Global Business Guide Indonesia

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Business Updates | What China’s Slowdown Means for Indonesia: An Investment Perspective

Close economic ties between Indonesia and China throughout the vast majority of the 2000's was rightly viewed as a point of emphasis for those extolling the Southeast Asian nation’s long-term growth potential. Ravenous demand for commodities such as coal and crude palm oil from China during the height of its boom saw Indonesia’s economy prosper in tandem as a major exporter of these raw materials. With projections from as recent as 2012 forecasting continued GDP growth in China above 8% until 2017 (The Economist, IMF), for many in Indonesia it was a case of letting the good times roll.

More recent developments, however, have forced a shift in this narrative. Cracks in the foundation of China’s economy – most notably a corporate and household debt level that stood at a record 207% of GDP as of June 2015 (Bloomberg) – have pressured its government to take corrective measures in carrying out structural reform for longer-term sustainability. The short-term implications of this are far-reaching, as evidenced by the global repercussions of a panic-induced mass sell-off of Chinese stocks on 24th August 2015 – an event that has since been dubbed ‘Black Monday’.

For Indonesia, whose main index fell by around 4% on Black Monday, the new reality of a protracted slowdown in China necessitates a reassessment of more than just the vulnerability of its capital market. As Indonesia’s foremost trade partner and an investor of growing clout in the ASEAN, China’s influence in the country runs deep and shapes the outlook for key industries not only in resource extraction, but also in manufacturing and infrastructure development. In this first instalment of a two-part analysis of Indonesia’s connection to China, further insights are provided into the prospective impact of slowing growth on the still fledgling investment relationship between the two nations.

Recent indications of an increased investment presence

China’s standing as the world’s largest manufacturer is well-documented; the country presently stills accounts for half of Asia’s output in this domain. The competitive advantages that allowed for this positioning, however, are slowly fading as China contends with labour costs that have risen 12% annually (The Economist). By way of comparison, an average factory worker in China earns $27.50 USD per day versus $8.50 USD in Indonesia.

In anticipation of the need to move their manufacturing operations, Chinese businesses have thus begun to explore the possibility of opening production facilities in Indonesia, among other Southeast Asian nations offering a cost-competitive workforce. Recent project announcements suggest that interest has picked up in the automotive sector with China-based automakers Sokon and SAIC intending to commence the construction of new factories in Indonesia this year.

Also entering the market aggressively are China’s smartphone brands and telecommunication firms, seeking to tap into a tech-hungry consumer base and adhere to new local requirements for a selection of electronic goods (See Rising Local Content Requirements for 4G Smartphones in Indonesia). This entry has occurred both in the form of joint ventures with local partners, as is the case with Huawei and ZTE in cooperating with Panggung Electric Citrabuana, and the opening of new manufacturing facilities – a course of action taken by companies such as Oppo.

With this said, despite a recent uptick in interest in Indonesia as a manufacturing centre serving ASEAN and its high potential consumer base, Chinese investors remain primarily drawn to projects within the field of smelters, power plants and cement production facilities. It is precisely this type of investment that accounted for the majority of the $800 million USD in realised FDI from China into Indonesia over the course of 2014. As shown below, this figure dwarfs FDI totals from previous years and suggests that the new administration under President Joko Widodo (who has already made official visits to China twice this year) has had some success in appealing to Chinese investors, given that the bulk of the 2014 investment took place post-election.

China’s Total Realised Investment in Indonesia (million USD)

Source: BKPM

Slowdown curbing China’s enthusiasm?

Early signs suggest that Indonesia is unlikely to bring in as much investment from China in 2015, with data from the first half of the year showing a disappointing return to the norm of previous years at $160.29 million USD. As to whether this can be explained more by the slowdown in China or by reticence related to Indonesia’s own economic difficulties is open to interpretation. Reports suggesting that China intends to follow through on plans to triple its offshore assets to nearly $20 trillion USD by 2020 (Financial Times), however, seem to point to the latter as being more likely. Certainly, the disappointing pace at which government spending has been carried out in Indonesia will have caused concern among Chinese investors looking to get involved in massive infrastructure development projects (See High Stakes for Indonesia’s New Infrastructure Push). Moreover, the impromptu cancellation of a high-profile bullet train project linking Jakarta and Bandung in which China was among the favoured bidders will do little to counter dwindling investor confidence.

Putting to one side Indonesia’s need to address ongoing challenges (See Action Needed to Put Indonesia’s Economy on Track); Chinese investment into the archipelago nation should not fall significantly as a result of a slowdown in the mainland. This assertion is based on the likelihood that China-based investors may seek to invest in projects such as smelters in Indonesia in anticipation of a jump in the price of related commodities once demand rises again. A weak Indonesian rupiah makes investment now an even more timely opportunity (See The Present Plight of the Indonesian Rupiah), though this advantage is mitigated to an extent for Chinese investors given the devaluation of the yuan.

In the event that investment into Indonesia from China does drop off substantially, it is worth keeping in mind that any negative impact felt will be lessened by the fact that China remains on the periphery of Indonesia’s list of main investors. The first quarter of 2015 marked the first time in history that China ranked within the top ten international investors in Indonesia, and the country still trails far behind nations such as Japan, Singapore and South Korea.

Indonesia’s Top Ten Investors in Q1 2015 (in USD million)

Source: The Jakarta Post

Despite close trade ties, China has seen only $1.8 billion USD of its planned $24.27 billion USD investments in Indonesia realised between 2005 and 2014 – a success rate of only 7%. As a means of boosting this percentage to 30%, President Widodo’s government has sought to address what it perceives to be the major impediment. According to the Chairman of the Indonesia Investment Coordinating Board (BKPM), Mr Franky Sibarani, the lack of knowledge on investment license proceedings in Indonesia as well as difficulties in finding suitable local partners has proven to be a disincentive to Chinese investors (The Jakarta Post, 04/04/2015). As such, Indonesia intends to open a BKPM representative office in Beijing in the near future, adding to branches already operating in Seoul, New York, London, Singapore and Tokyo, to name a few.

This course of action is a positive development, but serves as only a partial remedy to a complex problem. Chinese investors’ general passivity in regards to buying into the Indonesian growth story can be attributed to a whole host of factors, among which is their perceived preference for projects that allow for majority foreign ownership. Indonesia’s Negative Investment List prohibits this type of ownership structure across many industries – including areas of business that China has been most aggressive in entering overseas such as natural resources – and it is thus not surprising to see China’s involvement more or less limited to sectors with more permissive requirements in this regard, such as infrastructure development and power generation.

Whether this changes going forward depends in part upon Indonesia’s ability to move downstream and make available projects attractive to Chinese investors offering expertise in value-added manufacturing. The aforementioned smartphone and electronics industry stands as evidence of the immense potential in this type of cooperation, and could serve as a blueprint to the government in its efforts to spur the local production of globally sought-after goods. The significance of progress in this regard to the overall health of Indonesia’s economy is not to be overlooked, given the current trade imbalance that belies an overreliance on imports as well as the country’s overexposure to resource-hungry export markets.

Global Business Guide Indonesia - 12th September 2015

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Indonesia Snapshot

Capital: Jakarta
Population: 259 million (2016)
Currency: Indonesian Rupiah
Nominal GDP: $936 billion USD (IMF, 2016)
GDP Per Capita: $3,620 USD at Current Prices (IMF, 2016)
GDP Growth: 5.0% (2016)
External Debt: 36.80% of GDP (BI, Q2 2016)
Ease of Doing Business: 91/190 (WB, 2017)
Corruption Index: 90/176 (TI, 2016)