Indonesia’s construction sector will likely be a bright spot in an otherwise subdued economic growth story in 2016, as the country’s widening infrastructure gap and recent fuel subsidy reforms have driven a surge of new government spending into a massive public infrastructure programme.
New public projects – including ports and airports, more than 2500 km of roads, power plants, and oil and gas facilities – will drive industry growth over the medium term, while private sector investment is set to rise on the back of a number of proposed public-private partnerships (PPPs), even as the government moves to expand the role of state-owned enterprises (SOEs) in infrastructure delivery.
Although a number of challenges remain, most notably delays in budget disbursement and land acquisition, ongoing reforms aimed at improving timely project delivery, combined with a surge of new investment in construction materials, particularly cement, should keep the industry on a strong growth path in 2016.
Rising Infrastructure Demand
Indonesia’s previous administration recognised the importance of infrastructure development as a catalyst to drive down logistics cost, boost competitiveness and attract foreign direct investment (FDI). The administration of Susilo Bambang Yudhoyono unveiled in 2011 its Masterplan for Acceleration and Expansion of Indonesia’s Development (MP3EI), which is a long-term strategy aimed at transforming Indonesia into one of the world’s largest economies by 2025.
MP3EI placed a strong emphasis on infrastructure development through PPPs, although challenges including difficulty of land acquisition, regulatory uncertainty, burdensome red tape and lack of interest from the private sector due to the long-term nature of returns on major projects have limited development of PPPs so far. Lack of progress on infrastructure development is evidenced by sluggish infrastructure spending since 2012, and further progress of infrastructure projects such as toll roads has so far been limited, with just 140 km of new highway constructed between 2012 and 2014, despite an estimated deficit of more than 2500 km.
Timothy Daly, president director of real estate developer Nirvana Wastu Pratama (NWP Retail), told OBG, “Logistics and infrastructure remain a particularly unique challenge in Indonesia. One of the biggest burdens to the development of commercial real estate projects outside of Jakarta is access to the power grid. Using diesel-fuelled generators as a substitute is not an option, as additional operating costs make the project financially unsustainable.”
At the same time, an ongoing economic slowdown has had a negative impact on investor sentiment, putting pressure on the government to offer even more favourable terms to private infrastructure investors.
According to a February 2016 report published by DBS Vickers Securities, a Singapore-based brokerage firm, the timing is perfect for a major public infrastructure push: Indonesia’s economic slowdown, for example, has put pressure on the government to pump prime the economy through infrastructure spending. President Joko Widodo’s nine-pillar economic development strategy, Nawa Cita, was unveiled in 2014 and envisions increasing productivity and competitiveness, in part through enormous investment in infrastructure development.
Under the umbrella of Nawa Cita, the Widodo administration launched the National Medium-Term Development Plan, running between 2015 and 2019, which includes plans to construct 2650 km of road and complete maintenance on an additional 46,770 km of existing roads.
Connectivity and competitiveness will also benefit from the construction of 15 new airports and 24 seaports, as well as a 3258-km rail line linking Java, Sumatra, Sulawesi and Kalimantan, including 2159 km of intercity railway track and 1099 km of urban rail lines. In a bid to boost agriculture and social development, the government hopes to see the construction of 49 new dams and the rehabilitation of 1m ha of irrigation network, as well as 515,711 new affordable housing units.
The oil and gas and utilities sectors should also benefit from a surge in infrastructure development, with the Indonesia Investment Coordinating Board (BKPM) reporting plans to build two new oil refining units with capacity of 300,000 barrels per day each, as well as boosting electricity generation by 35,000 MW, with 7000 MW of projects already in the pipeline.
This infrastructure impetus is reflected in the 2016 state budget, with the Ministry of Finance announcing plans to earmark Rp313.5trn ($22.9bn) for infrastructure development in 2016, the highest allocation ever made to the sector. The government’s infrastructure spending has soared in recent years, rising from just Rp75trn ($5.5bn) in 2009, with 2016’s higher outlays reflecting the seriousness of the government’s intention to move ahead on major planned infrastructure projects.
In 2016 priority projects expected to break ground include construction of 769 km of national roads and 11,642 affordable apartment units, with the Ministry of Public Works and Housing reporting in December 2015 that it had already tendered various projects during the last quarter of 2015, under the government’s new system of pre-budget funding and early tendering.
As a result of a recent surge in government spending, the construction sector is outperforming many other segments of the Indonesian economy, which have been negatively impacted by the effects of falling commodities prices, particularly lower energy prices. Although the rupiah’s rapid depreciation between 2013 and mid-2015 has driven up the cost of supplies, with Statistics Indonesia (BPS) reporting that the cost of materials rose by 14.3% to hit Rp230.2trn ($16.8bn) in 2014, from Rp201.5trn ($14.7bn) in 2013, the sector’s contribution to GDP growth has simultaneously recorded double-digit expansion every year between 2010 and 2014.
BPS reports that the industry’s contribution to GDP at current market prices rose by 13.6% between 2010 and 2011 to reach Rp712.2trn ($52bn), equivalent to 9.1% of GDP, before rising by 13% in 2012 to hit Rp805.2trn ($58.8bn), 12.5% in 2013 to Rp906trn ($66.1bn), and a further 15% in 2014 to reach 1042trn ($76.1bn), or 9.9% of GDP. Although the number of construction firms in operation fell from 131,080 in 2013 to 129,819 in 2014, employment in the industry is on the rise, with BPS reporting worker numbers rose by 1.9% to hit 946,424 in 2014, from 928,729 in 2013.
Materials costs are increasing as a result of this rapid growth, with RLB Indonesia, a global property management firm, reporting in June 2015 that the prices of concreting sand, stone aggregate and Portland cement rose by 5.82%, 7.7% and 3.8%, respectively, between the first quarter of 2014 and the first quarter of 2015. Prices for high-tensile steel bars, mild steel round bars and structural steelwork simultaneously rose by 5.6%, 5.6% and 6.2%, respectively. This will provide significant opportunities to industrial producers operating in the country, as evidenced by a surge of new investment in the cement sector, with four new operators expected to begin producing in 2016, significantly boosting installed capacity, and eventually enabling regional exports (see analysis). Sim Putra Bradley, the president director of Beton Indotama Surya, told OBG, “If all the projects that the country seeks to achieve in the next five years were to start, we would not have enough construction materials. Raw materials are abundant, but permits are often complicated to get and getting to resources in remote areas is difficult. Furthermore, most heavy equipment is imported. Today, the construction material segment is an expensive sub-sector to invest in.”
Expansion into other areas outside of major urban areas also offers more opportunities. “Secondary cities offer good growth potential for construction materials and the paint and coatings sector, but it is important to keep enhancing distribution and branding in these regions,” Jun de Dios, president director of AkzoNobel Decorative Paints, told OBG. “One of the issues when providing materials to small developers and contractors is that their access to finance is still relatively low.”
The materials segment also means opportunities in the market for foreign investors offering high-quality products. “The sector is very open for foreign investors and will remain that way. Where international companies can distinguish themselves, and where there is still room in the market, is in the manufacture of high-quality building materials,” Kam Kettin, president director of building materials retailer Depo Bangunan, told OBG. “Indonesia lags behind and the demand for these types of products will continue to grow.”
Established in 2009, the Green Building Council of Indonesia (GBCI) promotes energy-efficient construction and certifies green buildings. The GBCI has introduced a rating tool called Greenship, which ranks buildings in land use, energy efficiency, water conservation, source materials, building and environmental management, and air quality. As of May 2016 the council had fully certified 41 buildings, while more than 150 were being assessed or registered.
However, according to Jendriko Silalahi, president director of local developer Artha Debang, there is still much to be done. Silalahi told OBG, “The use of green construction is still lagging behind, and this is in part due to higher costs for these materials, which are mainly imported.” Hanafi Atmadiredja, president director of ceramic manufacturer TOTO, agreed with this view. “The use of green construction has a lot of potential in Indonesia, but it remains relatively expensive,” Atmadiredja said. “While there aren’t more incentives and regulations, real estate developers will not choose this alternative.”
Private Sector Role Expanding
Although the government has been able to realise new fiscal space following Widodo’s move to cut $18bn worth of annual fuel subsidies in 2015, enabling his administration to channel more funding into SOEs for infrastructure development, the government has also stressed that private sector participation, most likely through new PPPs, will drive infrastructure growth in the future.
The government’s 2016 state budget structure reflects the effort to decentralise and expand the role of SOEs. The infrastructure budget at the ministerial level was reduced by 15%, or Rp29trn ($2.1bn) year-on-year (y-o-y) in 2016, while a capital injection to SOEs saw funding to these companies jump by 40% y-o-y, or Rp11trn ($803m).
Private sector participation in planned infrastructure development will be even more critical than government spending, however. DBS Vickers writes that while Indonesia is still in the early stages of its upcoming construction boom, as evidenced by the private sector’s low participation rate in infrastructure development – most projects are still handled or assigned by government agencies – 2016’s planned ventures will help galvanise the participation of private firms in the development process through PPPs, leading to higher employment for both SOEs and private contractors. There will also be knock-on effects for a number of sectors, such as affordable housing. Silalahi told OBG, “For the government’s affordable housing programme to succeed, it is essential to facilitate private participation, especially by improving transparency and reducing bureaucratic processes on what concerns licensing.”
According to a May 2016 report by Indonesia Investments, a subsidiary of Netherlands-based Van der Schaar Investments, Indonesia requires an estimated $450bn to fund the government’s infrastructure development plans through to 2019, while BKPM reports that the total cost of the country’s infrastructure needs will reach Rp5519.4trn ($402.9bn). However, state budgets are only able to meet roughly 50% of the required funds, or $230bn, with 30% of the total expected to be made up by private sector funding and 20% from SOEs.
In order to attract the $141bn of necessary private sector investment in construction projects, the government has adopted a host of new strategies aimed at improving the investment climate and boosting private finance, in addition to expediting processes and delivery at the public level.
Although public spending will also be impacted by tax revenue collection, with the government consistently failing to meet its tax collection targets, and expected to fall short again in 2016 (see Economy chapter), the government has also turned to debt markets to finance some of its larger projects, securing some Rp64trn ($4.7bn) from a bond auction to fund its 2016 state budget prior to the commencement of the new year. SOEs are also turning to debt markets: the country’s largest state-owned port operator, PT Pelabuhan Indonesia (Pelindo) II, became the first SOE to issue a global bond in May 2015, with a two-series issuance valued at $1.6bn (see Transport chapter).
Having already identified PPPs as critical for implementing major new infrastructure builds, the Indonesian government has ramped up its efforts to forge new partnerships with the private sector in recent years, including the issuance of Presidential Regulation 78/2010 on government guarantees for PPP infrastructure projects through the Indonesia Infrastructure Guarantee Fund, a single-window mechanism; the Ministry of Finance Regulation 260 of 2010, which establishes the procedure for requesting and providing such guarantee; and the 2012 Land Acquisition Law, which was brought into force by the Widodo administration in 2015. The National Development Planning Agency ( BAPPENAS) also moved to issue Regulation 3/2012, which establishes the procedures for implementation of PPP projects in infrastructure.
BAPPENAS maintains a PPP book, with the most recent, published in 2015, listing 38 projects available as PPPs, compared to 27 projects in the previous edition. According to the 2015 edition, 22 PPPs were in progress as of May 2015, lending an optimistic outlook to future private sector development, with projects including the Bandung Light Rail Transit system, West Semarang Water Supply and Tanjung Enim-Tanjung Api-Api railway project listed as “ready to offer,” while others, including development of a monorail system in South Sumatra, a toll road linking Manado to Bitung, and the Karama hydropower plant listed as prospective. The list of potential PPPs in 2015 included seven maritime transportation projects; the construction or redevelopment of 12 airports; and a number of new toll road, rail and utilities projects.
As a result of these reforms, in addition to 12 new government stimulus packages which include measures to reduce the time it takes to establish a business in Indonesia (see Economy chapter), the investment climate is slowly becoming more favourable to foreign contractors. Indonesia rose three spots in the “dealing with construction permits” category in the World Bank’s “Doing Business” report 2016, rising to 107th place out of 189 economies surveyed.
The total number of procedures required to obtain a construction permit is 17 in Jakarta, compared to the East Asia and Pacific average of 14.7, and the OECD average of 12.4. The total amount of time required to obtain a permit was 201 days in Indonesia, meanwhile, compared to the East Asia and Pacific average of 134.6 days, while cost as a percentage of warehouse value is 4.3, compared to the East Asia and Pacific average of 1.8.
One of the most significant growth drivers in the construction industry will be the government’s move to implement an early auction system and budget pre-funding in advance of the coming fiscal year, which will enable more stable progress in contract awards. As DBS Vickers reported in February 2016, the Ministry of Public Housing and Works, which is tasked with delivering more than 500,000 new affordable units and over 2500 km of new highway by 2019, attempted to expedite budget absorption by tendering 2016 road projects worth a collective Rp30trn ($2.2bn), equivalent to 29% of its budget in the 2016 fiscal year, during the final quarter of 2015, and signed contracts for projects worth Rp8.8trn ($642.4m) during the first week of 2016, pushing its budget absorption to 5-6% by the end of January, against 0.1% in January 2015.
Budget absorption has long been a major obstacle to timely infrastructure development, and as a result, the government has launched a pre-tendering system enabling disbursement of funds for projects in the coming fiscal year to be disbursed before the start of the year. Under the previous system, projects to be delivered in any given fiscal year could not be tendered or awarded until the fiscal year had begun, and had to be awarded before the end of the year, resulting in extremely slow construction growth during the first half of the year, followed by a flurry of rushed contract awards, or delayed projects. The new system offers various ministries and SOEs a greater degree of flexibility, and should see project disbursement rise during the coming fiscal years.
According to DBS Vickers, consolidation of Indonesia’s network of SOEs should be the next big catalyst for construction industry growth. In April 2016 the Ministry of State-Owned Enterprises (MSOE) announced it would consolidate operations of its public enterprises through the establishment of four new holding companies for SOEs in energy, mining, finance and toll roads. The consolidation, which will take place in July 2016, is expected to increase efficiency and provide better leverage to increase external funding, which will in turn support delivery of new infrastructure projects.
Under the proposed plan, state-owned oil and gas firm Pertamina and gas distributor Perusahaan Gas Negara will be integrated, while aluminium producer Indonesia Asahan Aluminium will become a holding company for mining businesses including Aneka Tambang, Tambang Bukit Asam and Tambang Timah. The MSOE will also appoint toll road operator Hutama Karya as a holding company managing Jasa Marga and Waskita Karya, and most significantly for the construction sector, will bring a number of state-owned construction and engineering companies under one umbrella to better coordinate infrastructure development.
In total, six new holding companies will be established, with the long-term goal of reducing the number of public units from 119 to 85 by 2019, through mergers, acquisitions and the establishment of new holding companies. The MSOE also plans to establish new holding companies for various insurance, mining, Islamic banking, venture capital, shipyards, port fisheries, IT, air service and electronics companies, according to a report by Singapore-based Dealstreet Asia.
Impact On Capital Markets
Adhi Karya is one such entity slated for restructuring, with DBS Vickers writing that the first test of SOE consolidation on construction growth will be the company’s planned 2016 acquisition by Waskita Karya Persero (WSKT), which should be positive given the current fragmented structure of Indonesia’s construction sector, as well as intensifying competition between state-run contractors.
Adhi Karya is a 51% state-owned firm engaged in infrastructure development, real estate, and engineering, procurement and construction activities, and was a fully state-owned enterprise until 49% of its shares were listed on the Indonesia Stock Exchange (IDX) in 2004. WSKT is a general contractor active in building roads, bridges, harbours, airports, factories and industrial facilities.
Improving investor sentiment has had an impact on listed construction companies, although uncertainty regarding delayed project and budget disbursement continues to weigh on capital markets growth. DBS writes that the country’s construction sector was trading at 21 times its paid equity as of February 2016, against a peak of 27 times in February 2015, reflecting choppy execution of the state budget and disappointing recent earnings from some companies. Nonetheless, the company writes that there is room for the sector to trade higher on the IDX, both from higher valuations and earnings upgrades. In addition, in September 2016 the Nikkei Asian Review reported that three of the country’s top construction SOEs – WSKT, Wijaya Karya and Pembangunan Perumahan – were planning to sell shares and raise up to Rp15.8trn ($1.2bn). WSKT is planning to raise Rp5.27trn ($384.7m) through an initial public offering of its subsidiary, Waskita Beton Precast, while the other two firms are aiming for Rp6.15trn ($449m) and Rp4.4trn ($321.2m), respectively, via a rights issue. The move is largely seen as being in response to the government’s infrastructure push, and Wijaya Karya announced that 71% of the proceeds from its rights issue will go towards priority projects, such as toll roads and power plants.
Land Acquisition Reforms
Land disputes have been a significant stumbling block for infrastructure development, although recent reforms in this area are also expected to improve project progress. Although land acquisition laws have offered the legal framework to acquire land in the public interest since 2012, the gap between law and enforcement is vast. Indonesia’s Land Acquisition Act was promulgated by the Yudhoyono administration in January 2012, followed by Presidential Regulation No. 71 of 2012 on Land Procurement Process for the Public Interest, which detailed the implementing regulations of the law.
The new legislation focused on reducing the time that is required for the land acquisition process in the case of public infrastructure projects, in addition to establishing a procedure for the processing of appeals, as well as a formalised framework for proof of land ownership.
Stakeholders expected these reforms to breathe new life into infrastructure investment, although local media reports that legal uncertainty and conflicting local and central government interests have prevented the law’s implementation, despite two rounds of revisions, with the process remaining burdensome and costly. The lack of land has also had knock-on effects for other segments. Budiawan Lebar, president director of Gading Development, told OBG, “The government needs to provide access to land uses, but also to make sure that the land would be used for the appropriate type of projects, as some developers get the land for affordable housing, but later they make non-affordable projects.”
However, in March 2015, the Widodo administration finally enforced full implementation of the Land Acquisition Act, which now includes regulations clarifying the timeframe for the land acquisition process, limiting it first to 559 days, and then to 512 days through the issuance of Presidential Decree No. 148 of 2015.
DBS Vickers writes that more progress on land acquisition reforms is expected during the second half of 2016, with project owners now able to participate in the compensation process, and request reimbursement from the state budget at a later date. The new policies are already having an impact, with the long-delayed Batang power plant, which had stalled for four years due to land acquisition issues, finally completing land clearing for construction in March 2016.
Jefri Darmadi, president director of hotel developer Jakarta Setiabudi Internasional, told OBG, “Land banks in Medan, Semarang and Batam will see a lot of economic activity because of the rising agricultural and manufacturing activities. This will have an impact on the future development of the residential segment.” Looking forward, a number of watershed projects will stand as a litmus test, including the Palembang-Indralaya Toll Road which is part of the Trans Sumatra Toll Road Project and the Soekarno-Hatta express rail link to Jakarta.
Serious challenges remain, as evidenced by recent developments in railway construction. Just days after a Chinese-led consortium including China Railway Construction and Wijaya Karya held a January 2016 ground-breaking ceremony for the country’s $5.5bn national rail project, which will connect Java to Bandung, the Ministry of Transportation halted the project, telling media the consortium had not gone through the proper approval processes, including land acquisition. However, much work remains to be done in creating an effective legal mechanism for terminating legitimate land rights, honouring compensation claims and tackling legal uncertainty.
Business & MICE
Outside of the more popular areas for tourism, investors are looking for new opportunities for tourism developments. For example, in December 2015 French hotelier AccorHotels held a ground-breaking ceremony for its Rp400bn ($29.2m) Pullman hotel, located in Mandalika, West Nusa Tenggara. The new facility is planned to capitalise on a rise in anticipated business and meetings, incentives, conferences and exhibitions (MICE) tourism arrivals. Demonstrating the high potential impact of new tourism developments on the construction industry, Vice-president Jusuf Kalla, has called on the Indonesian government to step up its current plans for infrastructure in the area, which is also slated for development as a special economic zone and would offer additional knock-on benefits to construction contractors (see analysis).
AccorHotels is one of four investors that have announced plans to build five-star hotels in Mandalika, including Jiva Samudera Birn Indonesia, the French Club Med chain and South Korea’s Lee’s. Although the Indonesia Tourism Development Corporation (ITDC) stated that only AccorHotels and Club Med have signed contracts for new hotel builds thus far, the others have signed memorandums of understanding to develop their own facilities, with JSB expected to build two hotels, as well as a convention centre. ITDC has targeted construction of 20 new hotels over the next 20 years.
Although land acquisition challenges and low levels of private investment will continue to challenge stakeholders, the construction industry’s outlook is extremely positive. RLB Indonesia reports that while industry growth may not reach double digits in 2016, the construction industry is expected to grow at an annual rate of 6.9% between 2015 and 2019 on the back of new PPPs. Although increasing competition could prove a challenge, improvements to competitiveness and efficiency are expected as public infrastructure projects continue to move forward. Construction in secondary cities and new hospitality builds in Jakarta, Bali and Kalimantan also offer new channels for private sector growth, further improving the investment climate for foreign companies.
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