A significant actor in global trade and investment, and a member of the G20 group of the world’s largest economies, Indonesia has achieved a strong record of attracting foreign direct investment (FDI) and rebalancing its trade patterns toward high-growth markets. The authorities have developed new markets for exports while encouraging investment in import-substitution industries. Their key priorities heading into the 2014 elections remain speeding up infrastructure development, improving labour flexibility, and bolstering trade and investment policies. While challenges remain in the investment environment, efforts to streamline procedures and ease bottlenecks have attracted investment in the natural resources and manufacturing sectors. As policymakers worked to contain a current account deficit of imports of capital goods and intermediary materials in 2013, long-term direct investors appeared more bullish than short-term portfolio investors.

Trade Patters

Despite a 6.7% contraction in net exports in 2012, the value of Indonesia’s trade has expanded significantly over the past decade, with a doubling of exports between 2006 and 2011 to $203.50bn. Rising demand for Indonesia’s key commodity outputs from Asian markets has spurred a redirection of trade. Yet with most FDI flowing to sectors linked to consumption, trade has been a smaller growth driver than household spending. This comes despite ASEAN-wide trade liberalisation that has encouraged conglomerates to expand their supply chains to Indonesia (see analysis). Japan was Indonesia’s top market in 2012, but its share of total exports fell from 22.28% in 2003 to 15.86%, according to the Asian Development Bank (ADB). China and Singapore, the next two markets, grew from 6.23% and 8.84% of exports, respectively, in 2003, to 11.4% and 9.02% by 2012. China’s significance as a source of imports also grew, with its share of Indonesian imports rising from 9.08% to 15.33% in 2003-12, though it was third behind Singapore and Japan in 2012 imports, with 13.6% and 11.88%, respectively. The US, Indonesia’s fifth-largest market in 2012, saw its share decline from 12.09% to 7.83% in the same span, while exports to the EU dropped from nearly 18% to 9.3%. The largest increases went to India, where exports doubled from 2.85% to 6.58% in 2003-12, and ASEAN countries – exports to Malaysia rose from 3.87% to 5.94%, and to Thailand grew from 2.28% to 3.49%.

“We are seeing an intensification of trade and FDI flows in ASEAN, particularly between Indonesia, Thailand and Vietnam in both directions,” Nick Gandolfo, HSBC’s senior vice-president of leading international business in Indonesia, told OBG.

Accelerated Growth

Trade with non-traditional markets in Africa, the Middle East, Eastern Europe and Latin America has grown even faster, albeit from a low base. Growth in trade with Africa accelerated from 14.42% annually in 2007-11 to 46.4% in 2011-12, while that with the Middle East rose from 7.7% to 43.23% in the same span, according to data from the Ministry of Trade (MoT). While traditional markets in Asia grew 40.64% annually in 2007-11 and 63.13% in 2011-12, markets in Europe and America contracted: annual trade growth with Western Europe slowed from 13.99% to –

4.27% in this span, while that with North America dropped from 10.69% to -14.83% (see analysis).

By the first half of 2013 the top 10 markets accounted for 73.6% of Indonesian exports, according to the MoT, while roughly 70% of exports stay in Asia, as per figures from private equity firm KKR. Although exports continued to contract into August 2013, with a 6.3% year-on-year (y-o-y) drop, a reversal of the oil and gas deficit to a small surplus helped to offset contracting non-hydrocarbons exports to a degree.

A 2013 report on trade patterns published by global accountancy and professional services firm Ernst & Young forecast export growth rates of roughly 15% annually until 2020, driven by rebounding demand in emerging Asian economies. Annual increases in trade with China, Thailand and South Korea were over 13%, stimulating demand for lower-value-added manufacturing exports – clothing and shoes in particular.

Terms Of Trade

As Indonesia is the world’s largest exporter of crude palm oil (CPO) and tin, the second source of cocoa and a major exporter of nickel (fifth), gold (seventh) and copper (eighth), commodities are a key earner, accounting for 62% of exports in the first half of 2013, according to data from Statistics Indonesia (BPS). Given its dependence on unprocessed commodities, Indonesia benefitted from major price upswings during the commodities super-cycle – with 74% of the 28.98% y-o-y growth in exports in 2011 driven by increases in price rather than volumes, according to KKR – but it has also been affected by depressed prices since the first quarter of 2012. “The price index of our goods exports declined by nearly 15% in 2012, mainly due to slower growth in our major trading partners, including India and China,” Luky Alfirman, head of the Ministry of Finance’s (MoF) centre for macroeconomic policy, told OBG. While CPO sales remain the single-largest export item with 13% of the total in the first quarter of 2013, according to BPS data, manufactured goods have grown in importance, driven by exports of machinery, electronics, ships and aircraft parts. Ship export sales grew 29.42% y-o-y in the first half of 2013, while footwear and ready-to-wear garments were up 9.9% and 3.9%, respectively, in the first half of 2013 according to data from the MoT.

Although these increases are significant, depressed prices for key commodity exports have dragged down sales values. Rebalancing of growth in China toward domestic consumption has led to declines in CPO, rubber, and key industrial metals like tin and nickel, whose prices declined 17% in the first half of 2013, and copper, which fell 12% in six months, while higher thermal coal exports from the US given the rise in its shale gas production have pushed down coal prices. New export tariffs of 20% on 65 unprocessed minerals (excluding coal) introduced in 2012 have also squeezed export volumes, although the majority were suspended amidst the August 2013 policy package from the MoF.

Record FDI

Despite shocks to Indonesia’s commodity export earnings, the economy has continued to prove a draw for FDI. Investment, at roughly 32% of GDP, is the second driver of growth after household consumption. Inward FDI (excluding hydrocarbons and non-bank financial institutions) rebounded from a low of $4.88bn in 2009 to $16.21bn in 2010, the year Indonesia overtook Thailand as the largest recipient of FDI in ASEAN, and $24.56bn in 2012, when Indonesia ranked as the world’s 20th-largest FDI recipient, according to data from the UN Conference on Trade and Development (UNCTAD). Investment ratings upgrades by Japan’s JCR in 2010, and by Fitch and Moody’s at the start of 2012, encouraged the higher FDI trend. Despite significant outflows in portfolio investment in 2013, FDI flows continued to grow, reaching $7.05bn in the first quarter of 2013 and $7.17bn in the second quarter – with Indonesia on track to achieving $28bn in inward FDI and Rp390trn ($39bn) in total investment, according to the Indonesia Investment Coordinating Board (BKPM). While FDI growth slowed slightly to $6.98bn in the third quarter of 2013, up 18.4% y-o-y, this was largely compensated by surging domestic investment, up 33% y-o-y to $1.92bn.

In the first half of 2013, FDI accounted for 68.57% of total investment, while the total stock of inward FDI ballooned tenfold in 12 years from 2000 to $205.66bn, according to UNCTAD. These record numbers were driven by greenfield investment, which accounted for 57.5% of all investment in the year to September 2013, while expansion of existing facilities accounted for 42.5%, according to BKPM. The four largest sources of FDI in 2012 remained Singapore, Japan, South Korea and the US with $4.86bn (19.8% of the total), $2.46bn (10%), $1.95bn (7.9%) and $1.24bn (5.1%), respectively, according to BKPM. Some uncertainty over official figures remains, however, given an October 2013 report published by the American Chamber of Commerce in Indonesia (AmCham) that noted the under-valuing of US FDI: it found that total US investment in Indonesia reached $65bn in the eight years to 2012, rather than the official $7bn figure. This was due to the use of corporate entities in tax havens like Mauritius (which channelled $1.06bn in FDI to Indonesia in 2012), the British Virgin Islands ($855.9m) and Cayman Islands ($8.5m) as well as Singapore and Hong Kong (see analysis).

Investor interest is expected to continue to grow. “Indonesia’s lower GDP projection will not deter foreign investors,” Armand B Arief, president director of UOB Bank, told OBG. “There is too much potential in the medium- and long-term for investors to ignore the opportunity in Indonesia. After the recent FDI forums in Indonesia, there has been a lot of follow up from foreign investors, however, the government is making it difficult because they can’t formally act on these inquiries until the central bank makes it official.”

Broader Focus

Despite adverse terms of trade for exports, a growing share of FDI has focused on manufacturing, domestic-oriented in particular. The share of FDI in Indonesia’s secondary sector grew from 20.58% in 2010 to 47.9% in 2012 and 63.3% by the third quarter of 2013, while manufacturing and services combined accounted for 76% of all FDI in the first three quarters of 2013, according to BKPM. “We did not expect a significant drop-off in inward FDI in 2013, despite adverse portfolio investment flows during certain times in the year, with a particular focus on consumer and retail, infrastructure and services,” Gandolfo told OBG. “Surabaya and Batam are probably the most active FDI destinations outside Jakarta.” The secondary sector’s reliance on imports of capital goods and intermediary materials, which accounted for 20% and 73% of all imports in 2012, means that higher FDI in manufacturing has driven import growth and widened Indonesia’s current account deficit (see analysis).

While disasters like the Fukushima tsunami and nuclear shutdown and the Thai floods in 2011 prompted automotive and electronics manufacturers to expand production chains within ASEAN, the strong pull of Indonesia’s vast domestic market and government measures to increase locally produced content both in manufacturing and in commodity processing have also provided impetus to growing investment. A full 15% of all 2012 FDI went to transportation equipment and machinery, according to KKR, a sign of value chains being established in Java, outsourced from southern China. “We are seeing the shift of investment from natural resources-based to value-added sectors,” incoming BKPM chief Mahendra Siregar said when the third-quarter 2013 investment figures were released.

The October 2013 report by AmCham found that while US investment in oil, gas and mining grew 11% in eight years to 2012, growth in manufacturing investment was nearly double that, at 21%. By 2012 52.2% of US FDI was in extractive industries and 46.1% in manufacturing. Significantly, the nature of firms investing includes small and medium-sized enterprises (SMEs), particularly from Japan, South Korea and Taiwan, according to BKPM – a sign multinationals are expanding supply chains to Indonesia.

“The growth in FDI from SMEs is largely because they are subcontractors to larger multinationals that are trying to fulfil government requirements to integrate more of their supply chains domestically,” Destry Damayanti, Bank Mandiri’s chief economist, told OBG. The largest deals by value in recent years have focused on the manufacturing, automotive, electronics, pharmaceuticals and telecommunications sectors, according to research from the University of Indonesia.

Value Added

Eager to transition to a higher-value-added production base, Indonesian authorities are striving to streamline investment procedures and promote investment to key sectors under the Masterplan for Acceleration and Expansion of Indonesia’s Economic Development (MP3EI) to 2025. Structured along six growth corridors, the plan aims to develop sorely needed infrastructure to support expansion in key strategic industries and jumpstart the country’s industrialisation. Meanwhile, the MoT’s five-year strategic plan to 2014 aims to increase non-oil exports, strengthen the domestic market and improve the availability of basic products. Given Indonesia’s surging capital goods and intermediate materials imports, driven by growing investment in final manufacturing, the authorities are conscious of the pressing need to develop intermediate industries. The Ministry of Industry’s industrialisation plan focuses on 35 priority industrial clusters in basic manufacturing, agro-industry, electronics and IT, transportation as well as creative and supportive industries. “The regional context is conducive for Indonesia to develop its intermediate industries,” Ndiame Diop, lead economist and economic advisor for Indonesia at the World Bank, told OBG. “As China rebalances there is quite a lot of investment flowing south, and Indonesia may be able to capture some of this.”

Raw Management

The government has adopted a carrot and stick approach to improving value-added output. The WTO noted in its March 2013 trade policy review that, “A number of measures… have recently raised concerns about the direction of trade and investment policymaking.” The Heritage Foundation puts Indonesia’s trade-weighted average tariff at 2.5%, but trade is constrained by non-tariff barriers (see analysis). The 2009 Mining Law allows only miners investing in local smelters to continue exporting unprocessed minerals from 2012 and plans for a total ban on the export of raw minerals from 2014, although investors in downstream processing may be able to continue such exports given the loosening of export restrictions in the government’s August 2013 policy package. The state also introduced progressive taxes on the export of mineral commodities, CPO and cocoa, and since August 2013 requires the sale of tin through local commodity exchanges (see Capital Markets chapter).

Indonesia also placed import restrictions and quotas on horticultural and animal products in 2011, restricting import licensing to a handful of importers and only four entry ports. While these were also relaxed in April 2013 due to rising food inflation, they elicited a number of WTO complaints from the US (see analysis). Meanwhile, on the investment front, new rules on bank ownership limiting single-owner (whether local or foreign) shares to 40% of a lender from 2012 were seen as a means of halting Development Bank of Singapore’s attempted majority takeover of Bank Danamon, in the absence of reciprocal access for Indonesian banks to Singapore’s market. This is prohibitive given the capital charges applied to minority ownerships on banks complying with Basel III rules (see Banking chapter).

New rules on mining ownership introduced in 2012 also require divestment to an 80% stake within six years of production (by 2018), and then 70%, 63%, 56% and 49% every year thereafter – with local initial public offerings not qualifying as divestment (see Mining chapter). In addition, as part of efforts to curb imports of intermediate materials and capital goods, the central bank has discouraged banks from lending to 10 import-dependent industries including telecoms and automotive manufacturing. “Bank Indonesia has encouraged banks to support investments that will reduce imports, which in turn should have a positive effect on the country’s balance of payments,” Sheky Lemasoa, HSBC’s head of corporate in Indonesia, told OBG. “However, these encouragements need to be clarified in terms of enforcement.”

On the incentives front, in 2011 Indonesia rolled out tax holidays of 5-10 years (followed by 50% reductions for two years thereafter) and 5% cuts in income tax for investment over six years for firms investing over Rp1trn ($100m) in one of the six MP3EI corridors in sectors like base metal processing, oil refining, petrochemicals, renewables, telecoms equipment and machinery. Labour-intensive businesses – those employing more than 100 staff – are also eligible for these incentives for investments over Rp50bn ($5m) in 129 sectors, including plantations, pharmacies and property. The government plans to expand these incentives in the fourth quarter of 2013 to firms from countries with no tax treaties with Indonesia and for those investing in research and development locally. In the two years since 2011 the government has only granted tax holidays to two investors: Unilever’s $133m oleochemical palm oil refinery and Chandra Asri Petrochemical’s $145m butadiene factory. While the approval process for tax holidays is complicated – with BKPM assessing the technical aspects and a committee including MoF, the Coordinating Ministry of Economic Affairs and the Tax Office approving them – the two main criteria are the amount of local content and jobs generated.

Negative List Revision

The 2007 Investment Law introduced greater clarity regarding which sectors are open to majority FDI. In practice, however, this has led to the publication of a “negative list” of sectors in which FDI is capped – mainly high-value-added sectors such as telecommunications towers, health care, pharmaceuticals production, courier services, small-scale retailing, creative industries and education – and those where it is barred, mainly related to national security and alcohol production. Investment restrictions vary from 45% to 95%, but there is no limit on the size of investment, the source of funds or whether production is export- or domestic-oriented.

The list was last revised in 2010 and extends restrictions to merged or acquired entities, with 20 industries barred from FDI, but the revisions also increased the FDI ceilings in sectors like courier services (from closed to 49%), health care (65% to 67%), large-scale construction (55% to 67%) and direct marketing (60% to 95%). In addition, it relaxed ceilings for ASEAN investors in areas such as marine transport and cargo handling and hospitality. While another revision was widely anticipated by end-2012, and is expected to relax the 75% cap on pharmaceuticals production among others, this has been delayed several times.


Indonesia is on track to achieve another record year for FDI. The outgoing administration is intent on seizing on financial strains as an opportunity to implement needed structural reforms. Notwithstanding the political transition, BKPM expects some Rp450trn ($45bn) in new foreign and domestic investment in 2014, a 15% y-o-y increase, while AmCham predicts some $61bn in new US FDI in the next three to five years alone. While measures aimed at curbing the current account deficit by reducing imports and expanding value-added exports will take time to bear fruit, concerted efforts to develop the industrial base are beginning to attract increased investment. Amidst the political debate, all the political parties agree on the need for investment and to expand international trade from its low base, although they will have to resist populist urges to impose restrictions.

While margins adequately compensate the risk for investors, authorities are conscious of the need to cut red tape, streamline burdensome regulations and improve best practice across all regions.

“Indonesia is the least-unattractive country in the world,” M. Chatib Basri, former head of BKPM and now Finance Minister, told international newspapers in April 2013. “Even though they have to deal with the problems of bureaucracy and infrastructure, the returns are higher than if you invest in Europe and the U.S. now.”

The government is steering improvements in its investment climate through BKPM, which established a taskforce to that effect including the Tax Office, Bank Indonesia and state power utility PLN. The aim is to reduce the time for connecting new businesses to electricity, water and telephone lines. In early 2013 BKPM cut in half the number of documents needed to apply for an investment licence and shifted to an online platform for processing applications. The Board is also seeking to coordinate across districts by establishing regional BKPM offices and operating best-practice competitions between districts.

The Customs service launched its electronic National Single Window in 2010 in order to streamline cross-border trading procedures. The enactment of the new ‘eminent domain’ law for land acquisition linked to infrastructure projects in December 2011 is an encouraging step, although delays in toll-road developments point to lingering challenges (see analysis) The central bank is meanwhile encouraging significantly higher bank lending to SMEs in stages to 2017, which should facilitate access to credit.

The administration has also sought to strengthen the anti-corruption commission (KPK), which has led cases against high-profile public officials including the Democrat Party’s treasurer in 2011, the Youth and Sports Minister in 2012 and the Constitutional Court’s Chief Justice in October 2013. Yet anti-corruption officials still do not hold subpoena powers that would significantly increase their power.

While improvements in the business climate are welcome, investors must contend with above-average inflation in land prices and staff costs. An April 2012 study by Japan’s External Trade Organisation (JETRO) found that the average cost of industrial land had nearly doubled from 2010 to 2012, to $196/sq m, while the availability of land in the Greater Jakarta region was problematic. Meanwhile, minimum wages increased by 18% nationwide in 2012 according to the ILO and as high as 44% in Jakarta. Although labour-intensive industries account for only 9% of employment in Indonesia according to BKPM, the potential for knock-on effects on the entire pay scale is a concern for investors. The government is proposing reforms to wage negotiations procedures in order to link wage increases to regional inflation rather than political bargaining (see analysis).