Special economic zones (SEZs) – known locally as Kawasan Ekonomi Khusus (KEK) – are the flagship industrial development programme of the government of Indonesia. The country is targeting 7% annual GDP growth through to 2019, and aims to reach upper-middle-income status by that year. One key factor in achieving this goal is accelerating the industrial sector. Domestic manufacturing growth has lagged behind that of regional competitors, as has overall economic development since the 1997-98 Asian financial crisis. Returning to growth based on manufacturing, not mining, is crucial to raising GDP per capita and creating sustainable jobs.
Certain sectors are doing well despite the weak manufacturing position. Food and beverages, leather and pharmaceuticals posted strong growth in the first half of 2017, but others, such as timber, textiles, and coal, oil and gas-related manufacturing, battled headwinds from product and labour costs.
Manufacturing is generally held back by a lack of competitiveness and established industrial bases. To address this, President Joko Widodo announced plans to build 15 industrial estates and 11 SEZs. All but three of these facilities are outside the more industrialised island of Java, with the aim to support employment and alleviate poverty in the rest of the country.
THE PERKS: SEZs are distinct from industrial estates, known as Kawasan Industri, with different legal status and unique incentives. The government’s economic policy packages support SEZs by providing fiscal motivation and permit processing for new investors in just three hours. Since Government Regulation No. 96 of 2015 came into effect, investors in SEZs have been eligible for the following incentives:
• Corporate income tax reduction of up to 100% for up to 25 years to taxpayers with new capital invested in production;
• A reduction in net taxable income of up to 30% of the amount invested in the form of fixed assets, prorated at 5% for six years of commercial production;
• Accelerated depreciation and/or amortisation;
• A reduction in withholding tax on dividends to non-residents to 10% (or applicable treaty rate);
• Extension of tax loss carry forward from five years to up to 10 years;
• The non-collection of value-added tax and luxury sales tax on the import and delivery of certain goods;
• The non-collection of Article 22 income tax on imports;
• Exemption or postponement of import duty on capital goods imports; and
• Exemption of excise tax on goods used to produce non-excisable goods. From the 11 planned SEZs, nine are now operational. The newest facility, SEZ Lhokseumawe, at the Arun Regasification Terminal in Aceh, was designated as such in February 2017. Most of the SEZs are focused around commodities and manufacturing, but those in scenic locations are primarily based on tourism.
OCCUPANCY: Historically, filling SEZ facilities with tenants has been difficult. Data on the broader category of industrial estates shows that only 31% of the planned hectarage had been occupied by tenants in 2013, under the previous administration. Realisation rates were highest in Java, North Sumatra (excluding Aceh), East Kalimantan and South Sulawesi.
Future prospects may be brighter with greater government focus on infrastructure, more competitive fiscal incentives and regulatory reform. From what PwC has seen, investors consistently look for six key factors when choosing to build factories: 1. SEZ availability and preparedness; 2. A skilled and cost-effective workforce; 3. Availability of transport infrastructure (ports, road and/or rail) to move goods to market and receive supplies; 4. Consistent and transparent regulations; 5. Proximity to customers and suppliers; and 6. Reliable and affordable energy.
Indonesia is in fierce competition for foreign direct investment with neighbouring Malaysia, Vietnam and the Philippines. Relentless focus on the six factors is needed to met occupancy goals in new SEZs, many of which are located in more remote regions where demand is uncertain, and suppliers and skilled labour not always available. Tax incentives indeed help, but attracting tenants by this avenue will come at the cost of decreased government revenue.
The provision of reliable and affordable physical infrastructure – ports, roads, rail and utilities – is also crucial to success. In many areas, comprehensive masterplans for transport links and energy access already exist. However, these are often not coordinated with the SEZs’ plans, nor do not they take into account the realities of sector-specific investment.
TRANSPORT: Good roads are at the heart of a successful SEZ. This is one area where SEZs already fare better than the typical town, as the provincial or national roads that serve them are generally sufficient to handle local traffic. However, fast toll roads are key for tourist destinations such as SEZ Tanjung Lesung, and the capacity of regional roads should be planned on the basis of SEZs achieving full occupancy – not just a few years ahead.
In terms of rail, a little under half of the country’s current SEZs feature existing or planned railways, which are largely used for commodity exports. Only one facility railway had been built as of mid-2017, at SEZ Sei Mangkei. Government Regulation No. 56 of 2009 prohibits intermediate stations on private railways, so investors can only build point-to-point. This hinders operational flexibility and the spreading of fixed costs over larger cargo volumes. Kereta Api, the state-owned railway company, may operate routes as it pleases. However, funding gaps and the sheer size of the SEZ programme means that government ministries and state-owned enterprises (SOEs) cannot be relied on alone to build track. Until SEZ developers and their partners – especially mining and plantation companies in commodity-exporting SEZs – can build commercial routes without legal hindrance and with government support of land acquisition, the opportunity for private sector railway investment will remain limited.
For seaports and airports, SOEs tend to dominate the economically viable development opportunities. It is unlikely that much private sector activity will occur in these areas for SEZs in the short term.
UTILITIES: Power is perhaps the more promising market for private sector investors. Over 25 Private Power Utilities – as off-grid third-party sellers are known in Indonesia – have been developed in industrial estates and SEZs. While mainly gas-fired projects have been developed to date, smaller solar photovoltaic initiatives are also under consideration. Unregulated tariffs and high creditworthiness have attracted investors. The key to success has been an anchor tenant (or Perusahaan Listrik Negara, the state-owned power utility company) willing to commit to offtaking power for at least the first five years while tenant occupancy ramps up.
When it comes to natural gas, only a handful of SEZs are within reach of a gas transmission line, and those that are generally rely on state-owned Pertagas or Perusahaan Gas Negara (PGN) to build distribution networks. Investors are seeking opportunities for private distribution networks, but the question remains where the gas would be sourced, if not Pertagas or PGN. Suggestions for liquefied natural gas (LNG) import terminals have been made, especially in the eastern half of the country where surplus cargoes abound from the LNG export terminals there. However, dedicated SEZ import terminals for LNG have yet to be built. Investors constructing natural gas infrastructure would likely need to supply their own offtaker, such as a gas-fired power plant or a petrochemicals factory. This requirement favours large, diversified conglomerates.
Thinly capitalised and over-regulated municipal water companies have been unable to notably grow Indonesia’s piped water coverage in many years. Private developers of captive water supply and treatment assets have thus emerged in a number of SEZs and industrial estates. Although the volume is small (for example, 50 litres per second), investors find it easier to secure offtake for these assets and face limited competition.
FUTURE SOLUTIONS: A common theme for all infrastructure sectors is that risk-averse infrastructure investors shy away from long-lived, capital-intensive projects with no guarantee of sufficient customers. Industrial tenants similarly dislike to build factories – with or without fiscal incentives – with no guarantee of reliable infrastructure or energy supply. PwC believes that two routes could be further explored: 1. Bringing in domestic or international private sector SEZ/infrastructure/real estate developers with the commercial experience, connections and credibility to attract tenants and secure infrastructure commitments at the same time. The SEZ programme is notable for its lack of private sector participation on the developer side. 2. Bringing in SOEs to act as anchor tenants. Where large projects – such as smelters or factories – are planned, they should be carefully coordinated with SEZs, and they should be willing to sign at least five-year take-or-pay offtake commitments with infrastructure providers. In this way, a base level of demand for transport and energy infrastructure is assured, and investment risk is lowered to better attract the private sector. Investors can sometimes become over-excited at the prospect of fiscal incentives or the promotions offered by SEZs, and subsequently fatigued by the difficulties of creating demand and handling logistics in remote locations. The key is balance – careful screening and analysis of potential locations for long-term commercial viability, and a realistic acceptance of commercial risk.
The government needs to continue its good work on streamlining regulation and offering incentives, but could also be more open to private sector-led development. In addition, the state needs to focus stakeholders to aggregate economic activity in sensible locations.
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