With its target of becoming a highly developed nation by 2025, Indonesia is aiming to bolster industrialisation and value addition, as well as expand its labourintensive manufacturing industry as it implements the Master Plan for the Acceleration and Expansion of Indonesia’s Economic Development (MP3EI.) An ongoing focus on industrial development has seen the government – including the new administration of President Joko Widodo – roll out a series of strategies and reforms aimed at improving the investment climate and attracting investors in high-priority sectors, including industry and manufacturing.

With foreign direct investment (FDI) having already surpassed government targets in 2014, and scheduled to more than double before 2020, the nation appears to be well on its way towards achieving its goals. However, the state will need to address a number of serious challenges, including infrastructure deficiencies, ongoing bureaucratic red tape and skills gaps in the workforce, before it can realise its MP3EI targets.

Historical Context

Industrialisation has seen the structure of Indonesia’s economy undergo considerable transformation over the past 50 years. Although the economy has historically been weighted towards the agricultural sector, with the government rolling out agriculturally friendly policies in the 1950s and 1960s to promote self-sufficiency, industrialisation and urbanisation began to gather pace in the late 1960s, according to a report by the Reserve Bank of Australia.

As oil prices tumbled in the 1980s, falling energy exports led the government to accelerate its industrialisation efforts in a bid to achieve economic diversification, and policies emphasised reduction of trade barriers and expanding the country’s participation in global trade. Following the Asian crisis of 1997/98, Indonesia’s increasingly strong growth outcomes have also seen a reduction in output volatility, as the nation evolved to become a major commodities exporter and growing manufacturing base. Between 1967 and 2009, manufacturing as a share of GDP rose by 19%, while agriculture’s contribution declined by 35%. This shift was accompanied by rapid urbanisation, which saw the urban demographic rise from 17.2% of the total population in 1971, to nearly half (49.8%) in 2010, according to Statistics Indonesia.

Today, the nation’s macroeconomic fundamentals are extremely conducive to industrial development. Urbanisation is expected to accelerate over the next 35 years, with the UN estimating the proportion of the populace living in cities will reach 71% of the total population by 2050, while a number of reforms aimed at supporting both growth in domestic industry, as well as new foreign investment, have improved industrialisation expansion prospects. Major new investment in infrastructure will reduce bottlenecks and high transport costs, while rising incomes, purchasing power and a rising middle class expected to exceed 140m by 2020 have led domestic consumption to account for two-thirds of GDP growth, according to a report by L.E.K. Consulting. As a result of these trends, FDI in 2014 reached Rp307trn ($25.4bn), outpacing earlier government projections, and driven by investments in the food, pharmaceuticals, and metals and electronics segments. This is expected to rise to Rp570trn ($47.1bn) by 2019. Investment is already supporting a number of segments to overcome challenges.

“While budget cuts to the Ministry of Public Works, combined with electoral uncertainty, contributed to a modest slowdown in the piping industry in 2014, substantial foreign investment in industry, particularly by Japanese investors, softened the landing somewhat,” Sandy Susanto, president-director of pipe supplier Rusli Vinilon Sakti, told OBG.


Launched by the Indonesian government to accelerate economic development and modernisation, MP3EI includes a number of ambitious targets over its 15-year timeframe (2010-25), including raising per-capita income to between $14,250 and $15,500 (from $9270 in 2013), and expanding total GDP to reach $4trn-4.5trn, (up from $878bn in 2013). To achieve these objectives, the government established three major goals, or pillars, to support its targeted GDP growth, which is expected to be between 6.5% and 7.5% annually. The first of these is to boost value addition and expand the industrial value chain, alongside efforts to increase the efficiency of the country’s industrial distribution network. MP3EI also targets encouraging greater production efficiency and improving competitiveness, as well as strengthening national innovation to improve the production process.

Critical Programmes

The government has identified eight main programmes – agriculture, mining, energy, industrial, marine, tourism, telecommunications and strategic regional development – as critical to meeting MP3EI targets. Development will be tailored to existing regional strengths, and concentrated in six economic corridors: Sumatra, a centre for natural resources and energy; Java, a national industrial driver and service provider; Kalimantan, a mining and processing hub; Sulawesi, which will be developed into an agricultural, fishery, oil and gas, and mining hub; BaliNusa Tengarra, a tourism and food support centre; and Papua-Molucca, which will focus on the food, fisheries, energy and mining sectors.

This structure will allow the nation to play to its strengths, which include the vibrant food processing and manufacturing segments; however, Indonesia will also need to address a number of significant challenges if it is to meet MP3EI’s industrialisation targets.

Cost Concerns

Despite its strong growth prospects, industrial development faces challenges, including rising input costs, import dependency and an infrastructure gap that has driven domestic transport costs to unprofitable levels. A 2014 World Bank report found that Indonesia has lost over 1% of annual GDP growth as a result of underinvestment in infrastructure, with the bank reporting that transportation problems are the most significant business constraints for manufacturing firms. According to the Indonesian Textile Association, shipping one container from central Java to Jakarta costs an estimated $600, compared to $200 to ship the same container from Jakarta to Shanghai.

“Indonesia has the potential to become a global supplier of garments. Policies, however, should be revised in order to attract more investments in this sector and build local competition, as well as facilitate exports to capitalise on Indonesia’s strategic location,” Anne Patricia Sutanto, the vice-president of the garment manufacturer Pan Brothers, told OBG.

The Widodo administration has addressed this issue by removing fuel subsidies in late 2014 – which had cost the nation over $20bn annually in recent years – later announcing plans to double capital expenditure in 2015 via a $12bn capital injection in the ministries of transportation, public works, public housing, and agriculture. These funds are expected to expedite road, rail, port and airport projects (see Economy chapter), although the government will require an estimated $477bn in infrastructure spending over the next five years, according to the Indonesia Investment Coordinating Board (BKPM). The total financing need will make the rollout of the state’s ongoing infrastructure public-private partnership (PPP) programme critical for industrial growth. “The government is expected to take a lead in a large transportation projects. They have an advantage to look at the feasibility of projects with a wider perspective, thinking about the impact on the country’s economy compared with the private sector, and they could invest heavily,” Takuya Yamakawa, the president-director of Hitachi Indonesia, told OBG.

While removing the fuel subsidy will have an impact on manufacturers’ bottom lines, market conditions are expected to help alleviate downside risk. “Changes in fuel subsidies could have a short-term effect on tobacco sales, but these will be counterbalanced by the investments of these savings in infrastructure. Higher purchasing power for most Indonesians and a growing middle class provide for the solid foundations of long-term growth and outweigh possible temporary fluctuations in sales,” Paul Janelle, president-director of tobacco firm HM Sampoerna, told OBG.

Import Dependency

Although Indonesia’s manufacturing base is expected to show the fastest growth in South-east Asia over the next five years in terms of new factories, rising input costs as a result of ongoing import dependency have also had a negative impact on growth. Import dependency is particularly harmful in light of the rupiah’s recent sharp depreciation, which saw it fall to Rp13,218 against the dollar in March, its lowest level since 1998, from Rp7558 in November 2011. With input costs rising, the nation’s dependence on imports, including steel and cotton, has also become a headache for stakeholders, although government efforts to improve its local processing and smelting industries and introduce new protectionist measures should dramatically reduce import dependency over the next decade, supporting domestic growth in these areas (see Mining chapter).

BKPM data shows that Indonesia’s steel industry, for example, is highly dependent on raw material imports, including pig iron, sponge iron and pellets. Furthermore, Indonesia imported 8.2m tonnes of steel in 2013, a sharp increase over 3.4m tonnes in 2009. These imports are estimated to have cost the nation $8.9bn in 2013, making the steel industry one of the biggest contributors to an ongoing trade deficit, which stood at $1.88bn in 2014 (see Trade & Investment chapter).

In February 2015 the government announced plans to safeguard Indonesia’s struggling steel industry through the introduction of a 15% import tariff on construction steel, effective April 2015. These moves are expected to reduce the impact of low-cost imports on the country’s domestic producers.

Protection vs. Investment

The steel tariff is one of several protectionist measures aimed at improving the domestic manufacturing sector, and came after the government moved to enact a long-planned ban on exports of raw minerals in January 2014. Local content requirements have also been put in place to support domestic producers. In shipbuilding, for example, over half of the materials must be made locally, expanding the market for steel and aluminium. “With 55% of a ship’s materials required to be sourced domestically, growing demand for naval defence, patrol and cargo vessels creates an opportunity for the local shipbuilding sector to be able to compete against foreign shipbuilders,” Harmanto Ahak, president-director of shipbuilder Palindo Marine, told OBG. These measures will ultimately bolster local growth and ensure an adequate supply of raw materials to domestic smelters, which should improve value addition initiatives.

A recent spate of investment announcements in the metals industry (see overview) indicates this strategy will pay off in the long term, and the Widodo administration’s selectively protectionist policies – which also include closing small-scale retail to foreign ownership and limiting foreign ownership in the frozen foods and storage sectors – should further support a growing base of domestic companies, particularly small and medium-sized enterprises. Investors need not fear the government will discourage foreign investment, however – rather, the authorities are targeting specific high-priority industries as offering benefits to both national interest and foreign investors.

Foreign Role

Indeed, MP3EI specifically highlights a growing role for foreign investors. BKPM stated in a recent report on MP3EI that the government’s limited budget means that many initiatives will be largely dependent on the private sector. In January 2015 BKPM launched a one-stop shop for investment in the country, assuming licensure responsibilities for 22 different ministries and government agencies. Indeed, renewed calls for investment in manufacturing have already seen investment take off in 2014, with Bloomberg reporting in January that Indonesia will see the construction of 54 new manufacturing plants over the next five years. These will contribute to making the MP3EI’s targets increasingly feasible, painting a bright forecast for the future of industrial development.