Global Business Guide Indonesia

Indonesia
Sign up for the GBG Indonesia Quarterly Business Intelligence Report for the latest news on your sector.
Sign Up
Business Updates | A Look into Indonesia’s Special Economic Zones

Buoyed by the success of the country’s existing FTZs in the Riau Islands of Batam, Bintan and Karimun; the Indonesian government in early 2014 announced its plans to develop three areas into new special economic zones. The introduction of these zones - to be located in Morotai, North Maluku; Tanjung Api-Api, South Sumatra; and Mandalika, West Nusa Tenggara - comes at a key time as Indonesia’s neighbouring countries also begin gearing up to attract investment in the lead up to the ASEAN One Market in 2015.

As investors weigh up the options available to them within the 600 million person strong ASEAN market, the Indonesian government will have to take stock of the successes and shortcomings of previous special economic zone projects. Investors too face the challenge of identifying the short and long term prospects that Indonesia’s current and upcoming SEZs offer when selecting a suitable investment destination in the region.

Infrastructural Stasis?

The new special economic zones add to those currently being developed in Sei Mangke, North Sumatra and Tanjung Lesung, Banten as well as the existing free trade zone in the Riau Islands of Batam, Bintan, and Karimun. In joining this growing list of designated investment friendly areas in Indonesia, it is expected that the most recently announced special economic zones will suffer from the same key issue that has in the past slowed growth in the country’s pilot FTZs and already plagues projects still under development: inadequate infrastructure.

Despite now being home to Indonesia’s largest shipbuilding industry, the Batam free trade zone still contends with issues such as the absence of a main port that can transport goods directly to international destinations. As a result, companies based in Batam must bear the costly burden of transporting goods through a third country. Furthermore, the Tanjung Lesung special economic zone currently being constructed in Banten is already experiencing difficulties in guaranteeing ease of accessibility from Jakarta due to a limited road network.

The challenges that infrastructural inefficiencies bring about have been made all the more noticeable as regional competitors begin to make their presence felt. Malaysia in particular has been successful in attracting Singapore based investment that could have otherwise flowed to Indonesia following the revamp of a road link between the city-state and an industrial complex in South Johor.

While the above certainly highlights Indonesia’s comparative shortcomings, it is also important to keep in mind that in spite of its lack of a main port, Batam now lays claim to the best infrastructure in Indonesia. As per the findings of a study by Political and Economic Risk Consultancy, the state of Batam’s physical infrastructure ranks higher than Thailand, Vietnam and India, and is more than twice as advanced as the rest of Indonesia. As the longest standing free trade zone in Indonesia, Batam has also implemented a one stop investment application process managed by a single governing body, the Batam Industrial Development Authority, to mitigate bureaucratic inefficiencies.

There are no quick fixes when it comes to lack of infrastructure. Companies deciding to establish operations in Indonesia’s special economic zones must therefore select strategically based on the surrounding infrastructure, available natural resources and the government’s overarching development plans such as the MP3EI which determines which sectors will potentially receive greater support and incentives. For example, the absence of duties within the zones means that industries which import components and parts not readily available in Indonesia such as electronic goods manufacturing and shipbuilding have flourished within the country’s existing FTZs by taking advantage of cost competitive labour.

Shipping Off to Batam

Given its advantageous maritime position, the Riau Islands province has seen its free trade zone status spur the development of a booming shipbuilding and shipyard industry that now stands as the largest in Indonesia. More than 150 major maritime companies currently operate in the province, including notable multinational companies McDermott International, Drydocks World, and Keppel Corporation.

The industry was further boosted by the implementation of cabotage laws in Indonesian waters in 2011 that has fuelled demand for local ships. The need for domestic shipping in particular has seen the Indonesian commercial fleet double in size between 2005 and 2013, from 6,041 vessels to 12,536 vessels (See Indonesia’s Shipping & Shipyard Industry). Moreover, the Indonesian National Shipowners Association (INSA) projects investment in offshore marine services to grow by upwards of 50% a year as a result of more than 18 new oil and gas blocks to be explored in the near future, most of which require offshore support vessels to carry out high-sea operations.

The Batam, Bintan and Karimun Island free trade zone through its removal of taxes on imported ship parts that cannot yet be sourced domestically thus stands as the most advantageous location to set up shipbuilding operations in what is not only a thriving domestic market but also a regional market soon to experience a rise in trade as a result of the ASEAN’s upcoming economic integration. The success of foreign and local businesses in this field also serves as a case and point of the need to ensure that domestic market policy complements an investor’s business development strategy as well as industry sector when choosing to operate within the country’s special economic zones.

A Surging Electronics Industry

The Batam free trade zone is also the setting for the success story of Indonesia’s electronics manufacturing industry. Rising demand for electrical appliances and household audio/video equipment among Asian consumers has encouraged major multinationals to further their presence in the region. As such, Batam has attracted industry giants including Sanyo, Panasonic, Siemens, Philips and Sony.

With the lure of a strong foundation of tech-driven consumers in nearby Singapore and China having acted as an incentive for setting up manufacturing operations in Batam, electronic goods producers now also profit from the rising purchasing power of Indonesian consumers. For a growing subset of these individuals, electronic goods are now being considered as essential goods as opposed to luxury products (See Indonesia’s Electronics and Home Appliances Sector).

The electronics industry like the shipbuilding industry has benefited from the Batam FTZ’s proximity to Singapore which has facilitated access to expertise and components due to the imminent ‘spillover’ which was identified in the 1970s when the zone was originally designated. The region’s success has therefore been somewhat dependent on unique factors and will not be easily replicated in the upcoming special economic zones. Investors in upcoming special economic zones are therefore encouraged to explore the region’s natural and distinctive advantages when assessing the region’s potential as an investment destination.

Pro-Processing in Commodities

Other strategic industries offered by Indonesia’s special economic zones include downstream processing in agricultural commodities, now boosted by a more steady supply of raw materials for domestic businesses following tighter government control of unprocessed exports (See Incentivising Downstream Investment; A Look into Export Tariffs on Agricultural Commodities). Downstream processing is therefore a further area to be developed in the context of the newly announced SEZs, and this is in keeping with the trend of focusing on industries tailored to an area’s strengths.

The Tanjung Api-Api special economic zone in particular has considerable potential for this type of venture, having been selected as a future site of downstream processing activities for rubber and mineral ore, including turning coal into gas. Sei Mangke in North Sumatra, scheduled to open in early 2015, is being developed into a centre for palm oil industries to accelerate the production of palm-based goods for the food industry such as cooking oil and shortening as well as oleochemicals and biodiesel.

Other Opportunities & Outlook

Foreign companies should also seek to lend their expertise in constructing large-scale infrastructure to address the prevailing issue within Indonesia’s special economic zones. There is therefore considerable scope for international construction agencies to participate in tenders for upcoming infrastructure projects. This extends to construction projects to build new roads, railways, bridges and transmission pipelines. The multiplier effect that such development will bring about is also not to be overlooked; supporting services within the zones such as financial services, property development and hospitality will also be very much in demand.

Entering Indonesia’s special economic zones and taking full advantage of them from an investment standpoint requires a long term outlook. Entering companies must be willing to first ensure that their industry is suited to the benefits made available in these areas as well as long term domestic and regional policies in their sector. This long term vision will be rewarded by Indonesia’s unique advantages in still being able to provide competitively priced and readily available land within the SEZs for expansion which has previously constrained businesses in markets such as Singapore and Malaysia.

Infrastructure will be the watchword for the government and investors and the success of the new special economic zones will hinge upon it. The government does appear to be taking action; a recent event in March 2014 held by the Investment Coordinating Board (BKPM) showcased the PPP infrastructure projects in special economic zones available to investors with particular uptake from Korean and Japanese investors. Should Indonesia be able to align infrastructure development with the goals of the MP3EI and supportive trade regulations, clear comparative advantages are to be found for investors who are prepared to trade off short term infrastructure obstacles for lucrative long term gains.

Global Business Guide Indonesia - 2nd April 2014

icone share