Indonesia and the battle to remain competitive

Eunice Ho, Senior Analyst and Lauren O’Neil, Senior Consultant

Since assuming office more than a year ago in October 2014, the government of President Joko ‘Jokowi’ Widodo has faced the challenge of a slowing domestic economy, with domestic growth declining from 6.4% in 2010 to a forecasted 4.8% in 2015. While many within Indonesia have attributed its economic slowdown entirely to problems in the global economy, the reality is that domestic factors are also partially responsible. Despite strong market fundamentals and the largest emerging middle class globally, Indonesia’s politics, regulation and governance, combined with high logistics costs and rising wages, have continued to undermine its regional competitiveness and investment attractiveness.

Jokowi’s administration inherited some of its misfortunes from the previous government. For instance, a ban on unprocessed mineral ore exports was sorely misjudged. However, since assuming office, Jokowi has failed to turn the tide of economic nationalism. Many of his government’s policies have instead further entrenched this trend, signalling to potential (and existing) investors that the optimism they had in Jokowi was misplaced. Many have refrained from making new investments, while others have looked to wind down investments as returns have become outweighed by political, regulatory and economic uncertainty.

However, there are signs Jokowi’s government is gradually finding its footing. A series of economic reform packages in rapid succession since July 2015 has helped instil a degree of confidence and demonstrated to investors that Indonesia is serious about plugging into the global economy. 

In essence, Indonesia has found itself behind the curve and confronted by emerging competitive pressures – most notably from the Trans-Pacific Partnership (TPP) - to which Indonesia is not party.

The official establishment of the Association of South-East Nations (ASEAN) Economic Community (AEC) on 31 December 2015, although significantly increasing indonesia’s regional market access, also presents  significant challenges,, not least in terms of highlighting weaknesses in Indonesia’s logistics and infrastructure deficiencies. Indonesia fell six places in the World Economic Forum’s 2015-16 competitiveness rankings for infrastructure to 62nd, lagging behind regional neighbours such as Malaysia (24th).

Despite continued delays (primarily due to issues surrounding land acquisition and corruption), there are growing indicators the government is serious about overcoming the infrastructure deficit. The World Bank reported in December 2015 that capital expenditure – a positive indicator of infrastructure expenditure – had risen 50% year-on-year in real terms in the third quarter of 2015. The budget allocated for infrastructure in 2016 is about IDR 300 trillion (USD 21.6bn), almost double the amount allocated in 2014. The government has also streamlined some bureaucratic processes to facilitate faster, more efficient infrastructure spending, with the public works ministry reporting an unprecedented budget absorption rate of about 93% for 2015.

While all of this provides some renewed optimism about the Indonesian market and the government’s desire to recommit to attracting foreign investment, we anticipate that investment in Indonesia will remain problematic in the medium term. Investors should continue to anticipate a significant level of regulatory and contract risk as government ministries remain hamstrung by unclear regulations and bureaucracy. A plethora of presidential instructions (including those relating to acceleration of infrastructure projects) do not equate to effective execution on the ground. Meanwhile, vested interests in traditionally lucrative portfolios – such as the energy sector – will continue to make their presence felt.

Indonesia’s ability to maintain its competitiveness under the AEC will, to a great extent, determine its willingness to accede to broader trade agreements, such as the TPP. Jokowi and reformist Trade Minister Thomas Lembong have publicly expressed support for Indonesia’s TPP accession, but failure to capitalise on the benefits of AEC accession would seriously undermine (at least in the public realm) its arguments for TPP membership.

Perhaps most significantly, the impending implementation of the TPP by its regional competitors provides Indonesia with renewed impetus to enhance its competitiveness, even if it does not eventually join the group. If nothing else, a fear of losing out to its ASEAN neighbours (four of whom have joined the TPP) would be the most compelling factor. Jokowi has officially signalled Indonesia’s intent to join the TPP, and has reportedly ordered a stocktake of the necessary regulatory reforms that Indonesia would need to undertake to do so. Needless to say, there are many and Indonesia is unlikely to join the TPP in the immediate future.

Nonetheless, these concerns have provided Jokowi with a political platform to encourage innovation and reform. At the most recent working group meeting of the ruling PDI-P party, Jokowi focused on Indonesia’s need to be more competitive. The February announcement of revisions to the negative investment list (DNI), a list which stipulates to what degree foreign investment is permitted in different sectors, tentatively suggest the government is serious about opening Indonesia up to greater competition (refer to figure 1). Notably, infrastructure priorities, such as toll roads, have been fully opened to foreign investors. However, as with all policies, the devil is in the detail. The extent to which  this ‘liberalisation’ will benefit businesses will only become more apparent once the actual list is released publicly.

Figure 1: Negative investment list revisions

20160226Indonesia regional competitivenessgraphic

What does this mean for Indonesia?

Despite some positive signs (reflected in the DNI revisions), those multinational companies that previously intended to set up or expand operations in Indonesia (at the core of Jokowi’s economic agenda to move Indonesia up the value chain, through skills and technology transfer and increased local content requirements), are now more likely to do so in Vietnam or Malaysia where, over time, the TPP will provide more regulatory certainty and preferential access to the 12 TPP member states. Indonesia’s knee-jerk reaction might be to resort to greater protectionism in the face of such competition. The government’s more recent actions nevertheless provide some measure of hope that a more rational approach will prevail in the longer term.

In the meantime, to improve the country’s competitiveness, Jokowi’s government needs to, at the very least, consistently demonstrate it will remain focused on reducing transport and logistics costs through major infrastructure investment to address the years of under-investment, which have contributed to Indonesia’s inability to reach its full economic potential.