Indonesia's inability to meet the rising energy needs of its businesses, from steelmakers to hotel resorts, threatens to put the brakes on growth in Southeast Asia's largest economy.

The recent update of Indonesia's sovereign debt rating by Fitch to investment status should help attract more investors. But analysts and industry watchers fear wasteful subsidies and rampant corruption will reduce crucial investment in the infrastructure needed to supply power.

Indonesia is not fulfilling its full potential because of these energy and infrastructure problems, said Erman Rahman, director of economic programmes in Indonesia at The Asia Foundation, a San Francisco-headquartered nongovernmental organisation.

A business can't grow when it is facing blackouts a few times a week, he said.

Almost half of 13,000 companies surveyed by the foundation in 2010 and 2011 experienced power outages at least three times a week.

Indonesia is the world's largest exporter of coal and the third-largest exporter of liquefied natural gas (LNG), but almost one-third of its citizens have no access to electricity. In outlying regions such as Papua, the figure rises to more than half.

A World Bank report for 2011 ranks Indonesia 161st among 183 countries in the ease of businesses getting reliable electricity supply, down three places from the previous year. In this category, Indonesia has received worse grades than Congo and Albania.

Recurring blackouts this year have forced hotels on the resort island of Bali to rely on diesel generators for back-up power, which costs more than regular power supplies.

The situation has improved, but there are still blackouts from time to time. We have to use diesel which is more expensive and adds to our costs, said a senior executive at a Bali hotel.

Due to poor transport links in the archipelago of more than 17,000 islands, movement of coal is hampered by lack of railroads. A lack of pipelines is one reason why only a small percentage of Indonesia's rich natural gas deposits are being utilised to power industries at home.

Indonesia needs to improve access to energy for the smaller islands to diversify the sources of growth now concentrated in greater Jakarta and Java, said Ferry Wong, head of research at Citigroup Securities Indonesia.

Indonesia's GDP is expected to grow by 6.3 percent next year, according to the country's central bank, while electricity demand is forecast to rise a robust 6.2 percent, the Economist Intelligence Unit (EIU) estimates.

SUBSIDIES PAIN

Heavy spending on subsidies and problems with land acquisition have held back investment in infrastructure.

Analysts say that with Indonesia growing at more than 6 percent a year, it needs to spend the equivalent of 5 percent of its gross domestic product a year to keep up with growing infrastructure needs.

While a newly-passed land acquisition law makes it easier for developers to secure land to build ports and power stations, there is political and public opposition to tackling subsidies.

The country's utilities sell power to end-users at subsidised rates of $70-$75 a barrel of crude oil, well below market prices of $95-$105 a barrel, said Citigroup's Wong.

If oil prices continue to rise, this will be a risk to Indonesia's economy because it puts a strain on the budget.

Finance Minister Agus Martowardojo said on December 13 that this year's fuel subsidy bill will total 168 trillion rupiah (12 billion pounds), up from the budgeted figure of 129.7 trillion rupiah because of increased demand and higher-than-expected average oil prices.

The government plans to remove fuel subsidies in April for private cars in Jakarta and Bali, but the selective nature of the cuts is likely to limit their effectiveness.

Motorcycles are exempt from the subsidy (cut), and there are roughly 10 times more motorcycles than cars being sold in Indonesia, said Martin Adams, an EIU energy analyst in Hong Kong.

State utility PLN cannot cover costs at current tariffs, which the government has been reluctant to raise, capping the power firm's ability to fund investment, analysts said.

There are plans to raise electricity tariffs in 2012 by an average 10 percent on average for most customers, which would cut an estimated $1.1 billion from the state subsidy bill. But there is no certainty rates will be raised. Early this year, the government proposed a 15 percent hike, but the legislature thwarted the plan.

CORRUPTION

Underinvestment at the lower levels of government is also a problem, with only 14 percent of local government budgets allocated to infrastructure, compared with 60 percent for personnel, a study by the Asia Foundation shows.

For road and bridge programs, the average funding allocated was only... around a quarter of the amount needed for periodic maintenance alone, said the report, Local Economic Governance 2011, based on a survey of almost 13,000 businesses conducted for the foundation by Nielsen Indonesia.

Corruption is also a problem, and one that has been exacerbated by Indonesia's decentralisation after longtime strongman Suharto resigned in 1998. Unlike during his tenure, officials in local governments far from Jakarta have the power to permit or block projects, and some provincial civil servants have grabbed the chance to enrich themselves.

The situation is worse than I had thought, people are paying up to $10,000 to $15,000 just to get these jobs, although their annual pay is just 10 percent of that, said Rahman.

Bribery also puts off foreign investors at a time when Indonesia is seeking $100 billion of private investment to overhaul its creaking transport network.

DECLINING GAS OUTPUT

In recent years, Indonesia has shifted away from using oil towards gas to generate power as rising crude oil prices boosted subsidy bills and the country became a net oil importer in 2004.

PLN plans to cut oil's share of the energy mix to 3 percent by 2013, from about 20 percent now. Analysts estimate that producing power from oil-based fuels costs it $15 per million British thermal units (mmbtu), but gas-fired power plants would only cost $12 per mmbtu.

But the lack of gas supply has prevented companies from taking advantage of the lower-cost fuel source, since producers earn more from higher-priced exports.

Gas shortages forced Krakatau Steel, Indonesia's largest steelmaker, to shelve plans to expand production capacity, President Director Fatwa Bujang said this month.

In response to the shortage, the government in July freed private firms to import natural gas for the first time.

Indonesia will export 362 LNG cargoes this year, down 15 percent from 2010. It is building LNG import terminals with nearly 10 million tonnes of capacity to meet demand.

LONG-TERM SOLUTIONS

The PLN, where Nur Pamudji was appointed as director last month, wants to boost the national electrification ratio to more than 73 percent next year, from below 69 percent now.

To reduce blackouts, the utility plans to add 10,000 megawatts (MW) of generation capacity by 2014 to the existing 30,000 MW.

But even if realised, Indonesia's energy woes could still cap its economic growth in the short term.

The government realises that it needs to remove subsidies, improve the business environment, install more generation capacity and extend the grid, but these are all long term undertakings and we can expect only gradual movement, said EIU's Adams.

(Additional reporting by Reza Thaher; Editing by Clarence Fernandez and Simon Webb)