Indonesia's emerging economy is in dire need of better infrastructure, while rising personal income is driving demand for residential and commercial property. These factors put the country squarely on the radar of the global construction industry. Builders in Indonesia benefit from a large and relatively low-cost workforce as well as growing domestic output of cement and other materials. At a time of weak building activity in many developed economies, rising investment and government spending make Indonesia one of the most important construction markets in the world. Construction spending growth in Indonesia will remain among the strongest in the region, according to technical and management support firm AECOM. AECOM's Asia Construction Outlook 2014 report rates Indonesia as the top country in terms of potential construction spending growth in the medium term.
Owing to high levels of capital investment, the construction industry handily outpaced Indonesia's overall economic growth over the past decade and has become an increasingly significant contributor to the country's GDP. After growing from 125.3 trillion RP in 2003 to 907.3 trillion RP in 2013, the industry accounts for roughly 10% of GDP today (Statistics Indonesia). The positive trend is bound to continue amid rising demand for housing (See Mass Housing Plan Spells Massive Opportunity) and ambitious plans for public infrastructure (See Indonesian Infrastructure: Tremendous PPP Opportunities).
Growth (Real) of the Construction Industry vs. Total GDP
Source: Statistics Indonesia
State-controlled companies have long played and continue to play an important role in Indonesia's construction industry, with Wijaya Karya (WIKA), Waskita Karya, Pembangunan Perumahan and Adhi Karya ranking among the largest players in the industry. All of them are listed on the stock market with the state holding a majority stake in each. State-owned enterprises are more successful in being awarded public-sector contracts than their private competitors and have displayed a strong financial performance in recent years thanks in large part to public infrastructure development. Leading private-sector players include Nusa Raya Cipta and Total Bangun Persada, which have likewise seen very impressive revenue and profit growth over recent years, while their project portfolio relies to a greater degree on commercial property. Global construction companies, many of which have their headquarters in Japan or China, have a strong foothold in Indonesia, particularly in complex infrastructure projects. Local companies are generally hard-pressed to compete with foreign companies' level of technical expertise and financial power.
Meanwhile, the vast majority of Indonesia's more than 100,000 registered building firms are small companies that cannot take on large-scale projects, with relatively few companies in the medium-size segment and a distinct lack of specialised, niche players. The market is in for a significant degree of consolidation in reaction to toughening competition. While owners of smaller companies are calling for government protection against large domestic and foreign players, mergers and acquisitions should prove the most straightforward way for them to increase their capacity and improve their odds of survival.
Based on public statements, the administration of President Joko Widodo, who was inaugurated in October 2014, appears to be no less committed to improving the state of public infrastructure in Indonesia than its predecessor, with government representatives naming better transportation and energy systems as the foremost task. In one of its first big decisions, the new administration did away with fixed petrol and diesel prices at the start of 2015, thereby slashing some three quarters off costly fuel subsidies and freeing up more funds for infrastructure spending.
The Master Plan for the Acceleration and Expansion of Indonesia’s Economic Development (MP3EI), which officially launched in 2011, has been off to a slow start amid insufficient interest in proposed public-private partnership (PPP) projects. This makes progress on the development roadmap now all the more urgent. The National Development Planning Agency (Bappenas) estimated the infrastructure investment need for the period 2015 through 2019 at 7,200 trillion RP at the national level alone, only a quarter of which is to be funded out of the state budget. While state-owned enterprises will chip in, the lion's share is expected to come from the private sector.
Legal reforms over the past years have created what observers consider to be a more favourable regulatory environment for PPP projects, including a more clearly defined process of land procurement that sets deadlines for various steps involved. This should make private companies more enthusiastic about engaging in infrastructure development. The increasing urgency for progress on PPP projects should also make the industry increasingly inviting for foreign companies. In a survey for the aforementioned Asia Construction Outlook, a majority of respondents expected the domestic market to become more open to foreign suppliers of construction services. In particular, the survey results indicate that Indonesia stands out as a country expected to become increasingly attractive for foreign companies to do business in.
The ASEAN Economic Community (AEC), scheduled to launch on January 1, 2016, will boost cross-border business in the ASEAN region and increase competition in construction as well as in other industries. The Indonesian Contractors Association (Asosiasi Kontraktor Indonesia – AKI) has warned that local businesses are ill-prepared to take on foreign competitors and thereby take full advantage of what will be an integrated regional market. It blamed this in part on internal inefficiencies and in part on high credit lending rates on the domestic market. For many Indonesian construction enterprises, a lack of scale and expertise is also a competitive disadvantage. Yet, while local businesses may see foreign companies as a threat to their market share, they also need to cooperate with them.
Partnering with experienced foreign players is in many cases the most straightforward way for private local businesses to get in on large-scale projects and at the same time benefit from a transfer of know-how, which in turn will help them catch up and adapt to international standards. For foreign companies, collaboration with local companies often paves the way to do business in Indonesia, and given the ongoing lack of human resources, technical and financial capacity at many local businesses, this is a particularly viable strategy in the construction and engineering industries.
Indonesia's construction industry is not without challenges, and one of the biggest at present is the high price of building materials, particularly imported ones. The property boom of recent years has driven up demand, while inadequate transportation infrastructure adds a logistical element to the cost of materials. That said, local and foreign cement makers have begun to invest heavily in Indonesia to increase their output. Much the same is true for steel makers. Moreover, regulations compelling mining companies to refine metal minerals in the country rather than exporting unprocessed ores – while heavily criticised as being overly rushed and ill thought through – are spurring investment in smelters. Production of glass, ceramics and other materials is also drawing rising investor interest (See Indonesia’s Building & Construction Materials Sector). Increasing domestic supply should help keep in check the price of construction materials going forward.
A challenge that may take longer to address concerns human resources. While Indonesia has a large and relatively young workforce, finding qualified and certified builders and engineers is hard. This is especially true outside of Java, where an increasing proportion of building activity is set to take place over the coming decades. Foreign companies in joint projects need to carefully vet their local partner's capabilities and standards. Another labour-related aspect to consider is the rapid increase in minimum salaries during recent years. For the time being Indonesian wages are still considered competitive, but unpredictable increases pose a threat to long-term planning. Until the country's labour laws undergo a thorough overhaul, it is hard to see increasingly vocal unions contend with what would be considered fair wage hikes elsewhere.
Indonesia limits foreign ownership in domestic enterprises in certain business areas, and those limits can be subject to unexpected changes. The so-called Negative Investment List (NIL) allows foreign shareholdings of up to 67% in construction companies and 55% in construction consulting companies. However, the amendment to the NIL in early 2014 has brought down maximum foreign ownership in construction projects in the oil and gas sector from 95% to 75%, 49% or 0%, depending on the specific activity. It is not so much the actual level of the ownership limit that harms Indonesia's investment climate, but rather the fact that changes frequently occur at short notice and with little industry consultation.
Contractors and investors willing to deal with these challenges can expect to enjoy long-term growth in Indonesia's construction industry. Housing needs, rail and road networks, ports and airports, power generation and distribution all point to growing demand as the country's economy matures and as the population grows in number and affluence. The industry's growth also spells attractive opportunities for suppliers of building materials and companies selling or leasing equipment.
Global Business Guide Indonesia - 2015
Contribution to GDP: 9.96% (Q3 2015)
Number of Contractors: 129,819 (2014)
Number Employed in the Sector: 7.72 million (February 2015)
Standardised Qualification: ASEAN Chartered Professional Engineer (ACPE) certificate and the National Construction Services Development Board (LPJKN) certification.
Relevant Law: Presidential Regulation No. 39 of 2014 on the Negative Investment List reserves low-technology and low-risk construction services for local SMEs and cooperatives. Foreign companies can establish representative offices in Indonesia and execute complex and high-technology projects in partnership with local companies, Minister of Public Works Regulation No. 10/PRT/M/2014 provides the guidelines.