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Unlocking foreign investment will drive Indonesia’s economy

Posted By on December 14, 2019 @ 06:00

President Joko Widodo has expressed frustration to his economic advisers in recent months over Indonesia’s failure to attract a ‘fair share’ of the foreign investment dollars going into Southeast Asia. Even as foreign investment into the region has recorded solid growth, its biggest economy has failed to attract a level of interest commensurate with its size.

Neighbouring Singapore absorbs the great majority of the region’s foreign direct investment (FDI)—close to half, according to ASEAN’s latest investment report [1]. Indonesia, whose economy is three times larger than Singapore’s, saw the size of its cut of the Southeast Asian investment dollar slip slightly from 13.9% in 1996 to 13.3% in 2016. It is a state of affairs that the OECD, in its 2019 review of FDI regulatory restrictiveness [2], at least partly blames on an excess of regulation.

As he begins his second and—barring a change to the constitution—final five-year term in office, Widodo is looking to boost investment to fulfil an ambitious goal of turning Indonesia into a US$7 trillion economy by 2045 [3], which would place it in the high-income club. He has structured the economic team in his new cabinet to place special emphasis on creating conditions more conducive to investment, both domestic and foreign.

Disappointingly, Indonesia failed to book an anticipated windfall from the US–China trade dispute as global businesses relocated out of China [4] to protect their supply chains. Vietnam has been the big winner there. FDI inflows into Indonesia at 1.9% of GDP [5] last year look small compared with the contribution it makes to many other Southeast Asian economies.

To succeed, Widodo will require a far more energetic and effective economic reform program than he produced in his first five years. Despite the promise of a war on red tape, Widodo’s administration produced about 1,300 more ministerial regulations than in the last term of his predecessor.

Widodo’s legacy as president might in large part be measured by whether his policy actions can shift the investment numbers. But there are two big hurdles to Widodo’s aims to modernise the economy through an injection of domestic and foreign capital.

First, Widodo starts his term amid considerable uncertainty over the state of the economy. In briefings for the president, his most reliable economic adviser, Finance Minister Sri Mulyani Indrawati, has predicted that a combination of adverse external conditions and internal bottlenecks will weigh the economy down in the next two years.

Some analysts believe the extraordinary stability of economic growth since 2014, averaging around 5% a year, is too good to be true [6]. The underlying economy is seen as much softer than official figures suggest. This is eroding state revenue, which in turn could force Widodo to curb spending on signature social and infrastructure programs. The government might test the statutory budget deficit limit [7] of 3% of GDP.

Second, policy execution has always been, and is likely to remain, haphazard at best. Widodo’s plans to boost investment rely on the success of a broad policy program that includes increasing labour market flexibility, placing a renewed focus on education and training, introducing bureaucratic and tax reforms, streamlining approvals and regulations, liberalising foreign ownership rules, and improving the quality of infrastructure and logistics. He aims to push through a ‘big bang’ reform by the end of the year by combining dozens [8] of pro-business measures in an omnibus law to overcome the usual procrastination of legislators.

Even as he embarks on this politically difficult agenda, there are contradictory impulses that stifle foreign investment. One example is a new law that establishes an elaborate set of requirements to certify that imported and locally manufactured products are halal or compliant with Islamic obligations; another is a suite of policy measures and decisions aimed at maximising national income and control in natural resource industries, previously one of the main draws of foreign investment.

Above all, an excess of regulation directly discourages investors. The OECD’s 2019 review cites Indonesia as one of the most restrictive countries assessed against a range of benchmarks, including ceilings on foreign ownership, approval procedures, restrictions on key foreign personnel, and other rules ranging from land ownership to corporate structure.

It found restrictions to be especially pronounced in services like communications, media and finance—industries that the OECD argues are powerful multipliers of growth and on which Widodo will rely to achieve his broader economic goals.

The array of nationalist political interests and vested business interests makes deep regulatory reform difficult. They are abetted by some historically rooted suspicions over the benefits of foreign capital. Prior to the 2014 elections, a major newspaper ran a series of articles warning of the perils of foreign ownership in key sectors.

In fairness, Indonesia has achieved a substantial opening since 1997 when it was hit by an economic crisis, yet so much more will be required to be competitive because other jurisdictions have been liberalising too.

Moreover, not all the relevant levers are in Widodo’s hands. Ministers often have their own agendas. The choice of key economic ministers is a mixed bag. Widodo added the title of ‘investment’ to the sweeping portfolio of his most powerful and effective minister, Luhut Panjaitan, a retired general.

He brought on board several ministers whose claims to office are grounded in business entrepreneurship, a pedigree that has not always translated to good stewardship in government. In the mix are several political-party appointees who risk being subject to expectations of competing loyalties.

Of perhaps greater significance is the divide between the macro and micro factors that determine the success and attractiveness of foreign investment. Foreign businesspeople cite a multitude of impositions, inconsistencies, inconveniences and inefficiencies that, while each seemingly small, collectively damage operations.

Their impact varies from enterprise to enterprise and industry to industry. Dealing with them will require a change of mindset that can only weakly be influenced from the top. There’s no doubt the president wants to throw open the door to investment and is willing to make some tough decisions to improve competitiveness. Since the start of his second term, he has moved to reduce restrictions on the types of foreign investment and make it easier to process paperwork.

But real progress is likely to be incremental. This won’t suit Widodo’s time horizons. He has two to three years to get things done before the election cycle turns the attention of his allies and appointees towards the presidential succession race.

Australian interests will be caught up in this as Canberra and Jakarta try to implement their Comprehensive Economic Partnership Agreement [9], due to come into force by early next year. It’s frequently remarked that business investment is an underdone part of the bilateral relationship. Total two-way investment amounted to just A$6.7 billion in 2018 in a combined economy of A$3.7 trillion.

One aim of the new free-trade agreement is to rectify that. Both sides will need to establish effective mechanisms to monitor and solve problems as they arise in individual cases. This will be labour-intensive and time-consuming, but it will be the only way to ensure success. The key will be to ensure engagement by business in the agreement’s implementation. Re-establishing a regular high-level business dialogue with relevant senior officials on both sides should be a near-term priority.

As a senior executive of a national business lobby recently commented, Indonesia seems to have an ‘allergy’ to foreign investment. The remedy might start with Widodo, and be aided by Indonesia’s economic partners.

But it will ultimately be determined by whether a wider constituency of government and business elites welcome the foreign dollar.

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URL to article: https://www.aspistrategist.org.au/unlocking-foreign-investment-will-drive-indonesias-economy/

URLs in this post:

[1] investment report: https://asean.org/storage/2018/11/ASEAN-Investment-Report-2018-for-Website.pdf

[2] review of FDI regulatory restrictiveness: https://www.oecd.org/daf/inv/investment-policy/Southeast-Asia-Investment-Policy-Review-2019.pdf

[3] US$7 trillion economy by 2045: https://www.thejakartapost.com/news/2019/10/20/the-main-thing-is-not-the-process-but-the-result-jokowis-full-inauguration-speech.html

[4] relocated out of China: https://jakartaglobe.id/context/indonesia-needs-reforms-to-attract-foreign-investment-survive-coming-global-recession-world-bank/

[5] 1.9% of GDP: https://www.thejakartapost.com/news/2019/09/10/foreign-investments-flow-to-neighbors-instead-of-indonesia-world-bank.html

[6] too good to be true: https://www.capitaleconomics.com/publications/emerging-asia-economics/emerging-asia-economics-focus/why-we-dont-trust-indonesias-gdp-data/

[7] budget deficit limit: https://www.bloomberg.com/news/articles/2019-12-12/fiscal-flexibility-may-be-a-good-thing-for-indonesia-fitch-says

[8] combining dozens: https://news.bloombergtax.com/daily-tax-report/indonesia-to-synchronize-82-laws-in-job-creation-omnibus-bill

[9] Comprehensive Economic Partnership Agreement: https://dfat.gov.au/trade/agreements/not-yet-in-force/iacepa/pages/indonesia-australia-comprehensive-economic-partnership-agreement.aspx

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