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Indonesia in 2015: Economic and Political Renewal Shifts Investment Focus
The year 2013 brought to the fore some serious challenges to Indonesia's economic growth model, which relies heavily on consumer spending on the one hand and raw commodity exports on the other. Important macroeconomic indicators turned gloomy, and the impression that the government failed to implement necessary reforms amplified pessimism among investors.

Indonesia in 2015: Economic and Political Renewal Shifts Investment Focus
It is interesting to note that a growing proportion of direct investment (both foreign and domestic) is going to areas outside of the country's traditional industrial heartland

In 2014, the country emerged from those challenges less scathed than some had anticipated, and anxiety over that year's parliamentary and presidential elections proved unfounded in retrospect. While the economy may have averted an overly hard landing, many of the underlying issues remain unresolved. Tackling them is a heavy burden on the shoulders of the new administration in Jakarta. The year 2014 may mark a turning point for Indonesia's economy with a lasting impact on foreign direct investment (FDI).

Indonesia's economy at a crossroads

Indonesia's economy did well from 2009 through 2011 thanks to strong demand for major export commodities, such as thermal coal, metal minerals, rubber and crude palm oil, and buoyant consumer sentiment on the back of rapidly rising wages and relatively stable inflation. Consecutive months of trade deficit and a continued devaluation of the rupiah in 2012 were among the first signs that all was not well with the country's macroeconomic set-up, and in 2013 it became painfully clear that the good times had ended, for the time being at least. GDP growth slowed significantly, inflation spiked as the rupiah's decline accelerated, and capital fled the country as foreign investors became concerned about a withdrawal of quantitative easing by the US Federal Reserve.

The year 2014 saw inflation stabilize and the rupiah decline arrested, albeit with a high degree of volatility. At the end of October, the currency traded at roughly the same level as it did at the beginning of the year. The lower exchange value supports the necessary adjustment in foreign trade, which may be why the central bank appears to be in no hurry to reverse the devaluation caused by the two-and-a-half-year-long downward trend. GDP growth, however, slowed to 5.1% year-on-year in the second quarter, the lowest rate since 2009. The slowdown is a sobering experience after years of boom, but it is at least in part due to tempered domestic consumption as the lower rupiah makes imported goods more expensive and because financial authorities slapped restrictions on consumer lending.

With hindsight, the period from mid-2012 through 2014 can be seen as a healthy macroeconomic correction that puts the economy on a more stable footing. In a July 2014 report on Indonesia's economy, the World Bank warned, however, that “the administration will face hard policy choices to address rising fiscal pressures and to implement much-needed reforms to deliver on the economy’s enormous potential.” Whether Indonesia's economy in 2015 can emerge stronger from a rough period will depend to some extent on an uncertain global environment, but likely to a larger extent on domestic political and economic reforms.

Foreign investment remains strong

FDI continued to grow strongly despite the macroeconomic difficulties and political uncertainties. In the first three quarters of 2014, Indonesia's Investment Coordinating Board (BKPM) registered inbound FDI amounting to 228.3 trillion RP, up 14.6% from the same period in the previous years. Domestic direct investment (DDI) grew at an even faster rate of 21.6% to 114.4 trillion RP. While still strong, it has to be noted that FDI grew at a more modest pace than in previous years. FDI rose by 26.1% in 2012 and by 22.4% in 2013.

Source: BKPM (data excludes oil & gas, banking & finance, insurance, and leasing)

It is interesting to note that a growing proportion of direct investment (both foreign and domestic) is going to areas outside of the country's traditional industrial heartland. FDI plus DDI to Jakarta and West Java declined from 45.4% of the total in 2010 to 26.8% in 2013 (but rose again slightly to 32.4% in the first nine months of 2014). Domestic investors are particularly swift to embrace opportunities in Central Java and East Java, increasing their investment more than 10-fold and 3-fold, respectively, from 2010 to 2013, while reducing their reliance on West Java. By contrast, foreign investors still prefer West Java, but have significantly curtailed their commitment to Jakarta from 39.7% in 2010 to 16.5% in the first nine months of 2014 (See Indonesia's Economic Potential: A Look Beyond Java).

Data from BKPM, the agency tasked with promoting and coordinating investment in Indonesia, also show that a growing portion of FDI has been used to start up new projects (grey) rather than expand existing ones (red).

Source: BKPM

Several factors at play that could impact FDI

Going forward, at least three events of 2014 are expected to have a lasting impact on foreign direct investment to Indonesia:

The presidential handover:

When the election commission announced the victory of Joko Widodo in the presidential race, the Rupiah strengthened and stocks rallied. Widodo's immense popularity is based on his image as a non-corrupt, humble and hands-on leader. The initial market reaction reflects the expectation that he can deliver on his promises to reform the bureaucracy and reign in graft in order to improve the business climate (See New Government May Reinvigorate Indonesia's Investment Appeal). Whether he can live up to that expectation is another question; his minority governing coalition may face stiff resistance in parliament when proposed reforms run up against vested interests. Widodo has issued a number of statements that pleased investors: These include his promise to expedite infrastructure projects, increase public spending on healthcare and promote rural development. All of these issues are seen as vital for economic progress, and if addressed successfully, they should see greater investment in the sectors affected. A member for Widodo's campaign team in July 2014 mentioned plans to allow foreigners to own apartments in major Indonesian cities and in Bali on the condition that they measure at least 200 square metres, which could spur demand for high-end real estate.

The new Negative Investment List:

Former president Susilo Bambang Yudhoyono in April 2014 signed into effect a new version of the Negative Investment List (NIL) though Regulation No. 39/2014. The list declares certain business fields closed for new FDI projects while others are subject to conditions and restrictions. The first overhaul of the list since 2010 is both good and bad news for foreign investors depending on the industry of interest. Business fields that are now more open to investment include land transportation infrastructure (formerly off-limits for foreigners), seaport services in public-private partnerships (PPP), where a foreign ownership cap was raised to 95% from 49% and PPPs in power generation and transmission (now 100% instead of 95%) (See Electrifying Indonesia – Opportunities for Independent Power Producers). Pharmaceutical companies and venture capital funds can now be up to 85% foreign-owned, up from 75% and 80%, respectively. The advertising industry has become more open for investors from ASEAN countries. By contrast, maximum foreign ownership in data communication networks has been lowered (65% from 100%); while telephone services such as call centres now have a 49% cap. Offshore oil and gas drilling (75% instead of 95%) as well as pipeline construction (49% instead of 100%) are now more restricted, while offshore drilling is completely closed (formerly 95%). Trading is also less open now, with foreign entities allowed a maximum stake of 33% (instead of 100%) in some import and distribution activities.

The mineral ore export ban:

Indonesia in January 2014 implemented a ban on the export of some mineral ores such as nickel and bauxite, underlining its determination to force the mining industry to process metals at home rather than ship them abroad in a raw form. Highly criticized in the industry ever since its inception though the 2009 Mining Law, the policy aims primarily at boosting domestic smelting, and it is showing some effect (See Metal Mining: Foreign Investment More Necessary than Ever). Citing BKPM figures, the Jakarta Post reported in July that the ban had triggered at least 50 smelter projects worth $31.4 billion in total to be realized in the next few years. The government's wider push to add value to domestic industries extends beyond metals and includes other commodities such as rubber and crude palm oil. Regardless of whether their overall effect is positive or negative, these measures will certainly prompt a reorientation of investment into downstream industries.

Foreign investment welcome if needed

The negative investment list and sudden changes to regulations create the impression that Indonesia invites foreign investment only in areas where there is an immediate need, while reserving other areas for domestic firms. In the upstream oil and gas and mining industries, there is visible political pressure to replace foreign capital with domestic capital as soon as there is enough of it, and enough know-how. Critics have accused Yudhoyono's government of “economic nationalism,” and some of their arguments are hard to refute. But to boost economic development while keeping the current account in balance, the country's external financing needs remain immense, and cherry-picking investment only where, when and as long as there is a lack of domestic capacity will not suffice.

It is too early to say whether the new administration in office since October will bring any improvement, but the end of the electoral year certainly increases the odds that pragmatism might once again trump populism. And if foreign investment is what it takes to tackle Indonesia's infrastructure bottlenecks, lack of energy, over-reliance on commodity exports and insufficient formal employment, then attracting more of it is the pragmatic answer. For FDI investment, this likely means a reorientation towards longer-term projects in the sectors where it is most needed and welcome. Over the coming decade, investment is expected to rise faster in infrastructure (specifically electricity and transportation PPPs), resource processing and some manufacturing activities (notably downstream processing) and services (especially health and education).

Global Business Guide Indonesia - 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)