New free trade agreement negotiations and investment reforms to accelerate Indonesian development

 

Although Indonesia’s export receipts hit a five-year high in 2018, imports surged as the country moved to deliver a massive infrastructure development programme, bringing the trade deficit to an all-time high after three years of surplus. The country remains dependent on raw commodities for much of its export revenues, and global commodity price volatility has weighed on the trade balance in recent years, while lower demand for Indonesian exports has further dampened the outlook.

Foreign direct investment (FDI) inflows also slumped in 2018 after recording five years of consecutive growth, with global emerging market jitters and Indonesia’s upcoming presidential elections affecting investor sentiment. Recent reforms to prevent capital outflow from China have further weighed on FDI growth, highlighting the importance of fostering stronger trade and investment ties with smaller partners, as well as leveraging its economic strength in major multilateral free trade agreement (FTA) negotiations. In March 2019 Indonesia signed the Indonesia-Australia Comprehensive Economic Partnership Agreement (IA-CEPA). The next focus is to sign a similar deal with the EU, the IE-CEPA. However, the tangible economic benefits of both deals remain unclear, putting the spotlight on the Regional Comprehensive Economic Partnership (RCEP), the world’s largest FTA encompassing China, India and ASEAN. RCEP negotiations are expected to conclude in 2019, offering Indonesia the opportunity to build on its burgeoning trade ties with India, as well as its leadership role in ASEAN.

With US protectionism and a Sino-US trade dispute looming in the background, Indonesia also has the chance to take on a leadership role in the revived version of the Trans-Pacific Partnership (TPP), the Comprehensive and Progressive Agreement for TPP (CPTPP), with considerable potential to boost trade and investment activity in the country.

Advantages

Indonesia’s abundant natural resources and diverse agriculture base offer numerous opportunities for investment in agriculture, manufacturing, infrastructure and tourism, supported by readily available supplies of timber, coal, tin, bauxite, copper and nickel. Its large, young and growing population and expanding middle class also offer a sizeable domestic market for potential investors and producers: with 265m people, Indonesia is the world’s fourth-most-populous country after China, India and the US, and the median age of its citizens is 28.

According to the World Trade Organisation, in 2016 Indonesia was the world’s 30th-largest exporter of goods, in addition to being the largest thermal coal exporter and top palm oil producer. The country also holds notable reserves of nickel, gold, copper and bauxite and a diverse array of agricultural commodities, including cocoa, coffee and tea.

The manufacturing sector, while still dwarfed by raw commodities, is also diverse and growing, supported by the textile and garment, footwear, rubber, electronic, motorcycles, wooden products, paper and light machinery segments. Indonesia remains highly dependent on raw commodity exports, however, leaving it vulnerable to global price shocks and prone to cyclical volatility that has seen its trade balance seesaw from deficit to surplus and back to deficit in recent years.

Oversight

Trade and investment supervision in Indonesia involves multiple ministries and government entities. Investment is primarily overseen by the Indonesia Investment Coordinating Board (BKPM), which serves as the government intermediary for potential foreign investors. BKPM is a non-ministerial government agency established in 1973, tasked with implementing policy and service coordination, with the overarching objective of seeking domestic and foreign investment that will accelerate the economy.

BKPM’s strategic roadmap aims to generate nearterm revenues by exporting natural resources, channel new investment into hard and soft infrastructure, and lay the groundwork for industrialisation. The roadmap also seeks to promote investment in education to develop a highly skilled, globally competitive workforce and transition into a knowledge-based economy.

The Ministry of Trade (MoT) oversees foreign and domestic trade, export promotion and consumer protection through nine directorates and agencies. The Ministry of Industry is also involved with overseeing and promoting industrial development through 12 directorates and agencies. Many of them are sector specific and dedicated to expanding priority industries, including chemical and textile products, metal, machinery, transport, electronics and agriculture.

Reform Packages

In an effort to reduce dependence on raw commodity exports, boost FDI inflows and support growth in value-added manufacturing, the administration of President Joko Widodo has launched 16 reform and stimulus packages since 2014. Notable among these is the 10th package, which was issued in 2015 and mandated a “big bang” economic liberalisation that reduced or eliminated foreign ownership restrictions in key sectors, including cold storage, crumb rubber processing, warehousing and tourism.

According to a February 2019 report in Asian Legal Business, the country’s negative investment list (DNI) will be dramatically revised in 2019. The list maintains foreign ownership restrictions across numerous sectors and segments, although since the Presidential Regulation No. 44 of 2016 it has permitted 100% foreign ownership in selected industries, such as e-commerce. The new DNI is expected to allow 100% foreign ownership in more than 50 additional sectors that were previously closed to foreign investors, with the government reporting that this will include the cigarette industry, oil and gas construction services, drilling services, power plants with a capacity greater than 10 MW, data communication system services and over-the-counter pharmaceuticals. Another important reform, and one of the first rolled out by the Widodo administration, sought to reduce red tape through the creation of a one-stop shop where investors can expedite the licensing process.

Streamlining Processes

In a further bid to enhance the process of obtaining a business licence, the government launched the online single submission (OSS) licensing system in July 2018 (see Legal Framework chapter). The ICT-based system integrates the processes of registration and obtaining licences from different ministries and government agencies, streamlining the process by merging several licences into one.

Previous rules and regulations on business licensing remain, however. Some of the rules mandated by BKPM are still applicable, including the minimum capital investment for FDI and the maximum debt-to-equity ratios. BKPM and other ministries are currently working together with the Coordinating Ministry for Economic Affairs to establish the extent of business licensing and facilities under the OSS system.

Ease of Doing Business

Government trade and investment promotion efforts have had a positive effect on the overall investment climate. The World Bank’s “Doing Business 2019” report ranked Indonesia 73rd out of 190 economies. While this is an improvement on the country’s 120th ranking in 2014, it is still lower than the 40th position targeted by President Widodo. Despite slipping from 72nd place in 2018, Indonesia recorded improvements across most categories, partly due to several positive developments undertaken in 2018. In the starting a business category, Indonesia combined various social security registrations and reduced notarisation fees in Jakarta and Surabaya, while different business registrations were also combined at Surabaya’s one-stop shop. The government also made registering property easier by implementing transparency reforms at the land registry, and reducing the time taken to resolve land disputes at the Commercial Court. Improvements were also recorded in the getting credit category as a result of moves to distribute credit information from retailers and utility companies. Indonesia still ranks low in the starting a business category (134th), as well as in the categories dealing with construction permits (112th), trading across borders (116th) and enforcing contracts (146th).

Economic Zone Incentives

A host of investor incentives are on offer at a network of industrial estates, which has expanded from 74 locations covering 36,300 ha in 2014 to 87 locations covering 59,700 ha in 2017. Additionally, Indonesia has also increased the number of special economic zones (SEZs) available to 12, of which four are currently operational.

Efforts to attract investment include the creation of numerous investor incentives for projects in SEZs, including tax holidays of up to 100% for 10-25 years for any investment over Rp1trn ($70.9m), and from five to 15 years for projects valued between Rp500bn ($35.5m) and Rp1trn ($70.9m). Other incentives include a reduction of up to 30% of net taxable income for investments in fixed assets, pro-rated at 5% for six years of commercial production, accelerated depreciation or amortisation, extension of tax losses carrying forward up to 10 years, reduced withholding tax on dividends paid to non-residents and value-added tax (VAT) exemptions for luxury goods that are either imported to SEZs or delivered among companies in other SEZs.

Customs exemptions are also available for all goods entering an SEZ, as well as goods being exported, except for leather, wood products, cocoa beans, crude palm oil and minerals. SEZ investors are also eligible to hold building rights for land under an 80-year lease, and to own property within an SEZ.

Industrial park incentives include VAT exemptions on the import and purchase of machine and equipment to produce goods, import exemptions on machines and materials used to produce goods and services, and corporate tax holidays ranging from 10% to 100% for five to 15 years from the start of commercial production.

Trade Activity & FDI 

According to MoT statistics, palm oil and coal dominated Indonesia’s export base, with exports of fats, oils and waxes totalling $23bn in 2017, followed by $20.5bn of mineral oils and fuels. Electrical equipment followed in third place, with $8.5bn of exports recorded, while rubber and rubber articles, and vehicles other than trains rounded out the top five, with $7.7bn and $6.8bn, respectively. In 2018 exports of non-agglomerated coal (excluding anthracite and bituminous) took the lead, rising by 34.3% to stand at $14.1bn, followed by refined palm oil with $13bn, bituminous coal with $7bn and liquefied natural gas with $6.5bn. Although the balance of trade had been improving steadily in the years since 2015, hitting a fiveyear high in 2017, rising oil prices and soaring imports led to a record trade deficit in 2018.

Annual FDI inflows have also slumped, contracting for the first time in five years in 2018 as weakening outflows from China exacerbated existing volatility – both in emerging markets globally and domestically in the lead-up to the 2019 presidential elections (see analysis).

Trade Balance

Indonesia recorded consecutive trade deficits in 2012-14, although MoT data shows that the trade balance swung from a $2.2bn deficit in 2014 to a $7.7bn surplus in 2015. This was largely caused by fuel import costs declining with global oil prices.

The trade surplus rose to $9.5bn in 2016 and hit a five-year high of $11.8bn in 2017, supported by rising global commodity prices. Meanwhile, the country recorded a 16.2% increase in export receipts to $168.8bn, even as the import bill rose by 15.7% over the same period to $157bn. In early 2018 Statistics Indonesia (BPS) reported that the increased surplus was mainly attributable to improved commodity prices, as well as an increase in exports to non-traditional markets including Turkey, Egypt and Brazil, which had supported robust export growth in 2017. BPS stated that it expected a larger trade surplus in 2018, but there were already warning signs in late 2017, with the country posting a trade deficit of $270m in December as manufacturers and construction companies increased their capital goods and raw materials imports.

Imports

Imports continued rising throughout 2018, and in January 2019 international media reported that Indonesia’s trade deficit was larger than forecast for the third month in a row. In December 2018 it exceeded expectations of $930m to hit $1.1bn, bringing the annual trade deficit to $8.56bn, the largest on record. According to MoT data, total export receipts rose by 6.7% to hit a five-year high of $180.2bn. Imports recorded a much sharper increase, rising by 20.2% to $188.7bn despite government efforts to reduce the import bill, which included introducing a mandate to increase use of domestic biofuels, raising import taxes and delaying large, import-heavy infrastructure projects. Bank Indonesia (BI), the central bank, also increased the interest rate six times in 2018 by a combined total of 175 basis points in an effort to bring the current account deficit down. These measures were not entirely effective, and Indonesia’s full-year current account deficit expanded to 3% of GDP in 2018, up from 1.7% in 2017 (see Economy chapter).

Speaking to the media in February 2019, a BI representative reported that the deficit is expected to rise further in 2019 due to fluctuating commodity prices and subdued global growth. The government seeks to lower the deficit to 2.5% of GDP by the end of 2019 through higher import taxes on consumer goods, an extension of the B20 biodiesel programme for domestic fuel sales to reduce oil and gas imports, and renewing its focus on tourism sector development, as well as offering fiscal incentives to natural resource exporters to keep foreign exchange earnings in the country.

Partners in Commerce

According to the European Commission, in 2017 Indonesia’s top trade partner in terms of value was China with $60.6bn, followed by Japan with $33.6bn, Singapore with $31.2bn, the EU with $29.7bn and the US with $27.3bn. Indonesia recorded its largest trade deficit with China in 2017 at $17.6bn, followed by Singapore at $4.4bn, while its top trade surpluses were with India at $10.7bn, the US at $9.9bn, the EU at $4.8bn and Japan at $3.8bn.

Though MoT data differs, it also shows that much of 2018’s trade balance deterioration was driven by surging imports from its main trade partners. The MoT reported that total exports to China rose by 17.5% in 2018 to $27.1bn, although imports simultaneously rose by 27.3% to $45.5bn. This brought the trade deficit with China from $12.7bn in 2017 to $18.4bn in 2018.

Rising levels of US imports also saw Indonesia’s trade surplus with the US drop to $8.3bn in 2018, down from $9.7bn in 2017, according to MoT data. Exports to the US rose by just 3.6% in 2018, while imports rose by 25.3%.

“Given the US’ protectionist policies, Indonesia’s textiles exports have increased with other countries, such as Brazil,” Michelle Tjokrosaputro, president director of Dan Liris, a local garment and textiles manufacturer, told OBG. “In order to sustain local production, the MoT and the private sector must formulate an effective response to protectionist trade policies that are being adopted by primary export markets.”

The situation is unlikely to improve in 2019, after the US Trade Representative announced it was reviewing Indonesia’s eligibility for generalised scheme of preference (GSP) trade privileges beginning in the second half of 2018. GSP privileges eliminate tariffs on a sweeping selection of trade categories – which were not specified – and the removal of GSP privileges will likely see US-bound exports drop considerably. The move could be a response to state-owned PT Inalum’s $3.9bn acquisition in December 2018 of a 51.2% stake in PT Freeport Indonesia, a unit of US company Freeport-McMoRan, giving it control of Indonesia’s Grasberg, the second-largest copper mine in the world.

A rising import bill and modest export growth has prompted stakeholders to call for export diversification and growth in non-traditional markets. India is a partner with high potential – although the MoT reports that Indonesia’s trade surplus with India fell from $10.04bn in 2017 to $8.7bn in 2018, this is still the largest surplus Indonesia maintains with any single trade partner, supported by India’s position as the top buyer of Indonesian biofuels and ASEAN’s biggest trade partner.

Transforming Trans-Pacific

Having signed the IA-CEPA in March 2019, Indonesia is currently focused on the IE-CEPA. Although both of these agreements highlight Indonesia’s commitment to economic liberalisation, free trade and globalisation, achieving tangible economic benefits with Australia and the EU could prove challenging. This means it is important to look elsewhere for potential partners (see analysis).

Immediately upon taking office, US President Donald Trump withdrew from the TPP, an FTA that also included Japan, Canada, Australia, Malaysia, Vietnam, New Zealand, Singapore, Chile, Mexico and Brunei Darussalam. The trade partnership was renegotiated and renamed the CPTPP. While Indonesia has not signed onto the new pact, future membership in the FTA could give it considerable negotiating power.

As noted by international media in April 2018, Indonesia’s interest in joining the CPTPP has been rising since Malcolm Turnbull, Australia’s then-Prime Minister, invited Indonesia to join the deal during a March 2018 special ASEAN Summit. Sri Mulyani Indrawati, the minister of finance, responded by telling media that Indonesia may join the agreement, provided some of its structural issues are addressed. The CPTPP entered into force in December 2018, and leaders of the signatory countries met in January 2019 to discuss expanding membership to include Colombia, Indonesia, South Korea, Thailand and the UK. According to international press, Indonesia’s membership would be of great benefit to CPTPP, with the US’ exit leaving a space for Indonesia to take on a leadership role in negotiations. Indonesia’s inclusion in the agreement would increase the cumulative GDP of signatories by up to 9.2%, to $11trn, while the country’s population of 265m people would significantly expand the market size for participating countries. This gives Indonesia considerable negotiating power as CPTPP signatories seek to attract new members.

In April 2018 Enggartiasto Lukita, the minister of trade, called on all ASEAN members that have not yet joined CPTPP – including Thailand, the Philippines, Myanmar, Laos and Cambodia – to sign on so that ASEAN can negotiate as a bloc, further improving the potential for a regionally and domestically beneficial outcome. Potential stumbling blocks for Indonesia and other potential ASEAN signatories include concerns over intellectual property right provisions, which could impact pharmaceutical prices and food security.

RCEP 

The most important agreement for Indonesian stakeholders is the RCEP, the world’s largest FTA comprising all 10 ASEAN members, as well as South Korea, Australia, New Zealand, India, China and Japan. RCEP offers potentially more benefits for Indonesian exporters, including the potential to expand its trade relationship with India, its top market for biofuel exports, and the ability to negotiate with other RCEP members as a unified bloc. Indonesia is acting as ASEAN’s lead negotiator in RCEP talks, cementing its position as the association’s most important economic power.

In November 2018 the government noted that substantial progress had been made in RCEP negotiations, announcing that ASEAN leaders had agreed to complete the deal before 2020, with President Widodo highlighting priorities for negotiating parties: flexibility, common interest, discipline in discussions, the setting of targets and concrete cooperation.

Outlook

Although global volatility, domestic uncertainty, modest export growth and soaring import receipts have weighed on the confidence of trade and investment stakeholders in Indonesia in recent years, the country’s growth prospects remain extremely bright. Ongoing efforts to liberalise the economy and attract further domestic and foreign investment will likely see sweeping revisions to the DNI in 2019, while Indonesia’s membership in a handful of important multilateral and bilateral trade agreements could also offer benefits, particularly if the country is able to leverage its large economy and population, and sizeable domestic market in FTA negotiations.

Industrialisation efforts will continue to benefit from investor incentives in a growing portfolio of industrial estates and SEZs across the country. These will further support the economy’s transition from being dependent on raw commodities to one that is driven by manufacturing exports. Meanwhile, gradual improvements to the business environment and infrastructure network are expected to help support an acceleration of macroeconomic growth over the years to come.

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The Report: Indonesia 2019

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