Historically, Indonesia’s industrial sector has long been content to target the low-hanging fruit of its sizeable captive domestic market for much of its output, while exporting primarily raw materials or low value-added products abroad. But in line with the evolution of the country’s economy, a strategic shift has been accelerating over the past decade, which is aimed at diversifying the industrial manufacturing sector and deriving greater value from domestic resources, in addition to providing more and higher- quality jobs for the growing population.
Shifting The Gears
This transformation has come as much out of necessity as choice, as the country has transitioned from being a net oil exporter to an importer over the past decade, and trade agreements have allowed greater access to the domestic market, necessitating greater capabilities and efficiencies of local industries to compete in the global marketplace.
Although sometimes initially painful, the government has remained steadfast in its desire to move up the value chain across many of the country’s most lucrative exports in the extractive industries. This includes strict export restrictions and tariffs on raw material in the agriculture and mining sectors – which rank as the highest-value exports for the country – as well as developing greater hydrocarbons refining and processing capacity. More recently, the government has also signalled a greater willingness to liberalise long-held restrictions on foreign companies operating in the country in an effort to attract further investment and modernise the national economy.
These deliberate steps have coincided with a sustained period of strong economic growth – both in Indonesia and the greater Asia region – drawing substantial investment into the industrial sector over the past decade. Even with growth slowing somewhat in recent years, the solid combination of stable macroeconomic regulation along with a consistent increase in domestic consumption has helped to propel the country’s manufacturing base towards becoming a strategic centre in the Asia-Pacific region.
Manufacturing accounted for around one-fifth of all economic activity in Indonesia in 2015, generating 20.8% of the country’s GDP for the year, according to data from the Bank Indonesia (BI). In spite of economic headwinds, the sector has performed strongly over the past decade, expanding from Rp1512.8trn ($110.4bn) in 2010 to a total of Rp2007.4trn ($146.5bn) in 2013 and Rp2405.4trn ($175.6bn) in 2015. The single largest contributor to the sector was the food and beverage industry, which was worth a total of Rp647trn ($47.2bn) in 2015; followed by the coal and refined petroleum products industry, worth around Rp307.7trn ($22.5bn); fabricated metal, computers, optical and electronic devices, with Rp226.7trn ($16.5bn); transport equipment, at Rp220.4trn ($16.1bn); and chemicals, pharmaceuticals and botanical products, with a total of Rp209.3trn ($15.3bn).
Currently, the sector is geared towards light industries, with the exception of a few heavy industries, such as steel fabrication, which supports the construction industry. Some of the largest manufacturing segments exhibiting the strongest growth include the automotive, electronics, textile, footwear, paper and furniture industries.
There is also a growing amount of downstream mining activity taking place due to increased investments in mineral smelters as a result of a piece of legislation that was enacted in 2009 and enforced in 2015, banning the export of nearly all raw minerals. However, some supporting industries have yet to feel the effect, according to Dr Ralf Von Baer, president director of BOSCH in Indonesia. “The mining equipment segment is currently struggling,” he told OBG. “However, the building technology segment has picked up thanks to a rise in construction and infrastructure investments.” Meanwhile, rising demand for defence infrastructure, caused in part by growing tensions in the South China Sea, is creating a new industrial opportunity for Indonesia.
“Recent global dynamics have brought significant impact; we have seen a trend of global arms sales and growth of defence industries around the globe,” said Abraham Mose, CEO of Pindad. “We will have more opportunities to contribute to arms sales in our region and to countries that have good politics and an economic relationship with Indonesia.”
In an effort to further grow the sector and more clearly delineate points of emphasis within the industrial manufacturing landscape, the government launched its updated Master Plan of National Industry Development (RIPIN) 2015-35 in mid-2015. This plan crystallised the state’s renewed focus on moving up the value chain and diversifying the economy, with the RIPIN 2015-35 projected to substantially increase the economic contribution of non-oil and gas manufacturing sectors operating within the country’s many industrial estates, particularly those located outside of Java (see analysis).
Over the next two decades the plan calls for a shift in the geographic production ratio from 2013 levels – which saw 27.22% of industrial production taking place outside of Java – to 40% by 2035. This will be achieved through greater incentives for companies in preferred alternate regions. Other industrial estate targets laid out in the RIPIN include the continued expansion of industrial estates with 36 new locations. This will require the acquisition of an estimated 50,000 ha of land in the areas outside Java and the establishment of new small and medium industry (SMI) centres, so that each district or city will own and operate at least one SMI centre.
Point Of Emphasis
To kick-start this development plan, the state has opened the financial taps to the sector in recent years. Funds are being directed both towards the industry itself in the form of incentives and industrial estate development (see analysis), but also in another crucial support function – infrastructure development. These priorities are reflected in a series of economic package policies (EPPs) that began rolling out in late 2015, aimed at boosting growth and improving the investment climate. EPP funds are being funnelled into a variety of priority areas, including deregulation, tax incentives for investment, a new formula for minimum wages and a revision to the negative investment list (DNI), a document delineating the sectors partially or fully closed to foreign investment.
Launched in September 2014, the first and second EPPs were focused on boosting industrial competitiveness through deregulation, including the cutting of red tape, enhanced law enforcement and business stability, tax cuts for exporters, facilitating investment licensing for companies operating in industrial estates, the relaxation of import taxes on capital goods in industrial estates and the development of the domestic aviation industry. The third, fourth and fifth packages were implemented a month later and introduced various measures that included cutting energy tariffs for labour-intensive industries, initiating a fixed formula to determine wages increases, funding soft micro-loans for over 30 labour-intensive, export-oriented small and medium-sized enterprises (SMEs), and allowing tax incentives for asset revaluation.
In November 2015 new tax incentives for investment in special economic zones were funded under the sixth package, followed by the seventh and eighth packages in December 2015, which allowed for the cancellation of income tax for workers in labour-intensive industries, free leasehold certificates for vendors operating in 34 state-owned designated areas, the removal of income tax on a total of 21 categories of airplane parts, new incentives for oil refining firms and a one-map policy to harmonise the utilisation of land.
The funding has continued to roll out going into 2016, with a ninth economic package launched in January that brought about a single billing system for port services conducted by state-owned entities, while the 10th package, rolled out the following month, removed foreign ownership restrictions on a total of 35 businesses and introduced further measures to facilitate growth in domestic SMEs.
Lastly, the 11th stimulus package, which kicked off in March 2016, targeted harmonising Customs checks at ports to curtail wait times, along with providing government-subsidised loans for export-oriented SMEs and creating a development roadmap for the pharmaceutical industry.
To protect Indonesia’s domestic businesses and jobs from strong international competition, the government has long placed restrictions on foreign investment and ownership across a broad range of industries deemed sensitive to the national interest. Codified in the DNI, these protectionist policies were loosened to an extent when in 2016 President Joko Widodo, who campaigned on a business-oriented platform, issued new regulations in 2016, opening dozens of previously restricted business sectors to foreign investors. The presidential decree, which was signed into law in May 2016, eased foreign restrictions across 35 business categories ranging from tourism businesses and movie theatres to transportation companies and construction firms, representing a significant departure from previous policy decisions. “This is the first time in many years, maybe more than 10, that Indonesia has taken steps to open up investment rather than close it,” Lin Neumann, managing director of the American Chamber of Commerce in Indonesia, told local press in May 2016. Neumann also noted that American companies have expressed interest in the sectors the government said it would open.
Open To FDI
Foreign companies operating in various manufacturing sectors are likely to be encouraged by the number of categories liberalised, with each industry open to either full foreign ownership or partial ownership, consisting of both minority and majority stakeholding capital investment. Previously restricted industrial sectors now open to 100% ownership include biomass pellet producers, crumb rubber – provided that a special licence is obtained from the Minister of Industry – fisheries processing and plantation crop processing. Other industrial sectors already on the unrestricted list or recently added include cigarette manufacturing, paper pulp, minting, cyclamate and saccharine production.
On the flip side, the decree also introduced new additions to the DNI, which the government cited as necessary to protect domestic SMEs and create wealth in the lower- and middle-income segments. As of 2016 the DNI included a total of 20 industrial sectors closed or restricted to foreign direct investment (FDI), which is an increase of four sectors on the 16 that were included under the preceding 2014 DNI regulation. Segments that are still closed to foreign investment in the industrial sector include the manufacturing of pesticides, alcohol, industrial chemicals and petrochemicals. In addition, no SMEs have been opened to foreigners, and businesses with an investment value of less than R10bn ($730,000) remain restricted.
Balance Of Trade
Complementing these incremental steps towards the greater liberalisation of Indonesian markets is the advancing of trade treaties of which Indonesia is party to. Such agreements promise to have wide-ranging implications across a large cross section of the manufacturing sector and include regional agreements, such as those made by the 10 countries of ASEAN, which has been dismantling trade barriers among its member nations for a number of years, with some of the most significant liberalisation taking place in 2015.
Indonesia’s membership in the ASEAN Economic Community (AEC), designed to allow for the free movement of goods, services, investment, skilled labour and capital throughout the region, is expected to generate many opportunities for investors given AEC’s combined GDP of around $2.3trn. However, there are reservations about the effect increased competition will have on Indonesian industry. “The productivity of Indonesia’s agriculture sector is very low compared to regional competitors,” Ronald Walla, president director of tobacco company Wismilak, told OBG. “What the AEC could be in the long term is either positive, since we will need to be on the top of our game, or negative, if we cannot keep up and they distance themselves.”
Indeed, developing the competitiveness of the sector on a global level is seen by many in the industry as essential for the country to be able to take full advantage of trade agreements. “Indonesia needs to prioritise the development of its competitiveness at a regional and global level, and then embrace the opportunities of agreements like the Trans-Pacific Partnership (TPP) and other free trade agreements (FTAs),” Anne Patricia Sutanto, vice-president of garment manufacturer Pan Brothers, told OBG.
As a member of ASEAN, Indonesia is currently privy to an FTA with Japan, a prime destination for a large number of Indonesian-produced products, including electronics, textiles and automotive parts. Trade agreements such as this are seen as key to the future of the sector. In addition, similar pacts with developed economies in the EU and the US are equally – if not more – important for many of Indonesia’s export-oriented businesses, which need lower tariffs to remain competitive internationally.
A Global Scale
Maintaining these trade ties is crucial for the viability of the sector, and much is riding on deepening ties between Indonesia and the EU. Trade with the EU currently occurs under a partnership and cooperation agreement, which came into force in May 2014, in addition to the EU’s one-way Customs duty discounts for developing countries.
However, Indonesia is pursuing enhanced cooperation through a new bilateral trade agreement, with negotiations to hammer out a new Comprehensive Economic Partnership Agreement (CEPA), announced in July 2016. Both sides have agreed to negotiate an ambitious and far-reaching agreement that facilitates trade and investment over a broad range of issues, including Customs duties and other barriers to trade, services and investment, and access to public procurement markets, in addition to competition rules and protection of intellectual property rights.
The first stage of negotiations is expected to get under way before the end of 2016. Indonesia is the sixth member of ASEAN to initiate negotiations for a bilateral FTA with the EU, following on the heels of Singapore and Malaysia in 2010, Vietnam in 2012, Thailand in 2013 and the Philippines in 2015. As of July 2016 the EU had completed negotiations for bilateral agreements with two of those countries – Singapore in 2014 and Vietnam in 2015.
If successful, the new CEPA could have substantial ramifications for Indonesia’s industrial sector. Trade in goods between Indonesia and the bloc amounted to over €25bn in 2015, according to the European Commission, with EU exports worth almost €10bn and EU imports from Indonesia totalling €15.4bn, resulting in a trade surplus for Indonesia of over €5bn.
Key exports to the EU include agricultural products, which amounted to €4.3bn in 2015, along with machinery and appliances, textiles and footwear, plastic and rubber products.
Similarly, buyers in the crucial US market, which is a key destination for a variety of imports, also need reassurance that Indonesia is willing to participate in the TPP agreement. This potentially game-changing pact aims to unite a vast economic bloc across the Pacific, with early signatories including Australia, Brunei Darussalam, Canada, Chile, Japan and Singapore. While ratification of the TPP is not yet guaranteed, if it does come to fruition, nations not included in the agreement could be left on the outside looking in. “Inclusion in the TPP would be very important. For us, FTAs are very helpful in creating more jobs and more foreign currency for the country,” Ade Sudrajat, chairman of the Indonesian Textile Association (API), told OBG. “Most of our US customers are waiting to see if Indonesia actually applies for the TPP. Words are not enough for our buyers. If we apply, then US customers would feel more comfortable and begin to move forward with plans for the next five years.”
Although increased access to favourable, wealthy export markets makes good financial sense for Indonesia, opinions are mixed on the benefits of other regional agreements, such as the China-ASEAN FTA. Signed in 2010, the agreement pits low-cost producers in China against Indonesian companies in the local market. This has resulted in a substantial influx of cheaper Chinese goods, causing disruptions in domestic economies and forcing Indonesian manufacturers to become more efficient in production and logistics or risk going out of business.
Indonesia’s steady economic growth and expanding road network has given rise to the largest single automotive market in South-east Asia, fostering the rise of a thriving domestic vehicle assembly industry and hundreds of supporting automotive and component suppliers.
Large-scale western vehicle producers largely ignored the Asian market for decades, opening the door for local players in the region to fill the gap. Japanese companies have largely cornered the market, with brands such as Toyota, Suzuki, Honda, Mitsubishi, Daihatsu and Nissan dominating the vehicle market. In 2014 Japanese producers generated 98.9% of all production, while auto companies from the US, Germany, South Korea and China accounted for the remaining industry output.
Heavily reliant on imports in the not-too-distant past, the Indonesian automotive sector has rapidly developed to supply not only the expanding domestic market, but also those overseas. Starting from scratch little more than a decade ago, automakers now export around one-fifth of their domestic output, which in 2015 reached a record high of 207,691 units, compared to 3759 vehicles in 2003, according to data published by the Association of Indonesia Automotive Industries (GAIKINDO). Hoping to add to this total, the industry continues improving capacity to compete with established regional auto manufacturing and exporting hubs, such as Thailand. As of 2016, the sector was only utilising around half of its annual capacity of approximately 2m vehicles.
Bump In The Road
Overall, sector production began to tail off in 2014 after three years of production increases. This was primarily due to the slowdown of economic growth in the country, as well as reduced fuel subsidies, which cut down on domestic sales. Prior to that, production rose steadily, roughly tripling from 2004 to 2014 as output spiked from 422,099 to 1.3m vehicles in the span of a decade.
But as domestic demand slowed in 2015, production followed suit, with only 1.1m units rolled out in 2015. According to the latest available data from the GAIKINDO, through the first four months of 2016 a total of 388,169 vehicles were produced, putting overall output on pace for 1.55m for the full year. Of the cars produced between January and April, standard compact cars accounted for most of domestic sales at 61.2% of the total. Affordable, energy-saving cars ranked second, with 15.7% of the market, followed by pickup trucks and trucks, with 14% and 6.1%, respectively, sedans (1.4%), double-cabin vehicles (0.8%), four-by-fours (0.5%) and buses (0.3%).
Vehicle production plants are located almost exclusively in West Java. As a result, the automotive parts and support industries are also centred around the province, with a smaller cluster of parts and components manufacturers still in East Java.
One government programme that continues to drive domestic demand is the 2013 incentive package for green cars. The low-cost green car (LCGC) label in itself is somewhat of a misnomer, as the cars are not required to be powered by electricity or other alternative fuels to secure the label, but rather meet fuel-efficiency requirements. The key component in the regulation is a luxury tax exemption for qualified cars, which is otherwise levied on all vehicle purchases in the country.
Other incentives include tax exemptions of up to 50% on capital expenditure for manufacturing equipment and raw materials, which can be extended for four years. In exchange, LCGCs are required to meet a number of technical requirements, including fuel consumption of at least 20 km per litre and a maximum engine capacity of 1200 cc. In addition, LCGC vehicles must have been built with at least 85% locally manufactured components.
As a result, these affordable, energy-efficient cars accounted for an estimated 15.6% of total production in 2015, with 160,452 vehicles produced between January and November, ranking the category third domestically behind standard two-wheel drives and pickup trucks. To fulfil this new and growing demand, a number of manufacturers have invested heavily in the sector, with factories operating lines dedicated to the production of LCGC-compliant vehicles. These include plants operated by Honda and Suzuki, which opened in late 2013, a joint Nissan-Datsun venture, which followed a year later, and, most recently, a Toyota-Daihatsu partnership, which started up in late 2015.
Similar to the automotive market, Indonesia’s large and increasingly affluent consumer base has provided fertile ground for electronics manufacturers from around the world to set up shop, first as a base to supply the domestic market, and secondly as an export hub to supply the larger region. As spending power has increased, aspirational purchases for all manner of goods – from refrigerators to smartphones – have followed a similar trajectory, particularly in urban environments. The acquisition rate on new electronics has surged in recent years, with the nationwide penetration rate of televisions increasing from 94% in 2009 to 98% by June 2014, while the smartphone penetration rate spiked from just 5% in 2011 to 30% by June 2014. This has fostered strong growth in recent years; the electronics sector expanded at a robust 6.4% per year between 2010 and 2014, reaching $13bn in 2014, according to the Indonesia Investment Coordinating Board. Since 2010 the fabricated metal products, computers, optical products and electronic devices manufacturing segment has likewise expanded, from Rp130.8trn ($9.5bn) in 2010 to Rp226.7trn ($16.5bn) in 2015, according to the BI.
Looking to cash in on this trend, both foreign and domestic electronics manufacturers are rushing to meet the increased demand, and thus Indonesia has attracted a wide range of brands to its shores, including Sharp, Schneider Electric, Philips, LG, Toshiba, Samsung, Panasonic, ABB and others. This has helped attract a flood of overseas investment to the country since 2011, as the metal, machinery and electronics industry has come to dominate manufacturing FDI. The segment’s $3.1bn inflows more than doubled that of the next-closest manufacturing segment in 2015 – food and beverages, which generated $1.5bn.
The segment has also shown sustained FDI growth over the past six years. Beginning with $589.5m in 2010, FDI increased by $2.84bn per year, on average, between 2012 and 2015. The vast majority of business areas in electronics are open to FDI, although certain types of activities are still subject to conditions or restrictions, such as the smartphone industry. The government is set to impose a 30% minimum local content requirement for the manufacturing of 4G LTE smartphones starting in January 2017. “The local government encourages the usage of local ingredients when it comes to mobile manufacturing,” Lee Kang Hyun, vice-president of Samsung Electronics Indonesia, told OBG. “However many basic ingredients, such as semi-conductors, are in lack of supply in Indonesia. Most of it comes from Malaysia or Vietnam.”
Not to be left out, a number of smaller domestic electronics firms, including Polytron, Quantum Home Appliances, Cosmos, Maspion, Tecstar and Sanken, are also active in the industry. Even in the face of growing pressure by larger international companies, local businesses such as these have been able to compete effectively by implementing clearly segmented market strategies, utilising their core strengths as well as strategically focused investment on research and development, and extensive aftercare services. Local investment in the metal, machinery and electronic industry totalled Rp7.94bn ($579,620), spread over 326 projects in 2015.
The majority of the sector’s output remains targeted at the sizeable domestic market, and exports are relatively limited. Electrical apparatus, measuring instruments and optics shipments totalled $8.8bn in 2015, down from $10.1bn the previous year and $10.7bn in 2013, according to the BI.
In the wake of decreased global demand, lower commodity prices and a deceleration in investment worldwide, which deeply affected the industry in 2015, many sectors are rebounding in 2016, supported by Indonesia’s strong macroeconomic underpinnings. Future growth will be facilitated by government policies that are intended to increase downstream activity by restricting the export of raw materials, as well as through further regulatory and financial support of key manufacturing activities.
As a whole, industries will continue to migrate towards more value-added activities, with the food and beverage, electronics and apparel segments all set for strong future growth. Activity will continue to centre largely on Java, although future development is expected to accelerate in other provinces, driven by government support along with rising costs in West Java. Much of the medium- and longer-term success of manufacturing also relies on developing the infrastructure needed to make the sector more competitive, including power, water, deepwater ports and natural gas pipelines.
Some sector players also argue that local industry needs to continue to work on developing and rolling out more environmentally friendly practices across the board. Better implementation of green factory concepts among Indonesian industries – practices such as waste management, natural lighting and other measures – remains an issue, and some local players seem to be unaware of the benefits of applying green practices.
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