Ready to be realised: If regulatory barriers can be overcome, massive potential awaits

As with many economic activities in Indonesia, it is the country’s unlikely geography that has determined the size, scope and characteristics of the construction industry. Indonesia is the world’s largest country composed only of islands, and the 15th largest by land area. Building ports, airport, bridges and other pieces of crucial infrastructure has always been a priority. The sector, consequently, is fragmented and features a wide array of players, local and national, large and small. Domestic firms provide building materials, although given geography, competition often comes down to transportation factors more than anything else. Java, however, remains the centre of business; with more than 80% of industry located there (along with most of the population and economic activity), the construction sector is naturally focused on the island.

Building Indonesia has been a slow process. Roads are clogged or in remoter areas ill-managed, airports lacking and ports inefficient. Attempts to address the problem typically amount to very little. About 80% of Indonesia-bound sea cargo docks in Singapore or Malaysia first, where ports are better. According to a World Economic Forum competitiveness study, Indonesian ports are ranked 95th out of the 139 countries surveyed. Some 23 toll road concessions have been awarded but have yet to see significant progress, such as an east-west toll road to bisect Java. But due to landclearing obstacles and a clunky bidding system resulting in many firms contracted to build small stretches of the road instead of a few doing bigger pieces, little progress has been made.

SUPPORT NEEDED: By summer 2011 infrastructure priorities had become an urgent issue. It is clear transportation bottlenecks are among the chief obstacles to economic growth, and likely a major disincentive for local and foreign investors. Indonesia offers cheap land, labour, a huge domestic consumer market and proximity to several other massive markets, including India and China. This makes the archipelago an ideal place for manufacturing, industry and more – except for difficulties getting the goods to market. The government estimates gridlock on Jakarta’s roads costs the economy around $1.5bn a year. Between cities, the average truck speed is 20-30 kph, when it should be 60-70.

Infrastructure is still lacking, with about half of homes having no electricity. There should be economic multiplier effects from spending in these areas, making Indonesia a regional manufacturing centre. “Indonesia is well positioned to become an export centre,’’ said Mike Gundy, president director of Bluescope Steel Indonesia, a unit of Australia’s Bluescope Steel. “While port operations could be more efficient, a much greater concern needing to be addressed is the supporting infrastructure leading to the ports.”

ACTING NOW: Adding to the sense of urgency is a current widespread desire to invest in Indonesia. After its resilience during the 2008-09 financial crisis, and given a global interest in investing in emerging markets, Indonesia is in the spotlight. If the country can attract and hold foreign investors, an infrastructure surge could be a driver of its economic growth and preserve international interest. If it cannot – and the history of corruption, policy inconsistency and bureaucratic confusion repeats itself – the moment could be lost.

Estimates on what is needed and how much it will cost vary. A report by the British Chamber of Commerce projected spending $70bn annually for the next five years will boost economic growth to about 7% per year. The government has pledged to spend $150bn on infrastructure projects over five years in its 2011 budget, and an additional $115bn in infrastructure projects are planned or under construction, as well as others that do not have a publicly stated value.

PRIVATE HELP: Indonesia currently lacks the financial resources to do all this on its own; it is estimated that the government can pay for only a third of these tasks.

Foreign capital and expertise are required and the government hopes that the public-private partnership (PPP) model will encourage the building of some key projects. The desire is that private firms will bid on the more high-value projects while public spending will complete those projects that are deemed to be necessary but unlikely to pay for themselves. “Foreign investment has shown positive increases, demonstrating the interest level of companies looking to capitalise on the growth of the region,’’ said Gundy. “However, fiscal incentives and tax holidays are necessary if the country is to remain competitive in the region.’’ Jakarta knows that the stakes are indeed high. One sign of this is the proliferation of government agencies formed to promote foreign direct investment. Other newly created tools are a guarantee fund that will serve to reassure foreign investors, several public investment vehicles to act as partners, roles for the country’s planning and investment promotion agencies and a special unit reporting directly to the president to oversee all the others (see analysis).

SIZE & SCOPE: Government data for the first quarter of 2011 shows the construction industry had real growth of 5.3% on an annual basis. The figure was less than had been expected and a slowdown from the 7% recorded in 2009. This reinforced concerns about the sector, including increases in the price of construction materials, legal uncertainties, bureaucracy-related delays and heightened costs. In residential construction, laws hindering foreign ownership hinder growth. In infrastructure, energy and electricity projects should fare better due to a lack of legal complications.

CEMENT: The cement market has always been among the region’s most expensive. It is dominated by three firms: Semen Gresik, Indocement Tunggal Prakasa and Holcim Indonesia. Prices are high regionally, with increased competition and new foreign entrants likely to further crimp margins. Analysts such as Octavious Prakarsa of Mandiri Securities say they believe prices have little room for growth before Chinese cement becomes an option. Materials prices for the sector rose about 11% from summer 2010 to summer 2011, Prakarsa said. While there is some nervousness on the part of foreign owners hit by the turmoil in global markets, there is nonetheless room for expansion locally.

STEEL: Steel prices as of summer 2011 were between 11% and 15% higher year-on-year, depending on the product. Krakatau Steel remains the market leader. The state-owned producer has a capacity of 2.9m tonnes a year, and sold shares in an initial public offering on the Indonesia Stock Exchange in 2010, a move which generated controversy. Krakatau offered investors a 20% stake in the company. Those investors then enjoyed a windfall when the price of the new stock surged approximately 49% on its first day of trading.

CONTRACTING: As in the steel and cement markets, Indonesia’s contracting market features state-owned enterprises that are among the biggest players, such as Adhi Karya, the largest construction firm in the country. It is looking to participate in PPP projects, particularly for road building, which would directly compete with Jasa Marga, which itself 70% owned by the government. Jasa Marga was formed after the government build the Jagorawi and Surabaya-Gempol toll roads, and the firm owns about 75% of the current total, with 531 km of completed roads in its portfolio.

Wijaya Karya is majority-owned by the government as well, and specialises in large infrastructure projects. Its current projects include a dam in Kalimantan and a water pipeline on Sulawesi. In the past the state has considered selling the firm as part of a larger effort to shed some of its commercial enterprises. These over 100, of which only a small minority are profitable. Wijaya Karya had a profit of Rp284bn ($34m) in 2010.

THE MASTER PLAN: The underpinnings of Indonesia’s infrastructure drive are found in the Master Plan for the Acceleration and Expansion of Indonesian Economic Growth (MP3EI), the country’s economic growth plan covering 2011-25. Key goals include making the economy one of the world’s 10 biggest by 2020 and boosting per capita income to $15,000 a year.

To do so, the economy will need to grow by 8-9% a year. Part of that growth will come from government spending on infrastructure. The hope is this focus on improving ports, transportation and electricity access will spur more growth from the private sector. While success will be based on many factors falling into place, a few major ones stand out. Roads and railway projects will not succeed without the passage of a new law making the eminent domain process easier and faster. The law is expected to be enacted by the end of 2011. PPP-centred plans for the future are not likely to take off before this happens, however.

OUTLOOK: Indonesia believes infrastructure is its path to sustained economic growth. Therefore conditions should be ripe for construction firms and their suppliers to prosper. To ensure this, the government will need to do its part by streamlining processes, clearing up uncertainties holding back a PPP-driven building expansion and cracking down on corruption.

Growth is all but assured given high demand, but meeting MP3EI goals will require a coordinated effort involving multiple government agencies, as well as the proper fiscal and monetary policies to head off inflation and keep building costs down. Should this happen, along with an expected GDP growth of 8% or more, millions of Indonesians could lift themselves out of poverty and join the consumption-driven economic rise.

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The Report: Indonesia 2012

Construction & Real Estate chapter from The Report: Indonesia 2012

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