Economic Update
Recently named the second-best reformer in East Asia by the World Bank, Indonesia is a burgeoning destination for foreign direct investment despite remaining obstacles including the July introduction of a new law limiting foreign participation.

The World Bank’s annual Ease of Doing Business report, released two weeks ago, cited a number of reforms that helped improve the country’s ranking from 135 last year to 123 this year. Specifically, it cites the progress made in the coverage of loans by the public credit registry and strengthened investor protection by increasing disclosure requirements.

The country also introduced a simplified process and new temporary permits that allow construction to begin while the full permit is being approved, cutting the time to obtain a building permit from 49 days to 21.

Despite these reforms, the report noted that at 105 days, Indonesia has the longest period in the region to set up a business, compared to 103 in Laos and five in Singapore. It also said the red tape surrounding business and commerce needs to be dramatically reduced.

Perhaps the real test of these findings is whether or not investors see the country as a worthwhile investment destination. With a 99% rise year-on-year in actual foreign investment for the first three quarters of 2007, Indonesia seems to be having no trouble attracting foreign capital. If domestic figures are added in, investment has risen by 115%.

Indonesia’s GDP grew by 6.3% in the second quarter, due in large part to falling interest rates and rising commodity prices on the global market. Exports have risen as well in the first two quarters.

As companies operating in the country move to expand their capacity to keep up with demand, there will be growing need for financing. The central bank predicts lending will increase by over 20% by the end of 2007. For the third quarter of this year, total lending rose 23% year-on-year, with 20% growth in the small- and medium-sized enterprise sector. Investment loans grew 26% and consumer loans rose 24% for the same time period. Businesses are investing in tourism, trade and manufacturing.

Foreign investors see big potential in the country’s domestic market, regardless of whatever troubles the World Bank reports.

However, new ownership limits introduced in July are expected to dissuade investors. The government announced a 49% foreign ownership cap on businesses operating in the multimedia, ports, airports and communication sectors. Caps ranging from 50% to 100% were placed on mobile telephone, construction and health services. The measure was roundly criticised by foreign and domestic business people, according to media.

Under the ban, foreign investment is restricted in 120 sectors, with outright prohibitions on investing in 25 specific sectors, including alcohol, museums, monuments and chemicals deemed to be “environmentally damaging”. However, companies already operating, or in the process of being licensed, in these sectors are not affected by the new legislation.

The ban was put into place due to concerns about the growing influence of foreign business in the country after a number of state asset sales following the 1997-1998 Asian financial crisis.

Yet Indonesia is looking to attract billions of dollars worth of investment to stimulate economic growth and development. New tax administration and investment laws passed by parliament earlier in the year were designed to liberalise investment. Tax and Customs reforms are also gaining momentum, according to the World Bank. The time it takes to clear Customs, as well as get refunds from value-added tax, continues to decline.

Another development likely to drive foreign investment in the coming years is the economic partnership agreement signed between Japan and Indonesia on August 20. More than 90% of the tariffs between the two countries will now be eliminated. Some $27.2bn in trade passed between them in 2006.

Japan imports at least 80% of its energy needs, receiving about 20% from Indonesia. As a result of the agreement, Japan will benefit from increased energy input while it assists Indonesia in building the additional capacity required to meet Japan’s strict production standards on imports.

While the partnership agreement is to be implemented in 2008, companies have forged ahead, signing energy deals worth $4.3bn the same day the agreement was signed. Japan’s Mitsubishi will be working with Indonesia’s Medco Energi and its state-owned oil company Pertamina to develop a gas field in central Indonesia. The field is expected to yield 2m tonnes annually, all of which Japan will enjoy exclusive rights to until 2025.

According to Indonesian Minister of Industry Fahmi Idris, 26 Japanese companies have announced plans to invest a total of $557m in Indonesia specifically because of the new agreement.

Partnerships with countries like Japan will require Indonesia to raise standards in certain areas, and as illustrated by the investment figures for this year, both consumer and investor confidence in the country seem to be rising.