The growth of Indonesia’s construction sector is largely being driven by a rapid ramping up of manufacturing investment. Until a few years ago the country was not favoured as a place to locate factories. A weak domestic market, substandard infrastructure, corruption, high interest rates, complex tax policies and better opportunities elsewhere discouraged most corporations from putting major assets on the ground. There were exceptions, such as the Japanese vehicle makers, but even they entered Indonesia in a manner that would not expose them too much to the complications that dominated the market. Now, manufacturers across the board are reassessing their exposure and choosing to make sizeable commitments in the country.

KEY FACTORS: The reasons for this turnaround are many, with the rapid growth of the domestic market perhaps foremost. Indonesia has a fast-growing economy and a rapidly expanding middle class. To date, it has been primarily a market for products that can be sold easily in developing countries – low-end products for the majority and low-volume, high-end ones for the elite. It was not an attractive place for mass production. Now, however, the consuming population is growing rapidly, yet it is still a place where wages for factory workers are some of the least expensive in the region, even after the increase in the minimum wage. Added to this is the fact that the ASEAN Economic Community is becoming a reality, and that a huge common market will soon be formed in the region. As the most populous country and the largest economy in the grouping, Indonesia could take centre stage.

Finally, issues elsewhere are convincing firms that they need to diversify their manufacturing base and create more robust value chains. Having key components made only in one industrial estate on a flood plain in a country that has faced major political instability over the past few years – Thailand – is an unacceptable risk that is now being better understood. Japanese firms, especially, have been making moves to establish more capacity in Indonesia. The issues in Thailand, anti-Japanese sentiment in China and the natural disasters at home have convinced them to hedge their bets and avoid concentration risk. The case for using Indonesia, with its relatively low wages and improved political environment, as a manufacturing base is increasingly convincing.

The rapid growth in consumption has also helped the property business, as retail companies begin to expand to second- and third-tier cities. Logistics networks have to be developed, and this will require investments to be made in warehousing.

LAND OF THE RISING SUM: Japanese manufacturers have long had a major presence in Indonesia, especially the car makers. They essentially control the local vehicle market, and many of these companies are now pushing to increase their presence in Indonesia. In June 2012 Honda began building its second car plant in the country, a $321m facility in Karawang, West Java, designed to build 180,000 cars a year. Production is scheduled to start in 2014. The company is also investing a similar sum in a new motorcycle factory 70 km from Jakarta that will be able to produce 1.1m units per year.

Toyota, the largest car maker in the country, announced in early 2012 that it was investing $534m in a second Indonesian plant, Karawang No. 2. The factory will be able to produce 70,000 cars per year, and eventually that could rise to 120,000 (and the company’s total capacity in the country to 240,000). Later in 2012 the company said that it will invest up to $2.7bn in Indonesia over the next seven years. Included in the investment plan is an engine factory, which will be up and running in 2013.

Other Japanese car firms are also broadening their manufacturing bases in Indonesia. Suzuki Motors said it will invest $800m setting up a new factory in West Java and expanding production at its existing facilities in Bekasi and West Java. Nissan Motors is investing $322m to increase the annual capacity of its Cikampek factory from 50,000 units to 180,000. Astra Daihatsu Motor is investing $233m to increase annual production from 330,000 units to 430,000, while Isuzu Astra Motor Indonesia is spending some $111m to boost its own capacity.

SUBCONTRACTORS: The manufacturers are being followed by subcontractors. This is a significant change. While Japanese suppliers have always followed the main manufacturers overseas, they have not gone to Indonesia in the same way that they built up in places like Thailand, where much of the Japanese supply chain is replicated locally. However, given the high yen and the natural disasters in Japan and Thailand, subcontractor networks are quickly being established in Indonesia too.

Denso, an electrical parts supplier in the Toyota group, announced in late 2012 that it is building a new factory in West Java to make starters, alternators, engine control products and other goods. The company said it was setting up the operation because of the growth in vehicle production taking place within the country. Denso currently has two factories in Indonesia, at Bekasi and Sunter, producing air-conditioning systems, radiators, spark plugs, filters and other items for the car industry.

Korea’s Hankook Tire is a major supplier to the Japanese manufacturers, and it is also making significant investments in Indonesia. The company is building a $320m factory in Bekasi, West Java, that will begin operations in 2014 with the capacity to produce 6m tyres per year. The total investment may eventually reach $1.1bn. In addition Bridgestone, the world’s largest tyre maker and holder of 38% of the Indonesian market, is increasing production, while Takata, the Japanese producer of car safety equipment such as seat belts, airbags and child seats, has also built a $20m factory in the country.

OTHER INVESTORS: Investments are coming from other countries and industries as well. General Motors is investing $150m to reactivate a factory in Bekasi, where production has been stopped since 2005, to build the Chevrolet Spin. The 11-ha facility will have an initial output of 40,000 units per year. The company has two other manufacturing facilities in ASEAN, one in Thailand and one in Vietnam.

In 2011 Procter & Gamble began construction of a 51,000-sq-metre, $100m facility designed to produce nappies. It is the company’s first factory in Indonesia and will be operational in 2013. Elsewhere, cosmetics maker L’Oreal has built its largest factory in the world in Indonesia at Cikarang. The 66, 000-sq-metre, $124m facility was operational at the end of 2012 and was able to make 200,000 products from the outset, though its total capacity could end up as high as 500m products per year. The company, which built a small facility in East Jakarta in 1986, is utilising the new facility primarily for the making of export products (around 70% of the output will be sold overseas), but the company also recognises the buying power of the Indonesian consumer.

Taiwanese electronics products manufacturer Foxconn is also planning to build capacity in the country. The initiative has been delayed, but the original idea was to start by manufacturing 3m handsets per year in West Java. Ultimately, the firm hopes to develop a 400-ha site, invest a total of up to $10bn, and produce 10m handsets a year and possibly other products, such as tablets and televisions. Most of the output would be sold in Indonesia.

While the demand is clear, it is occurring in an environment that may become difficult. Inflation – particularly for building products – is high, wages are under pressure and infrastructure is an issue. Capacity at industrial estates is also being tested, and the price of industrial land is rising. Still, much if not all of the capacity expansion scheduled for the next two years will go ahead. Japanese firms have been on the ground for many years and have good relations with the government and their local partners, and their increase in capacity is all but certain.

CRITICAL MASS: This bodes well for the construction industry. If the Japanese supply network is put into place, the manufacturing base will become exponentially larger and better established. The stakes will higher, and more infrastructure will be built. If a critical mass is achieved, still more manufacturing could follow – second-tier subcontractors and international competitors – and demand could grow further. In Thailand, Japanese manufacturers are the key tenants in the industrial estates, and their presence has helped to establish the estates, and the country, as good places to manufacture.

The Japanese are nevertheless sensitive to their surroundings, and will adjust their investments based on local conditions. They shifted from China to Thailand via their China+1 strategy, and are now moving from Thailand to balance their risk there. Indonesia is the new favourite, but should conditions deteriorate, prices get higher or the market be slower than forecast, future investment plans could be curtailed.