Regulatory changes boost Indonesian retail

 

In the wake of pro-business reforms and infrastructure development commitments, some of the world’s largest retailers have been expanding their presence in Indonesia. At the same time, the continued liberalisation of the sector has brought decreased levels of risk and increased market penetration. Today, Indonesia is home to a mix of modern and traditional retail outlets, with an uptick in e-commerce activity, which is both advancing the growth of the modern retail sector and creating new opportunities for entrepreneurs.

STATE OF PLAY: Despite modernisation and market improvements, retail has faced declining growth rates. According to data from the Bank of Indonesia, retail sales grew by 6.3% year-on-year (y-o-y) in June 2017, driven by higher demand during Ramadan and Eid Al Fitr. While this was an increase on the 4.3% y-o-y growth posted in May 2017, it was still well below the average recorded over the last decade of 11.4%.

This slowing rate of growth has stemmed from a fall in disposable income, as consumers have gradually felt pressure from increasing household expenses and a weakening rupiah. However, accelerating economic growth could help turn the tide for retail sales on the back of stronger commodity prices and increases in localised purchasing power, particularly in regions rich in mineral assets, such as Sumatra and Kalimantan.

Rising grocery prices have also weighed heavily on purchasing power and consumer confidence in the past, as currency depreciation, regional wage hikes and unfavourable import laws have all inflated the average cost of grocery baskets. However, according to a report by Danareksa Research Institute, consumer confidence in Indonesia has been increasing, resulting from a pick-up in economic growth of 5.02% and general core inflation of 3.02% in 2016, coupled with rising income per capita. While core inflation in 2016 was relatively stable, food ingredient and processed food prices had substantially higher y-o-y inflation levels in December 2016, reaching 5.69% and 5.38%, respectively. In the past, the government has rolled out assistance programmes for lower-income groups to help counteract rising food prices. However, in many cases, aggressive tax collection efforts have undermined food assistance efforts, while a number of accommodative tax amnesty programmes have resulted in reduced consumer spending. Despite these increases in food prices, grocery sales continue to out-perform non-grocery sales among modern retailers. Furthermore, while urban dwellers increasingly prefer to shop at modern retailers, the majority of food sales still take place at independent grocers.

TAX AMNESTY: When it comes to taxes, only 0.35% of Indonesia’s population submitted a tax return in 2014, according to Bloomberg. To increase the rate of compliance, the government has introduced a number of tax amnesty laws, with the most recent being passed in 2016. The introduction of Act No. 11/2016 gave tax avoiders the opportunity to sort out their books before the nation employed the Automatic Exchange of Information framework, which has improved the national tax office’s ability to detect tax evasion and track down its perpetrators.

The recent amnesty programme was intended to supplement the government’s budget, increase domestic liquidity, strengthen the exchange rate, decrease interest rates and stimulate investment. Policymakers believed the act would simultaneously develop a more robust taxation system with comprehensive and valid data, as well as raise revenue that could be funnelled into infrastructure projects.

Under the law, any offshore assets repatriated under the programme must stay within the country for a minimum of three years. With the amnesty period now over, however, individuals who decided to keep their holdings abroad will have to pay income tax on any assets they eventually bring back into the country.

While the amnesty was just one modest taxation effort, some believe that the programme – which ended in March 2017 – was too generous, and has both hurt compliant taxpayers and negatively affected retail activity. Some consumers held off on purchases in fear of being monitored, which created distribution hurdles in the supply chain. In addition, the repatriation of capital may lead to too much liquidity within the banking segment, thus creating a reckless lending environment and higher inflation rates in the long run. This could be problematic, as it might reduce both purchasing power and consumer confidence.

While the tax amnesty law has had several opponents, a number of industry analysts believe it will have a positive impact on the economy, and thus the retail sector, over the long term. Increasing the number of compliant taxpayers and taxable assets, they argue, will raise tax revenue and allow the state to allocate more funds to infrastructure and other necessary developments. In turn, improved infrastructure would help decrease the transport costs of goods, leading to lower consumer prices and higher consumption. All of which would serve to stimulate the economy.

TOP PERFORMERS: While 2016 was characterised by a slowdown in the growth rate of the retail sector overall, leading retailers managed to outperform the market average, with the top 10 registering greater sales than in 2015. This improvement in relative performance resulted from increased market penetration, with efforts to expand outlets throughout the country. The spread of convenience stores through the use of franchise agreements by Indomarco Prismatama, Sumber Alfaria Trijaya and Midi Utama Indonesia also helped to drive growth. In addition to expanding market coverage, the leading retailers boosted revenue by value sales of private label products and various in-store promotional offerings.

With modern retailers of varying categories expanding their footprint in South-east Asia, companies specialising in food and beverage production in particular are anticipating greater rates of growth. For example, Garuda Foods forecast its revenue to rise by 15% in 2017, up from a 10% increase in 2016.

EVOLUTION: As is the case in most emerging markets, Indonesia’s retail sector has historically relied on traditional vendors. However, a middle class with deeper pockets and increasing consumer confidence has been developing: from 2004 to 2013 the middle class roughly doubled in size, and consumer confidence in Indonesia in the third quarter of 2016 was among the highest in the world, according to market research agency Nielsen. This has resulted in notable growth in modern retailing.

The modern evolution of Indonesia’s retail segment began in the late 1990s, when policymakers decided to ease foreign investment restrictions. These decisions were first put into action with a number of regulations introduced in 2000, which allowed foreign direct investment in Indonesia for the first time. These enabled the retail giant Carrefour, a subsidiary of CT Corporation now under the name Transmart, to expand operations in Jakarta. The regulations also facilitated market entry for a number of other international retailers, which in turn has created a more competitive environment. This has taken market share away from traditional retail outlets through the creation of hypermarkets, supermarkets, convenience stores and minimarkets. While traditional markets still account for the largest share of the retail food industry, modern retailers are expanding their market share.

According to the US Department of Agriculture and Euromonitor International, modern retail consumption was highest among convenience stores in 2015, when it stood at Rp104.6trn ($7.9bn), followed by supermarkets with Rp66.2trn ($5bn) and hypermarkets with Rp42.9trn ($3.2bn). Indonesia has a relatively small number of key players dominating sales: according to statistics from Euromonitor International, in 2016 the two retail giants Indomaret and Alfamart had a combined market share of 89.7%.

Smaller players in the convenience store business have not fared so well. Modern Internasional, the owner of Indonesia’s 7-Eleven franchises, closed all of its stores in June 2017 due to “limited resources”. The firm announced this closure shortly after Charoen Pokphand Indonesia, an affiliate of the Thai conglomerate Charoen Pokphand Group, pulled out of a potential acquisition valued at Rp1trn ($75m).

Under Modern Internasional, 7-Eleven Indonesia had an eight-year lifespan, with a total of 161 stores at the end of 2016. While tough competition is partly to blame for the franchise’s closure, others have assigned responsibility to legislative measures, such as the 2015 nationwide ban on alcohol sales at minimarkets. Before this regulation, beer alone accounted for 8-12% of 7-Eleven’s sales. Regardless of the reasons for its insolvency, 7-Eleven held only a small share of the modern retail market: it made up only 0.7% of total retail sales among convenience stores in 2016, reaching Rp675.3bn ($50.7m). This already foreshadowed declining performance: it was a 24% fall from 2015, according to Euromonitor International.

Despite the closure of 7-Eleven, modern retail is generally very influential in the formation of Indonesia’s landscape: a growing number of malls, supermarkets and convenience stores are developing across much of the country, particularly in East Java, North Sumatra and North Sulawesi. Large shopping malls have also become a major feature of Jakarta: Pacific Place Jakarta has over 200 retail outlets; Mal Taman Anggrek has more than 500 stores, 18m annual visitors and 360,000 sq metres of retail floor area; and Grand Indonesia Shopping town is categorised as a mega-mall, with 641,000 sq metres of retail space. Other notable shopping malls include Pondok Indah Mall, Plaza Indonesia, Central Park Mall and Plaza Senayan.

COMMERCIAL RETAIL: According to Colliers International, three shopping centres are scheduled to open in Jakarta in late 2017 or early 2018, adding 139,000 sq metres of retail space to the market, with a further 45,000 sq metres under construction to be added by the end of 2019. This will increase Jakarta’s cumulative retail supply to approximately 4.75m sq metres by 2020. Aeon Mall in East Jakarta was the first to open in 2017, offering 71,000 sq metres in September. Greater Jakarta, the urban agglomeration surrounding the capital, had a cumulative retail supply of 2.52m sq metres as of August 2017, with another 225,685 sq metres under construction and scheduled to open by the end of 2019.

Demand for retail space is already relatively high, and rising – in 2016 occupancy of retail space in malls hovered around 85-86%, and in 2017 this is expected to increase to 87-88%. The majority of demand is for food and beverage space, supermarkets, home furnishing and entertainment, according to the Colliers report on the second quarter of 2017. In this period average rents in Jakarta climbed 5.2% y-o-y to Rp599,000 ($44.81) per sq metre per month, while in Greater Jakarta rents increased 7.4% y-o-y, to Rp368,000 ($27.51) per sq metre per month.

REGULATIONS: Over the last decade, regulations have been passed to help expand modern retail. After multiple protests from traditional market retailers, government authorities capped the number of permits granted to new convenience stores and enforced urban planning rules under Presidential Regulation No. 112/2007, naming limits on operating hours, zoning, distribution and supply, and other logistics activities.

The Ministry of Trade (MoT) released further rules under MoT Regulation No. 70/2013 and its amendment No. 56/2014 for traditional markets, shopping malls, and modern stores and outlets. Under these regulations, at least of 80% of sales must come from domestic products, and private label items may account for no more than 15% of stock-keeping units. Specialty stores, which require product uniformity and cannot source products locally, are exempted from this rule. These regulations also stipulate what kinds of goods certain stores may sell. Minimarkets are prohibited from selling fresh products in bulk, and they are also not permitted to sell alcoholic beverages near housing complexes, places of worship, bus and train stations, hospitals, youth centres or schools. Furthermore, one company may own no more than 150 retail outlets – any number greater than this must be franchised. Businesses already over this limit prior to the regulation, however, were allowed to continue their operations as normal.

Presidential Regulation No. 39/2014 established size requirements for fully or partially foreign-owned businesses, stipulating that minimarkets must have at least 400 sq metres of retail space, supermarkets a minimum of 1200 sq metres and department stores at least 2000 sq metres. However, in 2016 Presidential Regulation No. 44/2016 overrode No. 39/2014, relaxing many such restrictions on retail spaces receiving foreign investment. Among other things, this recent regulation allows department stores with less than 2000 sq metres of retail space to receive up to 67% of their funding from foreign capital. According to a statement by the Indonesia Investment Coordinating Board, foreign investors can also contribute up to 33% of funding to supermarkets smaller than 1200 sq metres and minimarkets smaller than 400 sq metres.

ONLINE: In 2016 foreign investors were allowed full ownership of e-commerce firms operated under the marketplace business model. Through Presidential Regulation No. 44/2016, foreign players in Indonesia may own 100% of this type of online business – daily deals and online classified advertisements, for example – provided that they invest a minimum of Rp100bn ($7.5m) to establish it. For investments below this level, companies may still be exclusively foreign-owned if they create at least 1000 local employment positions. However, for e-commerce investments not meeting these thresholds, foreign ownership is capped at 49%.

Growing GDP per capita figures, coupled with rising internet penetration and smartphone usage, give online shopping significant growth potential (see ICT chapter). As the fourth most populous country in the world, the domestic market is also in high demand. “Indonesia is an attractive destination for e-commerce firms because of the size of its consumer base. Competition for a share of the growing number of e-wallets is very high,” Ignatius Untung, chief of business and economy at the Indonesian E-Commerce Association, told OBG. “However, there is still a clear need for accurate and formal data on e-commerce in Indonesia to attract business investors.”

SHOPPING FACTORS: Before full potential can be realised, e-commerce companies have a number of challenges to solve. According to a McKinsey report, only 1% of retail sales in Indonesia were made online as of late 2016, compared to 8.5% in the US and 17% in China. This percentage indicates a persisting preference to visit physical stores, particularly shopping malls, as well as the propensity for locals to use cash rather than online payment methods: only 36% of working-age people in Indonesia have a bank account, according to the World Bank. This is approximately one-half the average rate of bank account ownership in the Pacific and East Asian regions.

In addition, geography presents some unique obstacles: the country comprises more than 13,000 islands, 922 of which are permanently inhabited. This means that building a stable delivery network and maintaining customer satisfaction levels is very costly. However, in spite of market gaps, major international e-commerce players are eager to battle for a market share in South-east Asia’s most populous country.

In early 2017 PwC released a report titled “Where Retailers Should Invest Next”, covering current investment findings and projections for coming years. As of the beginning of 2017 Indonesia had approximately 104m internet users and this number is expected to grow to 136m by 2020. Furthermore, as of late 2016, an estimated 110m people – 43.7% of the country’s population – had a mobile phone. The adoption of low-cost smartphones and the expansion of high-speed wireless networks are expected to underpin the development of these segments.

Further findings report rates of online versus in-store shopping, and the reasons shoppers prefer one method over the other. In a survey of 29 countries, online customers use e-commerce for one-third of their total store visits, with 36% using the channel because of better prices, 30% due to the wider variety of products available and 23% because of convenience. That being said, many consumers prefer shopping in-store, with the top-three reasons being sales associates’ knowledge of the products, the ability to check stock levels and real-time, personalised offers.

OUTLOOK: Bearing in mind the nation’s macroeconomic composition, the development of the retail sector will largely depend upon consumption patterns, which will continue to evolve as modern retail outlets increase their market penetration. Considering market forces, it appears very likely that modern retail will eventually dominate the Indonesian market. As an expanding middle class enjoys gains in purchasing power, hypermarkets, supermarkets and minimarkets are expected to be in higher demand across Indonesia, primarily in urban areas. However, expansion will have constraints, particularly in regard to land use, as these facilities must find suitable territory on which to operate (see Construction & Real Estate chapter).

Retail expansion throughout Indonesia is promising; however, the rate of growth of modern retail outlets is expected to slow, resulting from limited land availability and greater urban penetration. Rising smartphone usage and increasing demand for online services is projected to create double-digit growth rates for smartphones and other related devices, which will make communications the fastest-growing retail subsector in the coming years.

From a consumption perspective, spending power will depend on policymakers’ ability to strengthen the rupiah and limit inflation pressures. Government efforts to enhance tax compliance and collection, and to channel the extra revenue into much-needed infrastructure projects could, in turn, enhance Indonesia’s competitiveness and reduce costs for both retailers and final consumers. Investor confidence was given a further boost in May 2017, when the ratings agency Standard & Poor’s upgraded Indonesia’s sovereign rating to investment grade, which bodes well for the development of the nation’s entire retail industry.

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The Report: Indonesia 2018

Retail & E-Commerce chapter from The Report: Indonesia 2018

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