As a country that ratifies Paris Agreement, Indonesia must submit its Nationally Determined Contribution (NDC) which elaborates Indonesia’s climate actions that will be implemented as collective global efforts to tackle climate change. However, the financial needs to implement the actions cannot be covered by the state budget alone. Other sources of finance will need to be identified and mobilized to enable Indonesia in meeting its NDC. The role of the private sector, including the financial sector, is thus crucial to bridge the financial gap.
Recognizing the importance of the financial sector’s role, the Indonesia Research Institute for Decarbonization (IRID), in collaboration with the Center for Financial Sector Policy of the Fiscal Policy Agency, Ministry of Finance, held a discussion on 22 August 2024, to identify the opportunities and challenges that the financial sector is facing to finance Indonesia’s climate actions. The discussion revealed that the financial sector, particularly banks, welcomes the policies issued by the government of Indonesia on increasing sustainable finance in Indonesia and is interested in expanding its green funding portfolio. However, the sector currently lacks adequate information regarding the financing needs of the real sector.
As a follow-up, IRID collaborated with the Center for Financial Sector Policy of the Fiscal Policy Agency, Ministry of Finance, organized the second discussion on 6 November 2024 to gather further information on financial needs required in the energy and industry sectors, for decarbonization.
Some of the key findings from the discussion are the following:
A. Challenges in Financing the Energy Transition Faced by the Financial Sector
One of the main challenges identified was that to finance early retirement of coal-fired power plants (CFPPs) it is important to understand the financing scheme of the CFPP when it was constructed. Usually, the development of CFPP is financed through bank loans. When significant debt still remains in the balance sheet, the project will then be classified as no longer bankable. Moreover, when the power plant is planned for early retirement, phasing in the renewable energy will be required; hence, additional financing, resulting in the increasing of the overall cost. While transitioning, the power plant operator will face declining income due to lower productivity, but the operational costs remain high.
As a highly regulated sector, the banking sector must carefully assess the project’s bankability before committing funding, especially in the context of capital expenditure. While managing such a challenge, an alternative financing scheme for energy transition needs to be explored, for instance by increasing the efficiency of operational expenditure through cooperation with vendors.
B. Financial Sector’s Needs to Finance Climate Action in the Energy and Industrial Sectors
The financial sector needs to have more success stories from the energy transition program before deciding upon its involvement, for instance, financing the Green Industry Service Company (GISCO), an initiative promoted by the Ministry of Industry to connect the industrial sector with potential green funding sources. Therefore, identifying the required enabling environment of GISCO, in this case, or other energy transition program, such as appropriate regulations and frameworks that do not disadvantage the industry, is crucial.
Policy certainty and harmonization are vital in optimizing the role of the financial sector as a financial provider. On climate change issues, for, instance, currently, the Indonesia’s financial sector faces fragmented regulations, since the government bodies address climate change issues in silo. Leadership changes in government institutions also add to the uncertainties, which often results in restarting project implementations. At the same time, the financial sector needs to ensure financial certainty and sustainability of the project.
To offer competitive climate finance packages, the banking sector requires government policy support, such as insurance or guarantees. At present, domestic banks generally can only offer a financing tenor of around 10 years of project financing, whereas foreign banks can provide up to 20 years at a more competitive price. This leads to more project developers attracted to the financing package offered by foreign banks rather than the domestic banks.
C. Challenges and Opportunities for the Real Sector to Implement a Just Low Greenhouse Gases Emission Development
Challenges
Indonesia’s industrial sector is expected to contribute to the NDC while facing increasing market pressure, including from the European Union’s Carbon Border Adjustment Mechanism (CBAM) in 2026. Carbon pricing instruments, both market and non-market based, must be adopted in line with international standards, despite that the current regulations do not yet align with international emissions trading. The complexity increases with the fact that financing for industrial decarbonization in Indonesia, is still limited.
Although Indonesia has the carbon pricing instruments in the industry sector, the Government of Indonesia still needs to be responsible to ensure that carbon pricing implementation will be fairly implemented in the industry sector. This can be done by recognizing the different industry characters and scale and not adding more burden to specific subsectors.
Refinancing options for energy transition projects – from fossil fuels based to renewables – have not been widely accepted by financial institutions, despite the critical role of refinancing in removing debt-related barriers to green investment. The Cirebon CFPP case highlights a potential model using concessional refinancing and blended finance. However, such grant funding cannot be relied upon as a long-term solution. With the CFPPs in Indonesia still relatively new (at approximately 12-13 years of age), early retirement requires significant compensation.
Another scheme that can be used for financing is through greenhouse gas emissions trading, including by power plants. However, the implementation of carbon market is currently hindered by weak demand for credits. Under current Power Purchase Agreements (PPAs), CFPPs cannot adjust prices to reflect increased mitigation costs as the emission cap becomes more strict.The Government of Indonesia (GoI) could bear this cost burden for the State Electricity Company (PLN), recalling that PLN is a state-owned enterprise. To add, since coal subsidies (in form of Domestic Market Obligation (DMO) and Domestic Price Obligation (DPO)) are still provided for coal, the current carbon price is insufficient to serve as an incentive for CFPPs to invest in mitigation efforts.
In the industrial sector, to be effective, GISCO must learn from the growth of ESCO in Indonesia, particularly regarding the minimum appetite for the real sector to implement energy efficiency. One clear example is when industrial actors decided to do energy audit, with no implementation conducted as recommended by the ESCO. Therefore, it is important for GISCO to convince and ensure that the industries are shifting towards green industries.
Opportunities
JETP priority projects are open to all competitive financing proposals. Indonesia’s JETP scenario highlights that renewable energy investment will form a major part of the country’s energy transition efforts. Indonesia aims to add more than 80 GW of renewables by 2030, requiring nearly USD 100 billion. With JETP commitments at only USD 21,6 billion, private sector support becomes critical.
Global demand for green products can incentivize the transformation of green industries in Indonesia. Two international apparel brands are considering investing in Indonesia with a condition that the country can guarantee the provision of 100% renewable energy for their business operations. Failure to meet such demands could shift investment to regional competitors, such as Vietnam.
Notes: The full version of the discussion paper is only available in Bahasa Indonesia.
