Dealing with uncertainty, economic nationalism and poor infrastructure are par for the course when doing business in Indonesia
by Shoeb Kagda, TODAY, 11 May 2012
It is little wonder that Indonesians are the happiest people in the world, according to a recent study by a leading investment bank. Over 50 per cent of the population said they were very happy with their lives and have a positive outlook for the future.
What is there to be happy about?
Real wages are outstripping inflation; jobs are plentiful; lending rates are historically low and demand is robust.
It is often said that the economy is on autopilot, and is growing despite the government and the uncertain political environment. There may be some truth to this as public development expenditure has tailed off in the last few years and capital expenditure is dominated by the private sector.
If the macro-economic fundamentals remain strong, Indonesia will continue to enjoy strong GDP growth. But it faces the risk of being caught in the middle income trap if it does not increase infrastructure spending and raise productivity.
ROADBLOCKS TO PROGRESS
Lack of infrastructure has long been a bugbear for businesses and investors wanting to access Indonesia's hinterland. The country only has an estimated 5,000 km of roads; many of its major airports are operating at overcapacity and its seaports are inadequate to cater to growing intra-island trade.
The much heralded Trans-Java toll road remains a work in progress despite the plan being announced more than 15 years ago. The toll road would span 1,120 km and connect Merak in the west and Banyuwangi in the east once complete, but problems with land acquisition have stalled the project despite strong investor interest.
The government has been working hard to clear the roadblocks. In December it passed the new land acquisition law which will make it easier for investors to acquire land earmarked for public infrastructure projects.
Suryo Bambang Sulisto, chairman of the Indonesian Chamber of Commerce and Industry (Kadin), has said that the country needs an estimated Rp1,786 trillion (S$242 billion) to finance infrastructure projects over the next decade. As the government can only finance 30 per cent of this amount, the private sector will have to play an important role in building infrastructure in the country.
But progress is being made. Last month, President Susilo Bambang Yudhoyono inked a deal with the China Railway Construction Corporation to invest in the Rp100-trillion Sunda Straits Bridge linking the islands of Java and Sumatra. The 30-km bridge will link 80 per cent of Indonesia's 240 million people by road and rail, and will take about 10 years to complete.
If and when completed, the bridge will create new pockets of growth in west Java and south Sumatra and act as a major route for Sumatra's rich natural resources to reach the densely-populated island of Java.
And to meet the rising demand for air travel, the government has begun work to expand and upgrade the Soekarno-Hatta International Airport which serves Jakarta and acts as the main entry point for business travellers into the country.
Apart from transportation, the country will also have to invest billions in new power plants and Internet infrastructure. Many of these projects are private sector-driven, and investors often have to wade through red tape and bureaucratic inertia to get their projects moving.
Recognising the enormous economic potential of the Internet, the Ministry of Communication and Information launched a programme in 2010 to bridge Indonesia's Internet divide and hopes to have the whole country connected by next year. But, given the geographical challenge of linking 17,000 islands, that is a tall order - especially since many rural areas are poorly served by modern infrastructure.
THE BUSINESS COST OF UNCERTAINTY
Another major challenge is tackling rampant corruption. Some of the country's most prominent politicians have been tried and sentenced to jail terms, the latest being Nunun Nurbaeti, who received a four-year sentence for her role in bribing members of the House of Representatives banking commission with Rp480 billion in traveller's cheques.
While such high-profile cases grab public attention, many businessmen complain about having to constantly pay lower-ranking government officials bribes to get things done. This is where it hurts companies as it drives up the cost of doing business and contributes to uncertainty.
Indonesia is currently basking in the glow of international attention and its stature as a member of the G-20. It continues to draw more foreign direct investments than any other country in South-east Asia. But uncertain regulations - such as the new mining and manpower laws - have raised some concerns.
The new mining law, which restricts the level of foreign ownership and export of unprocessed raw materials, will take effect in 2014. The government also plans to levy a mining export tax of 25 per cent this year, jumping to 50 per cent next year.
The announcement sent mining stocks on the Indonesia Stock Exchange reeling and forced officials from the Ministry of Energy and Mines to retract the statement, saying no firm decision had been taken.
Such uncertainty is now par for the course for investors in Indonesia. Going forward, they will have to deal with growing economic nationalism, especially in the natural resources space - but at the same time, the opportunities that the country offers are too lucrative to ignore.
STAMINA REQUIRED
Doing business in Indonesia requires perseverance and stamina. It requires an ability to deal with unexpected challenges, as DBS Bank is finding out.
Although its S$9.1-billion acquisition of Bank Danamon last month is perfectly within the law, the country's central bank wants equal treatment of Indonesian banks operating in Singapore as a precondition for approving the deal.
Nationalist sentiments were also on display in the House of Representatives as hackles went up when the deal was first announced. Mr Achsanul Qosasi, chairman of the banking commission in parliament, said that, going forward, his commission is looking into introducing a ruling limiting foreign ownership in Indonesian banks.
How this deal will play out is anyone's guess but it illustrates the challenges in operating in South-east Asia's largest economy. The opportunities are huge - but so are the challenges.
Dual faces of Indonesia
Rising Indonesia offers huge potential - for those with the stamina to last the distance. This first of a two-part special report looks at the country's political cracks on the one hand, and the huge attraction of its middle-class market on the other hand
by Shoeb Kagda, TODAY, 10 May 2012
The last week of March was a tense time for many Jakartans and the business community. Large-scale demonstrations across the nation against fuel price increases evoked fears of 1998 when similar demonstrations brought down the government and led to rioting and looting.
Ultimately, the market's worst fears did not materialise. Indonesia did not go into meltdown despite the nation-wide protest against the government's proposed subsidy cuts. There was some violence, but most commentators and analysts viewed the whole episode as a sign of a healthy democracy.
In fact, investors were quickly distracted by the eye-popping price DBS Group paid for Bank Danamon on April 2 for a 67-per-cent stake.
The S$9.1 billion transaction is the largest such deal in Indonesian history and illustrates the country's strong economic fundamentals.
Bankers close to the deal were blown away by the price but agreed that it was fair value. "Bankers have been flogging the deal for the past two years but there were no takers because of the acquisition premium built in for Danamon," said one senior banker close to the deal. "This is a fantastic deal for DBS Bank and for minority shareholders in Indonesia ... It's a vote for Indonesia."
SUBSIDIES CAST A CLOUD
In the space of a week, both faces of Indonesia were on vivid display.
The fuel subsidy saga illustrates the often difficult political process the government has to navigate whenever it needs to make major changes or enact reforms.
The delay in raising domestic fuel prices will cost the government between US$20 billion (S$25 billion) and US$30 billion a year in fuel subsidies, according to World Bank estimates. But most political observes and economists expect the government and Parliament to come to some kind of consensus on the issue later this year.
"Much of the bullishness on Indonesia was around the long-term growth prospects," said Mr Shubham Chaudhuri, lead Indonesian economist at the World Bank. "With the delay in cutting the fuel subsidies, that is now at risk."
Mr Chaudhuri noted that the political storm surrounding the fuel subsidies seems to have been misguided as the subsidies benefit the wealthy more than the poor.
According to his calculations, anyone who owns a car enjoys Rp1 million (S$130) in subsidies a month and a motorcycle owner Rp100,000 a month - but the 60 per cent of the population that does not own a car or a motorcycle only gets a subsidy of Rp10,000 a month.
"The more important issue is the need to redirect spending to infrastructure development, healthcare, education agriculture helping poor households," he noted.
"It's not just about protecting the budget; there are the other developmental needs."
Clearly, fuel prices need to go up in Indonesia. The Rp4,500 per litre Indonesians pay is just 28 per cent of the world average fuel price. The fact that energy (fuel and electricity) subsidies make up 14 per cent of the government's budget makes little sense; this misallocation of resources needs to be corrected, but getting it done is easier said than done.
CRIPPLING POLITICAL FISSURES, AHEAD OF 2014 POLLS
The collapse in the government coalition over fuel subsidies is a harbinger of things to come, in the run-up to the 2014 general and Presidential elections.
Apart from the Democratic Party, led by President Susilo Bambang Yudhoyono, all the other major political parties in the coalition opposed the fuel price hike on the final day of voting in Parliament.
The failure to push through such a critical piece of legislation has crippled the government's ability to deliver any major initiative in the next two years. Politics, it seems, will get in the way of reforms going forward as parties jettison effectiveness for popularity.
"The big issue is subjective as the expectation that the government can deliver anything meaningful on the policy front is now negative," noted Steve Hanke, professor of Applied Economics at Johns Hopkins University and a close Indonesia watcher.
Although the failure to raise fuel prices may not bite the country in the immediate future, Professor Hanke said the big volcano that can erupt will come out of Europe.
Mr Fauzi Ichsan, Indonesia economist at Standard Chartered Bank, also expressed concern over the government's failure to raise fuel prices. "If the government cannot execute a plan that was discussed publicly and which had broad coalition support, its credibility is at risk. The next time it wants to do something, the probability of success will be questioned."
"The government's coalition partners are already looking at 2014 and the fuel price issue was a defining moment," he added.
"People will now ask if SBY is a lame duck President."
As accusations of betrayal circulate within the Democratic Party and the government, questions are being raised about the effectiveness of the coalition. The one party that has come out looking good from the episode is Golkar, currently led by Mr Aburizal Bakrie.
Although it backed out of the decision on the fuel price hike at the 11th hour, it left the government with some wriggle room by inserting a clause that allows the government to raise fuel prices if global oil prices remain above US$120.75 per barrel for six months.
"Bakrie now holds tremendous power and SBY is more dependent on him than ever," said Mr Ichsan. The businessman-turned-politician has in the past said he would block any move to unseat the President although he did not always agree with the President's policies.
FROM HUGO BOSS TO PORSCHE
Politics, however, are far from the thoughts of Indonesia's fast growing middle class.
Visit any mall in any of Indonesia's largest cities on a given weekend and a casual visitor will be pleasantly surprised. He will be faced with throngs of young people, hunched over their Apple computers, enjoying a Starbucks latte, tweeting and socialising with their friends.
Their parents in most likelihood will be shopping for groceries at the supermarket, loading their carts with foreign as well as locally made products and produce.
The visitor will also be astonished by the range of high fashion labels such as Hugo Boss, Hermes, Canali, Louis Vuitton and many others displaying their products in these malls.
On Jakarta's congested roads, Porsches are no longer head turners. European marquee car brands are falling over themselves to compete for the attention and the buying power of the new rich.
On a recent visit to Jakarta, Mr Carlos Ghosn, president and chief executive of Nissan, said the Japanese carmaker is targeting to increase its sales in the country threefold to 200,000 by 2016, by pumping US$400 million into a new manufacturing plant.
He is not alone in wanting to increase his sales in Indonesia. Almost every major carmaker in the world has woken up to the potential Indonesia offers. Honda and BMW have also recently announced plans to expand their presence in South-east Asia's largest car market.
The Indonesian Automotive Industry Association (Gaikindo) estimates that car sales will top one million this year, making Indonesia the largest car market in the region, overtaking Thailand.
A MIDDLE CLASS OF 30 MILLION
This newfound wealth is now on open display and no longer shocks, as it did in the past, in this country of 240 million.
This is the face of modern Indonesia: A fast urbanising country with a rapidly growing middle class, one that is estimated at more than 30 million strong, six times the size of Singapore's population.
Indonesia will achieve a per capita income of US$3,790 by the end of 2012. Rising income is fuelling domestic spending and economic growth. Last year, the country's gross domestic product (GDP) was the highest in the region at 6.5 per cent, the strongest it has been since the 1997 Asian financial crisis.
And although Bank Indonesia, the country's central bank, has lowered GDP growth this year to 6.3 per cent due to rising global economic uncertainty, most economists remain optimistic of robust economic growth.
The country's strong growth and positive outlook are reflected in it being granted investment grade status by ratings agencies Moodys and Fitch earlier this year. This will allow the country to borrow cheaply and attract greater foreign direct investments, two factors that will support continued economic growth.
REAL ESTATE BOOM WITHOUT BUBBLE
Domestic spending is not confined to car and consumer goods. Flushed with cash and encouraged by historically low lending rates, middle class Indonesians are also buying up choice properties in Jakarta and all other major cities, driving prices up by 50 per cent or more in the past 12 months.
Their desire for their first homes is proving a boon for property developers such as Lippo Karawaci, Ciputra and the Agung Podomoro Group. Not only do new luxury high-rise apartments dot the Jakarta skyline, sprawling new middle-class estates are sprouting up in the suburbs.
The property sector will continue to benefit in the current environment given that mortgage rates are falling, the middle class are buying their first homes and mortgage credit, which totalled US$19 billion, accounts for only 8 per cent of total loans and 2.2 per cent of GDP. A property bubble, therefore, is not about to develop.
This has not prevented Bank Indonesia and the Finance Ministry from acting to head off any potential future bubble. In March, they set a minimum downpayment for cars and homes to take effect in June. The minimum downpayment for homes was set at 30 per cent, higher than the current 20 per cent.
The central bank believes that loans for cars and homes have been growing too fast and want banks to be more prudent in offering these loans.
Shoeb Kagda is Group Editor in chief of GlobeAsia, Indonesia's top business magazine.
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