Competition between China and Japan should benefit Indonesia

The rising attractiveness of Indonesia as a regional destination for foreign direct investment (FDI) has been highlighted by its growing trade relationship with China, with leaders from both nations announcing over $60bn in potential new investments and financing in early 2015. Indonesia’s planned wave of national infrastructure projects is expected to gain from competition between China and Japan as both vie to establish stronger economic ties with the country, although the Indonesian government is now facing the complicated task of carefully balancing and prioritising its burgeoning relationships with both nations.

At the same time, the Sino-Indonesian trade relationship does face challenges: while China has become one of Indonesia’s most promising future sources of FDI, its spotty record in following through on economic pledges is a concern, while Chinese investors attempting to establish operations in the country have been hindered by bureaucratic difficulties.

Investment Milestones

According to the Indonesia Investment Coordinating Board (BKPM), the country’s largest investors in 2014 were Singapore, with $5.8bn in FDI, followed by Japan ($2.7bn), Malaysia ($1.8bn), the Netherlands ($1.7bn) and the UK ($1.6bn).

Until recently Chinese investment in Indonesia had been relatively limited, partly due to the fact that the two countries suspended diplomatic ties for 23 years prior to 1990. China began a wave of economic and investment liberalisation around the same time, which saw GDP, outward and inward FDI inflows, and bilateral trade soar; according to the World Bank, current GDP per capita rose from $314 in 1990 to $6808 in 2013, and FDI outflows as a percentage of GDP nearly doubled between 2005 and 2013, from 0.92% to 1.76%.

The world’s second-largest economy has seen its breakneck growth slow in recent years, however, and GDP growth hit its lowest rate in 24 years in 2014, to stand at 7.4%, slightly below government targets. With GDP growth expected to slide to 6.9% in 2017, compared to 9.1% annual average expansion between 1989 and 2015, the Chinese government and an increasing number of private Chinese firms are now seeking new regional investment opportunities in South-east Asia.

Prime Destination

During an October 2013 visit to Jakarta, Chinese President Xi Jinping told media he hoped to see trade between China and the ASEAN rise to $1trn in 2020, from $320bn in 2012. Offering the largest population and economy in ASEAN, and benefitting from a rising middle class and years of strong, successive GDP growth, Indonesia represents a prime investment destination for Chinese firms, and recent years have seen bilateral ties expand considerably.

BKPM reported in April 2015 that China was one of the country’s top 10 trading partners in the first quarter of 2015, with Chinese investment reaching $75.1m spread across 200 projects. This came after BKPM’s 2014 figures revealed that China had risen to become Indonesia’s fourth-largest trading partner during the fourth quarter – an historic first – with an estimated $500m of investment recorded during the period.

Indonesia’s new administration is focused on increasing bilateral trade with China, and Chinese investment is expected to continue on a strong upwards trajectory in the coming years, following a highly publicised meeting between Jinping and newly elected Indonesian president Joko Widodo in March 2015. The two leaders met in Beijing for a signing ceremony that saw a host of Chinese banks and state companies agree to discuss $63.4bn in new projects and financing.

Following the ceremony, BKPM’s chairman, Franky Sibarani, told media that although the deals are in the preliminary stages, the meeting is an indicator of both nations’ desire to build and enhance bilateral trade.

Closer Ties

The investment announcement came after a concerted effort by Widodo to strengthen ties between the two nations following his 2014 presidential election victory, in keeping with the strategy of his predecessor, Susilo Bambang Yudhoyono. Under Yudhoyono, bilateral trade between China and Indonesia quadrupled between 2005 and 2013 to reach $66bn, while bilateral investment hit $2bn, according to a report in The Diplomat.

Infrastructure

The Widodo administration’s move to eliminate fuel subsidies and channel billions of dollars into infrastructure projects bodes well for future Chinese investment in the country. Indonesia will require an estimated $400bn in new investment to close its infrastructure deficit over the next five years, of which 30% will be provided by public spending.

During his first meeting with Jinping in November 2014, Jokowi said that he wanted Sino-Indonesian trade ties to materialise into more concrete outcomes, particularly in infrastructure development. Later that month, Indonesia joined the Chinese-led Asia Infrastructure Investment Bank (AIIB), and officials from both countries have been discussing the feasibility of working together to implement their dual maritime strategies – Widodo’s global maritime fulcrum doctrine (see Transport chapter) and China’s 21st-Century Maritime Silk Road development plan.

Jokowi envisions transforming Indonesia into a global swing point for trade flows between the Middle East and North Africa, South Asia, and East Asia. The plan is founded on reviving the country’s maritime culture, improving management of oceans and fisheries, improving port infrastructure, shipping activities and maritime tourism, and bolstering maritime security.

Silk Road

China’s Silk Road plan, announced in Indonesia during Jinping’s 2013 visit, envisions “one road” running from China and South-east Asia to South Asia. The two strategies align easily, and progress on both should be mutually advantageous. Indonesia, certainly, could benefit as China invests heavily in its maritime expansion strategy, including the planned $40bn Silk Road Fund and $50bn contribution to the AIIB’s establishment. The newly launched Silk Road Bank is also hoping to attract $16bn in capital. A rising tide of investment is already benefitting ASEAN members, with China announcing plans to invest in a major port expansion project in Malacca, Malaysia, in February 2015.

In January 2015 Indonesia and China held their first-ever high-level bilateral economic meeting, in which key areas of cooperation – most notably transport and utilities infrastructure – were identified. BKPM reports that of the $63.4bn in planned investment, it expects $20bn in financing from Chinese banks, largely into the network of state-owned firms that are responsible for building much of the country’s infrastructure. The remainder would be sourced directly from China’s state-owned firms, which have already been active in new infrastructure builds, including the 5-km, $445m Suramadu Bridge, constructed by a consortium including China Road and Bridge Corporation, and China Harbour Engineering. At least $25bn of the funding from China will be channelled into infrastructure, including new power plants, expansion of seaports and railways.

China vs Japan

Rising Chinese interest also bodes well for Indonesia’s regional trade. With investment from Japan already showing a sharp rise over the previous decade, Indonesia is poised to negotiate more favourable deals as Japan and China compete for new projects, most recently a planned bullet train on Java, spanning over 700 km and linking Jakarta to Surabaya.

Although the Japan International Cooperation Agency had been involved in over five years of feasibility studies and lobbying for the $6bn project, the Indonesian minister of state-owned enterprises, Rini Soemarno, surprised stakeholders when she announced in April 2015 that the government is considering a Chinese proposal to build the railway, as part of a potential funding commitment from Chinese state banks. Soemarno noted that the proposal is attractive because, unlike Japan, the Chinese government does not require Indonesia to provide a funding guarantee.

Rail Link

In January 2015, the governor of Central Kalimantan and president of local firm Perkeretaapian Tambun Bungai Mulyadi Sendjaya, representing the China Railway Consortium Group, signed a joint agreement for the construction of a 425-km railway linking Pucuk Cahu to Batanjung. The $5.47bn contract includes a four-year construction period, after which the consortium will operate the line for 50 years, before transferring ownership to the provincial administration.

Outside of transport infrastructure, the country is also benefitting from rising utilities, manufacturing and industrial investment from Japan and China. In April 2015 China Minsheng Investment announced plans to lead a group of Chinese companies to establish a new industrial zone that is expected to bring $5bn in investment across Indonesia’s steel, power, cement, aluminium and infrastructure sectors. Meanwhile, Japan’s Inpex Corporation announced plans to acquire a stake in the 330-MW Sarulla geothermal power plant in June 2015, and the country has announced billions of dollars worth of new manufacturing investments in recent years, most notably Mitsubishi’s planned $600m facility in West Java (see Japan analysis).

Balancing Act

Although rising Chinese investment is a promising solution to Indonesia’s infrastructure challenge, the government will need to manage the delicate task of maintaining a strong relationship with both countries, while simultaneously improving the realisation of planned Chinese investments.

Although Chinese commitments are expected to soar, the country has a history of failing to follow through on investment pledges, with BKPM reporting that China has disbursed just 7% of its funding commitments since 2005, compared to Japan’s 62%. Major funding announcements are not uncommon, and during his 2013 visit to Jakarta, Jinping announced a similar spate of investment deals, valued at $28.2bn. At just $2bn in 2013, bilateral investment between the two remains comparatively low, while the Lowy Institute for International Policy noted in 2015 that some Indonesian stakeholders have been frustrated by the quality of Chinese construction, particularly in utilities projects.

Chinese investors are also facing notable hurdles in moving forward on planned projects. At a May 2015 investment forum in Beijing, Chinese attendees cited a number of challenges in establishing Indonesian operations, including the complicated process of obtaining land permits and environmental impact analysis certificates, as well as problems with land acquisition. The country’s infrastructure deficit is also driving up logistics costs and often compels investors to construct their own support facilities, while industrial and manufacturing investment has been stunted by difficulties in negotiating favourable electricity rates with state-owned electricity company Perusahaan Listrik Negara, which holds a monopoly on distribution.

Chinese companies are simultaneously grappling with increasingly stringent policies regarding foreign work permits. Although China’s investments in Africa and elsewhere in Asia usually involve importing Chinese labour for manufacturing and construction jobs, the Indonesian government announced in March 2015 that it will improve employment prospects for nationals by restricting foreign work permits. This is a move that could also pose a problem for future investment.

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The Report: Indonesia 2015

Trade & Investment chapter from The Report: Indonesia 2015

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