Open for business? Investing in Indonesia’s new era A report from the Economist Intelligence Unit Sponsored by Shell Open for business? Investing in Indonesia’s new era © The Economist Intelligence Unit Limited 2015 Open for business? Investing in Indonesia’s new era Contents Preface Author biographies 2 Reform or conform: Indonesia’s political landscape Jack Hewson, contributing editor, The Economist Intelligence Unit Promoting policy certainty, unlocking investment potential 7 Wijayanto Samirin, co-founder and managing director of Paramadina Public Policy Institute, and economic advisor to Vice President Jusuf Kalla Regulation and economic nationalism in Indonesia: The investment impact 13 Keith Loveard, senior analyst, Concord Consulting Indonesia’s logistics services sector: The key to boosting growth potential 17 Josephine Bassinette, manager, operations and portfolio, World Bank Indonesia Moving up the value chain: the rise of Indonesian manufacturing 23 Destry Damayanti, executive director, Mandiri Institute Working towards a sustainable future for Indonesia’s rural economy 27 Steve Rhee, programme officer, natural resources, Ford Foundation © The Economist Intelligence Unit Limited 2015 Open for business? Investing in Indonesia’s new era Preface Saying a country has entered a new era after an election is a familiar conceit However, Indonesia has earned it President Joko Widodo, known locally as Jokowi, was elected in 2014 and represents a break for the world’s fourth-most populous country from years of being run by political elite Even before taking presidential office, he had won national popularity for his hands-on approach as governor of Jakarta, community walkabouts and humble origins Before his political career, Jokowi, the son of a timber collector, sold furniture He also represents the political outsider who brings new perspective to Indonesia’s nagging issues that overshadow its budding promise Woeful infrastructure, deeply embedded political corruption and growing wealth inequality are long-running problems that compounded the challenge of slowing growth and falling commodity prices in 2014 The Economist Intelligence Unit (EIU) expects GDP growth to average 6.1% a year in 2015-19, compared with growth of around 5% in 2014 The rebound will come from an improvement in the business environment stemming from structural reforms initiated by Jokowi’s administration In addition, as Indonesia becomes better integrated into global supply chains, its manufacturing sector can grow and boost exports © The Economist Intelligence Unit Limited 2015 At the November 2014 APEC CEO summit in Beijing, Jokowi closed his formal address by saying: “We are waiting for you to come to Indonesia We are waiting for you to invest in Indonesia.” This report is focused on the opportunities and challenges of investing in the country, and the EIU asked experts from research, industry and academia on how long South-east Asia’s largest economy may have to wait Shell 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 Open for business? Investing in Indonesia’s new era Author biographies Jack Hewson 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 bachelors in politics and philosophy from the University of Manchester and a masters in investigative journalism from City University London Josephine Bassinette has been the manager of operations and portfolio for the World Bank in Indonesia since 2012 Prior to coming to Indonesia, she has had a long career in the World Bank Group including in Afghanistan, China and Mongolia, and many years in the Middle East region including projects associated with the challenges of trade and logistics between the West Bank and Gaza and its neighbours Wijayanto Samirin is the vice rector of Paramadina University, and is also the co-founder and managing director of Paramadina Public Policy Institute Before joining Paramadina in 2007, he worked in investment banking and the hedge fund industry for ten years Recently, he was appointed as expert staff to Jusuf Kalla, Vice President of Indonesia Mr Wijayanto, a Fulbright scholar, has published four books and more than 100 columns in national as well as international media Destry Damayanti has spent more than eight years with Mandiri Group as a chief economist In May 2014 she was also appointed as the executive director for the Mandiri Institute, an independent think-tank founded by Bank Mandiri She was also recently assigned as chair of the Economic Task Force at the Ministry of State Owned Enterprises which reports directly to the minister Before joining Mandiri Group she worked at Citibank, the British Embassy, and the Ministry of Finance Keith Loveard has been reporting on Indonesia since 1990 After a career in journalism in Australia, he became the Jakarta correspondent for Hong Kong-based Asiaweek magazine in 1990 He worked for the Indonesian government as an advisor on public affairs to the Ministry of Industry and Trade in the Megawati administration and for many years was a guest lecturer on media management at the Ministry of Foreign Affairs Following the change of government in 2004, Mr Loveard joined Concord Consulting, where he is senior risk analyst Steve Rhee has held research and policy posts at several institutions, including the Center for International Forestry Research (CIFOR) and the US Department of State He has worked on natural resource governance in Indonesia since 1996 and has also worked in mainland South-east Asia, Timor-Leste and Nepal Mr Rhee has received broad recognition for his evidence-based policy work, including being selected as a Fulbright Scholar, a US National Science Foundation grant recipient, a postdoctoral fellow at Harvard and Columbia Universities, and the American Association for the Advancement of Science’s (AAAS) Science & Technology Policy Fellowship n © The Economist Intelligence Unit Limited 2015 Open for business? Investing in Indonesia’s new era Reform or conform: Indonesia’s political landscape Jack Hewson, contributing editor, the Economist Intelligence Unit A ldi Pradono sits on a beat up sofa waiting for his next fare on Jalan Bangka Raya, a busy street in south Jakarta Working as a motorbike taxi driver he must pay for his own bensin, or gasoline Despite a 30% fuel subsidy cut in November 2014, a policy of new President Joko Widodo, most of his old customers still want the old fares “I only made three million rupiah (US$235) a month before the price went up, so it’s harder for me,” he said “But, yes, I’m still glad I voted for Jokowi, we’re proud of him here.” The ability of Jokowi to implement unpopular subsidy reform is a measure of the current strength of his political capital But it may also be an early indicator of his apparent willingness to prioritise economic sense over approval ratings The archipelago nation needs massive investment to continue the almost 6% average GDP growth rate it has experienced over the past decade This may pose challenges for Mr Aldi right now, but in the long term it’s good news for Indonesia The archipelago nation needs massive investment to continue the almost 6% average GDP growth rate it has experienced over the past decade The government estimated that the 2014 fuel subsidy cut would save 120trn rupiah (US$9.6bn) that could be redirected into infrastructure spending and government services This is a good start, but Jokowi has said US$500bn of investment will be needed—mainly from the private sector—to achieve his target of 7% annual GDP growth by 2019.1 Much to To secure foreign investment, the new administration will need to address a number of long-standing regulatory and policy issues, including abstruse business licensing processes, widespread corruption and nationalist elites that have historically obstructed foreignoperated businesses Jokowi himself will need to clarify his position on “resource nationalism” through his handling of the unprocessed mineral ore export ban, which was upheld by the constitutional court in December 2014 The imposition of punitive taxes on the export of Type minerals, like copper, iron ore and lead, has been successful in forcing foreign miners to commit to build smelting facilities But the more stringent criteria for miners of Type minerals, like Moestafa, Berni; Chatterjee, Neil and Mathieson, Rosalind “Widodo targets Indonesian growth unseen since Asia crisis.” Bloomberg, July 23, 2014 © The Economist Intelligence Unit Limited 2015 Open for business? Investing in Indonesia’s new era Mind the gap Current account balance, % of GDP Indonesia Emerging Asia 2010 2011 2012 2013 -2 -4 Source: EIU nickel, bauxite and tin, appears too demanding to be met and seem likely to result in little benefit for either Indonesia or the mining industry as exports decline and workers are laid off Despite the mineral ore export ban’s lack of nuance, carrots and sticks will be needed to guide Indonesia’s industries up the value chain As global commodity prices fall, Indonesia can no longer rely as much on its resource extraction industries to drive GDP growth Moreover, Indonesia’s weak position in global supply chains does not help its current account imbalance, as high-value imports flood in to feed a domestic consumption boom With an additional 90m Indonesians expected to join the consumer class by 2030, reviving Indonesia’s manufacturing sector must be a priority for the incoming government.2 Widening gap Despite these bright economic forecasts, the divide between Indonesia’s rich and poor is widening Between 2003 and 2010, the consumption of the richest 20% of Indonesians grew by 6%, but for the poorest 40% of households, it grew by only 1% This inequality is particularly pronounced in rural areas and Indonesia’s more remote eastern provinces where rural transportation infrastructure is hazardous and electrification ratios are as low as 30% Access to healthcare and education can also be limited, of very poor quality, or non-existent The over-development of industries, like coal mining, palm oil and pulp and paper, is also the main driver of Indonesia’s prolific carbon dioxide emissions, and is damaging rural communities— many of which have not benefitted from the resource-extraction and agribusiness boom Despite bright economic forecasts, the divide between Indonesia’s rich and poor is widening Pushing his reforms through parliament may pose significant challenges for Jokowi While his “everyman appeal” has earned the support of Mr Aldi and millions like him, this popularity Budiman, Arief; Chhor, Heang; Razdan, Rohit and Sohoni, Ajay “The new Indonesian consumer.” McKinsey&Company, December 2012 © The Economist Intelligence Unit Limited 2015 Open for business? Investing in Indonesia’s new era is not reflected in the House of Representatives (DPR) where he is opposed by the Red and White Coalition (KMP), loyal to losing presidential candidate Prabowo Subianto, a former special forces commander and head of the Gerindra Party The KMP is backed by Golkar, the former political wing of the military and Indonesia’s second largest party, which is regarded as a vehicle for Indonesia’s old political elites Much of Indonesia’s establishment view Jokowi, who has campaigned on an anti-graft platform, as a threat to their supremacy Policy obstacles Unless cracks appear in the KMP, Jokowi may struggle to enact his policy agenda © The Economist Intelligence Unit Limited 2015 Unless cracks appear in the KMP, Jokowi may struggle to enact his policy agenda For example, he has been able to cut subsidy funding without the approval of parliament However, proactively diverting the funds into infrastructure will require a revision of the 2015 state budget, and he will not be able to that without parliamentary approval Open for business? Investing in Indonesia’s new era The Democrat Party (PD), led by former President Susilo Bambang Yudhoyono, is considered the most likely organisaion that could be persuaded to leave the KMP over its opposition to a controversial bill to abolish direct regional elections However, it is unlikely that KMP opposition will be uniform and the nuances of getting other legislation passed are likely to be complex and varied, depending on the content of the legislation Jokowi has a clear vision for Indonesia’s economic expansion over the next five years, but it remains unclear if this vision can be implemented n © The Economist Intelligence Unit Limited 2015 Open for business? Investing in Indonesia’s new era Promoting policy certainty, unlocking investment potential Wijayanto Samirin, co-founder and managing director of Paramadina Public Policy Institute, and economic advisor to Indonesia’s Vice President Jusuf Kalla M attract global investment and to allow its economy to flourish illions of spectators from all over the world—including thousands of Indonesians, who stayed up until the early hours—tuned in to watch the Spanish football league’s premier fixture in October 2014 Unlocking Indonesia’s potential Home to about 40% of South-east Asia’s population, land mass and economic capacity, Indonesia is a country with huge economic potential But there is a disparity between potential and reality For example, despite huge foreign direct investment growth over the past decade, Indonesia’s FDI to GDP ratio is still only 2.6%, half that of Vietnam Investment faces three main obstacles: policy uncertainty, infrastructure reliability and quality of human capital The match, also known as El Clasico, is the faceoff between La Liga’s two greatest teams: Real Madrid and Barcelona Like the British Premier League, or the German Bundesliga, La Liga is a multi-billion dollar enterprise— with millions of viewers drawn in by the quality of the football And one reason why La Liga generates such skilled playing is because its referees stringently enforce the rules of the game The world of investment is not so different and just like La Liga, Indonesia needs clear and fair rules to Improving human capital and infrastructure will take time and will require mid- to long-term Inward FDI South-east Asian economies, 2013 Inward FDI, in USDbn (2013) 23.0 Indonesia 2.6% 12.9 Thailand 3.3% 12.3 Malaysia 3.9% 8.9 Vietnam Philippines Inward FDI/GDP (2013) 3.8 5.2% 1.4% Source: UNCTAD, Indonesia Investment Coordinating Board E rnst & Young Indonesia, Gadjah Mada University and Paramadina Public Policy Institute “Partners in Prosperity: The Impact of US Foreign Direct Investment on the Indonesian Economy.” AmCham Indonesia, 2013 © The Economist Intelligence Unit Limited 2015 Open for business? Investing in Indonesia’s new era of two Indonesian companies in the port of departure A ship leaving from Bangkok takes only three days to get to Jakarta; yet the verification report may be one week behind, leaving the ship idle in port Likewise, laws and regulations, covering everything from the sale of marine fuel oil (currently about 2530% higher than international market prices), dock workers and the nationality of officers and crew under Indonesia’s cabotage laws, are limiting competition, adding to costs and making it harder for more reputable shipping lines, both domestic and foreign, to compete n Process uncertainty and irrationality: Efficient port operators around the world use up-to-date computer systems and operational protocols that move goods in and out of ports quickly, securely and with certainty These are yet to be fully embraced in Indonesia, meaning ports across the archipelago are congested, often chaotic and cause delays for both international and domestic trade In one industrial estate in west Java, manufacturers report that they hold, on average, an extra US$1m in inventory compared to competitors in Malaysia to account for the operational uncertainties associated with receiving goods on time Invest or unblock? Clearly, there is an enormous need for investment in Indonesia’s ports Across Indonesia, port infrastructure is unable to handle demand and the requirements of modern logistics for the country’s growing economy As much as US$60bn of additional investment is needed from both public and private sectors over the next five to ten years This includes dredging to support larger ships where appropriate, expanding and 19 © The Economist Intelligence Unit Limited 2015 reinforcing docks to accommodate cranes and loading areas to support more efficient handling of containers on and off ships, new jetties to separate cargo handling from passengers in more remote islands, and facilities for storage and the better movement of trucks Investment in the interface between ports and the hinterland is also essential so containers can be moved efficiently out of ports, and trucks can enter with certainty and support rapid unloading of ships once in berth In locations like Ambon, containers sprawl over the port, with cargo being discharged piece by piece into trucks, while food carts and small shops operate inside supposedly secure premises Overall, ships have to spend too long calling in Indonesian ports, raising costs and discouraging shipping lines from stopping at Indonesian cities The World Bank and Pelindo II, a state-owned port operator responsible for many of Indonesia’s biggest ports, are preparing a study of the potential investment needs of some 20 key ports But if port infrastructure is looked at in isolation, investments like these will not make a difference to the big ports of Java, Sumatra and Sulawesi, much less places like Jayapura, Ambon, and Sorong Rather, the entire supply chain needs to be considered in prioritising and aligning public infrastructure investment This means coordinating investments that promote connectivity, including road connections, freight handling areas and energy supply for things like cold storage These investments will result in higher rates of return, not only in the ports, but in port cities more widely They are likely to produce better outcomes than investments focused exclusively, for example, on expanding ports to accommodate extremely large ships Open for business? Investing in Indonesia’s new era In addition, from the largest to the smallest ports, there is a huge amount that can be done to improve regulatory frameworks that could have an immediate impact In fact, these “soft” improvements are a necessary precondition to extracting more value from existing and future investments in infrastructure The new administration has announced its intention to streamline regulatory mechanisms and unnecessary processes that hamper business These are but a few that could be rolled out relatively quickly: to ensure compliance with INSW and to screen out redundant or corruptionprone regulations n Change regulations which limit competition in areas such as dock handling, marine fuel supply, ship inspection Many of these requirements are linked to provision of services by a single entity, often a state-owned enterprise, with predictable consequences on efficiency, cost and transparency Can the prices be the same in Java and Papua? n Wide application of the “berth window” system: Well-run ports have fixed times for ships to dock, unload and reload (similar to airports) These systems are linked with the necessary stevedoring and ground transportation Putting this system in place would not only reduce the time that ships are in port and improve utilisation of port facilities, but would also force vessel operators to adhere to fixed schedules (or drop out of the business) This would improve supply chain management and reliability State-owned port operators have begun to implement elements of this system in some ports Indonesia’s geography and demography mean the costs of shipping and logistics will always be higher in Indonesia’s east than in the bustling population centres of Java In Iceland, the country generally runs efficient ports, but its cost of shipping is considerably higher compared to mainland European ports This is because Iceland’s isolation and relatively small population mean ships calling at its ports are smaller and have to burn more fuel to make the trip The reality of Iceland’s trade also means that ships will need to leave Iceland with relatively more empty containers, making the trip less profitable and imports more expensive n Finalise and institute the “one-stop” National Single Window (INSW), an ICT-based platform to facilitate more efficient, transparent and predictable border clearance processes In practical terms, it would mean shippers would fill out one electronic form, rather than up to 12 forms all of which require direct interaction with different agencies Indonesia’s eastern islands will have lower shipping costs if they operate more like Iceland, but it will always cost more to get goods there and the bulk of trade will likely remain primarily one-way However, shipping costs alone probably contribute less to the high cost of goods in the eastern islands compared with the lack of a pull supply chain An unfriendly business environment, scattered communities, difficult land acquisition and a lack of energy infrastructure discourage businesses from setting n Set a mechanism to ensure alignment and integration of any new trade procedure © The Economist Intelligence Unit Limited 2015 20 Open for business? Investing in Indonesia’s new era up in the region Even if shipping were efficiently run and goods could reach Papua at the same cost as the central islands, consumers may not see much improvement without this pull What then for the fishermen? For the fishermen of Kampung Pulo, the answer lies in the potential supply chains that could transport their tuna beyond Jayapura Investment in physical infrastructure and more efficient port operations in the east would improve the flow of trade within Indonesia and could create an eastern Indonesian consolidation centre—enticing ships steaming past on the run from Australia to the north Trade in and out of the eastern islands could also be increased if other industries, like cattle, could be encouraged through a more friendly business environment and better trade policies Energy investment is required to support cold storage for higher value-added farming and manufacturing Much also depends on changing the regulations and restrictions which discourage higher-end Indonesian shipping and encourage corruption In the short term, the government could make it easier for well-equipped refrigerated Indonesian ships to carry fish from Papua and the Maluku islands to Jakarta, Singapore, Hong Kong and beyond Recent high profile arrests of Malaysian and Vietnamese fishing fleets operating illegally in Indonesian waters imply that there is a good international market nearby n 21 © The Economist Intelligence Unit Limited 2015 Open for business? Investing in Indonesia’s new era Across Indonesia, port infrastructure is unable to handle demand and the requirements of modern logistics for the country’s growing economy © The Economist Intelligence Unit Limited 2015 22 Open for business? Investing in Indonesia’s new era Moving up the value chain: Reviving Indonesia’s manufacturing sector Destry Damayanti, executive director, Mandiri Institute O n the day of his inauguration as finance minister in October 2014, Bambang Brodjonegoro told reporters that his priority would be to maintain Indonesia’s economic resilience by boosting industry It is encouraging to see that such a key figure in the administration of Joko Widodo has his priorities right Over the past 15 years, Indonesia has experienced a period of de-industrialisation as manufacturing growth failed to keep pace with broader economic expansion In turn, de-industrialisation has made the structure of the manufacturing sector increasingly fragile— pushing the current account further into deficit and weakening Indonesia’s position in global production networks De-industrialisation has made the structure of the manufacturing sector increasingly fragile Manufacturing has not kept up South-east Asia’s biggest economy has enjoyed rapid inflows of foreign investment since 2011, fueling economic expansion, but 23 © The Economist Intelligence Unit Limited 2015 De-industrialisation by the numbers While Indonesia’s GDP growth has averaged just below 6% for the past decade, manufacturing growth has lagged at 4%-5% In early 2000 manufacturing contributed 30% of GDP, but by 2013 this contribution had dwindled to just 24% Indonesia’s manufacturing sector is consequently trailing behind its regional rivals Indonesia’s export of manufactured goods as a percentage of GDP in 2012 was only 8%, much lower than Malaysia (46%), Thailand (44%), Vietnam (50%), China (23%) and the Philippines (17%) Low exports of Indonesia’s parts and components, which account for 1% of GDP, compared with more than 7% for both Malaysia and the Philippines— further illustrate Indonesia’s failure to secure a strong position in global production networks Sources: EIU, WTO, UN Comtrade the manufacturing industry has been forced to import growing amounts of raw materials and capital goods to keep up Over the past six years, this trend has become increasingly pronounced In 2013, the percentage of products Open for business? Investing in Indonesia’s new era manufactured from imported raw materials increased to 68% of total manufactured products, up from 62% in 2008 As investment inflows have increased concurrently with raw material imports, Indonesia has endured an ongoing current account deficit: reaching around 4.4% of GDP in the second quarter 2013, before it eased to 3.1% in third quarter 2014 Exacerbating these difficulties is the fact that 93% of Indonesia’s manufacturers produce medium and low value-added goods, such as basic electrical products, textiles and ores-slag, while imports are dominated by medium and high value-added goods, such as technology products, machinery and iron and steel It is not surprising then that the trade balance of the manufacturing sector continues to face pressure As a consequence manufacturing is highly exposed to global economic conditions and exchange rate fluctuations And the high dependence on imported raw materials means Indonesian exports are not more competitive when the value of the rupiah depreciates Theoretically a weak rupiah should make Indonesian exports cheaper and more attractive But Bank Mandiri’s economic team concluded differently We discovered that 1% depreciation in the value of the rupiah often results in a 1.3% decrease in manufacturing sector imports, as these imports became more expensive However, we also noticed that exports decreased by 0.3% even though a depreciating rupiah should theoretically make export goods cheaper It seems obvious from these findings that strengthening Indonesia’s processing industries is a very important part of the major structural reforms needed in the manufacturing sector The spirit of industrialisation must be re-embraced by Indonesia’s business community Three strategies to improve manufacturing The spirit of industrialisation must be reembraced by Indonesia’s business community and regulators and there are three specific areas of manufacturing that Jokowi’s administration should prioritise n “Mother industries”, or manufacturing industries that have extensive links with other industries: These operations provide raw materials for more complex manufacturing Economic development, accompanied by increasing demand for infrastructure, property, automobiles, consumer goods and food and beverages, will of course lead to growing demand for raw materials like steel and plastics Meanwhile refining capacity needs to be upgraded to better meet domestic demand, both in the industrial and transportation sectors This strategy must be supported by solid energy sector policies that enable the development of renewable energy and reduce dependence on energy imports To this end the recent fuel subsidy cuts are a promising step and savings from the subsidy reforms should be diverted into incentives for investors to develop major manufacturing industries © The Economist Intelligence Unit Limited 2015 24 Open for business? Investing in Indonesia’s new era n Labour intensive industries: These businesses are characterised by strong export competitiveness with high import dependency, like textiles, footwear and food and beverages Of course, Indonesia should develop its high-tech industries to increase productivity and rise into the group of upper middle-income countries But since unemployment remains high at around 6.3%, labour-intensive industries have to be promoted, especially those that are export competitive In doing this, imported components should be replaced as much as possible, particularly in the textile and food and beverage industries where import needs are high n Industries that have entered into regional production networks yet have a high import dependency: This category includes automotives and electronics Even though replacing imported components for these two industries is dependent on the policies of foreign companies and governments, creating a favourable investment climate, improving connectivity infrastructure, and enhancing the capacities of domestic businesses in the production value chain will lead to greater efficiency and competitiveness This should serve as an incentive for foreign manufacturers to turn Indonesia into a main production base Execution of these three strategies will require a strong and consistent commitment on the part of Jokowi’s administration Tax incentives, import duties and improved access to finance will be required, among other measures The development of industrial areas would also help to support manufacturing expansion 25 © The Economist Intelligence Unit Limited 2015 Much can be learned from China In the steel industry Chinese manufacturing is supported to enhance their value chain and compete internationally through cash and land grants, tax incentives and encouraging companies to move from debt to equity The Chinese petrochemical industry also has clear targets to boost the use of domestically manufactured raw materials In Thailand, the government encourages investment in the petrochemical industry in the form of land ownership and tax incentives, and there are reduced import tariffs for machines needed to support the processing industry Legislating change Legislation targeting the expansion of Indonesia’s processing industries during the previous Yudohoyono administration included the Coal and Minerals Mining Law, which took effect in early 2014 The law placed an effective ban on the export of unprocessed mineral ore, unless miners build processing smelters to generate raw materials for domestic Open for business? Investing in Indonesia’s new era industries The ban has forced miners to pay attention to the government’s demands and many are building processing facilities In this regard the legislation has been partially successful, but the terms of the ban have been too harsh for some miners—particularly of Type minerals, like nickel and bauxite— and many smaller mining operators may go out of business Moreover, because the law has not been backed up by comprehensive policies in other sectors, the ban’s effectiveness has been diminished The abruptness of the measures has also been perceived as jarring and unreasonable by many foreign investors With the reduced tax and export revenues that resulted from the mineral ore export ban, many were surprised that the law was actually implemented Going forward the government must learn from these experiences to ease transition to new policies to boost manufacturing Two challenges to reviving manufacturing Targeted measures are needed to encourage industrial development, but there are also broader challenges to be met Firstly, the government must improve the quantity and quality of Indonesia’s infrastructure, which is considered the biggest impediment to doing business in Indonesia According to the IMD World Competitiveness Yearbook 2014, Indonesia ranked 54 of 59 countries in infrastructure adequacy in 2014, far behind Malaysia at 25 and Thailand at 48 levels Unfortunately only 7% of Indonesia’s labour force has graduated at university level, compared with 29% in the Philippines and 17% in Thailand Indonesia’s technological readiness is limited—ranking 77 on the World Economic Forum’s 2014 Global Competitive Index compared with Malaysia’s ranking of 60 and Thailand’s at 65 Indonesia’s labour productivity is also below Malaysia and Thailand Indonesia should not rely too heavily on the primary resources sector Addressing these issues will be crucial to attract investors to Indonesia, particularly in the manufacturing sector Indonesia should no longer rely too heavily on the primary resources sector, as falling global commodity prices are unlikely to recover in the next few years Nor should Indonesia continue to suffer current account pressure at a time when the economy is growing and in-bound investment is rising Jokowi must implement policies that will build on Indonesia’s resilience in the face of macroeconomic turmoil and win Indonesia a more secure position in global production networks It is time for the manufacturing industry to be revived and take a central role as an engine of growth and source of employment n Secondly, steps must be taken to improve the quality and availability of skilled labour Labour productivity and technology capability are closely related to a country’s education and skill © The Economist Intelligence Unit Limited 2015 26 Open for business? Investing in Indonesia’s new era Working towards a sustainable future for Indonesia’s rural economy Q&A with Steve Rhee, programme officer, natural resource governance, Ford Foundation I ndonesia’s rural economy is dominated by the agribusiness and forestry sectors Oil palm and pulp and paper collectively account for approximately 7% of Indonesia’s GDP, and the nation is both the world’s largest producer and exporter of palm oil But these industries face criticism on multiple fronts Oil palm and pulp and paper plantation establishment are primary drivers of marginalisation of rural Indonesians and deforestation that threatens Indonesia’s endangered species and broader biodiversity Moreover, Indonesia’s status as the world’s third largest emitter of carbon dioxide is chiefly attributable to its deforestation and the draining of peatland Researchers from the University of Maryland concluded in 2012 that Indonesia lost 840,000 hectares of primary natural forest—the fastest rate of deforestation in the world, almost double that of Brazil in the same year.13 At the same time, rural Indonesians are voicing their dissatisfaction at the lack of benefits from the oil palm industry Smallholder farmers and other groups complain that they are being marginalised by large plantations, and there are thousands of conflicts between companies and rural communities who say that their land has been stolen from them The following is based on an interview conducted by the EIU in November 2014 In September 2014, Asian Agri, Cargill, Golden Agri-Resources, Wilmar and the Indonesian Chamber of Commerce and Industry signed the Indonesia Palm Oil Pledge (IPOP) The signatories have committed to improve environmental stewardship, expand the social benefits of the industry and improve the competitiveness of Indonesia’s sustainable palm oil What will be the key challenges in meeting this pledge? Meeting “deforestation-free” and “conflict-free” requirements entails similar things, regardless of whether they’re the stipulations of IPOP or any other sustainability agreement Companies are obliged to prove the traceability of a product back to the point of origin, monitor deforestation, and prevent and resolve conflicts with communities Preventing conflict means that companies use a process of “free, prior and informed consent” with communities they want to contractually engage Resolving conflicts means neutral, fair and transparent mediation The future competitiveness of sustainable Indonesian palm oil and market access to consumer-sensitive markets such as Europe and the US will be a major motivating factor to honour the IPOP commitments and with their resources it may be possible for them to meet them However, this all remains to be seen argono, Belinda Arunarwati; Potapov, Peter V; Turubanova, Svetlana; Stolle, Fred; and Hansen, Matthew C “Primary forest cover loss in Indonesia over M 2000-2012.” nature climate change 4, 730-735, 2014 13 27 © The Economist Intelligence Unit Limited 2015 Open for business? Investing in Indonesia’s new era What are the difficulties for smallholders and how may they be overcome? Historically the playing field has been extremely inequitable for smallholders For example, even when smallholders first engage in contractual relationships with companies, they are not aware that committing their land to oil palm means that their land may be transferred to the state at the end of the contractual relationship Smallholders also face difficulties accessing credit, which in turn means they may struggle to purchase decent farming equipment or germplasm, among other things The legal requirements for large plantations to involve smallholders has also been reduced, and the recently revised Plantation Law is thought to have further weakened their position Under the Perkebunan Inti Rakyat (PIR) or “estatesmallholder” schemes set up under Suharto in the 1980s, all plantations were legally required to help establish and purchase oil palm from what were termed “plasma smallholders” If you imagine a human cell: the large plantation is the “nucleus” and it is surrounded by plasma smallholders, who typically have around two hectares of land per smallholder and have a contractual agreement to supply the nucleus The nucleus-plasma ratio started off as 20:80 in 1986, but by the early to mid 2000s it had shifted to 80:20, as it is now.14 The Ministry of Agriculture and the newlyformed Ministry of Environment and Forestry, and Ministry of Agrarian Affairs and Spatial Planning, must develop mechanisms that prevent discriminatory practices against smallholders, and educate smallholders on what contractual terms are reasonable Also, there needs to be support to help smallholders participate in “deforestation-free” and “conflict-free” palm oil markets to get a fair return This includes first gaining clarity on forest and land tenure so as to avoid conflicts between companies and communities or between communities The Ministry of Agriculture is also working with the Ministry of Finance to come up with a system to provide smallholders with easier access to credit Implementation will be the key, especially in rural areas where local vested interests may interfere, and where permitting authorities and law enforcement are often riddled with corruption Historically the playing field has been extremely inequitable for smallholders The monocultural development of palm oil has left some critics worried that Indonesia is too exposed to fluctuating prices How can diversification help reduce these risks? Adaptation to a mixed crop system may indeed be best, because farmers are always vulnerable to market prices, and increasingly vulnerable to erratic weather patterns due to climate change In a sense having a mixed crop system is like hedging against these variables and the government ought to incentivise a shift towards that E ditor’s note: This shift in the nucleus-plasma ratio is documented in “The biofuel boom and Indonesia’s oil palm industry: The twin processes of peasant dispossession and adverse incorporation in West Kalimantan”, a paper by Claude Joel Fortin from Saint Mary’s University in Canada 14 © The Economist Intelligence Unit Limited 2015 28 Open for business? Investing in Indonesia’s new era There are a multitude of other smallholder crops and fruit trees that can be grown: candlenut, durian, coffee, cocoa, spices, and rubber are still big There’s a real multitude of these products along with livestock—cows, goats, chickens A lot of these crops are better suited to cultivation by smallholders than oil palm You also have a whole number of home industries making confectionary and food items out Education is very important in helping people to understand better business and agricultural practices 29 © The Economist Intelligence Unit Limited 2015 of these products and these are small but important steps up the value chain Progress has also been made in forestry An organisation called Telepak has been working with villagers to secure forestry rights and help them sustainably harvest and manage those forests, as well as improve their organisational management They have received certification from the Forest Stewardship Council (FSC)—an international non-profit organsation that guarantees sustainable practices and gives them export market access, and they are now able to sell at a higher price than they could before being certified Right now they’re just selling certified logs but Telepak is exploring whether the communities can start manufacturing something at the village level, whether it’s furniture or other products Open for business? Investing in Indonesia’s new era What additional services and infrastructure are needed to encourage sustainable rural development? Education is obviously very important in helping people to understand better business and agricultural practices Other than improving the basic education given to schoolchildren, the government also needs to invest more in agricultural extension services —which teach farmers better techniques and help them get access to better resources— and ensure that these services are actually provided, which has not been the case in the past Healthcare has also been often nonexistent out in the provinces, so the rollout this year of BPJS Kesehatan—a national health insurance program that is supposed to cover all Indonesians—should help, assuming health facilities are functioning in the provinces Road infrastructure needs to be radically improved for both local communities and the businesses operating in rural areas Fortunately, the new administration seems to be moving fast on land and maritime infrastructure More electricity is also needed The national electrification rate was 76% in 2012, according to the International Energy Agency, but in rural areas it’s far lower, sinking as low as 30% in West Papua There’s huge potential for the use of distributed power using renewable feedstock, particularly small hydro and biomass from the waste products of the palm oil and other industries There have been recent increases in the feed-in tariffs to encourage the construction of renewable power plants of 10MW or less but the government needs to more One slightly less obvious aspect of infrastructure development that’s improving things for local communities is affordable mobile phone coverage Even in the most remote areas that I go to now you can get some kind of cell phone signal In the village where I used to live in Northern Kalimantan, near the Malaysian border—everybody’s on Facebook there Broadband is still unobtainable, but at least you can get a decent signal on your phone, which has a lot of positive impacts In the village where I used to live in Northern Kalimantan, near the Malaysian border —everybody’s on Facebook there If you’re a farmer and you’ve already gone to market then you either sell at a low price or you have to take it back home—which will cost you double So with mobile phones people are much more aware of prices But there are still problems with local elites controlling prices and the market—and this is where the government needs to step in n © The Economist Intelligence Unit Limited 2015 30 Open for business? Investing in Indonesia’s new era While every effort has been taken to verify the accuracy of this information, The Economist Intelligence Unit Ltd cannot accept any responsibility or liability for reliance by any person on this report or any of the information, opinions or conclusions set out in this report 31 © The Economist Intelligence Unit Limited 2015 LONDON 20 Cabot Square London E14 4QW United Kingdom Tel: (44.20) 7576 8000 Fax: (44.20) 7576 8500 E-mail: london@eiu.com NEW YORK 750 Third Avenue 5th Floor New York, NY 10017, US Tel: (1.212) 554 0600 Fax: (1.212) 586 0248 E-mail: newyork@eiu.com HONG KONG 6001, Central Plaza 18 Harbour Road Wanchai Hong Kong Tel: (852) 2585 3888 Fax: (852) 2802 7638 E-mail: hongkong@eiu.com GENEVA Rue de l’Athénée 32 1206 Geneva Switzerland Tel: (41) 22 566 2470 Fax: (41) 22 346 9347 E-mail: geneva@eiu.com [...]... 2015 22 Open for business? Investing in Indonesia’s new era 5 Moving up the value chain: Reviving Indonesia’s manufacturing sector Destry Damayanti, executive director, Mandiri Institute O n the day of his inauguration as finance minister in October 2014, Bambang Brodjonegoro told reporters that his priority would be to maintain Indonesia’s economic resilience by boosting industry It is encouraging to... difficult time competing with its neighbours even in areas where it should have a competitive edge in terms of labour costs or inputs For foreign investors, the relatively high logistics costs in Indonesia will make them less likely to invest A number of interlinking factors contribute to this inefficiency: Open for business? Investing in Indonesia’s new era n Port management and shipping: Tanjung Priok,... capital increase, it is natural that Indonesian businesses will take on more work In the meantime the machinations of domestic business elites, mobilised by antiforeign sentiment, are still obstructing the investment that Indonesia needs n © The Economist Intelligence Unit Limited 2015 16 Open for business? Investing in Indonesia’s new era 4 Indonesia’s logistics services sector: The key to boosting growth... unprocessed mineral ore, unless miners build processing smelters to generate raw materials for domestic Open for business? Investing in Indonesia’s new era industries The ban has forced miners to pay attention to the government’s demands and many are building processing facilities In this regard the legislation has been partially successful, but the terms of the ban have been too harsh for some miners—particularly... Promoting Investment, Nurturing Prosperity”, illustrates how companies operating across Indonesia have to comply with different local regulation in hundreds of districts The complexities and costs are enormous Investing Across Borders, World Bank 2010 Excluding media industry © The Economist Intelligence Unit Limited 2015 10 Open for business? Investing in Indonesia’s new era Another obstacle to investment... banking system, then Indonesia must be open to foreign capital in order to support the economic growth he has promised, ” he said Open for business? Investing in Indonesia’s new era nationalist line However, this does not mean that foreign investment will suddenly become easier Factors beyond central government control Lengthy bureaucratic processes faced by prospective foreign investors mean doing business. .. has become increasingly pronounced In 2013, the percentage of products Open for business? Investing in Indonesia’s new era manufactured from imported raw materials increased to 68% of total manufactured products, up from 62% in 2008 As investment inflows have increased concurrently with raw material imports, Indonesia has endured an ongoing current account deficit: reaching around 4.4% of GDP in the second... encourages investment in the petrochemical industry in the form of land ownership and tax incentives, and there are reduced import tariffs for machines needed to support the processing industry Legislating change Legislation targeting the expansion of Indonesia’s processing industries during the previous Yudohoyono administration included the Coal and Minerals Mining Law, which took effect in early 2014... and Vietnamese fishing fleets operating illegally in Indonesian waters imply that there is a good international market nearby n 21 © The Economist Intelligence Unit Limited 2015 Open for business? Investing in Indonesia’s new era Across Indonesia, port infrastructure is unable to handle demand and the requirements of modern logistics for the country’s growing economy © The Economist Intelligence Unit... Economist Intelligence Unit Limited 2015 26 Open for business? Investing in Indonesia’s new era 6 Working towards a sustainable future for Indonesia’s rural economy Q&A with Steve Rhee, programme officer, natural resource governance, Ford Foundation I ndonesia’s rural economy is dominated by the agribusiness and forestry sectors Oil palm and pulp and paper collectively account for approximately 7% of Indonesia’s .. .Open for business? Investing in Indonesia’s new era © The Economist Intelligence Unit Limited 2015 Open for business? Investing in Indonesia’s new era Contents Preface ... logistics costs in Indonesia will make them less likely to invest A number of interlinking factors contribute to this inefficiency: Open for business? Investing in Indonesia’s new era n Port management... remains unclear if this vision can be implemented n © The Economist Intelligence Unit Limited 2015 Open for business? Investing in Indonesia’s new era Promoting policy certainty, unlocking investment