Restoring investor confidence in Indonesia

Indonesia’s GDP growth rate has been slowing for a number of years, falling from 6.5% in 2011 to 5% in 2014 and 4.7% in first-quarter 2015 – the lowest rate since 2009. From third-quarter 2014 to fourth-quarter 2014 the economy contracted 2%, and then in January 2015 the country experienced deflation of 0.2%, according to Bank Indonesia (BI). Foreign direct investment (FDI) on a committed basis grew by 13.5% in 2014, down from 22.4% the year before. Nevertheless, the economy is seen to be doing well for a number of reasons, and analysts expect the GDP growth rate will begin to pick up in 2015. The rupiah has stabilised, foreign reserves are approaching the highs hit in 2011 and confidence is being restored.

Early moves made by the government of the new president, Joko Widodo, and key initiatives and reforms being undertaken appear to be helping the economy considerably, especially on the FDI side. With the application of the right policies, the country could return to growth above 6%, and perhaps eventually reach the 7% target set by the new president. “We expect a rebound in 2015,” Andry Asmoro, a senior economist at Bank Mandiri, told OBG.

Key Moves

Following his inauguration in October 2014, President Widodo quickly took a number of vital and positive economic steps. The most important was the scrapping of the fuel subsidy, which had been in place since the 1970s. In November 2014 the price of petrol was increased from Rp6500 ($0.54) per litre to Rp8500 ($0.70) per litre, and the price of diesel from Rp5500 ($0.45) to Rp7500 ($0.62) per litre. As of January 1, 2015 the price of petrol was set at the market rate, though diesel remained subsidised. After full liberalisation, the price of petrol fell to Rp7600 ($0.63) per litre.

In many respects, the president’s policy was saved by global forces and trends. With the price of crude oil falling sharply on the international market, the price of petrol remained stable despite the end of the subsidy. As a result, the reform was achieved without sparking widespread protests and without taxing individual budgets. In the past, Indonesian governments had faced considerable opposition when the idea of ending of subsidies was even mentioned.

New Focus

The new policy will have a significant impact on the economy. If the 2015 budget had been implemented as planned, the subsidies would have cost $22bn, or 19.8%, of central government spending. According to public comments by the finance minister, Bambang Brodjonegoro, the reforms will reduce spending on subsidies by some 83%. The money freed up will now be available for more productive investments. Over the past half decade the country has committed more to the fuel subsidy than it has to infrastructure and welfare combined. The effect of the change was almost immediate. The minister of energy and mineral resources, Sudirman Said, announced in early 2015 that the government will double expenditure in the key areas of public works, transport and agriculture.

New plans include the construction of 2600 km of roads, 15 airports, 24 ports and 3258 km of railway. The addition of around 35,000 MW to state electricity company Perusahaan Listrik Negara’s current capacity of 52,000 MW is also on the cards, according to the minister of national development planning, Andrinof Chaniago.

The investments to be made in infrastructure have the potential to boost the Indonesian economy in both the short and long term. The spending alone will contribute significantly to expansion. Infrastructure outlays are set to increase 1.5 times in 2015 over the previous year to Rp281.1trn ($18.03bn). A total of Rp57.82trn ($4.8bn) will go towards roads and Rp30.53trn ($2.5bn) towards water management, according to the local press. The government said it would commit Rp5519.4trn ($456.23bn) to infrastructure over the next five years.

According to Asmoro, this is a move from unproductive expenditure to more productive spending.

Single Window & Taxes

The investment in infrastructure will also help improve the environment for FDI, which will have an impact on growth in the longer term. At present, foreign investments are held back in part by the lack of adequate transport, port facilities and reliable power. Widodo has taken decisive aim at these shortcomings, promising in late 2014 to improve the country’s ranking in the World Bank’s “Doing Business” report (Indonesia was ranked 114th out of 189 countries in 2014).

According to local press reports, the president hopes the focus on infrastructure will help bring the country’s growth rate back above 7%. Infrastructure improvements may also help reduce the inflation rate. Bottlenecks caused by poor infrastructure lead to price increases that can quickly slow growth, and this is a particular problem in an economy spread across so many islands.

The Widodo administration is working to change the way in which foreign investment is processed in the hope that this will also help improve the country’s “Doing Business” rankings and facilitate inward investment. Key to this strategy is the development of the One-Stop Service (PTSP) at the Indonesia Investment Coordinating Board (BKPM), which was inaugurated in late January 2015 by the president.

The idea is to improve front-of-the-house operations, transforming the documents-processing window into a place of more interactive and proactive services and consulting, and by integrating the actual decision-making within the offices of the board. A total of 22 ministries will have their offices stationed at BKPM so that investors can lodge their applications directly with the respective ministries.

More authority for licensing will also be transferred to a single location. Of the 1250 possible authorisation categories in the country, the government aims to have almost half of those moved to BKPM, according to local press reports.

BKPM says the building of a power plant currently requires 52 permits from 10 ministries, and that it takes 1100 days for all the applications to be processed. The board wants to reduce the time required by 80% under the PTSP.

“The investors will not have to go all around Jakarta to get approvals,” Indra Darmawan, director of international cooperation at BKPM, told OBG.

In addition, the government is working to boost the fiscal side by increasing tax revenues. Currently, the country has just 30m registered taxpayers and only about 2% of them pay taxes. Indonesia’s tax collection totals about 12% of GDP (against Malaysia’s 15.5% and Thailand’s 17%), according to 2012 Global Heritage Foundation data. Widodo has set a high tax collection goal for 2015: Rp1489trn ($123.11bn), up from Rp1240trn ($102.5bn) in 2014, and is taking measures to make administration more effective, according to a report in The Jakarta Post. Salaries of tax officers will be increased by 250% to reduce graft, and an amnesty will be declared to encourage Indonesians to bring money home from overseas. Finally, the tax office, which is within the Ministry of Finance, will become an independent agency.

Making Promises

More generally, the election of Widodo has resulted in an improvement in sentiment and a fundamental shift in politics. He successfully ran both Surakarta and Jakarta, as mayor of the former and governor of the latter, gaining a reputation as both a pragmatist who was able to bring together disparate elements of society and as a clean politician. He is also seen as a relative outsider who can get things done without being excessively beholden to party politics.

Since being elected, he has quickly fulfilled promises, set a political tone and established goals that suggest he will follow a course that is effective and balanced. For example, when the president stopped by BKPM for a surprise visit in early 2015, he spent more time talking to the investors than he did with the officials at the board. This impressed people at BKPM as it showed that he was more interested in understanding what the users of the service need than scoring points with the bureaucracy. 7% GROWTH: The president has been particularly keen on finding solutions that generate results and has asked the leaders of China how they were able to achieve such fast growth. The message has been that openness to investment can be achieved without losing independence, and that the vested interests in the country will not necessarily lose out if the markets are opened further. While Widodo is sure to face challenges along the way, he appears to be meeting them by arguing common cause with those who oppose the measures taken. He is calling for policies that stimulate growth, and this seems to have a wide appeal. “The message from Jokowi,” said Edimon Ginting, deputy country director for the Asian Development Bank (ADB), using Widodo’s popular nickname, “is we all want 7% growth.”

A more open Indonesia with a more effective and efficient bureaucracy would help boost FDI, which is seen to be leading to more domestic manufacturing. That would, in turn, result in less pressure on the capital account. Indonesia has been a country long powered by the consumer. In 2013 household consumption was 59.2% of GDP, higher than its regional peers (Malaysia with 51.1%, Thailand with 53.7% and Singapore with 37.7%) and far higher than export-oriented economies (China with 34.1%).

A shift to more investment and less consumption would help lead to more sustainable growth and insulate the country from external shocks. Already, the numbers are starting to head in the right direction. The country reported a trade surplus of $186.8m in January 2015, after recording a $1.9bn trade deficit in 2014 and a $4.1bn trade deficit in 2013.

Inflation has been tame, which is also adding to overall confidence. While the consumer price index hit 8.36% for 2014 overall due to the increase in the fuel price, deflation was reported in April 2014 and the outlook is for a reduction of price pressures. Overall, the country remains well below its historical average inflation rate of around 11.5% since 1997. The IMF expects the inflation rate to be within BI’s target of 4% – plus or minus 1 percentage point – in 2015. The current account deficit is also expected to drop and stay within acceptable limits.

According to an IMF statement released in December 2014, following the completion of the fund’s Article IV consultation, “Inflation has temporarily risen following the November 2014 increase in subsidised fuel prices, but is expected to return to within BI’s 2015 target band by the end of [2015]. Notwithstanding soft commodity prices, the current account deficit is projected to decline to around 2.8% of GDP in 2015, supported by rising manufacture exports as well as a lower oil import bill.”

Legal Reforms

A number of reforms have already been made that promise to help the economy grow in the medium and long term. The 2012 Land Procurement for the Public Interest Law was designed to make it easier for the government to gain control of property needed for infrastructure projects. For projects that deal with roads, rail, ports, irrigation, oil, gas, power distribution and a number of other critical areas, a precise process and timeline have been set out for the acquisition of the land needed. The law was seen as an important step in economic development as many vital projects had been held up because the relevant government ministries were unable to gain control of the necessary land. Under the law, a measure of certainty could be achieved, and its passing resulted in considerable optimism amongst foreign investors.

In early 2015 the law underwent its third revision. The latest iteration allows all qualified projects to benefit from its provisions regardless of how much land had been acquired as of the date of the law’s passing. Originally, only projects that had not yet acquired three-quarters of the needed land would qualify to use the 2012 rules. In addition, the revision allows the private sector to fund the land purchases, rather than just government entities. This may help accelerate the process, as government disbursements can take more time to realise than funds raised in the markets. The revisions are designed to make the acquisition process easier and to further expedite the development of vital infrastructure.

High Rates

Despite growing optimism and positive policies, concerns remain about the Indonesian economy. The cost of money is one area of worry. The central bank increased its benchmark interest rate from 5.8% in 2013 to a high of 7.8% in late 2014. It argued that it needed to tighten to keep the current account deficit low and the currency stable, as the country is dependent upon foreign investment and cannot risk a quick outflow of funds from the market. “We depend upon capital inflow, so stability is important,” Eddy Handali, the rating director for Fitch Ratings Indonesia, told OBG.

But many economists and politicians in the country feel as though the rate has been too high. They say that while controlling the capital account deficit is important and maintaining the currency is necessary for the economy, economic growth is most important. According to research conducted by Purbaya Yudhi Sadewa, executive director at financial institution Danareksa, in recent years drops in interest rates have been followed by the strengthening of the currency, while increases in the benchmark rate have coincided with the decline in the value of the currency. Sadewa believes that while the interest rate gap between other markets and Indonesia is important for investors, they are also sensitive to economic growth and will tend to respond positively to faster GDP growth. “We need to worry about the current account, but we should not overkill the policy,” he noted. “If we grow 4-4.5%, foreign investors will be hesitant to invest.”

The central bank eventually did cut interest rates. In February 2015 BI lowered the benchmark rate from 7.8% to 7.5% in a move that surprised the market. In the weeks preceding the cut, considerable pressure was put on the central bank, with the president, parliamentarians and private economists encouraging a shift in policy, but the central bank was seen as adamant and unlikely to change course.

Even optimists see that the central bank is stuck in a bit of a monetary box. If it eases up enough on interest rates to make a difference, the current account deficit could slip to dangerous levels. If it fails to cut rates, growth could slow to levels that scare off foreign investors, the economy could be harmed and the national balance sheet weakened. “What is good for the trade balance may not be good for fiscal stability,” Helmi Arman, an economist at Citibank, told OBG.

Economists worry that the government has put itself in an impossible position and will be compelled to pursue measures and push for monetary policies that will ultimately cause problems. In July 2014 Widodo promised that as president he would get growth back above 7% in the near term and would deliver 5.7% in 2015. But given the economic realities, this can only be accomplished by dangerous compromises in terms of the current account and possibly the currency. The single-minded bias towards growth is part of the president’s appeal, but it also worries economists. “Jokowi is setting his own trap by promising a rate of 5.7%,” Eric Sugandi, senior economist at Standard Chartered, told OBG.

Overcoming Hurdles

Concern is also growing as to whether the government will be able to stimulate the economy with infrastructure spending and whether enough new infrastructure will be constructed to make a difference in growth. While the government has promised to increase spending, and while money has been freed up as a result of the end of the fuel subsidy, it has historically been difficult to get money disbursed even when it is available. According to a recent Jakarta Post article, ministries are reluctant to spend their budgets too fast for fear that quick spending will raise suspicions that not all procedures were followed and that officials may have been illegally influenced. The ministries tend to be methodical in processing funds and, as a result, are rarely able to spend all they have been budgeted. Ministry of Finance figures published with the article show that in the four years to 2013 only one ministry was able to utilise its entire budget: the Ministry of Agriculture, in 2012. The others have averaged about 90% disbursement rates. With budgets in some areas exploding under the new government, it is not clear whether the relevant ministries will be able to, or even have the capacity to, spend all the money allocated to them.

The international picture also raises concerns. With China slowing, Japan struggling and the US threatening to raise interest rates, the Indonesian economy is vulnerable. Its export markets are weak, and investors, on whose money the country depends, are starting to look elsewhere for yield. Falling commodity prices have certainly helped the economy and the administration considerably. The drop in oil prices has taken the heat off inflation and allowed the government to end the fuel subsidy without causing turmoil. But at the same time, Indonesia’s economy is dependent upon commodity prices. The country is a major producer and exporter of coal, rubber, palm oil and tin. While it reported a trade surplus in January 2015, its exports slumped, declining 8.1% on the year. For the January-May 2015 period, exports decreased by 11.84% to $64.72bn.

Economists also note that the fall in commodity prices is starting to take a toll on consumption, as many people in the country are dependent upon the sale of commodities. “In one way, we benefitted from low oil prices,” Asmoro said. “On the other hand, we were hurt by lower commodity prices.”

Political Meddling

Politics are starting to get in the way as well. While Widodo was elected as an outsider who would be able to work effectively across party lines, and while he was able to prove his effectiveness early on by getting the fuel subsidy scrapped without too much resistance, reality is starting to reassert itself. Locally, his presidency was viewed negatively after the first 100 days, with The Jakarta Post saying many influential people in the country were giving the new administration the “thumbs down”. They said Widodo had been unable to carry out promised reforms, and he was failing to demonstrate leadership qualities.

An ongoing battle regarding the nomination of a person accused of corruption by the country’s anti-graft body for the role of police chief also led to significant dissatisfaction early in Widodo’s term.

The biggest problem relates to the encouragement of foreign investment. While the president has made a number of moves aimed at improving the investment environment, the concern is that these will be ineffective and leave the country without the much-needed industrial base. The one-stop shop scheme has been met with considerable scepticism by analysts. They concede that the process may become easier at the front end and at the highest levels, but they wonder whether the real investment bottlenecks, which reside largely at the lower levels, will be resolved. Governors still have a considerable say in the process, while authorities within the system that judge projects on technical merits cannot be circumvented.

Critics also note that the land acquisition law has so far gone untested and may not work all that well in the end. They add that previous administrations have tried their own one-stop services before, and their efforts have not made BKPM significantly more efficient. “Investors do not have to go from one ministry to another,” Sugandi said. “But they still have to do the paperwork.”

Ultimately, the president’s effectiveness hinges on the way he handles nationalism and protectionism. A number of measures are on the table to restrict foreign investment, especially in banking, insurance, mining and industry, and these are increasing scepticism amongst foreign investors. Whether the laws themselves cause harm or not is not as important as the uncertainty they create. If foreign investors face the possibility of fundamental changes in their ability to own and operate local assets, they will be less likely to invest. And while the president recognises the importance of foreign investment, his hand may at times be forced and he may have no choice but to agree to increase restrictions. “If Jokowi keeps playing the nationalism card, foreigners may be unwilling to come to Indonesia,” Sugandi said.


Indonesia is working off a sound economic base. The decline in GDP growth has been stopped and the country is starting to make the transition from a consumption- and export-dependent economy to one that is more driven by investment, manufacturing and perhaps even the export of finished products. Risks remain, particularly in terms of overly aggressive policies on the one hand and implementation issues and protectionism on the other. If the right balance can be struck and the government’s plans can be translated into tangible projects, many see the possibility for growth to return to levels that are higher than regional and global averages.


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The Report: Indonesia 2015

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