With economic growth of 6.1% in 2010 and widespread predictions of continued expansion in 2011, Indonesia’s industrial sector is attracting more attention from international investors than ever before. The country is also making a major effort both to shift away from resource-based industries to more value-added sectors, and to boost its fundamental economic infrastructure in ways that will directly benefit investors. With six new economic corridors and six priority industry groups established, the nation of some 17,500 islands is also set to give its distinctive regions and its small and medium-sized enterprises (SMEs) more of a focus in industrial planning. At the same time, public-private partnerships (PPPs) and close involvement with the private sector are high priorities for development.

CRUNCHING THE NUMBERS: Figures from the Central Bureau of Statistics (CBS) show Indonesia’s annual GDP growth rose from 5.7% in 2005 to 6.1% in 2010. In contrast to many economies, GDP continued to grow during the global downturn, at 6.2% in 2008 and 4.5% in 2009. The non-hydrocarbons sector is behind much of the expansion, with industry playing a major part. Indeed, the CBS figures show that while oil and gas have been in decline over the above-mentioned period – 2005 registered a 1.66% reduction in value in hydrocarbons and they fell by 2.31% in 2010 – the non-oil and -gas sector continued to expand, with 5.27% growth in 2005 and 5.09% in 2010. The CBS divides the non-oil and -gas sector into several categories, which combined accounted for 21.55% of total GDP in 2010. Within the industrial sector, the largest amongst these categories was food, water and tobacco, which together contributed 7.24%, while the fertilisers, chemicals and rubber industry contributed 2.74%, and the textiles, leather and footwear segment contributed 1.93%. Other categories include wood products and forestry, at 1.25%; paper and printing, at 1.02%; cement and mineral extraction, at 0.71%; and iron, metal and steel, at 0.42%. The non-industrial transport and ports category makes up approximately 6.06%.

IMPRESSIVE IMPACT: The industrial sector’s impact on overall GDP growth is substantial. Indeed, when manufacturing in oil and gas is added in, the manufacturing sector as a whole comprised 25% of GDP in 2010, according to CBS data. Manufacturing also contributed greatly to the country’s export earnings. The data shows that in the January-December 2010 period, manufacturing or free on board (FOB) exports totalled $98bn. This was a 33.47% hike on the same period of 2009, when the total value of FOB exports was $73.43bn. Manufacturing exports also amounted to some 62.14%, by value, of Indonesia’s total exports in 2010.

Those exports were dominated by 12 industrial sub-sectors, with the top three being crude palm oil and coconut processing, which together contributed 17.6% of total export earnings in 2010; textiles, which contributed 11.4%; and iron and steel, machinery and automotives, which contributed 11.1%. The year 2010 saw the sector receive some impressive investments, both from domestic sources and from overseas. Some Rp3.26trn ($391m) of domestic investment went into the organic chemical, chemical product and pharmacy segment – the top recipient in the non-oil and -gas sector – along with $798m of foreign direct investment (FDI). Other big recipients were the paper, paper product and printing segment; iron and steel; machinery and electronics; and rubber and plastics. Going into 2011 CBS figures show the country’s industrial production index, which measures annual changes in output for manufacturing, mining and utilities, saw a 4.9% rise in June after 5.35% growth the month before. The rate for 2010 overall was 3.6% and 3.5% for 2009, demonstrating again the remarkable degree of insulation from the global downturn Indonesia has managed.

PLANS & PLANNERS: Indonesia has set itself the goal of becoming an industrialised country by 2025, meaning that by then, industry will be globally accepted as the country’s economic base. The goal is to achieve this via sustainable competitiveness, enabling manufacturing to both compete and succeed internationally.

In 2008 the National Industrial Policy was passed by presidential decree and aimed at government ministries, state agencies and the private sector. The state has long pursued a cluster-based policy for industrial development, seeing this concentrating of resources and infrastructure as the most efficient way to develop the sector. The 2008 policy mapped the guidelines for 35 clusters, each for a particular priority industry. A Road Map of Core Competence Industrial Development was set out for 18 provinces and five districts.

In 2010 a new presidential policy targeted accelerated development for a more focused group of industries (fertilisers, sugar, agro-oleo-chemicals, and oil and gas condensates) while also facilitating further development of special economic zones. The body assigned responsibility for this accelerated development was the Ministry of Industry, currently headed by Mohamad Hidayat. Two other key bodies are the central government’s National Development Planning Agency and the Indonesia Investment Coordinating Board (BKPM).

SIX FOCAL POINTS: From 2010 to 2014 the Ministry of Industry is focusing on improving the competitiveness of six core groups, all of which have been selected for their potential to significantly expand and add to the nation’s GDP. The six are labour-intensive industries; small and medium-sized industries; capital goods industries; natural resource-based industries; high-growth industries; and special priority industries.

To give this focus concrete form the government is providing fiscal incentives, state budget allocations, administrative support and direct construction of infrastructure. PPPs are also being used to bring private sector assistance to this development programme.

Dovetailing geographically with these six priority industry groups are six economic corridors. These are in Sumatra, Java, Kalimantan, Sulawesi, Bali-Nusa Tenggara and Papua-Maluku. Each of these corridors focuses on a particular industry or set of industries for which it has some competitive advantage. Thus, Sumatra is for palm oil and rubber, along with petrochemicals in Banten, shipping in the Riau Islands and coal in South Sumatra. On Java, the corridor focuses on manufacturing textiles, automotives, electronics, shipping, petrochemicals, steel, cement and industrial electronics. On Kalimantan, key sectors are palm oil, coal, steel and aluminium, and oil and gas condensates. Sulawesi, meanwhile, focuses on nickel and fisheries, and Bali-Nusa Tenggara on tourism and fisheries. In Papua-Maluku, activity centres on petrochemicals and copper.

INFRASTRUCTURE BACKBONE: In tandem with the corridors, a substantial effort is being made to improve basic infrastructure in transport, energy and information and communications technology (ICT). The country has long realised one major challenge to industrial development is the poor state of its infrastructure, which raises production costs and negatively impacts efficiency. “We want to meet with the government to discuss our concerns regarding the insufficient social infrastructure in Indonesia and develop a long-term plan, as this problem is driving up our costs and bringing our competitiveness down,” said Man Gyu Yim, the president director of Samsung Indonesia.

Indonesia’s current five-year development plan, which runs from 2010 to 2014, seeks to pull in some Rp1429trn ($171.5bn) of investment into infrastructure, with Rp511trn ($61.3bn) coming from the state and the rest from state-owned companies, regional governments and the private sector. Some Rp407trn ($48.8bn) of the non-state investment should come from PPPs.

MAKING IMPROVEMENTS: The success of this investment drive will be crucial for industrial development overall, with the Indonesian authorities working to implement a number of improvements to the existing structures for investing in industry. First, an expediting of licensing procedures to start a company is under way, with the time this takes now slashed from 47 days to 17 days in the Jakarta area, with times shortening elsewhere too. A “one stop” integrated system for investment services has also been set up at the national, provincial and regency/city levels. This is run through the BKPM, with an integrated computer system now in place for 33 provinces and some 44 regencies and cities. The next stage will be to connect this to the Indonesian National Single Window system for Customs clearance and the release of cargo.

The sometimes controversial negative investment list – the register of conditions attached to types of foreign investment and business activity – is also being simplified and clarified, with the overall theme of making more sectors open to foreign involvement.

INCENTIVES: There are also a series of investment incentives available. These fall into five broad areas: general tax facilities, energy benefits, infrastructure benefits, import and trade benefits, and local government incentives and trade credits. On the first, official regulations in 2007, 2008 and 2009 have all seen tax reductions for companies investing in specified business lines, while 2011 also saw a major new incentive. In August 2011 the government announced plans for tax breaks on foreign investments of over Rp1trn ($120m) in certain key areas. The breaks include a tax holiday of 5-10 years from the start of commercial operations for such investments, followed by a possible 50% income tax reduction for two years, provided the business is considered a “pioneer”. The new regulation targets five sectors specifically – base metals, oil refining, petrochemicals, renewable energy and the machinery or telecoms equipment sector – but other producers may also benefit if they have broad backward and forward linkages in the supply chain. “The country would greatly benefit from a universal policy governing tax holidays and tax incentives. With improved clarity it would be easier to attract investors to the country,” Maurits Lalisang, the president director of Unilever, told OBG in an interview.

In terms of energy, the government offers incentives for renewable usage and development, such as in bio-gas and geothermal power. There is also a major boost in electricity supply under way, with a new 10,000-MW programme of power station construction. This aims to address another capacity constraint – the availability of power for industry, particularly in less developed corridors. More generally, infrastructure receives support from government guarantees in PPP project land procurement funding. Meanwhile, there are exemptions from import duties on machinery, goods and materials for companies producing goods, provided the good is not yet produced domestically to required specifications and quantities. Local governments, along with the Indonesian Export Financing Agency and Indonesian Credit Insurance, provide additional incentives if their requirements are met. The BKPM is the venue for facilitating PPP projects, with this agency involved in investment promotion, as well as in providing services to investors and coordinating local and central government bodies and agencies.

All of these incentives are attractive for foreign companies looking to set up shop in Indonesia. “With rising costs in China and an increase in the availability of rubber, we envisage the possibility of companies relocating their tyre production to Indonesia,” Luigi Carlo Gastel, the president director of Pirelli, told OBG.

LOOKING TO THE FUTURE: The industrial sector now has a clear and coordinated structure for its development, with the drive for investment already reaping rewards. In 2010 a total of $23.38bn of investment was realised, $16.61bn of that in FDI. In the second quarter of 2011, year-on-year growth in overall FDI was up 21.1%, according to Finance Asia. Some of the challenges to growth are hindering all economies at a time of global uncertainty, yet Indonesia has shown itself in the past few years to be often isolated from international trends, thanks to its huge domestic market and, in 2008, lack of connectivity to global financial markets. How the global economy fares ahead will therefore likely have an impact, but perhaps not as strongly as on some other countries. “While the global economic crisis has not had a major impact on Indonesia, in my experience there is often a lag before the real effects are felt. Therefore, it is advisable to carefully monitor the situation,” said Lalisang.

Many businesses thus see the challenges as more domestic. A longstanding concentration of political and economic power in Java, particularly in Jakarta, has left infrastructure elsewhere in poorer condition. Investors remain focused on Java, where around three-quarters of all industry is located, widening the gulf between the centre and regions. This similarly applies to human resources, with Java and Jakarta attracting most qualified staff. Thus, moving industrial development into the regions is a challenge.

In the past as well, doing business in Indonesia has entailed a great degree of bureaucracy, with a lack of transparency and a multiplicity of authorisations leading to frequent allegations of graft. These are now taken seriously and the government has been involved in a lengthy battle to both increase transparency and combat corruption – a battle likely to last some time.

OUTLOOK: Indonesia’s government has made a move up the value chain a central goal of industrialisation plans. One way this is being done is through extra taxes on raw material exports in an effort to boost domestic processing. Interest rates have also been high, as the central bank tries to combat inflation.

At the same time, the move towards more economic integration within ASEAN, and between ASEAN and regional giants such as China and India, is also leading to greater competitive pressures on Indonesian industry. “Following the China-ASEAN FTA, the textile industry realised that to compete with China, we had to shift our strategy such that we focus our core business towards the production of more value-added products,” said Agus S Tjandra, the president director of Ateja, an interior fabric manufacturer. This, of course, is also an advantage for those Indonesian businesses that can exploit the new markets this affords.

Nonetheless, there is still political pressure for a more protectionist economic agenda. Yet, with a developing infrastructure backbone, national and local policy commitments to industrial growth, and increased interest from investors, the hope is that Indonesia can use these challenges to move itself forward to its 2025 goals.