With full-year realised foreign direct investment (FDI) hitting a new record in 2014, Indonesia’s trade and investment flows have improved considerably over the last 10 years. The capital account deficit was brought back under 3% that year, and at the end of 2014 and in early 2015 the country reported a trade surplus after years in the red. Due to stronger economic growth and new policy initiatives, the uptick could become a sustained trend.
However, risks remain. The government and monetary authorities need to keep a grip on policy, making sure they maintain discipline without being too strict. Early indications are that the new administration and the monetary authorities will work effectively towards achieving the right balance through consistent, steady improvements.
The boom times of recent years, when the country was benefitting from the rise in commodity prices, were mixed in terms of its international balances. While GDP was rising at rates of around 6% a year, trade and money flows were beginning to deteriorate. The current account balance dropped from +2% in 2010 to -3.2% in early 2014. The trade balance also went negative in that time.
The country swung from steady surpluses to consistent deficits since early 2012, hitting $4.06bn in 2013, or 2% of GDP (a ratio not seen since the 1960s), according to Statistics Indonesia (BPS). When the economy thrived, demand picked up as consumers increased spending and as companies bought equipment needed for manufacturing and mining. Imports grew by 43.7% in 2010 and 30.3% in 2011, according to Bank Mandiri research. While exports grew rapidly as well – up by 32.1% and 27%, respectively – they did not keep pace with imports.
The imbalances led to a deterioration of a number of key indicators. Foreign exchange reserves fell by about 20% from their peak in late 2011 to the recent low in 2013 and began to reach levels that are considered by some to be dangerously low, according to an article in the Jakarta Post.
Import cover fell below seven months and analysts quoted in the press started to worry that the country could be vulnerable to weaknesses in the global economy and outflows of investment funds. They said that Indonesia and India were the most vulnerable to capital flight and were most at risk if the US Federal Reserve started raising rates. As the ratios crossed key thresholds, the rupiah fell from 9600 to 12,800 to the dollar in a two-year period, breaking through the lows reached during the 2008 global economic crisis. For a time in 2013, it seemed as though the currency was in freefall.
It turned out that the mini-crisis of 2013 and early 2014 was little more than a passing storm. As the currency fell and as Bank Indonesia (BI), the central bank, began to institute tight monetary policy, the trade situation righted itself. Towards the end of 2014, the picture greatly improved and the numbers were in positive territory by January 2015. The current account deficit returned to below 3% of GDP – rebounding to 2.95% in the fourth quarter of 2014 – a level considered safe by economists, the IMF and others.
In fact, the situation was never all that dire in the first place. Import cover was never below 5.5 months, which is not far from recent historical averages, and is far higher than the danger points that were hit in the late 1990s and in 2008, when it reached 3.5% and 4.6%, respectively. Throughout the instability experienced in recent years, passive investment has held up. Foreign holdings of local currency bonds continued to rise and hit new records.
The Broader Picture
In some respects, the troubles experienced in 2013 were part of a larger rebalancing, one that was very much being pushed by the monetary authorities, and the rough patch was in a way engineered. It was the official policy to reduce consumption and encourage stability with higher rates, and to prepare the country for the inevitable increase in interest rates in the US.
By early 2015, the instability of previous years started to look less like a problem and more like part of the solution, and it turns out that Indonesia may have been a bit ahead of its time. Currencies globally generally weakened against the dollar after the rupiah’s decline, so in the end the rupiah was just a bit faster in getting where others were heading.
With a currency war brewing in Asia, it may have positioned itself well. In the year to early 2015, the rupiah strengthened against the yen as Tokyo launched another offensive against deflation. It also has been stable against the Singapore dollar and has strengthened slightly against the Malaysian ringgit.
While Agus Martowardojo, the governor of BI, said in early 2015 that the central bank would continue to intervene in the markets in order to support the currency, he also noted that the rupiah was at a reasonable level, and that the bank was more interested in stability than in a precise rate. In March 2015, Agus reiterated his stance that the currency was within the bank’s target range.
Room For Manoeuvre
The international situation is such that the central bank has been able to adjust its policy recently, cutting the benchmark interest rate in early 2015 from 7.75% to 7.50% in a move that surprised the market. The current account surplus remains a problem, and some analysts feel that the country is now in danger of breaching the 3% target. However, with the US Federal Reserve indicating that it may not increase rates too soon, and with inflation less of a threat globally in recent years, the central bank has some room for manoeuvre on rates. Recent rate cuts regionally – in China, Singapore and India – also took some of the pressure off the monetary authorities.
The argument has been gaining ground within Indonesia that the central bank should not be so focused on the current account, and should instead be more preoccupied with growth.
Economists and politicians say that during times of high interest rates – such as 2008-09 and 2013-14 – the country’s currency fell against the dollar, while during times of rate loosening – 2012-13, for example – the currency rose. They believe that a strong correlation exists between growth and the exchange rate, since growth is what attracts foreign investors, according to analysis published by Indonesian financial institution Danareksa.
Some argue that the current account is the wrong target altogether. While the number is a problem if it goes negative in the extreme, a high deficit is very much in evidence when the economy is healthy. The current account has been negative during times of rapid growth in the country – reflecting the need to import as industry develops – and positive when the economy was sluggish. It was in deficit through 1997, in surplus from 1997 through 2010, and then in deficit again in 2011, 2012 and 2013.
Economists agree that imports are too high and that the country needs to begin to invest in more domestic production, but they say that to get there will require a period of heavy importing. “The deficit is about 3% now,” said Edimon Ginting, deputy country director of Asian Development Bank Indonesia. “I am not worried, as long as it’s under 4%.”
The trade surpluses reported in December 2014 and January 2015 were largely the result of the declining imports. Exports fell by 8.09% in January year-on-year (y-o-y) – after a 13.8% drop in December 2014 – but that was more than balanced by a 15.6% fall in imports. The drop in imports that month was largely the result of a decline in consumer goods purchases, which were down by 20.25% from January 2014, according to BPS data.
Falling Oil & Gas Imports
However, the real driver was the fall in oil and gas imports. In January 2015, oil and gas imports were down by 40.42% yo-y as prices plummeted. Imports of oil and gas products had been rising for a number of years. They grew by an annual average of 10.83% between 2010 and 2014, although imports were down slightly in 2014 over 2013 ($43.46bn versus $45.27bn), according to data from the Ministry of Trade.
The country has been in deficit in oil and gas overall since 2012 – though in January 2015, a balance in the category was almost achieved again – and the country’s overall trade deficit since 2012 has been the result of its trade deficit in oil and gas products.
Palm Oil Takes a Hit
However, just as Indonesia has benefitted from the fall in oil prices, it has been hurt by the decline in the prices of resources in general. Exports of palm oil and related products declined from $4.98bn in 2013 to $4.2bn in 2014, and are down from a recent high of $8.78bn in 2011, according to Ministry of Trade data.
The price of palm oil fell from a high of some $1250 per tonne in February 2011 to a recent low of just $624.54 per tonne in December 2014, according to CME Group future data.
Overall, palm oil production also declined, from some 27m tonnes in 2013 to an estimated 25m tonnes in 2014, according to industry association and Ministry of Agriculture data. To boost export levels, Indonesia followed Malaysia by reducing export taxes on the product in October. The rate in Indonesia had been 9% as of September 2014.
Other commodity exports also suffered as prices and demand declined. Coffee exports fell from $1.17bn in 2013 to $1.03bn in 2014. The export of copper ores and concentrates went from $3.01bn in 2013 to $1.68bn in 2014. The decline in this case was as much a matter of policy as it was of price. In the first nine months of the year, shipments of the commodity ground to a halt after an export tax was imposed on semi-refined products and a complete ban was placed on unrefined products. The hiatus ended in September 2014 when the major producers reached a deal with the government on new tax and royalty rates that would allow for sales overseas to resume. However, most of the year was lost, and the producers have said that their mining activities will be reduced even after the agreement.
Metals Exports Stopped
Other metals were also caught up in the new policy. Iron ore, lead and zinc concentrate exports stopped for six months until the miners agreed to pay the export tax. The tax starts at 20% and will rise to 60% in 2016 before an outright ban is put into effect in 2017.
Positives on the Negative List
In early 2014 the government came out with a revised negative list. While some changes were included to encourage more FDI and international participation, overall the new list remains largely restrictive.
Under the terms of this new list, electricity generation for plants that are built under a public-private partnership (PPP) arrangement may be 100% foreign-owned during the concession period, as opposed to the usual 95% limit.
Port facilities can be 95% foreign-owned under a PPP agreement, against the usual limit of 45%. Pharmaceutical company ownership was increased to 85% from 75%. Production of films went to 51% for ASEAN investors, up from 0%. The limit on foreign ownership of venture capital was increased to 85% from 80%, while opinion research polling was opened to 51% foreign investment for ASEAN citizens, although it is still closed to others.
At the same time, investment ceilings for some sectors were reduced. Small power generation under 10 MW went to a maximum of 49% foreign equity, down from 100% (under a PPP). Drilling services on land were totally closed to foreign investment, from 95%, while drilling services offshore went from a 95% maximum to 75%. Oil and gas support services, in which 95% foreign ownership had been allowed, were closed completely, as was the installation of electric power infrastructure.
The maximum foreign ownership of telecoms services was reduced from 100% to 49%, data communications services went from 95% to 49% (unless integrated with wired/wireless/satellite telecommunications services, in which case the maximum is now 65%), while internet services went from 65% to 49%.
Agricultural investments are limited to 30% foreign ownership, down from 95%. Internet content provision has been reduced to 49%, from 100% if the foreign company had a local partner.
Other sectors are also under threat. The new Insurance Law, passed in 2014, does not set a foreign ownership level but nevertheless leaves the limits to supplemental regulations. This could mean bringing the foreign insurers back to the existing 80% limit, which has been broken by a number of participants due to capital increases, or a new 49% limit. Likewise, a banking bill calls for a reduction in the foreign ownership of banks to 40% from the current 99%, bringing the country more in line with restrictions in other economies in the region (see analysis).
In September 2014 a new plantations law was passed. The original bill had included a provision that would limit foreign ownership to 30%, from the current 90%. In the final version, that restriction was eliminated, but in the end the law did include several stipulations relevant to foreign investors.
Under the law, foreign-controlled plantations must: be independent of foreign plantation companies; utilise all land acquired within six years; process their output within the country; transfer technology; and use domestic banks. The threat also remains that a shareholding limit could be imposed at some point. The law allows for a cap to be placed on ownership through presidential decree.
After the election and inauguration of President Joko Widodo in 2014, the sense was that many of the protectionist measures that have been put into place in recent years would be scrapped and that the new president would work to find ways to encourage more foreign participation in the market. He had proved himself a pragmatist good at balancing interests, and it was hoped that his skills could be utilised to open markets while at the same time satisfying nationalists, according to reports in the international press.
Forces at home also suggested a president erring on the side of openness. In press reports published in late 2014, advisers to the new president acknowledged that he would be facing considerable domestic pressure to protect markets, but added that the president was under equally strong pressure to achieve 7% economic growth. The only way to effectively hit that pace is to keep reforming the economy and push it towards more openness, adviser Fauzi Ichsan commented at the time.
Early indications are that President Widodo will push for a more liberal investment and trade environment. Right after his inauguration, he called for the creation of a one-stop shop at the Indonesia Investment Coordinating Board. In early 2015 he ordered the country’s diplomats to focus on the facilitation of foreign investment.
While the president’s campaign did include a measure of nationalist rhetoric, even his party’s more nationalistic members have indicated that they are favourable to foreign investment if it is targeted towards the areas with the greatest need. The president’s party has said, in comments published in the local press, that it will push Widodo on restrictions in mining but that it would seek to encourage more international participation in infrastructure and agriculture.
The president has specifically targeted the country’s ranking in the World Bank’s “Doing Business” survey. Indonesia was ranked 114th in the 2015 report, slightly up from 117 a year earlier (out of 189 nations), but behind Ukraine, Lebanon, Zambia and Egypt. In the “starting a business” category, it was ranked 155th; in the “paying taxes” category, 160th; and in the “enforcing contracts” category, 172nd.
Meanwhile, Indonesia was ranked 107th in Transparency International’s corruption perception index in 2014, and the country received a score of 8.37 out of 10 – with 10 being the worst possible – in the Political Economic Risk and Consultancy’s 2012 Bureaucracy Efficiency Index.
To achieve his “Doing Business” improvement goals and his targets for foreign investment, the president is emphasising the building of infrastructure. He is helped in this by the fact that this is one area of the economy where almost everyone agrees that improvements are needed, and that foreign funds will be required to make these improvements. The lack of power, roads and ports, among other things, leads to bottlenecks in the economy and holds back foreign investment in other sectors, according to the Indonesian Chamber of Commerce and Industry, KPMG and others. Issues relating to transport and power supply make it difficult for some international companies to make a commitment to the country.
The president has called for the spending of approximately Rp280trn ($23.1bn) on infrastructure in 2015 and an estimated Rp5500trn ($455bn) over the next five years.
In addition to raising funds domestically, through the increase in taxes and the retasking of funds previously used for the fuel subsidy, the government is also establishing an infrastructure bank.
According to comments by the Ministry of Finance quoted in the press, the plan is to invest $1.63bn in Sarana Multi Infrastruktur, a state-owned financial company, increasing capital six-fold. The company will be merged with Perusahaan Investasi Pemerintah, and the resulting entity will be called the Indonesian Infrastructure Financing Agency.
This recapitalisation and restructuring will allow the institution to access more international funding and increase the size of its loan book. The plan is to have the bank up and running by 2017.
In addition, the president is proposing the creation of a land bank, to be jointly administered by the Ministry of Finance, the Ministry of Public Works and the Ministry of Transport, which will help in the acquisition of land for large infrastructure projects, according to Bloomberg.
President Widodo has been working on bureaucratic reform as well. In the wake of the crash of AirAsia QZ8501, which had been flying over Indonesian airspace when it ran into trouble, the president has ordered a full review of the government’s management of the sector, which could result in an overhaul of regulations, state-owned airports and of the air traffic control systems. After the tragedy, it was found that serious breakdowns had occurred in the administration of air transport in the country. The president is also looking to improve the collection of tax. He has set higher targets for tax revenue and is working to upgrade the tax department of the Ministry of Finance into an independent agency.
Reviewing the Rules
Indonesia has been working in recent years to review the rules governing foreign investment, and some of the steps taken could have a negative impact on investment flows. In early 2014, the country said that it would be terminating all of its 67 investment treaties, beginning with its agreement with the Netherlands.
There is a growing sense among resource-rich countries that these agreements are tilted in favour of foreign investors, the main point of contention being the use of investor-state dispute settlement (ISDS). ISDS clauses allow private companies to sue governments in international tribunals, and potentially be awarded great sums of money without ever making their case to a domestic court.
South Africa has said that it too will end its investment agreements, while Australia has said it will not agree to ISDSs in newly signed treaties. Most treaties come with sunset clauses, so existing projects would be protected for a decade or longer, but new investors would lack such protections.
Indonesia’s concern about these treaties comes following the case that was brought against the country by London-based Churchill Mining. The company is seeking compensation for the revocation of mining licences for the East Kutai Coal Project in East Kalimantan. Churchill Mining bought a 70% interest in the mine in 2008, but two years later the local government transferred the concession to another company. The local government said that the original transfer of the ownership stake to Churchill was illegal, and that the foreign company has engaged in illegal logging at the site. Churchill is seeking $2bn in damages.
There are some indications that the president is in favour of protectionism within certain, targeted sectors. Press reports in early 2015 indicated that President Widodo had asked local tech companies to maintain control so that Indonesia can build its own domestic technology giants. Later reports indicated that the original CNN Indonesia story had overstated what was being proposed, and executives quoted in follow-up pieces said that the president was simply advising the companies to wait before selling to foreign investors so that they could achieve a fair value for their equity.
The new administration has declared that Indonesia is open for business, and due to its promise to achieve fast growth in the coming years, it is likely to follow through with key reforms.
Nationalistic pressures will keep the liberalisations targeted and within certain limits, and the laws and regulations relevant to banking, insurance and mining are expected to remain dynamic. However, economic necessity will also play a role, and this should mean that there will be considerable opportunities available in a number of sectors – especially infrastructure and manufacturing – in the years to come.
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