provided. This is particularly true for capital-intensive projects like geothermal development, which requires substantial foreigninvestment in order to take off (Ahmad 2010a).


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Table 4: Emissions Projections in 2020 For Indonesia

Emissions (Gt)

ReductionTargets(26%)

Reductiontargets(15%)

2005 BAU 2020 Giga ton % of BAU Giga ton

Peat 0.83 1.09 0.280 9.5 0.057

Waste 0.17 0.25 0.040 1.6 0.030

Forstry 0.65 0.49 0.392 13.3 0.310

Agriculture 0.05 0.06 0.008 0.3 0.003

Industry 0.05 0.06 0.001 0 0.004 Transport 0.008 0.3 0.0

Energy 0.37 1 0.030 1 0.010

Total 2.12 2.95 0.767 26 0.422 Source: Ahmad(2010a)


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2. Challenges and Opportunities for Indonesian sectorsThe big question now is: Could these emissions reduction be achieved without harming

the economy and welfare of the population? And what are the costs and benefits toIndonesias economy from adopting a low carbon growth strategy?Most economists would agree that environmental policies and economic growth aremutually compatible, once proper costing of social and environmental externalities isaccounted for. Carbon pricing is seen as an essential instrument to achieve this. Byputting a price on carbon (and other greenhouse gases), incentives are changed in such away that individual actors have to internalize the environmental damage they are causing.The relative price of emissions-intensive goods will be pushed up and emissions will bereduced. First, consumer demand will now be directed towards less emissions-intensivegoods. Second, it will force suppliers to make their goods less emissions intensive, by for

instance adopting more energy efficient technologies or buy renewable electricity. Third,it leads investors to invest in less emissions-intensive projects. Fourth, carbon-pricinggives a financial incentive for entrepreneurs to develop new and less emissions-intensiveproducts (Sterner 2003, Helm and Hepburn 2009, IMF 2008)Revenues from carbon pricing could offset economic costs of mitigation. This can beachieved in various ways. Revenues could be used to reduce other taxes and possibly turna cost into a gain. This would offset at least part of the costs of pollution control, andraise the prospect of a double dividend from the introduction of a carbon tax (IMF2008).


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Box 1: International experience with carbon pricingThe European Emissions Trading Scheme (ETS) is the largest GHG emissions trading scheme inthe world. Setup in 2005 in line with the GHG emissions reduction targets under the Kyotoprotocol, the ETS caps emissions of about 11,500 power and industrial installations in 25 countries

and six major industrial sectors. The ETS has been plagued by several problems, and has resultedin volatile prices, but analysis does indicate it has helped reduce emissions (by 2-5% againstbusiness-as-usual according to Ellerman et al., 2010).Outside of the ETS, the Regional Greenhouse Gas Initiative (RGGI) was set up in 2005 by sevenNortheastern states to form the first mandatory cap-and-trade program for reducing CO2 in theUSA. Unlike in the EU, permits are mainly auctioned. Prices have been low starting from 1.86 USDin 2008 to 3.51 USD for the latest allowance period (2009-2011). New Zealand has passed legislationfor an ETS in 2008 and has initiated a transition scheme starting Jul 1, 2010. In this transitionperiod (July 131 December 2012), participants in the ETS will buy emission units at a fixed priceof 25 NZ$ per unit, with energy, industrial and liquid fossil fuel sectors being able to buy at half theprice.

The global experience with carbon taxes is mainly limited to European countries. Many Europeancountries (notably Germany, all Scandinavian countries, France) have applied fuel taxes, energyand emissions taxes party contingent on carbon content. Denmark imposed the Worlds firstcarbon tax on fossil fuels in the early 1990s, and this is held partly responsible that for the fact thatits emissions have fallen by 5% since 1990 despite annual average growth of just over 2%. Germanyhas a tax on electricity. In these countries, various exemptions are typically provided for industries.In the electricity sector, both Finland and Germany tried to impose taxes based on type and sourceof electricity production, but the EU Court found this discriminated against imported energy.Sources: World Bank 2010 Sterner 2003

Recent macroeconomic modeling efforts have attempted to simulate the impact of certainmitigation policies on the Indonesian economy. The Ministry of Finance in its GreenPaper (2009) has simulated the effects of a carbon tax on the Indonesian economy. Acarbon tax on fossil fuel combustion would lead to emissions reductions and at the sametime improve economic growth and poverty alleviation. Several policies need toaccompany the tax. First, the tax is passed through to consumers of electricity and fuel.Second, revenues are used to reduce other taxes and provide cash transfers and other non-distortive poverty alleviation measures. Specifically, revenue from the carbon tax isrecycled through a reduction in sales tax.The carbon tax would be set at Rp80.000 per ton of CO2. It is expected to reduceemissions from fossil fuel combustion by about 10% relative to business-as-usual.Additional reductions can be achieved through specific sectoral policies such asgeothermal power support or the selling of carbon permit exports, estimated to yieldUS$2 to US$3 billion by 2020 in export revenue per year in todays dollars (Ministry ofFinance 2009).Modeling efforts carried out under the Governments and World Bank Low CarbonDevelopment Options Project have relied on different policy scenarios to simulate


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impacts on the economy.3

First, several carbon prices were used to estimate theeconomic and social impacts of REDD. The best outcomes in terms of Indonesiareceiving revenues from REDD using a price of 20 USD / ton of CO2 equivalent. Thisassumes certain income distribution proportions between government and households,taking account of rural-urban and Java and non-Java households. Although there is a

slightly slower national growth, growth is positive in several regions, indicating positivedistributional income flows from the centre to the regions.Second, a policy of gradually removing fuel subsidies starting in 2010 and fullyabolishing them by 2015 yields positive growth, poverty alleviation and emissionsreduction results. This assumes a policy that ensures that 100 % of saved expenditures isrecycled back to economy via government spending.Third, policies to increase energy efficiency by lowering carbon intensity - in theelectricity sector can yield positive results, if the cost of technology is carried by thegovernment, which uses its budget to pay for the knowledge from abroad.

Fourth, increasing energy efficiency in the private manufacturing sector can also yieldbeneficial outcomes under certain assumptions. If energy efficiency is increased by 10percent from 2010 to 2015 at a cost of up to 0.5 percent of total output by 2015, thengrowth, poverty and emissions reduction goals are achieved. Investment costs areassumed to be paid to foreign investors by the government. Sectors include textile, foodand beverages, cement, basic metal and rubber.Table 5: Results from Computable General Equilibrium (CGE) ModelsEconomicModeling Studies

GDP (% relativeto base case)

Poverty (%) Reductions inemissions (%

relative to basecase)MoF Green Paper2009 (Indonesia 3-E Model)

0.4 -0.6 -10.1

Low CarbonEconomyScenarios 2010(Dynamic Inter-Regional CGEModel)

- REDD -0.04 -2.54 -0.32-Gradual fuelsubsidy removal

3.46

-7.61 -0.01

- Electricity sectorIncrease energyefficiency

0.45 -2.81 -0.02

3 The following relies heavily on Ahmad (2010b).


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- Energy efficiencyin private sector

0.05 -1.04 -0.06

Source: MoF (2009), Ahmad (2010b)Note: Best case scenarios were selected in this table.

These models illustrate the point that low carbon growth outcomes can be achieved bydifferent means. Various options of mixing fiscal instruments (either using carbon taxesor energy subsidy removal) and technology based policies (i.e. investing intechnologies to increase energy efficiency in the power and manufacturing sectors) canresult in positive economic and social welfare outcomes.However, one insight emanating from the simulations is that each policy instrumentneeds to be backed up by complementary policies to ensure social compensation andfairer distributional outcomes. Removal of fuel subsidies needs to be accompanied by

well-targeted support for the poor. Effective REDD policies require effectivemechanisms for inter-regional fiscal transfers and strong and coherent governmentforestry policies (Ahmad 2010).The National Climate Change Council (DNPI 2009) has estimated the potential costs andbenefits of different sectors of undertaking mitigation efforts. It estimates Indonesiaspotential to reduce GHG emissions at up to 2.3 Gt per year by 2030. This is projected toamount to 7 percent of global emissions in 2030.The study identified over 150 abatement opportunities in six major sectors: forestry &peat land, cement, power, agriculture, transportation and buildings. Over 80 percent ofthese abatement opportunities lie in the forestry and peat sectors. Unlike in many othercountries, the costs of abatement are estimated to be relatively low at around 3 Euros/ tonof CO2 equivalent in 2030 (DNPI 2009). 4 Table 6 shows the abatement costs by sectors.The point here is that Indonesia should be a very attractive target for clean energyinvestors, if one looks at relative abatements costs only.

This cost estimate does not include implementation and transaction costs, which for some abatement opportunities can

be significant (DNPI 2009, p.13).


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Table 6 : Potential and costs of abatement

Reduction potentialAverage reductioncost

MtCO2e/year EUR/MtCO2 e

Forestry 1100 7Peat 700 6

Power 220 19

Agriculture 105 5

Transport 100 -80

Building 50 -38

Cement 10 -5

Source: DNPI 2009

3. Policy Challenges in Adaptation, Forestry, and Energy

Indonesias RPJM the governments main policy document for economic developmentplanning - has mainstreamed climate change mitigation and adaptation intopolicymaking. The governments planning document has recognized the importance oflinking economic growth and environmental issues in its longterm development agenda.Broadly stated, environmental objectives are framed as a result of ineffectivemanagement of natural resources. Rapid depletion of resources and pollution will havesocial costs in terms of reduced quality of live, particularly in health costs and decreasedfood security. Priority areas include controlling environmental degradation and pollution,installing an early warning system to deal with large catastrophes like tsunamis, andenhance the institutional capacity to overcome natural disasters (Bappenas 2009, p. I-45).Adaptation challenges include the following priority sectors.5 In agriculture, the mainconcern is about food security. Productivity losses especially in rice production - arefeared due to changing weather conditions and loss of crop land due to land conversion.The health sector needs to invest in strengthening the institutional capacity to anticipateclimate-related outbreak diseases like upper respiratory disease and viral-based diseases.This also requires increased investment into sanitation infrastructure.Disaster risk management needs to build up an early warning system to dealt with theincreasing risk of flooding and other climate related disasters.Water management issues includeimproving watershed management and protection.Changed rain patterns will require more efficient water planning, storage and distributionsystem.

5 The following is based on the summary provided in Ahmad (2010).


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From the emissions profile and the projection scenarios discussed above, it is clear thatforestry sector and energy mitigation issues are the priority issues for Indonesia.Accordingly, the governments main planning document, the RPJM has prioritized theforestry sector in its climate change platform. Policy action plans aim to strengthen the

institutional capacity and inter-agency cooperation to manage peat lands; rehabilitateforest lands, targeted to reach 500,000 ha per year; increase policy efforts to reducedeforestation rates and optimize funding existing mechanisms such as the IHPH (ForestUtilization Right Fee); the PSDH (Forest Resource Fee) and the Reforestation Fund(Bappenas 2009, p.I-56).The Reducing Emissions from Deforestation and Forest Degradation Scheme (REDD+)presents Indonesia with the opportunity to receive financial incentives from developednations to stop converting forests to prevent the release of carbon into the atmosphere.The government is developing REDD pilot projects in the forests of Central Kalimantan,East Kalimantan, East Java and West Nusa Tenggara provinces. The projects would

assess the drivers of deforestation, institutional and legal frameworks and theestablishment of REDD incentive mechanisms.Indonesia has signed a new agreement with the Norwegian government to reducedeforestation in Indonesia's forests and peat land. Norway pledged to provide US$1billion that would be disbursed based on emission reductions in the forest sector. Thegovernment is in the process to set up a special agency to manage the money flows fromthe REDD+ and the Norwegian trust fund.

However, the question is to what extent the money from REDD schemes can be used toempower local people and encourage them to protect forests. About 10 out of 35 million

poorest people of Indonesia live in or surrounding the forest area. About a quarter oftheir incomes depend upon the forest resources, including biodiversity (Ahmad 2010).Future REDD project designs need to balance the right of local communities to accessforest resources and the need to safeguard the carbon sequestration functions of theforests (Ahmad 2010)

However, past and existing policies in the forestry sector have not been successful in thisregard. Policy distortions have skewed the incentives away from conservation andsustainable harvesting. For instance, taxes and incentives were not used as

!" REDD+ could provide the

appropriate institutional framework to change the incentive structures and direction ofIndonesias forest management.

#$%"&&&&'())

provides performance-based payments to regional (mainly district)

governments, through areformed DAK system.Payments are linked to the achievement


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of milestones and outcomes. Regional governments have full control over the design andimplementation of projects, while the central government acts as the main link to theinternational and national aspects of the scheme (Ministry of Finance 2009).

The challenge in the energy sector is to secure grid expansion and increase electricity

supply, but at the same time to reduce the carbon intensity of power generation. Aspreviously shown, emissions and energy per capita are increasing in Indonesia, mainlydue to the increased share of coal in the energy mix. From a purely financial point ofview, coal is the most viable option, as there are sufficient reserves to be found inIndonesia.In addition, the reality is that that in Indonesia power outages are quite common. Firmsoperate under an infrastructure constraint, which affects their decisions to invest. Powerrationing affects investment certainty and output decisions and in turn impact onemissions outcomes. One manifestation of this uncertainty is the significant proportion offirms investing in captive power, i.e. in own electricity generation capacities. In

Indonesia, captive power sold to PLN was estimated to be 6620 MW in 2005, comparedto PLNs installed capacity of 22,284 MW (IEA 2008). he prevalence of captive power

in Indonesia also contributes to higher emissions rates, as most of this non-grid supplyrelies on non-renewable sources.However, the reliance on coal-based power generation only is clearly notenvironmentally sustainable and Indonesia needs to make more use of its plenty non-fossil based energy sources. These include sources like geothermal and micro hydro,which show the most development potential. Currently, only about 2 percent of itsrenewable energy potential is used. In its Energy Blueprint 2005-2025, the governmenthas formulated ambitious renewable energy targets. By 2025, 17 percent of total energy

use should come from renewable sources, with particular focus on promoting geothermalenergy development (IEA 2008).The Government plans to increase the capacity of geothermal energy production from1100 MW in 2010 to 5000 MW in 2014 (RPJM 2009). Several policy measures havebeen taken to increase investment in geothermal development. First, tax incentives forinvestments in geothermal and other renewable energy have been installed. Second, thereis financial support from the state budget for renewable exploration. Third, regulation onpurchasing pricing of geothermal energy supply have been issued. 6 These policies arealso accompanied by the governments plan to tap into international climate financingmechanisms. Loans worth US$ 400 million will be channeled to Indonesia via the CTF

6Presidential Decree No. 4 / 2010 which assigns to PLN acceleration of power plant development usingrenewable energy, coal, and gas and mandates PLN to develop and purchase power from renewable energyresources (January 2010). MEMR Ministerial Regulation No. 32/2009 on Purchase Standard Price ofElectricity Power by PT PLN from Geothermal Electricity Power Station (December 2009). MEMRMinisterial Regulation No31/2009 on the purchase price of electricity from renewable energy (November2009). MOF Ministerial Regulation No. 24/2010 on tax incentives for renewable energy development wasissued in January 2010 (World Bank 2010b).


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(Clean Technology Fund) for leveraging other capital investments for geothermal(Ahmad 2010, World Bank 2010).However, the common theme linking all three priority areas of forestry, energy andadaptation issues is providing investment and regulatory certainty for infrastructure

projects. Investment climate issues have been a regular concern in Indonesia. AlthoughIndonesia improved its rankings in the Doing Business ratings in 2010 it ranked 122 ascompared to 129 in 2009 there are still large concerns on the side of investorsspecifically with regard to contract enforcement and regulatory issues (World Bank2010a). Corruption is still an important obstacle, although the recent TransparencyInternational Index has showed a slight improvement in ratings for Indonesia (RPJM2009). Infrastructure quality in Indonesia also ranked at relatively low levels, as seen inTable 7(ADB, ADBI 2009).Table 7 : Infrastructure quality, selectedcountries

Country Road Rail Ports Air Electric Power Overall

World 3.8 3.0 4.0 4.7 4.6 3.8

G7 5.7 5.4 5.4 5.8 6.4 5.7

Asia 3.7 3.6 3.9 4.6 4.1 3.8

East Asia 4.7 4.8 4.8 5.1 5.3 4.6

Southeast Asia 4.2 3.2 4.3 5.1 4.7 4.2

Singapore 6.6 5.6 6.8 6.9 6.7 6.7

Hong Kong 6.4 6.2 6.6 6.7 6.7 6.3

Malaysia 5.7 5.0 5.7 6.0 5.8 5.6

Korea 5.8 5.8 5.2 5.9 6.2 5.6

Thailand 5.0 3.1 4.4 5.8 5.5 4.8

China 4.1 4.1 4.3 4.4 4.7 3.9

Indonesia 2.5 2.8 3.0 4.4 3.9 2.8

Vietnam 2.6 2.4 2.8 3.9 3.2 2.7

Score: 1 = underdeveloped, 7 = extensive, international standard

Source: ADB and ADBI (2009)

Overcoming these regulatory and policy uncertainties is particularly important forrenewable energy investment. Capital-intensive projects like geothermal development arebased on high initial fixed costs and need to be based on complex contractual

arrangements. Investors seek to receive some guarantee for their investment returns andrisk mitigation mechanisms between the involved parties need to be developed.In addition, reducing energy price distortions matter much for providing the right signalsto investors. The existing fuel and electricity subsidies not only exacerbate wastefulenergy consumption, but also distort the incentives to invest in clean energy production.As long as fossil fuel and coal-based electricity generation is produced at lower cost


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that is not fully reflecting the true cost of electricity by including environmental costs ofelectricity generation then renewable energy will not be competitive.Given that the Indonesian government faces budget constraints, renewable energyinvestment depends on private domestic and foreign investment. Improving the

investment climate is therefore essential. International subsidy mechanisms like the CTFcould provide valuable resources to kick-start large-scale renewable energy investmentand could be used to fund initial high fixed costs of renewable energy production andassist the government in implementing social compensation programs to the poor.Ultimately, however, political economy factors and political will are decisive in drivingthe impetus for policy and regulatory reforms. Effective implementation of reforms is avery political process involving negotiating and coordinating budget and projectimplementation at different levels across agencies, between Jakarta and the regionalgovernments and between the government and the parliament. Controlling money andresource flows between these different layers is a source of power and corruption. This is

especially true for low carbon development projects such as REDD and renewable energyprojects. Ensuring both transparency of money flows from international sources andeffective implementation of projects will be a key challenge for policymakers.ConclusionThis paper looked at argues that comprehensive environmental policies framed within alow carbon economic growth strategy is essential to achieve sustainable developmentobjectives in Indonesia.The first part explains the rationale behind a low carbon economic growth policy andhow Indonesias emissions profile and projection scenario determines its mitigationopportunities and challenges.The second part looks at specific economy-wide and sector benefits and costs if climatemitigation policies were to be implemented in Indonesia. It finds that economic policyoptions can be crafted to achieve growth, poverty and emissions reductions. Tacklingemissions from forestry and peat land provide the best mitigation opportunities forIndonesia.The third part looks at specific policy challenges arising in specific priority sectors adaptation, forestry and energy. The binding constraint in all three sectors is theregulatory and investment uncertainty underlying infrastructure investment.Indonesias emissions and cost abatement profile provides plenty of opportunities to tapinto international climate finance mechanisms and private investment to launch large-scale investment into low carbon development options. However, there is still a need tostrengthen the domestic political consensus on the viability of pursuing a low carbondevelopment strategy. Moreover, the domestic institutional capacity specifically with


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regard to improving the regulatory and investment climate needs to be strengthened toattract more private investment.Thus, embarking on a low carbon development strategy requires a complex reformprocess. It requires policy coordination in several major areas: fiscal (carbon pricing),

investment and technology policies, energy / forestry sector reforms, and broaderstructural reform. Sequencing these reforms is a matter of political judgment and dependson political economy factors driving the reform processSpecific policy recommendationsAssistance and investment from foreign donors like FNS and private investors fromGermany should flow into the key priority programs of the Indonesian government. In thefollowing, some of the main recommendations flowing from existing GOI policydocuments are extracted, mindful of investment opportunities for German official andprivate assistance.

First, provide policy support in developing economic instruments and the regulatoryframework to support low carbon development. Currently there is still limitedcapacity and expertise in adopting tax instruments to promote green growth.Environmental taxation is still a relatively under-developed policy field in Indonesia. Inaddition, with funding opportunities from carbon finance related products and servicesincreasing, there is a specific need to build up domestic expertise in this regard. TheGreen Paper of the Ministry of Finance could serve as a good policy base, as it haslooked at various fiscal policy options to address climate financing issues. Germany hashad considerable experience with environmental fiscal policy reforms since the 1990sand is ideally laced to provide technical assistance.Second, invest in policy support to enhance regional analytical capacity-building.There is a need to strengthen the overall institutional and policy framework to coordinateclimate change and environmental issues, specifically on the regional level. Regionallow carbon development growth options need to be formulated and integrated into thenational planning and budget process. Financing regional capacity-building to produceanalytical products to support the policy process is one key investment area for Germandonors.Third, invest in policy support to develop a regional financial and fiscal mechanismfor channeling REDD transfers. Implementing policy actions to mitigate emissionsfrom land use change and forestry sector under the REDD framework will be the mainpillar of Indonesias climate program in the coming years. In order to guarantee aneffective flow and monitoring of money from the centre into the regions, the governmentneeds to develop a regional finance mechanism to manage this process.This mechanism should consist of two main elements. First, it needs to have an effectiveinter-governmental fiscal transfer system to channel funds from national to regionallevels. Second, it needs to have a proper incentive mechanism in place to ensure that


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REDD payments are linked to desired project outcomes. Third, the mechanism shouldhave an efficient framework for forest fiscal management, which includes incentives forregional stakeholders to scrutinize REEDD transfers. Financing the study anddevelopment of such an integrated fiscal and incentive framework is a potential area forGerman funding sources.

Fourth, provide policy support and invest in strengthening the institutional andregulatory framework for scaling up renewable energy supply in Indonesia .Indonesias renewable energy potential is huge. However, take up of renewable energysupply has been slow due to a mix of structural problems underlying the electricitysector, investment climate issues and lack of technical expertise in promoting greenenergy sources.Since the 1990s Germany has embarked on an ambitious program to promote renewableenergy production on a large scale. Policy advice and technical expertise could beprovided to the government to extract the main lessons for the Indonesian context. One

key area is to adopt feed in tariffs (FITs) to facilitate renewable energy projects likegeothermal energy and make them financially attractive to investors. This involves acomplex set of policy coordination and German expertise could provide valuable insights.Fifth, share German technical expertise on small and medium enterprisedevelopment and link it to develop rural renewable energy projects. Rural energysupply in Indonesia will to some extent depend on non-grid small, community-basedenergy producers. Germany has considerable experience in promoting the growth ofsmall and medium scale enterprises in Indonesia. In addition, Germany and the GTZ havealso experience in developing some micro hydropower projects. Linking these two issuesby for instance investing in the domestic financial sectors capacity to assess and providegreen micro-finance schemes would be a valuable investment.Sixth, provide policy support and technical assistance in building up the domesticcapacity for infrastructure financing. Infrastructure development is the key challengeto meet mitigation and adaptation objectives. Without adequate investment into greeninfrastructure such as geothermal energy plants or mass rapid transport systems Indonesia will be in a bad position to adopt a successful low carbon growth path.Guarantee and risk-sharing and - mitigation mechanisms will also be necessary to provideinvestors with additional incentives to put money into projects.These facilities can be provided by the establishment of a Low-Emission DevelopmentFinancing Facility (LEDFF), as proposed by the DNPI and UNFCCC (2009). TheIndonesia Green Investment Fund (IGIF) under the Ministry of Finances GovernmentInvestment was established in 2009 to take up such a function. German technicalassistance could assist the government in leveraging private and market-based sources offunding for low-emission development programs/projects.Seventh, stay engaged in and provide policy support for overall economic andgovernance reforms in Indonesia, based on demand driven by domestic stakeholders


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Like in many other countries, economic and low carbon development reforms are anongoing and continuing process. They are also very complex processes, difficult toimplement in the right sequence and thus require careful analysis. Continued transparentand frank policy dialogues are the best means to achieve this.

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Helm, Dieter, and Cameron Hepburn.2009. The Economics and Politics of ClimateChange. Oxford University Press: OxfordIMF. 2008. The Fiscal Policy Implications of Climate Change. Paper prepared by the

Fiscal Affairs Department, February 22, 2008. IMF: Washington D.C.www.imf.org/external/np/pp/eng/2008/022208.pdfInternational Energy Agency. 2008. Energy Policy Review of Indonesia. OECD/IEA:ParisInternational Energy Agency (IEA). 2009. Sectoral Approaches in Electricity Building Bridges to a Safe Climate. IEA/OECD: ParisMinistry of Environment (2007). National Action Plan For Climate Change.Ministry of Environment and BPPT (2009). Indonesias Technology Needs Assessment

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