Hopes and doubts - EIU Perspectives - The Economist

Hopes and doubts

Perspectives on the long road to Indonesia’s economic development.

Sponsored by Shell

Hopes and doubts Perspectives on the long road to Indonesia’s economic development

Contents

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Preface

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Author biographies

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Testing Indonesia’s security in the post-Jakarta era Jack Hewson, Contributing editor, The Economist Intelligence Unit

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Joko Widodo’s Indonesia: Control and reform Aaron Connelly, South-East Asia Fellow, Lowy Institute

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“This is still an open country” An interview with Luhut Panjaitan, Coordinating minister of political, legal and security affairs, Republic of Indonesia

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Cognitive dissonance: Unclear signals about foreign investment from Indonesia Paul Rowland, Independent consultant

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Indonesia: Investment opportunities for growth Bambang Brodjonegro, Minister of finance, Republic of Indonesia

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Boosting manufacturing with investment in infrastructure Scott Younger, Director, PT Nusantara Infrastructure

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Making Indonesian manufacturing an engine of growth again: Now or never? Ndiamé Diop, Lead economist for Indonesia, World Bank

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© The Economist Intelligence Unit Limited 2016


Preface In politics, high hopes are nearly always trailed by crushing disappointment. Indeed, it seems fair to characterise the first year in office of Indonesia’s president, Joko Widodo, as disappointing. Since his administration began in October 2014, Jokowi, as he is known locally, has presided over average economic growth of less than 5% year on year, below Indonesia’s ten-year annual average of 5.9%, and a slump in the value of the rupiah to less than its level during the 1997–1998 Asian financial crisis. Emerging markets globally have encountered slower growth and increased volatility of their currencies, but investors have reasons to be concerned in Indonesia. Economic stimulus in the form of increased government expenditure on public works and services has stalled. Protectionist policies from the era of previous president, Susilo Bambang Yudhoyono, have continued. The tragic attacks in January 2016 urgently added security to the number of issues on the policy agenda, though the ultimate implications are far from clear for now. Domestically, Jokowi has struggled to burnish his graft-busting credentials. He was forced to drop his nomination of Budi Gunawan as police chief after Mr Gunawan became the target of an investigation by the Anti-Corruption Commission (KPK). The EIU is cautious about the administration’s ability to implement significant reforms, such as the removal of protectionist rules governing

trade and foreign investment and the inflexible labour market. Therefore, growth is forecast to be below potential, with GDP expanding 4.8% in 2015 before ticking up to 5.2% in 2016 and 5.5% in 2017 thanks mainly to private consumption. The outlook is not completely grim. The administration’s recent focus on economic reforms is hopeful, as are the appointment of cabinet members that bring new thinking and a fresh approach, such as Thomas Lembong, a former private equity investor who was appointed trade minister in August 2015. The report brings together a variety of perspectives on Jokowi’s first year in office and Indonesia’s economic outlook. It begins with an assessment of the political implications of the January 2016 attacks in Jakarta. Then the report will turn to policy challenges, providing two different perspectives on the government’s progress in Jokowi’s first year. Next, the report provides contrasting views on the investment environment. Finally, two views on Indonesia’s potential as a manufacturing hub will be shared. Hopes and doubts: Perspectives on the long road to Indonesia’s economic development is an Economist Intelligence Unit (EIU) report, sponsored by Shell. The sponsor commissioned this project but had no editorial input into the report, which is solely the work of the authors. The editors of this report were Kevin Plumberg and Jack Hewson from the EIU. n


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Author biographies AARON CONNELLY is a research fellow in the East Asia Program at the Lowy Institute for International Policy in Sydney, where he focuses on South-East Asia, particularly Indonesia and Myanmar, and the US role in the region. Prior to joining the Lowy Institute, Mr Connelly worked at Albright Stonebridge Group, a commercial diplomacy consultancy headquartered in Washington. There, he assisted companies and non-profits in understanding political risks to investments and operations in South-East Asia. Aaron completed graduate studies at Georgetown’s School of Foreign Service, and conducted research on a Fulbright scholarship at the Centre for Strategic and International Studies in Jakarta. LUHUT PANJAITAN is Indonesia’s coordinating minister for political, legal and security affairs. Prior to this position, he served as President Joko Widodo’s chief of staff. A former fourstar army general, Mr Luhut was trade and industry minister during former president Abdurrahman Wahid’s administration. He is also a former ambassador to Singapore and founded Toba Sejahtra Group, a private company with major interests in coal, oil and gas, electricity generation and agriculture. Among myriad responsibilities, Mr Luhut oversees security measures, including efforts to tackle the threat of ISIS and terrorism in Indonesia. He is also in charge of shaping the country’s response to China’s growing military presence in the South China Sea.

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PAUL ROWLAND is a Jakartabased consultant and analyst. He has spent more than a dozen years in Asia and the six years prior in Eastern Europe where he led large operations in emerging market countries. Over the past three decades, Mr Rowland has advised senior government officials including presidents, prime ministers, cabinet ministers and members of parliament as well as civil servants and diplomats at all levels in more than thirty countries from Mauretania to Mongolia. BAMBANG BRODJONEGORO is the current Indonesian Minister of Finance. He served as Vice Minister of Finance under the previous administration between 2013 and 2014 and as the Head of Fiscal Policy Agency between 2011 and 2013. Mr Bambang received his bachelor’s degree from the Faculty of Economics at the Universitas of Indonesia, and completed his PhD in economics at the University of Illinois at Urbana-Champaign. He served as Dean of the Faculty of Economics at the University of Indonesia between 2005 and 2009.


NDIAMÉ DIOP is the World Bank’s current lead economist for Indonesia. In his sixteen years at the World Bank, Mr Diop has published Journal articles and books in the areas of economic growth, trade, fiscal and monetary policies. While much of his career was based in Washington, DC, Mr Diop has had two country assignments, to Tunisia (as World Bank representative, 2007-2010) and to Indonesia (as lead economist, since July 2012). He currently leads a large team of economists providing technical support to governments based on international best practices and producing evidence-based analyses on Indonesia, including the Indonesia Economic Quarterly.

JACK HEWSON is a journalist and consultant analyst based in South-East Asia. He has produced video and written reports for a range of media organisations including The Economist Group, Al Jazeera English, the Guardian, and FRANCE 24, since first reporting on Indonesia in 2011. He holds a bachelor degree in politics and philosophy from the University of Manchester and a masters in investigative journalism from City University London.

SCOTT YOUNGER is a highly experienced chartered civil engineer with more than 38 years of experience across many countries in Asia. He has degrees from Glasgow University, UC Berkeley and Hong Kong University and is a Fellow of the Institution of Civil Engineers and Honorary Research Fellow of Glasgow University. Mr Younger has served many years on the Boards of BritCham and EuroCham in Indonesia and since 2003 on the Board of the International Business Chamber of which he is Senior Vice Chairman. He is a recognised authority on infrastructure, writes professionally, contributes regularly on the subject in regional business magazines and is a speaker at conferences. He has also been recently appointed as the Chancellor International of President University, Greater Jakarta.


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Testing Indonesia’s security in the post-Jakarta era Jack Hewson, contributing editor, the Economist Intelligence Unit

n January 14, shortly before 11am, the first of six explosions reverberated around Jalan MH Thamrin, central Jakarta, followed by the fizz of small arms fire.

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Speaking on the day of the attacks, Jokowi said, “The people do not need to be afraid and should not be defeated by these terrorist acts... I hope that people remain calm because it is all controllable.”

The busy thoroughfare connecting the iconic Selamat Datang Monument roundabout to Merdeka Square became the stage for a gun-battle that resulted in the deaths of three civilians, one policeman and four Islamist militants.

Jokowi is right. Indonesia remains a predominately moderate Muslim country, the vast majority of which is opposed to the jihadist cause. The number of Indonesian militants per million citizens is also very low: between 1 and 3 per million, compared with 18 per million in France, according to The Atlantic magazine.

The incident, the first major terrorist incident on Indonesian soil since the 2009 bombings of the Marriot and Ritz-Carlton Hotels, will challenge President Joko “Jokowi” Widodo to coordinate the country’s security forces and combat extremist propaganda by the perpetrators, the so-called Islamic State (IS). These steps will be crucial if returning fighters reinvigorate the archipelago’s beleaguered terror networks, culminating in a deadly Paris-style attack, as authorities fear.

A measured response Jokowi has thus far been praised for his measured response to the attack. While further terrorist attacks appear likely, Jokowi has made it clear that a renewed terror threat must be kept in perspective.

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This cannot be considered a significant military threat. Neither can it currently be considered a threat to Indonesia’s economy. Rates of foreign investment have been largely unaffected by previous terror incidents and while Indonesian stock prices tumbled on January 14, they bounced back the next day. Such market rationality is reassuring, though more deadly attacks could have significant economic consequences. Following the Bali bombings in October 2002, many countries issued travel warnings against travel to Bali and the numbers of foreign tourists visiting the island declined by 57%. Approximately 2.7m tourism workers lost their jobs.


The main consequences of the January 14 attack are likely to be political rather than economic.

Political consequences For now, however, the main consequences of the January 14 attack are likely to be political rather than economic. On the day of the incident both the military and police were quickly deployed. The arrival of armed soldiers was likely due to the presence of military units tasked with protecting the nearby presidential palace. But confusion over who is in charge may be exacerbated further in the coming months if the military seeks a more significant role in counter-terrorist operations. For years the military has sought to re-insert itself into the domestic security roles that it lost to the police during reformasi — and a renewed terror threat may present an opportunity to realise this institutional ambition. The current Security Minister Luhut Panjaitan served as the commander of Densus 81, a Suharto-era counter-terrorist special forces unit, and old loyalties may motivate him to advocate for greater military involvement. Panjaitan is also uniquely positioned to do so. As one of Jokowi’s few close allies within the

establishment, Panjaitan’s support is valuable to the politically isolated president — yielding him significant bargaining power. Indonesia, however, will probably be safer if responsibility for counter-terror operations is left with the police, which has far greater operational intelligence, amassed over the last 14 years. In response to the 2002 Bali bombing, which killed more than 200 people, the Indonesian government in 2003 set up Densus 88, an elite detachment of the police tasked with breaking down Jemaah Islamiyah (JI), the perpetrators of the attack. Over the past 13 years, Densus 88 has been successful at capturing and killing JI’s leadership, crippling its capacity and amassing valuable operational intelligence in the process. It is critical that the police retain its role if the security forces are to successfully contain the emergent threat of IS — whose ambitions and capabilities are greater than any terror threat observed over the past five years. From 2010 until last week, in part motivated by the brutality with which Densus 88 has pursued its terror targets, jihadists had largely focused their attacks on the police. Fortunately their efforts were characterized by poor organisation and incompetence, with three suicide bombings only resulting in the death of the attacker. However, as demonstrated by the January 14 attack, which police believe was masterminded by Bahrun Naim, an Indonesian currently fighting for IS in Syria, IS is having an influence on the strategic objectives and methodology of domestic terrorists.


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New efforts needed

Counter terror forces will need to show considerable adaptability, collaborating across borders to infiltrate new networks.

The police were targeted on January 14, as in previous incidents, but so too were foreign workers and a Starbucks café, lending international significance to the attack. It was also a multi-staged operation, which intended to draw in a crowd before detonating ancillary devices, several of which remained unexploded. The perpetrators were also ultimately able to initiate a complex plan without detection, demonstrating effective operational security. And the attack was more ambitious than any other in the last five years.

Firstly, reform of the prison system is needed to prevent the spread of jihadist ideology and to prevent coordination between prisoners and terrorists on the outside. Recidivism is a major issue among terror inmates, with at least 40 convicted terrorists having reoffended after their release. Inside Indonesia’s prisons, extremist clerics are largely unsupervised and may easily disseminate information to other prisoners. January 14 attacker Afif Sunakim is believed to have been influenced by notorious cleric Aman Abdurrahman during his stay at Cipinang Prison in Jakarta. Many prisoners also have easy access to jihadist contacts and materials through the Internet on their smartphones.

Competition between emerging IS “franchises” in the region may also precipitate greater terrorist activity, as different factions seek to claim leadership of IS in South-East Asia.

According to National Police Chief Badrodin Haiti at least five jailed militants were in communication with the plotters of the January 14 attack in the lead-up to the incident.

On January 14, Jakarta police chief Tito Karnavian reportedly said that the attacks in Jakarta were part of a rivalry between Filipino jihadist groups and Bahrun Naim over who would lead any IS group in the region.

Secondly, IS propaganda must be countered online.

Counter terror forces will need to show considerable adaptability, collaborating across borders to infiltrate these new networks.

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Beyond strong policing and renewed attempts to infiltrate nascent IS terror networks, there are a number of additional measures that will be required to counter the Indonesian jihadi threat.


Jihadists are targeting young people online with limited success. The government should launch campaigns on platforms like Facebook, Twitter and YouTube to challenge extremist narratives. Until now the arguments of jihadists on social media have been left largely unchallenged.


Thirdly, de-radicalisation programs must be established to target those deported back to Indonesia after failed attempts to reach Syria.

Jokowi has received praise for his even-handed response to January’s terror attack thus far. But there remains much work to be done. n


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Joko Widodo’s Indonesia: Control and reform Aaron Connelly, South-East Asia Fellow, Lowy Institute

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y the time Jokowi emerged from the state palace in a crisp white shirt to announce his first cabinet in October 2014, it was approaching evening. The announcement had been due to take place hours earlier on the lawn of his new residence. However, Jokowi was delayed by demands for special consideration in the composition of the new cabinet from party leaders and other wealthy supporters of his presidential campaign. Most critically, former President Megawati Sukarnoputri, the chair of Jokowi’s Indonesian Democratic Party of Struggle (PDI-P), vetoed several selections at the last minute. As journalists checked the time and wandered the lawn, Jokowi’s lieutenants furiously sought acceptable replacements. The lineup that emerged was a disappointment. It included many officials who owed their loyalty to Ms Megawati, or to Vice President Jusuf Kalla, or to National Democrat party chairman Surya Paloh, and others with a reputation as opponents of good governance. The announcement thus raised two questions that have come to define Jokowi’s presidency. First, to what extent is Jokowi in control of his administration? And second, to what extent is the president himself a reformer?

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First, the good news In the days before Jokowi took office, concern for the stability of his new administration focused on the intentions of the opposition Red and White Coalition (KMP). Led by Golkar party head Aburizal Bakrie and defeated presidential candidate Prabowo Subianto, the reinvigorated opposition had cohered to a greater degree than at any point in the past decade, and promised a strident stance. In that feverish environment, Jokowi operatives even fretted that the opposition might try to round up enough votes to attempt to impeach the new president.

The greatest success of Jokowi’s administration has been the way in which he quietly co-opted the opposition.

The greatest success of Jokowi’s administration has been the way in which he quietly co-opted this opposition. Indeed, he has now pushed two budgets through the opposition-controlled legislature, including measures to drastically cut


fuel subsidies, once the third rail of Indonesian politics, with minimal resistance from the KMP. He has done so by spreading patronage to his erstwhile opponents; by, for example, signing a decree authorising legislators to pay for personal vehicles with state funds, and by authorising a US$62m state loan to one of Bakrie’s companies. Jokowi’s strategy presents risks because he was elected on the promise of a cleaner, more efficient government. The spread of patronage through regular channels, such as the award of contracts to politically connected state-owned enterprises, could prove a drag on Jokowi’s ambitious infrastructure investment program, leaving him a disappointing record to take into his re-election campaign in 2019.

If patronage spreads through irregular means, allegations of graft could damage Jokowi’s reputation with voters.

Moreover, if patronage spreads through irregular means, allegations of graft could damage Jokowi’s reputation with voters. A sensational scandal that brought down the speaker of the House of Representatives in December illustrates the risks. The speaker, Setya Novanto, resigned after he was accused of trying to extort US$4bn in shares from the local unit of Freeport-McMoRan. In a secret recording, Mr Novanto is heard

asking Freeport-McMoRan for a 20% stake in the company, and implies that his request has the blessing of the president and his top lieutenants. All those concerned in Jokowi’s administration have denied any knowledge of the apparent extortion attempt. But if the scandal does force Jokowi to rein in his aides’ efforts to secure legislative support – legitimate or otherwise – the president could find a hungry KMP once again spoiling for a fight — frustrating his efforts to push through his legislative agenda, and himself bogged down by legislative investigations into his administration’s conduct.

Controlling his own coalition Managing differences within his own coalition has been a significant challenge for Jokowi. As one presidential advisor has noted, Jokowi is up against not just the KMP, but also “the other KMP” — Kalla, Megawati, and Paloh. His vice president, party chair, and primary financial backer, respectively, have competed over appointments and tangled over policy differences. Jokowi has sought to satisfy them by appointing their allies to key positions, in ways that have diminished his administration’s reputation for good governance. The Agriculture Ministry is led by a young Kalla protégé. The job of Attorney General, a particularly sensitive position with regard to efforts to fight corruption in the legal system, is held by a Paloh ally, just as Paloh has come under suspicion of corruption. And in a grave error, Jokowi sought to install Budi Gunawan, a former aide-de-camp to Ms Megawati, as national police chief.


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Barely half of Jokowi’s cabinet members are technocrats, while the other half primarily serves to satisfy the oligarch leaders of parties in his coalition. Jokowi would come to regret each of these appointments, but none more so than that of Mr Gunawan. Shortly after Mr Gunawan was nominated as the police chief candidate, the Corruption Eradication Commission (KPK) named him a graft suspect. The police responded by naming each of the sitting KPK commissioners suspects for various crimes with little evidence. Under the law, criminal defendants cannot continue in public office, so the move had the effect of considerably weakening the leadership of the KPK, Indonesia’s most trusted and popular institution. Rather than standing up for the KPK and risking a showdown with both Ms Megawati and the police, Jokowi vacillated for weeks before delivering a compromise. Mr Gunawan would ultimately become deputy chief instead of chief, while KPK leaders with mixed credentials were appointed on a temporary basis to serve out the remaining nine months of their predecessors’ terms. (Since then, a new slate of weaker leaders, chosen through a process involving the president and the legislature, has taken up full terms). While the KPK has continued to mount investigations against some powerful figures, it has since shied away from other obvious targets.

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Jokowi’s actions in the Budi Gunawan affair undoubtedly weakened the KPK, and set a disturbing precedent for police impunity, which is likely to leave corruption in the police force unchecked for years to come. Jokowi’s motley crew of coalition partners and backers are likely to throw up other similar tests in his remaining three and a half years in office.

Is Jokowi a reformer? Jokowi rose to prominence as a can-do mayor in Solo and as governor of Jakarta. However, his record since the election has prompted many foreign analysts to question whether Jokowi not only lacks control, but also the reformist instincts that they associated with his tenures at the municipal and provincial levels. To some extent, this question is inextricably linked to Jokowi’s lack of control. At the most fundamental level, Jokowi promised during his election campaign to transform Indonesian politics by refusing to offer cabinet seats to party leaders in exchange for their support in the legislature, and to compose a cabinet comprised mostly of technocrats. But barely half of Jokowi’s cabinet members are technocrats, while the other half primarily serves to satisfy the oligarch leaders of parties in his coalition. And while he initially refused to offer cabinet seats to entice opposition parties to defect from the KMP, the next cabinet reshuffle is likely to be the result of just such a deal. Jokowi’s earlier use of patronage to secure legislative cooperation was no less problematic. Rather than changing the rules of the game, Jokowi has spent his first year learning to play it better.


Moreover, on questions of specific policies, Jokowi’s record as a reformer has been mixed. Jokowi understands that Indonesia’s infrastructure deficit holds back its economy, and has pledged to address it through an ambitious portfolio of infrastructure projects, many of which have been stalled for years under his predecessor. To do so, he seems also to understand that he needs to attract massive amounts of foreign investment. Yet, his ministers spent much of the early months of his administration implementing regulations that were inimical to foreign investment and trade. At no point was this juxtaposition clearer than in April 2014. Jokowi promised investors “incredible profits” at a World Economic Forum conference in Jakarta, and told them to call him if they had a problem. Two days later, Jokowi delivered a keynote to leaders of non-aligned countries at the 60th anniversary of the Asia Africa Conference, in which he called for a new global economic order with a diminished role for Western institutions. And as the rupiah and share market plunged in the months that followed, Jokowi doubled down on protectionism, increasing tariffs on hundreds of items. His appointment in August 2014 of Thomas Lembong, formerly a Singapore-based private equity investor, to trade minister signaled a shift in Jokowi’s approach. In an interview on his first day in office, Mr Lembong told Bloomberg that “protectionism always backfires in the end”. Over the remainder of 2015, Jokowi and Mr Lembong introduced seven packages designed to kickstart growth and foreign investment. These packages have improved the investment climate, but mostly at the margins, through the reduction of red tape in permitting processes. Dozens of

measures have been announced with little follow-up on implementation. Yet Jokowi clearly believes himself to be a reformer, particularly in how he defines himself in relation to his predecessor, Susilo Bambang Yudhoyono.

Jokowi clearly believes himself to be a reformer, particularly in how he defines himself in relation to his predecessor, Susilo Bambang Yudhoyono.

The anti-SBY Toward the end of Mr Yudhoyono’s ten years in office, Indonesian public figures began to increasingly voice a critique of Mr Yudhoyono that combined reformist, nationalist and populist arguments. During Mr Yudhoyono’s term, they suggested, Indonesia had become weaker. They argued that laws had gone unenforced, corruption had flourished and public resources squandered. They saw Mr Yudhoyono’s globetrotting attempt to raise Indonesia’s profile on the world stage as nothing more than an ego trip, and some even believed he had given foreign governments and businesses special consideration in exchange for adulation. Jokowi, by contrast, came into office promising humility. Though he was worth more than US$2.5m by the time he assumed office, he played


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up his humble background on the campaign trail. Campaign posters bragged that his suits were worth no more than US$100. While Mr Yudhoyono had ordered the purchase of a Boeing 737 for presidential travel, Jokowi flew in economy class on commercial flights during the campaign and into the early days of his presidency. Jokowi also presented himself as a firmer hand in what he perceived to be an increasingly dissolute Indonesia under Mr Yudhoyono, calling for a “mental revolution” in an op-ed published during the campaign. In his election manifesto, he pledged to “reject the weak state”, and promised to get tough on corruption, drug trafficking and illegal fishing. Although this agenda presented an opportunity for the reform of certain state institutions that had been enervated by corruption, it also provided an increasingly popular critique of the role of foreign governments and investors in Indonesia. Foreigners, the argument went, were complicit in and profiting from the weakness of the Indonesian state. During the 2014 election, Mr Prabowo championed these views, lecturing on the dangers of “foreign intervention”. He and his followers attracted more attention — and from foreign investors, more concern. But much of Jokowi’s rhetoric has still accepted these nationalist concerns as valid, even if it has not seized on them like Mr Prabowo. Insofar as nationalist posturing supports the narrative that Jokowi’s presidency has served to correct the perceived failures of Mr Yudhoyono’s time, it is likely to continue to play a role in policymaking in his administration.

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Where the rubber meets the road Jokowi is thus faced with a dilemma. He will not be able to achieve his ambitious development goals without foreign investment. But the measures he must take to welcome foreign investment upset Indonesians’ nationalist sensibilities, —with which Jokowi appears to be at least partly in sympathy. Starting last August, with the appointment of Mr Lembong as trade minister, he has sought to split the difference by making minor permitting changes, and making the dramatic but unrealistic announcement that Indonesia would join the Trans-Pacific Partnership. He has also sought sovereign partners, particularly China and Japan, who may be willing to overlook the risk that the Indonesian system presents to foreign investors. This will not be enough to attract investment on the scale that Indonesia requires. If Indonesia is to avoid another lost decade, Jokowi must take on corruption and local incumbents who have used the regulatory regime to take advantage of foreign investors. Doing so would be politically treacherous in any political environment, but will be even more so given Jokowi’s weak political position and tenuous hold on the policymaking apparatus. n



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“This is still an open country” An interview with Luhut Panjaitan, Coordinating minister of political, legal and security affairs, Republic of Indonesia

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okowi has had a mixed report card since taking office in October 2014.

His early successes included the rolling out of ambitious health and welfare programmes, cancelling fuel subsidies and diverting government funds into much-needed infrastructure spending. But there have also been a number of setbacks that have brought Jokowi’s judgment into question. The executions of foreign drug convicts resulted in widespread diplomatic condemnation, dominating international news coverage of Indonesia. And a series of seemingly protectionist policy announcements have appeared to contradict Jokowi’s rhetoric that the country is “open for business”. This apparent lack of coherence has led some to question Jokowi’s key objectives. As Indonesia’s first leader to come from outside of the traditional political or military elite, there are also concerns about his ability to project power and push through his policy agenda. In December 2015, the EIU interviewed Luhut Panjaitan, coordinating minister for political, legal and security affairs, and a long-time business partner of the president, to elaborate on the Jokowi administration’s policy priorities.

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What ideology is guiding Jokowi and his policy agenda? Are the interests of big business or those of the working man Jokowi’s biggest priority? Indonesian politics doesn’t really fit along classic lines of left or right wing, but I suppose Jokowi is a centrist, somewhere in the middle. He is a reformer. Jokowi doesn’t mind big investors. But, while we want to see growth, we also want to see growing equality. Take government regulations on the ownership of palm oil with regard to the relationship between conglomerates and smallholder farmers. Since Suharto’s time, the conglomerates have benefited too greatly, often in the face of regulations that are supposed to ensure a fair share for smallholders. But now, for the first time, we are trying to enforce these regulations so that proper profit distribution actually happens. Otherwise, the gap between the rich and poor on the Gini coefficient will become bigger. If young people see that the rich are taking all the spoils, and that their families have nothing, this will be detrimental. We have to see this as a potential problem in the near future — we must avoid the anger of youth.


So Jokowi is a centrist; he’s a reformer;, but he’s also a nationalist, because of his political party, the Indonesian Democratic Party of Struggle (PDI-P) — a party of the nation and the people. He sees nationalism as the glue holding the country together, and with 250m people and many islands, this is necessary. But with regard to Jokowi’s nationalism, the orientation is for the greater benefit of the country. However, I have to make it clear that nationalism is different from protectionism. We are very welcoming of foreign investment. Even this afternoon we had a cabinet meeting and we were saying we don’t have a problem if the majority of investment in infrastructure over the coming years comes from foreign sources. We are creating more and more incentives for FDI.

But are there not contradictions to this supposedly open foreign investment policy? For example, more industries were added in 2014 to the government’s negative investment list, which bars foreign investors from designated industrial sectors. No, this is not the case. Take foreign ownership of property, for example. I just spoke with our coordinating minister of the economy, and in the coming months there will be a liberalisation of property ownership. If you look at the whole package of economic regulations being rolled out by Jokowi, all of these packages are about simplifying permitting which will benefit investors, whether they are foreign or local. I think Jokowi understands that for supporting economic growth in the future, it will be impossible without the support of foreign

investors. FDI is a must. Domestic investment and government investment are not enough; FDI is very important. We don’t want to see any protectionism at all in this country; don’t get me wrong on that. I make it clear. I understand that some journalists, some in the US say that our policies are protectionist. And I say: No don’t worry, this is still an open country, but we like to see the benefits for the people of Indonesia as well as the investors. I don’t see contradictions in Indonesia’s foreign investment policy. Jokowi is trying to take Indonesia into a new era. He’s trying to take Indonesia from a commodities-based economy to a manufacturing-based economy. For example, he has taken the money freed up from abandoning fuel subsidies and moved it into infrastructure spending. Again, we see this with the continuation of the unprocessed mineral ore export ban. This measure could affect the economy for a while, but he understands that. We are suffering in the short-term, and perhaps in one year’s time, but our economy is showing signs of improving, in the third quarter [Indonesia’s GDP expanded] 4.73%, giving strong indications that his policies are on the right track.

So going forward, what will be Jokowi’s economic policy priorities in 2016? One particular policy priority this year will be addressing inefficiency. We have to take it out.


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For example, in logistics, waiting time for ships at Jakarta’s Tanjung Priok Port is 7-14 days at the moment. And we want to bring that down to 3-6 days next year. This would mean a lot. We will also seek greater efficiency in tax collection. The number of Indonesian taxpayers right now is less than 1m, whereas the middle class right now is 45m. Why only 1m people? [We want to address] problems and inefficiencies in the system. So how will we address these inefficiencies? [Through] linkages between the tax office and the business community. We have the database — in the local election there were 172m voters registered for the local election. So now we can use this data infrastructure to pursue taxation. In two years’ time, we think that maybe 3m or 4m people will be paying taxes. If that happens then I’m very confident that we can boost our tax revenue from about 1,350trn rupiah right now to 1,800 or 1,900trn rupiah. And then we’ll have more money for infrastructure. There are many fields in which similar inefficiencies need to be addressed, and we are using places like Singapore and the US as models to aim for.

What obstacles might we anticipate in Jokowi pushing through his policy agenda? Many perceive Jokowi to be beholden to bigger political figures, particularly Megawati Sukarnoputri, leader of the PDI-P. Is Jokowi a leader in charge of his own destiny? Well he very much respects Ibu Megawati, no doubt about that. He said to me “She’s much

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older than me, Pak Luhud, she’s the chair of our political party, [and] being a Javanese I have to be polite to Ibu Mega; it’s my culture”. And there’s nothing wrong with that, but that’s not to say that he does everything that Ms Megawati says, and Ibu Megawati understands this. With Pak Jusuf Kalla, the vice president, I think the relations are also very good, and I think he also understands the limits of what he can say or push. I think Jokowi now understands that he has the tools or power that nobody can touch. That’s the prerogative of the president. He understands he has the tools and he [already knows] how to use these tools. With the armed forces he has said: “Hey, you remember that I am your commander-in-chief, and your loyalty is to me”. He has said this very openly. Earlier, he was perhaps less assertive, but now he’s firm. Now he talks to ministers authoritatively. This afternoon in the cabinet he reprimanded someone for changing their mind; he said he “didn’t want to hear it anymore”. In this regard he is becoming firmer. Maybe in his first six months in government Jokowi needed some time to adjust to his new office, but right now he really understands his position. He is very firm now… He knows that he has the power.

Jokowi has previously been criticised for appointing too many members of the PDI-P to ministerial positions, reportedly to keep senior members of his party happy. However, the latest cabinet reshuffle included more


experienced technocrats in key positions. Is Jokowi becoming freer to appoint whom he pleases? Yes indeed, but at the same time he needs to maintain a political equilibrium. He cannot just ignore that issue. But I think he’s putting more and more professionalism into the strategic positions like in the case of Thomas Lembong, the new minister of trade. The latest appointments are not partisan. Mr Lembong doesn’t even belong to a particular political party. I have spent a lot of time with the president and the latest cabinet reshuffle indicates that he is more confident. The economic team right now is quite okay. He is becoming more experienced in his position and the economy has improved — so he understands that his economic programmes are working well.

The recent allegations against former DPR house speaker Setya Novanto, who has been accused of demanding billions of dollars in shares from Freeport McMoran to help secure an extension of their mining contract in Papua, raise fresh questions over this administration’s ability to eradicate corruption. How is Jokowi going to address these issues? I do not believe Setya personally requested US$4bn from Freeport. I’m not trying to defend him, but I don’t see how that happened. He may have resigned, but this is due to the politics, and I don’t want to go into this. But how could this request for billions of dollars in shares possibly be carried out. How could you give away a 20% share of the company, when Freeport is a public company? How could you ask anyone like the

head of Freeport, “Give me 20%, give me 30% of the company”? Setya’s not stupid. You also have to remember that the original recording [of the conversations alleged to have taken place between Mr Novanto and Maroef Sjamsoeddin, Head of Freeport Indonesia,] has not been heard in court.

The case involving Mr Novanto and Freeport remains subject to an investigation, but it seems clear that Indonesia’s corruption eradication commission (KPK) has been weakened since Jokowi took office. No high-ranking officials have been pursued by the KPK since January, when the police launched numerous counter-investigations against the commission — widely construed as revenge for the KPK’s naming of then national police chief candidate Budi Gunawan as a graft suspect. No, I reject that. If you don’t discover any highranking officer to be corrupt, well then you’re not forced to do so. The KPK is still doing its job well. Just because there aren’t any high-level officers being caught doesn’t mean the commission is not doing its job well. If so many high-ranking officials have already been caught by the KPK then it means that we have improved the overall system, so that’s also a caveat on that argument.

Nonetheless, many observers see a need to strengthen anti-corruption measures. Can we anticipate moves to this effect in 2016? We want to revise the KPK’s regulations, and there must be an oversight committee, which


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is a new addition, similar to the Hong Kong KPK. We will also introduce criteria to establish if someone is healthy enough to undergo the processes of investigation. For example, if someone has a stroke and is dying, and they are unable to testify, then pushing them to do so is a breach of their human rights. Also, if you’re tapping someone’s phones, then the procedures to do this must be conducted exclusively from within the KPK, not outside. n

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4

Cognitive dissonance: Unclear signals about foreign investment from Indonesia Paul Rowland, Independent consultant

“

W

e are waiting for you to come to Indonesia. We are waiting for you to invest in Indonesia,” Jokowi pronounced at the APEC CEO’s Forum in October 2014. Thus began the international charm offensive aimed at jump-starting Indonesia’s economy and meeting the president’s goal of 7% growth by the end of his mandate. In April 2015, Jokowi doubled down. “Indonesia must undergo crucial restructuring,” he told over 700 business, government and civil society leaders in the opening session of the 24th World Economic Forum on East Asia. “Today, we must change from consumption back to production, from consumption to investment in our infrastructure, investment in our industry, but most importantly, investment in our human capital, the most precious resource of the 21st century.” He closed his remarks by encouraging any investors who had problems to call him personally. Jokowi is aware that Indonesia needs private investment from within Indonesia and from foreign sources to achieve ambitious goals for infrastructure development and economic growth. Indeed, the government did get off to a good start. The decision made early on to end subsidies for gasoline was a politically courageous gambit

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for a new president and may prove to be one of his most significant accomplishments. Another strong position was taken against illegal fishing, and it has, for the most part, been effective. Particularly encouraging was the announcement of a one-stop shop that promised to cut the red tape and time that it takes to register a company in Indonesia.

The government is clearly on the right track in setting up the one-stop shop but can be faulted for creating unrealistic expectations.

Cognitive dissonance This promising and energetic start stalled after a series of poor decisions that shook his supporters and the investment community alike. While the president was extolling the virtues of investing in the fourth-most populous nation in the world, line ministries were busy drafting policies that directly contradicted the president’s pitch, creating a state of confusion for investors. The Merriam-Webster Dictionary defines cognitive


dissonance as “the psychological conflict resulting from incongruous beliefs and attitudes held simultaneously”. The administration clearly suffers from this condition. In late 2014, a stream of ready-fire-aim policy announcements by line ministries directly contradicted the “open for business” mantra coming from the president’s office. The Ministry of Manpower announced that there would be mandatory Indonesian language tests for all foreigners seeking a work permit. That idea was dropped but another regulation was put in place in July 2015 that required work permits for foreign-based directors and commissioners of Indonesian companies and for even short-term deployments to Indonesia of foreign-based company staff. A ban on alcohol sales in small stores, a ban on the import of second-hand clothes because they could transmit AIDS and a cut in import quotas for Australian beef by 80% raised questions about Indonesia’s openness and depressed investor confidence. By mid-2015, the country was falling significantly short of its growth forecast of 5.7% with actual second quarter growth closer to 4.7%. Revenue collection was woefully short of the ambitious targets set in the January budget revision and spending on significant infrastructure projects was much lower than forecast. The rupiah eventually plunged to a 17-year low against the US dollar.

Diagnosis and treatment The president, to his credit, correctly diagnosed the problem and began to implement corrective measures. He shuffled his cabinet in August,

dumping some, moving others and bringing in some fresh blood to fill senior coordinating minister posts, notably Darmin Nasution to head the economic team. Perhaps most significant was the removal of the controversial Rachmat Gobel from the Ministry of Trade and his replacement with Harvard-educated Thomas Lembong. A less heralded move was to place Pramono Anung in the role of Cabinet Secretary. A veteran legislator and party official, Mr Anung has quickly moved to assert the president’s will in coordinating policy moves across government. Finally, the move of Luhut Panjaitan from the role of chief of staff to the president to the post of coordinating minister for political, legal and security affairs brought some needed heft and focus to that position. The shuffle was followed by a series of policy changes labeled “stimulus” or “deregulation” packages beginning in September. The packages have been rolled out every few weeks and, while generally positive, have been largely incremental and tactical in nature. The government seems to be addressing specific problems that they viewed as holding up investment. Perhaps the most significant change was the revocation of a Ministry of Manpower regulation on foreign workers that placed onerous requirements on foreign and Indonesian firms that employ international professionals and managers. Taken together, the shuffle and the policy changes have been a net positive for the economy. But do they add up to a strategy, something that the Jokowi administration desperately needs to put in place if it is to attract the hundreds of billions of dollars of investment it needs to boost growth?


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The single window The government did, as promised, set up a onestop shop, or ‘single window’, for investors. One year later, has it been as effective as hoped? Can the Investment Coordinating Board of the Republic of Indonesia (BKPM) actually fulfill its role as Indonesia’s investment promoter while it is still the guardian of the negative investment Llst, which bars foreign investment from selected industrial sectors? While creating a one-stop shop for investors is undoubtedly a good idea, the reality, for some investors at least, is that the acquisition of permits now sometimes takes longer, as BKPM adjusts and learns the ropes. Some line ministries and other agencies have resisted ceding authority and, while some agencies have officials embedded at BKPM, not all have the authority delegated to them to make a decision, causing further delays. One potentially exciting change is that the national government has, as of the end of December, empowered BKPM to issue a certain type of mining license, known as an IUP. This move basically claws back the role of provincial and local governments in the issuance of licenses to foreign mining companies and should herald substantial savings in both time and money for miners, at least in the long term. However, there are a number of reasons to doubt that the change will produce quick results. First, it will take time to develop the administrative capabilities of BKPM staff to take on this role. According to a foreign legal advisor with a Jakarta-based law firm, that will likely initially contribute to longer delays.

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Second, authority has not been transferred from the Ministry of Energy and Natural Resources (ESDM) and, while a ministry staff member is to be placed at BKPM to speed up the process, the pace of adaptation from existing procedures may also add to delays. Finally, there are no sanctions in the new regulations for governors, mayors or regents who refuse to comply with the measure. Given the revenues involved, local executives are likely to resist handing over this power and miners could potentially be caught in the middle of an extended battle between local and national authorities. The government is clearly on the right track in setting up the one-stop shop but can be faulted for creating unrealistic expectations as to how quickly it will help to speed up the process.

Revenue and taxation The government has set ambitious revenue targets that are supposed to power the SOE-led infrastructure surge, but fell far short of its goals in 2015. In 2016, the revenue targets are even more ambitious. Does it make sense to double down on a failing policy or plan reforms that ramp up revenue over a twoor three-year period? A leading Indonesian analyst and economic advisor to former President Susilo Bambang Yudhoyono, Raden Pardede, recently suggested that expecting to dramatically increase revenue through tax overhauls is a good idea in the long term but unrealistic and potentially damaging in the short term. Aggressive tax regulations


scare investors; aggressive tax collectors scare them even more. Business needs time to adapt to changing regulations and methods of enforcing them. Business needs predictability.

Work permits Another issue of concern to foreign investors is whether they can get work permits for their foreign senior executives as well as the technical and administrative staff that they need. While the Ministry of Manpower dropped a language test proposal after it was deemed impractical, further restrictions on working in Indonesia were put in place in July. Most of these restrictions were then rescinded in October, but the overall number of expatriates working in Indonesia has dropped by nearly 20% from a year ago. “For Rent” signs pepper houses in expat enclaves and some international schools have reported a steep drop in registrations. While some of the departures can be attributed to the downturn in global commodities prices, stories abound about the difficulty in obtaining work permits. While some of the more onerous regulations have been rescinded, the problem is deeper than just regulations. Often, the line ministry or agency responsible for the area of work, for example financial services or oil and gas, are delaying or withholding approvals for work permits for people that the employer deems qualified. Furthermore, even when approved, the work permits are often for shorter durations, resulting in an endless cycle of renewal applications. The problem is not limited to foreign companies. Indonesian companies are also complaining that they cannot hire the staff that they need. The former head

of the Indonesian Chamber of Commerce, Surya Sulisto, has repeatedly stated that Indonesia needs foreign expertise. The government cannot underestimate the degree to which this problem acts as a practical barrier to investment.

Deregulation vs reregulation While many regulations have been revised, eliminated or are being examined, a few others have been put in place. One example is in the food industry. A European official charged with facilitating business-to-business opportunities pointed out that some smaller and medium-sized European firms are at the point of abandoning years of investment due to burdensome new regulations that require Indonesian inspectors to travel to their facilities in Europe. This trend will only worsen once a new Halal law begins to take effect in coming years.

Positive, not negative Rather than adding incremental policy fixes, what is needed is a coherent long-term strategy that reverses the protectionist trends of the past decade and opens the doors to foreign capital and international talent across economic sectors. It should begin with radically revising or eliminating the negative investment list as the very name suggests that private investors are not welcome. Such a strategy would face stiff opposition from some quarters, but average Indonesian citizens tend to care most about jobs, prices and services more than they do about who provides them. And a government that scores in those areas will likely be rewarded at the polls. n


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5

Indonesia: Investment opportunities for growth Bambang Brodjonegro, Minister of finance, Republic of Indonesia

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ndonesia is open for business.

Convergence theory posits that developing economies will catch up with developed countries by replicating their production methods, technologies and institutions. Crucially, this will occur with the help of FDI. Generally long term in nature and less vulnerable to economic shocks than fickle portfolio flows, FDI not only provides a welcome source of funds and new job opportunities, but also a training ground for domestic industries. Indonesia wants and needs FDI now more than ever. And by partnering with Indonesia, foreign businesses have much to gain. Indonesia already offers a favorable environment for investors with its stable political climate, strong macroeconomic fundamentals, good strategic geographic position, abundant labour and natural resources. The 2016 budget document provides many reasons for optimism, including an economic growth forecast for 2016 of 5.3%, driven by private consumption, government spending and investment. Indonesia has adopted a disciplined fiscal management framework that balances shortterm stability with the goal of longer-term economic growth. This point has been reinforced in the 2016 budget document.

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Reforms, both enacted and planned To make Indonesia an even more attractive investment destination, a number of reforms have been enacted by this administration. For instance, since taking office last year we have streamlined the process for obtaining an investment license by establishing the One Stop Service (OSS). The OSS provides quick, simple and transparent support to businesses seeking to operate in Indonesia. The government has also created a stable system of wage adjustments through new provincial minimum wage regulation to assuage investor fears of excessive increases in labour costs. These are only a few among a series of actions designed to enhance the investment climate.

We recognise that further reform is needed to help the economy transition from dependence on commodities. The government has also announced additional policy reforms since September 2015. The reforms aim to maintain purchasing power and to


promote investment by making it easier to do business and providing specific stimulus where needed. Measures to maintain purchasing power include: increasing the taxable income threshold by almost 50%; reformulating the minimum wage calculation; fuel and energy price adjustments; and an additional allocation of rice for the poor. To provide stimulus to the business sector, the government has provided tax holidays and tax allowance changes; simpler and more streamlined permit requirements; integrated logistics facilities; the expansion of Kredit Usaha Rakyat (KUR), the government’s smalland medium-sized enterprise credit program; and some additional incentives for Indonesia’s special economic zones. Through the implementation of these reforms, the administration has made it clear that structural reforms are the key policy drivers for the future. But while we are working to make Indonesia more attractive to foreign investors, there of course remain challenges.

Resource-full Despite Indonesia’s stable macroeconomic situation and domestic market potential, we are aware of the current uncertainties of the global economy. One obstacle to an even higher growth trajectory is Indonesia’s high dependence on primary export products. This has placed pressure on our economy as global commodity prices have weakened.

We recognize that further reform is needed to help the economy transition from dependence on commodities. The focus will be on both providing a strong domestic value-added industry base and creating new opportunities for business. Indonesia has been recognized as a country with very robust domestic consumption. Household consumption remains the key driver for economic growth, contributing more than 50% of Indonesia’s economic growth. Domestic consumption has helped Indonesia maintain stable growth over a series of global economic shocks. But consumption alone will not be sufficient to boost overall income and wealth to levels that can push Indonesia beyond its middle-income status. In general growth theory, a higher economic growth trajectory requires a higher level of public capital stock. The multiplier effect of capital stock to total growth is much higher than that of consumption. Accordingly, this administration has identified infrastructure as its top priority by increasing public sector infrastructure funding and seeking to accelerate the delivery of infrastructure development via the private sector.

Investment-led growth This administration has also successfully eradicated fuel subsidies that have for years drained up as much as 287trn rupiah (US$20.7bn) from the annual budget. But even with this cash freed up, more sources of finance will be needed to fund infrastructure development.


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State-owned enterprises will be required to develop infrastructure projects and greater private-sector involvement will be encouraged through public-private partnerships (PPP). The government is providing capital to increase the financing capacity of SOEs, while also providing financial guarantees for high-risk infrastructure projects.

Indonesia. There remain many other opportunities for foreign investors to partner or collaborate with local businesses. The government is also committed to regularly reviewing the negative list to ensure that there are many opportunities for domestic and foreign investors.

These are some of the measures that demonstrate the current administration’s commitment to delivering investor-friendly reforms.

However, despite global uncertainty and other obstacles listed here, improvements in the policy environment in Indonesia have meant that FDI has been flowing in steadily.

Switching from consumption to investment-led growth is critically important to achieving our goal of higher growth and increased employment. However investment-led growth is not without risks and challenges. Large increases in investment may pose inflationary risks to the economy. Furthermore, increased investment needs to be supported by strong revenue collection. To address these challenges, the government’s five-year National Medium Term Development Plan has laid out a comprehensive development strategy, including investment targets and sources of financing. Besides the infrastructure gap and the challenges of dealing with bureaucracy, the government realises that the strict negative investment list is often raised as a barrier to increased investment. While the negative investment list may limit the total size of investment made in the country, it is government policy to provide an investment climate that supports the sustainability of some domestic business segments. We would like to emphasise that the sectors listed in the negative investment list represents a very small fraction of the total investment opportunities available in

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FDI flows

In the third quarter of 2015, total direct investment reached 140.3trn rupiah, with 66% of these investments categorised as FDI. From January through to September this year, Indonesia’s cumulative FDI reached 266trn rupiah. In the same period last year, cumulative FDI was a less impressive 22.8trn rupiah. The fact that our quarterly realisation of direct investment has been steadily improving over the past few years clearly signals that, despite global uncertainties, Indonesia is increasingly an attractive destination for investors. Indonesia offers both domestic and foreign investors incredible growth opportunities. Further, this government’s reform strategy, designed with the objective of improving the ease of doing business, clearly reflects the government’s commitment to supporting investment in the longer term. It will take some time to see these reforms come to fruition, but we have embarked on a path guiding us towards an even higher economic growth trajectory in the future. n



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6

Boosting manufacturing with investment in infrastructure Scott Younger, Director, PT Nusantara Infrastructure

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nvesting in infrastructure and to some extent education have been high priorities on government agendas over the past decade. But this investment has been blocked by a number of factors, notably bureaucratic strictures. This has led to a critical situation with a negative impact on the overall development of the economy, particularly on manufacturing. The current growth rate of less than 5% can partly be blamed on a weak global economy, but is also a reflection of perennial lack of action regarding infrastructure development. Finding the means to accelerate the infrastructure build is key to improving GDP with all sectors requiring immediate attention. Over the next 25 years, Indonesia’s youthful demographic mix provides the potential for impressive production output, but this will not happen without the infrastructure required to support an increased manufacturing base. Improvements in education at all levels, with an increasing emphasis on research and development, will also be needed to realise this potential.

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Indonesia’s youthful demographic mix provides the potential for impressive production output, but this will not happen without the infrastructure required to support an increased manufacturing base.

Power: Demand exceeds supply

Consequently, various locations, notably Sulawesi and Lampung, have been experiencing phased power cuts. For domestic consumers this is a headache, but for manufacturers and other commercial enterprises it can be damaging. In the coming months, this situation is likely to deteriorate further because of the dearth of power projects coming online. Short-term measures, such as shipping in emergency power-plant vessels, will be necessary for much of the next decade for regional, coastal towns.

Indonesian electricity demand, that increases at 6% per annum, has finally exceeded supply.

The floating power supply vessel that was dumped a kilometre inland by the 2004 Aceh tsunami



stands not only as a monument to the disaster, but to the fact that regional power shortages are nothing new. The government has estimated that over the next few years a minimum availability of new power per annum should be in the order of some 7 gigawatts, or 35 gigawatts over the lifetime of this government in order to meet demand. In the short term, the level of project preparation is insufficient for this to happen and many businesses will have to resort to their own power sources. In the past this has been achieved through the use of onsite diesel generators, and a number of businesses still retain these. The minimum time for development of a new, reasonably sized power plant from conception to operation is four years, assuming permits and licenses can be processed smoothly. The government will mainly rely on thermal power units (coal and gas), but is also expecting to ramp up contributions from geothermal and hydro plants. The advances made in battery storage technology should make solar power an alternative attractive option for direct control of electricity requirements for manufacturing businesses or industrial estate developers as well. Obviously, further manufacturing developments and even mixed township or resort developments will have to consider being self-sufficient in power requirements since the ability of the state to supply from central grid sources will not be available for quite some time ahead.

For major centres such as Greater Jakarta, which is likely to become home to 50m people over the next 25 years, the challenge of sourcing water is considerable.

Water supply: Stress mode Indonesia is well supplied with rainwater; more than 3,000bn m3 per annum falls on the archipelago, even though 40% of this is received by Papua. However, most of the country’s 131 water basins are in stress mode, meaning that for critical months of the year demand significantly exceeds supply. With the steady urbanisation that is taking place, not just in Java, but at city and town centres elsewhere too, the water demand profile is changing with domestic, municipal and industrial requirements increasing. For major centres such as Greater Jakarta, which is likely to become home to 50m people over the next 25 years, the challenge of sourcing water is considerable and needs to be addressed more quickly than before. In addition, a more serious effort to start tackling sanitation properly must be at the top of the infrastructure build out over the next decade. If Greater Jakarta is to be a safe and liveable 21st century conurbation, this must be a priority.


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The state planning agency, BAPPENAS, has estimated that approximately US$65bn will be needed to meet the 2015 Millennium Development Goals with regard to water supply and sanitation by 2019, with approximately 50% of these funds to emanate from private sector sources. The biggest blow to the water sector was the constitutional court’s cancellation of the 2004 Water Law earlier this year, which in practice meant a reversion to a 1974 version of the law. This older law is certainly not fit to meet the current demands of the country. In 1974 the population of the country was not much over 40% of today’s 256m and then there was an urgency to regenerate a poorly functioning rural/ agricultural sector with an emphasis on irrigation. The cancellation of the 2004 law was necessarily challenged by government, and this appeal is expected to be effective over the coming two years, in which time the government must prepare and ratify a law that addresses current and future needs, in the process ironing out anomalies from the 2004 law. In the manufacturing sector, it is quite common for large enterprises to make their own provision for both water supply and waste treatment. The frequent absence of adequate raw supply should also accelerate the promotion of equipment and methods to recycle wastewater for reuse, an essential ingredient for upgrading existing and new urban developments.

Roads: Not just quantity but quality needed Indonesia’s total road network amounts to approximately 480,000km of road, 90% under

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Indonesia has the lowest road density of any country in Asia.

regional jurisdictions. In fact, Indonesia has the lowest road density of any country in Asia and is assessed as needing the equivalent of some 500,000km more. There is also the question of quality with about 50% of the regency road network in poor condition. It is therefore not surprising that road logistics costs are as high as they are. The problem is arguably exacerbated when examining the network of primary and toll roads that serve the main urban centres such as Greater Jakarta, to which the main manufacturing/ industrial bases are attached. Here the road network to outlets for products is among the most jammed of anywhere globally. Accordingly, there is attraction for new ventures to seek other locations, in order to keep logistics costs to a minimum, perhaps through attachment to one of the several Special Economic Zones (SEZ) that have been established.

Ports and shipping: Overdue upgrades The main port network across the archipelago is managed by four state-owned enterprises, Pelindo I-IV. However the largest of these, based in Jakarta, has been renamed the Indonesian Ports Corporation. Each caters


to a segment of the country from west to east, respectively. The long-term plan is to amalgamate the four state-owned enterprises into an Indonesian Ports Corporation. On top of this, there are a number of local government ports and special purpose ports for shipping commodities which are largely owned by private companies. Until the mid-2000s, there had effectively been little or no investment in the ports sector for two decades, such that their condition was not fit for purpose as the economy started to expand post-2004. For the first few years from 2004 onwards, port improvements were handled through government budgets, but even then port operations remained inefficient and port dwell times were excessive. Accordingly, the current government has highlighted the need to upgrade significantly the maritime sector as quickly as possible, building on the work that has started in the overdue expansion of the container facilities of Jakarta’s main port at Tanjung Priok. Some 46 of the more important ports have been marked out for improvements and expansion across the country. The work is to be financed through a mixture of government budget, loans and private sector investment. A special case is being made for the largely neglected ports in east Indonesia. It has been recognised that in some cases there is merit in having significant ports located in SEZs with the purpose of these to attract inward investment, and with an emphasis on manufacturing industries.

Airports: Underserved Indonesia has experienced double-digit growth in passenger traffic for most of the past decade, and many airports are now carrying passenger numbers well beyond their design capacity. Furthermore, the advent of the “open skies policy” of the ASEAN Economic Community (AEC) is expected to liberalise regional air transport and further boost traffic. Jakarta’s Soekarno-Hatta airport, originally designed to carry 25m passengers annually, is now the eighth busiest in the world, carrying more than 60m passengers every year. While extensions are being carried out to the airport to partly alleviate the pressure on operations, it is evident that further capacity to serve the Greater Jakarta area is overdue. Short-term measures are being put in place with the reopening of the preceding city airport at Halim in East Jakarta, which was closed in 1985, and in ramping its capacity up to carry 10m passengers. Recently Garuda announced that from July 2016 it is to use the Pertamina Pondok Cabe airport, to the south of the city, to handle some short haul domestic traffic.

In infrastructure, the estimated shortage of qualified civil engineers is more than 100,000.


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Bali’s Ngurah Rai, the country’s second busiest airport, has been upgraded with improved facilities, but further expansion is constricted by the inability to put in another runway at the current location. There is increasing pressure for the construction of a new airport to be located in the north of the island. Overall, when comparing the number of airports that serve major metropolises such as London, New York or Los Angeles, Greater Jakarta is currently underserved. More airports in Java – such as at Kertajati in West Java, which will become the new international airport for Bandung – are required as quickly as possible. Additionally, ten second-tier airports, including Lampung, need to be upgraded and expanded, some of which could be made attractive to private sector investment. Smaller locations are to be handled by the Ministry of Transport. Altogether the locations of major airports are important to key commercial industries such as light goods, courier services and certain foodstuffs. And these in turn help larger manufacturing enterprises operate more efficiently with their efforts to minimise logistics costs.

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Education and skills Many commentators draw attention to the relatively poor quality of the general education system across the country, a lack of qualified teachers and generally poor output from schools. Overall there is a shortage in numbers of qualified teachers and technical staff, in particular of those in engineering and sciencebased professions. In infrastructure, the estimated shortage of qualified civil engineers is more than 100,000, which is a serious situation should the rate of project implementation accelerate as required. Regarding manufacturing, the companies that are now established fully realise the need for undertaking training and this has to be understood by all new investors in the sector. In addition, manufacturing requires access to large numbers of electrical and mechanical engineers and technicians that are currently in short supply. Good quality education and training is fundamental for providing the foundation for research and development, which in turn is required for product design and subsequent manufacturing. Furthermore, with the advent of the AEC, Indonesia will be in competition with its regional neighbours in a bid to attract manufacturing ventures and related investment. It will need to address education and training even more seriously than it has considered in the past to ensure that it competes successfully. n



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7

Making Indonesian manufacturing an engine of growth again: Now or never? Ndiamé Diop, Lead economist for Indonesia, World Bank

F

rom 2003-2012, the world went through one of the greatest commodities booms of all time. And as one of the most commodityrich countries in the world, Indonesia reaped the rewards. Benchmark international prices for coal, crude palm oil, rubber and crude oil each rose threefold, in real US dollar terms, between 2000 and 2010. Indonesian exports increased sharply, investment recovered to pre-1997 Asian financial crisis levels, and household incomes increased, boosting private consumption.1 Annual GDP growth averaged 5.8% in this period. But one of the side effects of the commodity boom was to render manufacturing activities unattractive to investors. Why invest in manufacturing if the returns to investment in commodities are a multiple of what can be earned in the manufacturing industries? Now that the region’s economic headwinds have changed, this over-reliance on commodities has come at a cost. Since 2012, commodity prices have fallen dramatically and are expected to remain persistently low. Lower commodities prices pose delicate macro-fiscal challenges as they

undermine export and government revenues, investment in key resources sectors and nearterm growth. The end of the commodities boom should be interpreted as a unique opportunity to revive manufacturing industries.

While Indonesia comprises about half of ASEAN’s total labour force, it represents only 16% of the grouping’s manufacturing exports.

Commodities boom and the premature decline of manufacturing industries Once a global industrial powerhouse, Indonesia’s manufacturing sector has been sluggish since the early 2000s, with commodities overtaking manufacturing as Indonesia’s largest exports in 2006. Today, seven out of the top ten export products of Indonesia are commodities and about 60%

See World Bank (2014): Avoiding the Trap. 2014 For some commodity products, exporting in an unprocessed form is rather the norm. This is the case for coal for instance. This is also the case for copper concentrate for which most of the value-added is already obtained at the “concentrate” (i.e., minimal processing) level. 3 This is somewhat expected. Engel’s Law effects in consumption imply that demand for services tends to increase with income due to higher income elasticity of demand for services relative to agricultural and manufacturing products (Chenery and Syrquin 1975; Chenery, Robinson, and Syrquin 1986). 1 2

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of the country’s exports are commodities or commodity-related (Figure 1). Most of the commodities are exported unprocessed. Concurrently, high-tech exports as a share of total manufacturing exports declined from 16% to 11% in 2005-08.2 While Indonesia comprises about half of ASEAN’s total labour force, it represents only 16% of the grouping’s manufacturing exports. The consequence of these structural developments has been premature de-industrialisation. A decline in the share of manufacturing output in GDP is observed across Asia (Figure 2).3 However, Indonesia’s deindustrialisation is happening at a low level of per capita income, and hence is ‘premature’. This reflects the fact that limited investment went into manufacturing from 2003-2012. Although Indonesia’s investment-to-GDP ratio rose to 32% in 2012, higher than India’s 30%, 85% of

Fig 1: Commodities have taken over manufacturing as the largest exports (share to total export, percent) Manufacture based

gross capital formation was accounted for by construction. FDI grew by 21% to US$23bn in 2014, but was concentrated in services (retail, trade and finance) and agribusiness — not in infrastructure or manufacturing. A key factor behind the decline in manufacturing is the appreciation of the real effective exchange rate (REER). This corresponds to the nominal effective exchange rate (the value of a currency against a weighted average of several foreign currencies) divided by a price deflator or index of costs. It is well-known that rents from commodity resources tend to inflate nominal wages and prices in the areas where the commodities are produced and in the non-tradable sectors. Thanks to the high (international) price for their products, firms in the booming sectors can afford higher wages. Similarly, firms in non-tradable sectors (e.g., hotels, restaurants and retail trade) can accommodate increasing wages and

Fig 2: Indonesia’s global manufacturing market shares are low and stagnant (percent) Tiongkok (LHS)

Commodity based

Indonesia (RHS)

Malaysia (RHS)

70

18

3.0

60

15

2.5

12

2.0

9

1.5

6

1.0

3

0.5

0

0.0

50 40 30 20 10 0 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013

1990 1993 1996 1999 2002 2005 2008 2011 2014

Source: COMTRADE based on WITS and World Bank staff calculation

4

For related theoretical developments, see Corden and Neary 1982, Corden 1984. For empirical tests of these concepts, see Rodrik 2008; Havrylyshyn 2010. © The Economist Intelligence Unit Limited 2016

36


Philippines, Vietnam and Malaysia, not because of how much workers were paid but because of how little they produced (the dramatic rise in unit labour cost in Thailand reflects the same issue). Malaysia illustrates how high labour productivity is crucial for cost competitiveness. Despite high manufacturing wages, Malaysian workers remain competitive because of their high productivity. Their unit labour cost is slightly higher than Indonesia’s, despite wages

prices by passing them on to consumers. In nonresource tradable sectors such as manufacturing, however, firms are price-takers and cannot pass on the increases in non-tradable prices (including wages). Thus, an increase in the price of non-tradable goods relative to tradable goods is an obstacle for manufacturing industries because it renders these sectors less profitable than the services sector or the booming resources sectors.4

The role of labour productivity

Only about 30% of Indonesian firms are in the formal sector compared with 95% in Brazil and 96% in China.

Indonesia’s labour cost patterns are striking. While Indonesia has the lowest wage cost in US dollar terms in Asia, this advantage is lost when adjusted for labour productivity (Figure 3 and Figure 4). Unit-labour costs — the ratio of how much workers get paid to how much they produce — were in 2014 higher than in the

Fig 3: Manufacturing average monthly wages (in real 2012 US$) China

Indonesia

Fig 4: Unit labour costs (2012 = 100)

Malaysia

Philippines

800

160

600

140

400

120

200

100

0

80 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: Calculations based on CEIC data

37


2011

Thailand

2012

2013

Vietnam

2014


that are 7-8 times higher. Wages in China have increased threefold since 2005, but lack of data prevents us from calculating unit labour costs. It is not clear, therefore, that China is losing costcompetitiveness, since rising wages may be offset by productivity increases. Labour productivity depends on the types of production (for example, low versus higher value-added production), levels of technology used, skill levels of workers and work disruptions. Indonesia gradually ascended the manufacturing value chain in the 1990s, but this trend was reversed by the commodities boom, and high-technology exports as a share of total manufacturing exports declined. Levels of value addition, technology and skills are also strongly correlated with the level of informality in production. Only about 30% of Indonesian firms are in the formal sector compared with 95% in Brazil and 96% in China.

The role of indirect costs Surveys show that Indonesian firms incur large indirect costs due to poor logistics, and cumbersome licensing and permitting procedures. This places them at a disadvantage to their peers operating in countries where these costs are lower. The Indonesian government’s recent policy packages to reduce these costs are therefore timely. Good logistics is a vital prerequisite for supplying domestic markets efficiently and competing internationally. At about 24% of GDP, the cost of logistics — moving goods around the country,

5

6

as well as in and out — is high in Indonesia, while Thailand spends about 16% of GDP on the same. For Indonesia, this difference amounts to US$70bn per year. A recent World Bank survey of manufacturers across Indonesia’s major agglomerations shows a breakdown of logistics costs. Average total logistics costs reflect transport and containerhandling costs (40% of the total), inventory costs (26%), warehousing (17%) and logistics administration (17%). Inventory costs are clearly much higher than in some of Indonesia’s competitors, at only 13% of total costs in Malaysia and 16% in Thailand. High inventory costs reflect uncertainties in the supply chain. A key source of uncertainty lies in hinterland connections. Costs of bringing containers to Jakarta’s main port are double those in Malaysia, although distances are similar. A survey of 83 trucking firms operating in Greater Jakarta highlights why: prolonged idle and waiting times due to congestion, long queuing at the port, and low efficiency in synchronizing cargo deliveries and pick-ups. Regulatory procedures, licensing and permitting at the central level are also complex, imposing additional delays and costs. Along with construction permits, paying taxes and enforcing contracts in Indonesia are among the most cumbersome procedures globally (World Bank Group, Doing Business survey).5 The government has announced the establishment of many special economic

It takes more than 200 days to get a construction permit. This performance is below the regional (East Asia and Pacific) average and its peer countries’ performance: the Philippines ranked 95th, China 90th, Thailand 26th, and Malaysia 18th. Economic zones are normally established to act as catalysts for trade, investment, and wider economic growth. In different countries and at different times, however, the specific objectives vary, from attracting FDI to creating employment to experimenting with reforms. © The Economist Intelligence Unit Limited 2016

38


zones (SEZs), which could help reduce the regulatory burden for specific sectors and products immediately while the nationwide regulatory reform effort continues. Given what is constraining competitiveness in Indonesia, SEZs could be designed as favourable micro-climates for productivity growth. Tax incentives, when provided, could be linked to productivityraising actions such as training workers to enhance labour productivity.6

The time is now for Indonesia to regain competitiveness in manufacturing The constraint on manufacturing growth imposed by the appreciation of the real exchange rate during the commodities boom is now largely removed. Commodities prices are no longer where they once were, and this improves the relative attractiveness of manufacturing activities for investors seeking high returns. Furthermore, since 2013, the sharp nominal depreciation of the rupiah should have improved prospects for Indonesian manufacturers, although to what extent is unclear. While the rupiah has clearly weakened vis-à-vis the US dollar, Indonesia’s rupiah has slightly appreciated vis-à-vis the Japanese yen and other currencies due to high inflation. Furthermore, while a weaker rupiah would lower the cost of Indonesia’s finished products in international markets, it also raises the cost of imported parts, eroding the pick-up in net trade that Indonesia would gain from a softer currency.

That said, with inflation coming down from its high level of the past three years (4.6% expected in 2016 against an average 6.5% in 2013-15), the REER is likely to be more supportive to manufacturing exports going forward. The government’s recent reform drive is another factor providing a favourable context for reviving manufacturing competitiveness. For the first time in years, the policy direction seems to be shifting from inward-looking policies that increased costs and discouraged new private investment and competition, to policies that reduce the regulatory burden on firms and embrace global trade. This is illustrated by the government’s seven policy packages over the past four months and its expressed interest in joining the Trans-Pacific Partnership (TPP). This recent change in policy direction, if sustained, will provide the right context and levers for Indonesia to enhance its global competitiveness.

Powerhouse potential? Today, more than 50% of Indonesian workers are employed in agriculture and low-end services. Indonesia should seek to expand job creation in manufacturing and high-end services.7 The average productivity of workers in manufacturing remains five times higher than in agriculture.8 Indonesia will see rising aggregate productivity growth if most of the 15m or so additional individuals who will join the labour force by 2020 are employed in manufacturing and high-end services. But manufacturing productivity is still far lower than in Malaysia, Thailand and China.

The skills requirement in the high-end services sector is however higher, implying that the scope for job creation in manufacturing is much larger given the average levels of skills in the labour force. 8 World Bank (2014): Indonesia: Avoiding the Trap. 7

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The challenge is therefore not only to create jobs in manufacturing, but to enhance workers’ skills and transform jobs into better-paid ones.

If Indonesia is to reach its goals, now is the time to pull out all the stops to return to its former status as a manufacturing powerhouse. n

The drawbacks identified earlier can be overcome if the country adopts specific measures: n First, with labour productivity-raising measures, such as in-firm training, access to credit to finance new equipment and new technology, and facilitating workers’ mobility by reducing labour market rigidity. n Second, with measures to reduce logistic costs, by strengthening inter-agency coordination for better logistics policy reform implementation; reducing regulatory bottlenecks in the supply chain and enhancing trade facilitation; and closing gaps in logistics infrastructure. n Third, by facilitating licensing and permitting, reducing costs of doing business and promoting FDI, for instance by reducing the negative investment list, to inject new capital and technologies in closed sectors. SEZs could also help by rapidly providing favourable micro-climates for firms’ and workers’ productivity growth. Many of the barriers to industrialisation, from bureaucratic red tape to poor-quality infrastructure, are well documented. The challenge has often been finding the right entry point. The recent policy packages provide a framework for implementing many needed reforms, together with the momentum created by Indonesia’s expressed interest in joining the TPP.


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