2014_indonesia

THEREPORTIndonesia2014

ECONOMY ENERGY INDUSTRYBANKING TOURISM CAPITAL MARKETSREAL ESTATE CONSTRUCTION TRANSPORTINSURANCE TELECOMS & IT INTERVIEWS

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CONTENTS INDONESIA 2014

In it for the longtermPage 32

A significant actor in international trade and amember of the G20, Indonesia has a strongrecord of attracting foreign investment. Theauthorities have developed new markets forexports while encouraging investment inimport-substitution industries, and their keypriorities remain speeding up infrastructuredevelopment and improving labour flexibility.

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SNAPSHOTIndonesia in figures

COUNTRY PROFILEIslands of diversity: A melting pot of cultures Viewpoint: President Susilo Bambang Yudhoyono A crucial time: Elections are set for 2014Interview: Xi Jinping, President of ChinaInterview: Yasuo Fukuda, Former Prime Ministerof JapanComing together: Looking forward to the AEC

TRADE & INVESTMENTIn it for the long term: Investors are committingEasing access: Reducing bottlenecks in financeInterview: Muhammad Lutfi, Minister of TradeConsumer strength: A rise in spending power Interview: Le Luong Minh, Secretary-General,ASEANViewpoint: Sri Mulyani Indrawati, ManagingDirector, World BankStriking deals: New agreements to boost tradeInterview: Paul Wolfowitz, Former US Ambassador to IndonesiaInterview: Wishnu Wardhana, Chair, ABAC, andPresident Director and Group CEO, Indika EnergyDiversifying sources: Attracting investors

ECONOMYTighten up: Enacting structural reformsInterview: Dipo Alam, Cabinet SecretaryInterview: Jokowi, Governor of Jakarta

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Shared responsibility: Private investment Interview: Suryo Sulisto, Chairman, IndonesianChamber of Commerce and IndustryInterview: Jusuf Wanandi, Vice-Chairman, Centrefor Strategic and International StudiesJust the job: Sustaining employment gainsAn active role: Keeping the long term in mindBalancing growth: Macroeconomic challengesInterview: Edward Soeryadjaya, Chairman andFounder, Ortus HoldingsInterview: Prijono Sugiarto, President Director,Astra InternationalImpetus for reform: Opening new sectors to FDIEastern promise: Investing in East JavaLinking up: Connectivity plans for East JavaInterview: Tri Rismaharini, Mayor of Surabaya

BANKINGStrong fundamentals: Sustained growthProviding support: Improving access for SMEsViewpoint: Agus D W Martowardojo, Governor,Bank IndonesiaInterview: Alan Richards, CEO, HSBC IndonesiaAlternate channel growth: Mobile payment systems promise to expand the sector’s reach

CAPITAL MARKETSEye on the long term: Supporting real growthInterview: Muliaman D Hadad, Chairman, Otoritas Jasa Keuangan Interview: Eko Yuliantoro, CEO, Bahana SecuritiesA growing appetite: Drawing in investors Hedging your bets: Regulatory changes are set tosupport the growth of trading Commodities exchange: A new ban onunprocessed ore exports

Stocks & Bonds: Share analysis & data provided

by Bahana Securities

Austindo Nusantara Jaya: AgricultureBJBR: BankingGaruda Indonesia: TransportMalindo Feedmill: PoultrySri Rejeki Isman: TextilesTotal Bangun Persada: Construction

INSURANCEGrowth mode: Demand and sector expansion Dialogue: David Beynon, President Director, TokioMarine Life Insurance Indonesia; and WilliamKuan, President Director, Prudential IndonesiaInterview: Elvyn G Masassya, President Director,Social Security AgencyFrontier for takaful: Making space for growthInterview: Tim Shields, President Director, ACEJaya ProteksiBroadening health coverage: Expanding benefitsWeathering the storm: Creating the tools to handle natural disastersLetter of the law: Legal framework is catching upwith sector growth

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CONTENTS INDONESIA 2014

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Diversificationunder wayPage 147

The energy sector remains a key contributorto state revenues, accounting for 58% of thetotal in 2012. Oil output from maturing fieldsis steadily declining, although this is offsetto a degree by enhanced oil recovery effortsas well as a rise in natural gas production.

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ENERGYDiversification under way: Broadening the mixFuelling growth: Keeping up with demand From the core: Geothermal potential is highInterview: Karen Agustiawan, President Director,PertaminaInterview: Nur Pamudji, President Director,Perusahaan Listrik NegaraColouring between the lines: Regulatory hurdlesThe price is right: Subsidies for petrol Roundtable: Andhika Anindyaguna, CEO, SugihEnergy; Jon M Gibbs, President, ExxonMobilIndonesia; Lukman Mahfoedz, President, MedcoEnergi; Roberto Lorato, President Director, Premier Oil Indonesia; and Hardy Pramono, President, Total E&P IndonesieA balancing act: Rising domestic demand for fuelNo stone unturned: Exploring new resources Trade winds: Hydrocarbons receipts growingHydro potential: Diversifying energy sources

MININGMoving into gear: Key legal changes Golden promise: More transparency Divesting interest: New framework for licencesInterview: Martiono Hadianto, President Director,Newmont Nusa TenggaraInterview: Arsjad Rasjid, Vice-President Directorand Group CFO, Indika Energy

INDUSTRY & RETAILBack on track: Leveraging strengths Building up metals processing: New policies

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Interview: Irvan K Hakim, President Director andCEO, Krakatau Steel Interview: Klaus Lesker, Member of the ExecutiveBoard, FerrostaalRevving up a sector: Greater market sharePharmaceutical boom: New opportunitiesInterview: Hiroyuki Fukui, President, Toyota MotorManufacturing IndonesiaMiddle class reconsidered: New highs and lowsThe e-commerce question: Paving the wayInterview: VP Sharma, CEO, Mitra AdiperkasaSteady development: Transforming retail make-upTempering retail: A moratorium on new malls

CONSTRUCTIONStill growing: Demand drives the sector forwardIn high demand: Building materials are seeinginvestment and capacity expansionA vital role: The equipment market is growingReady or not: ASEAN integration will challengethe domestic construction sector

REAL ESTATEA favourable environment: Strong fundamentalsA new asset class: REITs have plenty of potentialRoom to grow: Demand for industrial landInterview: Michael Widjaja, Group CEO, Sinar MasLandGo east: Opportunities are expanding on theisland of Bali and beyondInterview: Santoso Gunara, President Director,Danayasa ArthatamaInterview: Eddy Sindoro, Chairman, ParamountEnterprise

INFRASTRUCTUREA change in focus: Expanding access to utilities Interview: Djoko Kirmanto, Minister for PublicWorksOpportunities abound: Encouraging private sector investment in the sectorInterview: Stuart Dean, CEO, General ElectricASEANInterview: Bobby Umar, Chairman, IndonesianEngineers AssociationFilling the gap: Improving institutional capacityand inter-ministry coordination

TRANSPORTBy land or by sea: Private sector involvementcould help integrate the transport networkInterview: Emirsyah Satar, CEO, Garuda IndonesiaInterview: Sukmawati Syukur, President Director,MonorailThe promised land: Challenges in acquiring land Prioritising ports: The modernisation of ports is aprerequisite for economic expansionSeizing momentum: Shortcomings in infrastructure supply are being addressedInterview: Djarwo Surjanto, President Director,Pelindo III

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CONTENTS INDONESIA 2014 5

THE REPORT Indonesia 2014

Moving into gearPage 177

Recovering from a commodity price slumpin 2012, the mining sector comprised11.24% of GDP in 2013, building on itsstrong record in mineral production. Thegovernment is revamping the frameworkregulating mining contracts to secure alarger proportion of revenues for the state,including the limitation of metallic miner-al exploration areas to 5000-100,000 ha.

Consolidate to accumulatePage 280

Long-awaited consolidation in the tele-coms sector is set to boost profitability,paving the way for greater investment innetwork infrastructure. Demand for spec-trum continues to grow while the mobiledata services market remains underdevel-oped. In addition, the country’s internet-savvy population is encouraging the growthof e-commerce and cloud services.

A favourable environmentPage 229

With GDP growth hovering around 6%and middle-class wealth expanding rap-idly, demand for real estate, especially inJakarta and Bali, has surged. Luxury realestate prices have been rising so fastthat, to curb the risk of a property bub-ble, the government has introduced newloan-to-value rules and prohibited banksfrom lending to unfinished projects.

Subjects of changePage 326

The educational system is large andrelatively well funded, although linger-ing structural issues and capacity con-straints remain a challenge. While thecountry works to overcome hurdles touniversal health care and a shortageof medical staff, the private sector isfocusing on building up capacity.

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TELECOMS & ITConsolidate to accumulate: A reduction in thenumber of players could help shore up ARPUInterview: Arief Yahya, President Director,Telekomunikasi IndonesiaInterview: Hasnul Suhaimi, CEO, XL AxiataHorse before the cart: Paving the way for dataTowers of strength: Capital intensive segmentcould be set to pay off in the coming yearsAll down the line: An internet-literate populace Network news: International connectivityThorny issue: The rise of smartphones

TOURISMA day in the sun: Changes to the tourism offeringGetting their hands dirty: Tourism villages andecotourism expansionInterview: Anthony Akili, CEO, Smailing ToursThe main events: A key high-value nicheNatural wonders: Komodo National Park set todrive tourism growth in the regionMoving up the ranks: More international touristsNeeding a boost: Supporting creative industries

AGRICULTUREKeeping the ball rolling: Boosting sustainabilityA full plate: Maintaining reliable supplies of riceInterview: Franky Oesman Widjaja, PresidentCommissioner, Sinar Mas Agribusiness and Food Interview: Franciscus Welirang, Director, Indofood

EDUCATION & HEALTHSubjects of change: The government’s top-downinitiatives are proving a challengeHairpin turns: The road to educational reform All change: Plans to provide universal care Growing interest: The private sector is set tobecome more involved in the industryInterview: Nafsiah Mboi, Minister of HealthInterview: Hasbullah Thabrany, President,SEAPHEIN

TAXPwC

Evolving environment: Changes to the tax systemand regulations for potential investorsViewpoint: Ay-Tjhing Phan, Tax Leader, PwCIndonesia

LEGAL FRAMEWORKLubis, Santosa & Maramis

Potential risks: Anti-corruption measures Fighting corruption: Strengthening the system Viewpoint: Todung Mulya Lubis, Senior Partner,Lubis Santosa & Maramis

THE GUIDEHere be dragons: Komodo National ParkHotels: Someplace specialListing: Helpful numbersFacts for visitors: Useful information for visitors


SNAPSHOT6

Indonesia in figures

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Smartphone users, 2011-17

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Retail sales index growth (y-o-y), 2013-14 (%)

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SOURCE: BKPM BPJT: Indonesia Toll Road Authority; MoT: Ministry of Transportation

Project Agency Value ($ m)

Pandaan Malang toll road BPJT 418

Cisumdawu toll road BPJT 779

Manado-Bitung toll road BPJT 353

Pekanbaru-Kandis-Dumai toll road BPJT 1690

Maloy International Port MoT 287

Makassar New Port MoT 360

Cilamaya New Port MoT 3450

Soekarno-Hatta International Airport Rail MoT 2083

PPP projects, 2013-14

SOURCE: SKK Migas *(000 boe/day)

Oil Gas Condensates Total

2006 883.25 1367.86 122.74 2373.85

2007 836.01 1300.49 118.39 2254.89

2008 852.63 1332.13 124.15 2308.91

2009 826.63 1421.77 122.33 2370.73

2010 824.45 1581.59 120.45 2526.49

2011 794.30 1502.66 107.8 1610.46

2012 762.82 1455.27 97.09 2315.18

Production of oil, gas & condensates, 2006-12*

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Electricity consumption, 2000-11 (KWh per capita)

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SNAPSHOT 7

SOURCE: AUUI

2011 2012 % change

Gross premiums 34.48 39.41 14.3%

Gross claims 12.96 17.80 37.4%

Net premiums 16.90 19.61 16.0%

Net claims 8.92 10.71 20.0%

Reinsured premiums 15.52 17.33 11.7%

Reinsured claims 5.21 8.80 68.9%

Total costs 5.0 5.58 11.7%

Operational result 1.03 1.80 75.3%

Investment income 39.21 47.10 20.1%

Non-investment income 30.69 33.95 10.6%

Assets 69.95 81.16 16.0%

Profit before tax 4.55 5.54 21.8%

Profit after tax 3.94 4.80 21.9%

Non-life insurance indicators, 2011-12 (Rp trn)

Travel & tourism spending by type, 2007-14 ($ bn)

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Production index growth of manufacturing, 2010-13*

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2011 2012 2013* 2014*

Real GDP (annual % change) 6.5 6.2 5.6 5.3

Consumer price index (annual % change) 5.4 4.3 7.3 6.7

Current account deficit (% of GDP) 0.2 -2.8 -3.4 -2.6

Budget balance (% of GDP) -1.1 -1.9 -2.5 -2.3

Major trading partner GDP (annual % change) 3.6 3.4 3.4 3.9

Projections for key indicators, 2011-14

SOURCE: Indonesian Stock Exchange

Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013Volume of share trading (bn) 271.72 215.89 310.59 375.97 383.62Value of share trading (Rp trn) 287.69 252.99 297.03 376.05 482.35Value of government bond trading (Rp trn) 398.04 550.40 472.38 389.89 545.67Value of corporate bond trading (Rp trn) 43.46 32.72 43.63 42.19 57.60Jakarta Composite Index high 4224.0 4262.6 4375.2 4940.9 5214.9Jakarta Composite Index low 3654.6 3984.1 4236.3 4305.9 4418.9No. of listed companies 445 454 459 464 472No. of listed government bonds 90 91 92 92 93Value of government bonds (Rp trn) 791.18 812.80 820.27 853.87 888.51No. of listed corporate bonds 96 97 99 91 94Value of corporate bonds (Rp trn) 167.47 171.32 187.46 196.44 205.37No. of asset-backed securities issuers 4 4 5 5 5Value of asset-backed securities (Rp trn) 1.25 1.15 1.98 1.89 1.70

IDX trading statistics, 2012-13

9

Country ProfileEncouraging development of value-added industriesTaking on a growing role within the regionParliamentary and presidential elections due in 2014Moving towards the introduction of AEC at end 2015

COUNTRY PROFILE AT A GLANCE

With a population of 247m, Indonesia is the third-largest democracy

While the Republic of Indonesia is less than sevendecades old in its current form, the South-east Asiannation of more than 17,500 islands has had a muchlonger history under other names. In fact, the name“Indonesia” was first used in 1850 by British anthro-pologist James Richardson Logan as he referred tothe extensive group of islands widely known as theIndian or Malayan Archipelago. HISTORY: Archaeological evidence indicates thatthe ancestors of modern humans were present onthe archipelago as early as 1.9m years ago, while evi-dence of modern humans goes back around 40,000years. By 2000 BCE, the islands were inhabited by adiverse group of peoples known as the Austronesians.These peoples exhibited impressive maritime skilland took full advantage of the archipelago’s loca-tion, engaging in extensive inter-island trading. Suchburgeoning trade prompted the speedy develop-ment of agricultural techniques and rice cultivationmethods that facilitated pockets of growth in theform of villages, towns and cities. Islam first enteredthe region around the 8th century CE, althoughmeaningful conversions did not occur until the 14thcentury beginning in Samudera Pasai (North Suma-tra) and continuing in Makassar and central Java inthe 17th century. By this time, Islam had become thearchipelago’s principal religion. IDENTITY: Pancasila constitutes the original philo-sophical foundation of Indonesia and consists oftwo Sanskrit words, panca meaning five, and sila

meaning principle. These five inseparable and inter-related principles, which were first articulated inspeech delivered by Indonesian Nationalist leaderSukarno, include the following: nationalism, human-itarianism, representative democracy, social welfareand monotheism. These five principles became arelative blueprint for the growth and progression of the Indonesian nation and their significance in society remains even today, despite variations in their interpretation and order over the 20th century.

The flag of Indonesia is embodied by two equalhorizontal bands of red (at the top) and white (atthe bottom). The colours are derived from the ban-ner of the Majapahit Empire of the 13th-15th cen-turies; red symbolises courage and white, purity. INDEPENDENCE & THE PATH TO DEMOCRACY: TheDutch colonisation was well established in Java bythe mid-18th century, and the Dutch continued toconsolidate their power over the following two cen-turies. However, the first 30 years of the 20th cen-tury saw a rise in the popularity of the notion of inde-pendence and nationalism amongst the region’sincumbent population.

The Second World War brought with it the Japan-ese invasion and ensuing occupation, which sig-nalled the end of Dutch rule and acted as a catalystfor the previously suppressed Indonesian independ-ence movements. As such, when the Japanese occu-pation finally ended as the Japanese forces surren-dered in the Pacific, it was only two days before thecountry’s first President, Sukarno, declared Indone-sian independence on August 17, 1945. Following thisdeclaration, it took six weeks for the allied Dutch andBritish forces to arrive, by which time Indonesiannationalist forces had established themselves. Theconflict which followed represented a final attemptby the Dutch to re-establish their authority. Howev-er, with the British withdrawing towards the end of1946, and following four years of intermittent fight-ing and consistently fierce criticism of the Dutch bythe UN, The Netherlands formally recognised thesovereignty of a federated Republic of the UnitedStates of Indonesia on December 27, 1949. On August17, 1950, precisely five years after the proclamationof independence, Sukarno proclaimed a single uni-tary Republic of Indonesia.

While the first democratic elections were held in1955, the years which followed were fraught withpolitical, economic and social volatility. In 1957Sukarno declared and implemented a system of

11


Islands of diversityA melting pot of cultures and ethnic groups, the nation holds a significant regional role


“Guided Democracy”, declaring himself presidentfor life in September of 1963. He presided over araging political sea within which the civilian nation-alist leadership, the Islamic leadership, the Indone-sian Communist Party (PKI) and the army were allopposed to each other.

However, the situation reached a breaking pointon September 30, 1965 through an attempted PKIcoup against Sukarno’s government. Following theimpromptu formulation of a “New Order” coalition,comprised of students, Muslim communities andarmy factions, the PKI coup was swiftly and brutal-ly defeated in the months which followed. By thispoint, however, Sukarno was in failing health and hewas replaced by an army officer largely responsiblefor halting the coup, Major General Suharto.

Assuming full power in March 1967, Suharto’sreign endured seven consecutive five-year terms inoffice, within which time a system of highly cen-tralised governance appeared, including transmigra-tion policies and coerced resettling of many Javanesepeople – a legacy of which remains today in the formof ethnic tensions. During this time, the annexationof both West Papua and East Timor sparked inter-national condemnation, while the population start-ed to express its frustration towards the widespreadcorruption and Suharto’s brand of authoritarianism.

When the Asian financial crisis of 1997-98 prompt-ed the currency to plummet and inflation to soar,students took to the streets to voice their griev-ances, supported by the greater population.

Eventually, under widespread pressure to resign,Suharto left office on May 21, 1998. His position wasfilled by his vice-president, Bucharuddin Jusuf Habi-bie. Habibie restored order by regaining IMF supportfor economic stabilisation programmes and begin-ning a period of considerable governmental changeunder the banner of “Reformasi”. POLITICAL LANDSCAPE: In 1999 Indonesia’s firstfreely contested parliamentary elections since 1955

were held with Abdurrahman Wahid, a well-knownintellectual and leader of Indonesia’s largest Mus-lim organisation (Nahdlatul Ulama, NU), sweepingto victory. His leadership style, however, was lesspopular and unrelenting questions concerning hiscompetency and health meant he was dismissed inJuly 2001 in favour of his vice-president, MegawatiSukarnoputri. Though head of the Indonesian Dem-ocratic Party of Struggle (PDI-P) and Sukarno’s eld-est daughter, Megawati’s reign was also short-livedand she was defeated in the September 2004 elec-tion by retired army general and Democratic Partycandidate, Susilo Bambang Yudhoyono. Widelyreferred to as SBY, Yudhoyono served as the first dem-ocratically elected president in Indonesia’s historyand was re-elected for a second five-year term in2009. While SBY’s popularity has remained stable,the same cannot be said of the Democratic Party,which has failed to secure a significant portion ofthe vote in Parliament.

Fresh presidential elections will take place in July2014 and since he will have served the maximum oftwo terms permitted, SBY’s presidential career endshere, although it has been confirmed that he willremain as his party’s chairman. While the July 2014elections are wide open, there are a number ofdiverse candidates making 2014 an increasingly sig-nificant year for Indonesia.

In terms of Indonesia’s greater regional involve-ment, after chairing the Association of South-eastAsian Nations (ASEAN) in 2011, the country has con-tinued as an increasingly influential member. In recentyears Indonesia has continued strengthening itsdiplomatic relations with neighbouring countriesincluding Malaysia, Singapore and the Philippines,while it has also boosted long-term cooperation withJapan. Indonesia has also occupied an integral rolein assisting the resolution of territorial disputesbetween Thailand and Cambodia.

The next stepping stone for ASEAN is the ASEANEconomic Community (AEC), which is likely to cre-ate numerous opportunities for investors in theregion with a combined GDP of around $2.3trn. TheAEC is designed to allow the free movement of goods,services, investment, skilled labour and capital inthe region (see analysis). HUMAN CAPITAL & FOREIGN INVESTMENT:Indonesia’s young and growing population is one ofthe country’s strongest assets. The country’s mid-dle classes also continue to expand.

The government has continued its focus on thepromotion of creative industries, areas which haveseen considerable success in neighbouring coun-tries such as Thailand. At present more than 8m peo-ple work within these industries which contributeapproximately 8% to Indonesia’s GDP.

Local and foreign corporations are increasinglyinvesting in Indonesia, realising the potential of thecountry. The country is targeting the provision ofimproved vocational training opportunities for grad-uates. Such a focus coalesces well with Indonesia’s

12

The current president is the first democratically elected president in Indonesia’s history



continual support and encouragement of the devel-opment of value-added industries. Through invitingtargeted investment and adapting existing regula-tory frameworks the government has taken signifi-cant steps to facilitate foreign investment and thedevelopment of value-added industries.

Investment currently accounts for roughly 32% ofthe nation’s GDP. While the country’s naturalresources are still plentiful, by channelling foreigndirect investment into the right areas the govern-ment is ensuring that true potential, in terms of val-ue and manufacturing, is achieved. NATURAL RESOURCES: Indonesia is a countryrenowned for its abundance of natural resources,which include oil, gas, coal, nickel, tin, copper, goldand silver. While slightly down on the year before,the country’s total oil production for 2012 stood at861,000 barrels per day (bpd), accounting for approx-imately 1.2% of the world’s oil production. Indone-sia had proven oil reserves of 3.7bn barrels as of theend of 2012, according to BP’s “Statistical Reviewof World Energy 2013”, while it imported around480,000 bpd during the year in light of consistent-ly increasing domestic demand for fuel.

Indonesia remains the world’s largest exporter ofthermal coal, exporting a total of 304m tonnes in2012 to countries such as Japan, South Korea, Chi-na and India. The country’s coal resources total 60bntonnes and are estimated to last 83 years at currentproduction rates, with the three largest depositslocated in Kalimantan. Around 60% of Indonesiancoal is lower-quality or sub-bituminous coal. Despiteprice volatility towards the end of 2012, productioncontinued at the rate of 370m tonnes at the end ofthat year. Other minerals produced in Indonesiainclude tin, nickel, gold and silver.

Production continued to increase in 2012, reach-ing 26.5m tonnes on the year, up from 23.5m tonnesin 2011 and 21.8m tonnes in 2010, according to theIndonesian Palm Oil Association (GAPKI). The major-ity of this was exported, with 18.22m tonnes shipped

in 2012. Through the first seven months of 2013exports were on pace to outperform 2012 with a totalof 12.21m tonnes shipped, and the US Departmentof Agriculture projected total 2013 output of around31m tonnes (28m tonnes by GAPKI). The total areaof oil palm cultivation in Indonesia was estimated at8.2m ha – an increase of more than 100,000 ha over2011. The plantations are concentrated in Sumatra,Kalimantan and Sulawesi.

While there has been talk of a reduction in exporttaxes, this has yet to materialise, and lower tax lev-els in Malaysia continue to give it an advantage.Higher taxes have also been applied to CPO asopposed to downstream products made from CPOas part of a government-initiated shift to promotethe development of downstream industries.

Concerns over deforestation of rainforests remaina major issue, although there are efforts to addressthe situation, and many Indonesian companies havejoined the Roundtable for Sustainable Palm Oil, anorganisation established in 2004 with the objectiveof promoting the growth and use of certified sus-tainable palm oil. ENERGY: Around 86% of Indonesia’s energy comesfrom conventional thermal sources, with hydroelec-tric power accounting for 9%, and geothermal andother alternative energy sources for 5%. The govern-ment recently set an ambitious target of reaching90% national electricity coverage by 2020. The coun-try is keen to develop nuclear power and in early 2014the government announced a nuclear power plantwith a capacity of 30 MW would be built in the west-ern part of Java. In terms of alternative energy sources,Indonesia is focusing on solar power, with the gov-ernment planning to build 36 new solar power plantsespecially in isolated and border areas. Due to therapidly increasing demand for power, a 10,000-MW“fast track” plan has been under way since 2004 ina major bid to boost output, predominantly throughthe construction of coal-fired thermal power plants.

15


Indonesia’s crude palm oil output reached 26.5m tonnes in 2012, up from 23.5m tonnes in 2011

The country’s demand for power is increasing rapidly


While the completion date has been pushed to 2014,it is being followed by a second Power TransmissionDevelopment Project. This development project aimsto further stabilise the power system in Java andBali, while also expanding the supply of power to east-ern and western areas. Perusahaan Listrik Negara,the state-owned energy distribution firm, is in chargeof the development projects and accounts forapproximately 85% of generated power. A 2009 Elec-tricity Law aims to reduce the state-owned firm’smonopoly on distribution and encourage the par-ticipation of private firms in the power sector. POPULATION: With a population of approximately247m made up of more than 300 different ethnicgroups, Indonesia is the third-largest democracy inthe world while also being the world’s most popu-lous Muslim nation. Indonesia is currently the world’s16th-largest economy, while Jakarta is the country’smost populated city, with more than 10.18m inhab-itants living within an area of 740 sq km. Other majorcities include Surabaya, Bandung, Medan andSemerang. Java is the most populated island in theworld with 141m people spread over 128,298 sqkm, which is equal to just 7% of Indonesia’s totalland mass. The population has more than doubledsince 1971, when it was 119.2m, while it continuesto grow at a rate of 1% per year. It is estimated thatby 2050, the country’s population will exceed 420m.

Indonesia is home to more than 300 different eth-nic groups. The largest groups, according to the2009 census, are the Javanese (41.7%), Sundanese(15.4%) and Malay (4.1%), closely followed byMadurese (3.3%), Batak (3%), Bugis (2.9%), Minangk-abau (2.7%) and Betawi (2.5%).GEOGRAPHY: Indonesia has a total land mass of1.90m sq km, spread over an archipelago of around17,508 islands, some 6000 of which are inhabited.With a coastline of 54,716 km, Indonesia has 1107km of land boundaries with its neighbour Malaysia,820 km with Papua New Guinea and 288 km with

East Timor. The archipelago acts a meeting placebetween the Pacific and the Indian oceans, while alsobridging the Asian and Australian continents. Thisunique position has had an influence, affecting thecountry’s cultural, social and political make-up. LANGUAGE: Indonesian is an Austronesian languagewhich stems from the country’s various cultural andlinguistic groupings, the majority of which are eth-nically Malay. As part of the country’s independencemovement during the 1930s, the language – a stan-dardised form of Malay – became titled as BahasaIndonesia and has since become the dominant lan-guage in terms of government and media commu-nication, education and business.

Local dialects and languages such as Balinese,Javanese and Sudanese are still used in certain areasof the archipelago. The popularity of the English lan-guage has continued to increase. This has likely alsostemmed from the middle and upper classes send-ing their children to schools where English is the mainlanguage of instruction. RELIGION: The Indonesian Constitution guaranteesfreedom of religion with the government currentlyrecognising six religions, namely Islam (86.1%), Protes-tantism (5.7%), Catholicism (3%), Hinduism (1.8%),Buddhism (around 1%), and Confucianism (less than1%). On the island of Bali, unlike the rest of the coun-try, more than 93% of the population practices Bali-nese Hinduism, while in certain rural areas, animismis still practised. CLIMATE: Due to its proximity to the equator, Indone-sia’s tropical climate is accompanied by average tem-peratures of between 28 C and 34 C in coastal areas,and 23 C in the mountain areas. Temperatures remainsimilar year round with little variation from seasonto season. The dry season lasts from June to Octo-ber, while the rainy season runs from December toMarch. The country’s relative humidity stays between70% and 90%. Located over the Ring of Fire, themeeting place of tectonic plates, Indonesia can be subject to earthquakes and volcanic eruptions.

16

The country has a total coastline of more than 54,000 km and is home to over 17,000 islands

Indonesia has a multitude of different religions and ethnic groups


COUNTRY PROFILE VIEWPOINT

President Susilo Bambang Yudhoyono

The rapid expansion of business has changed our 21st-century economic landscape for the better. Govern-ments will remain important in formulating economicpolicies but, without the help of the private sector, wemight not be able to provide more jobs for our citizens.We know that whatever country one comes from, thetop national and local agenda is going to be jobs.

Already, global growth in 2013 is showing differentdynamics. Advanced economies are experiencing recov-ery and showing positive growth, while emergingeconomies – including the so-called BRICS countries(Brazil, Russia, India, China and South Africa) – are fac-ing a slowdown. They are also suffering from large tradedeficits, capital flight and depreciating currencies. Thisis also true for the APEC region.

In some APEC advanced economies, growth is gain-ing strength. Meanwhile, APEC emerging economiesneed further momentum for growth. Not withstand-ing this, APEC economies remain a crucial source of glob-al growth. According to the IMF, as a group, APEC isexpected to grow by 6.3% in 2013 and by 6.6% in 2014– which is more than twice the world average.

At present, APEC economies account for 54% of glob-al GDP and 44% of global trade. Within the region, tradehas grown nearly seven-fold since 1989, reaching over$11trn in 2011. In the past 25 years, average tariffs inAPEC have declined by close to 70%. The total cost ofconducting business across borders decreased by twosuccessive rounds of 5% tariff reductions: resulting innearly $59bn of savings for businesses. All this showsthat with its combined potential, APEC is in the idealposition to help the recovery of the global economy.Therefore, APEC members – through individual and col-lective measures – must put extra efforts to promotegrowth. Let me highlight some possible measures.

First and foremost, we all need to do our part in help-ing prevent protectionist policies, and continue on ourpath of trade liberalisation in ways that uplift the well-being of all our citizens. We must also ensure that ourtrade relations are not only strong but also balanced.

Second, we need to intensify efforts to stimulateinvestment within our region so as to maintain growthand create jobs. There is major opportunity for this aswe are experiencing a rapid growth of the middle class.

Third, we need to develop more and better infra-structure as an essential element for our connectivity.This will of course help not only to facilitate trade andinvestment, but also boost job creation. APEC needs totackle inefficiency in the supply chain. We have to makeit easier, cheaper and faster to conduct trade in goodsand services across borders. In this regard, it is crucialthat we promote connectivity as a priority.

Fourth, to ensure growth with equity, we mustembrace the SMEs that form the backbone of all oureconomies. Fifth, we must work together to ensure thefinancial stability, which is an absolute requisite for sus-tainable economic activities, including trade and invest-ment. APEC members can help to stabilise the globalfinancial market through bilateral as well as regionalinitiatives. These include regional financing agreementsand the Financial Stability Board. The Chiang Mai Ini-tiative Multilateralisation is a good example of the closecollaboration among some APEC members.

Sixth, to ensure development for all, we must not for-get to provide a social safety net for the poor and finan-cial inclusion for shared prosperity. Finally, APECeconomies can only achieve all this if we intensify ourpolicy consultation and coordination.

Indonesia envisions the future of this region as pros-perous, stable, dynamic, inclusive and forward-looking.Our objective is to make the APEC region the epicen-tre for the world’s economic advancement. I believethrough close collaboration with the business commu-nity, APEC can achieve the following priorities: Attaining the Bogor Goals: APEC economies haveachieved tremendous progress toward achieving theBogor Goals. But while APEC has reduced average tar-iffs from 16.9% in 1989 to 5.7% in 2011, restrictive non-tariff measures, lengthy Customs procedures and poortransport infrastructure still pose challenges to trade.

18

Realising potential President Susilo Bambang Yudhoyono on promoting economic growth



Therefore, as we continue to work for trade andinvestment liberalisation, as well as deeper regionaleconomic integration, we must ensure we have thecapacity to tackle those challenges. We have to be ableto address growing trade barriers, financial instabilityand fluctuating commodity prices. Achieving sustainable growth with equity: Today,APEC economies are confronted by new challengesthat could cause disruption and stunted growth. Impor-tant among these is population growth.

The global population has grown rapidly from just over5.5bn people in 1994 to more than 7bn people today.By 2045 there will be 9bn people worldwide. Much ofthis population increase will come from the Asia-Pacif-ic region, placing a great burden on the supply of ener-gy, food and water for our people. We cannot achieveAPEC’s goals without ensuring the principles of inclu-sion in our economic development. Therefore, main-taining a growth path that is sustainable and inclusiveis of great importance. Our efforts should focus oneconomic empowerment, engagement of stakehold-ers, enhancement of small and medium-sized enter-prises’ global competitiveness through innovation, andtapping women’s productivity in the economy. It is alsocritical to ensure financial inclusion, strengthen foodsecurity and improve access to health services.Promoting connectivity: Unlike in 1994, the adventof new technologies has opened new ways for peopleto do business with each other, across countries, andacross continents. Improving connectivity, therefore,becomes a critical development priority.

I believe that focused and improved physical, insti-tutional and people-to-people connectivity will helpintegrate our region. It will also facilitate the flow ofgoods, services, capital and people of the Asia-Pacificregion. Thus, we must work together to strengthenconnectivity through infrastructure development andthe promotion of infrastructure investment.

Indonesia will work with both APEC leaders and allother stakeholders to help advance progress on these

three priorities. After all, the success of our country isstrongly tied to the success of other nations.

Like other emerging markets, Indonesia is facingsome head-winds resulting from financial market tur-bulence. Yet, this situation is manageable and theIndonesian government is responding to it with a pack-age of focused policy measures, including substantivestructural reform. As a result, in recent times Indone-sia’s financial market has stabilised.

We believe this is only a short-term challenge, andwe remain confident that the long-term prospects toinvest and grow are enormous, as Indonesia will remaina land of opportunity and growth.

Indonesia has become a trillion-dollar economy witha large middle class. Our democracy is strongly rooted,and this makes Indonesia well-placed for foreign invest-ment. Global consultancy McKinsey & Company pre-dicted that Indonesia’s business opportunity will increaseup to $1.8trn in 2030. This opportunity ranges from con-sumer services, agriculture and fishery, and naturalresources to education, industry and infrastructure.We continue to create a better business and investmentclimate, addressing many of the challenges. We havemade steady progress, including major bureaucraticreforms to strengthen government institutions.

To accelerate economic growth, in May 2011, welaunched the Master Plan for the Acceleration andExpansion of Indonesia’s Economic Development 2011-25 (MP3EI). In the next 14 years, we are aiming to reachover $460bn worth of investments in 22 main econom-ic activities, integrated in eight programmes. Theseinclude agriculture, mining, energy, industry, marine,tourism and telecommunications.

Therefore, the MP3EI offers a great number of oppor-tunities for international investors. Let us build a strongpartnership together and forge a resilient APEC. Let usalso ensure that APEC continues to bring prosperity toall the people in the APEC region.

The above is an excerpt from the speech at the APEC

CEO Summit 2013, Bali, Indonesia on October 6, 2013.

19


COUNTRY PROFILE OVERVIEW

Indonesia declared its independence in 1945

With the year ahead set to see the much-anticipat-ed election of a new president and new nationaland regional legislatures, 2014 will likely be a timeof great political activity in Indonesia. Some 15 par-ties (three just local to Aceh) will contest for the votesof approximately 175m potential voters, 67m ofwhom will be casting a ballot for the first time. Theelections may also give rise to a new impetus forreform, as the country debates a range of issues –from how to tackle corruption to the role of religionin politics. Underscoring many of these debates isalso the question of how best to manage rapid eco-nomic growth and the social changes it engenders,as Indonesia becomes increasingly globalised andurbanised, with a surging population and greaterstanding and responsibility both within the regionand the world at large. In facing these challengingissues though, the country can draw on a growing,modern tradition of democracy – as well as on anancient history of compromise and consensus.THAT WAS THEN: Forming part of an active vol-canic arc, the country is known both for its richly fer-tile soils – and for its periodic natural disasters. Inmore recent times too, it has become known asSouth-east Asia’s largest nation and one of theregion’s most vibrant economies.

Indonesia consists of some 17,508 islands, inhab-ited by around 247m people, according to figuresfrom the World Bank. More than half of the popu-lation lives on one of the archipelago’s smaller islands– Java – with the capital, Jakarta, accounting forapproximately 10m of those citizens.

The archipelago’s early history saw the spread ofthe Dongson culture, which originated in Vietnamand southern China around 1000 BCE, to Indonesia.The culture brought with it irrigated rice-growingtechniques and animal husbandry skills.

During the 7th century CE the Hindu-Buddhistempire of Sriwijaya rose on the island of Sumatra andbecame a major trade power, controlling most of the

trade in South-east Asia at the time due to its loca-tion on the Strait of Melaka, while the BuddhistSailendra dynasty and the Hindu Mataram dynastythrived in central Java between the 8th and 10th cen-turies. In the following centuries, a series of king-doms rose and fell on the archipelago. DECLARING INDEPENDENCE: Yet while the islandsof this country are dotted with the remains of ancientcivilisations, Indonesia itself only came into being lessthan 70 years ago. Symbolically, that was when, onAugust 17, 1945, a group of Indonesian nationalistson the island of Java declared independence fromthe Netherlands.

The Dutch, Indonesia’s former colonial masters, hadfirst arrived in 1602, expanding their empire overthe centuries that followed. It was not until the1930s that Aceh finally came under Dutch tutelageand the current borders were established.

The Second World War changed the balance ofpower in Asia, however, first via the conqueringJapanese, who took control of what was the DutchEast Indies in a rapid campaign, vanquishing mythsof European superiority. This gave impetus to a waveof nationalism throughout South-east Asia.

On August 17, 1945 then, with the Japanese stillin occupation and before the Dutch had returned,several of Indonesia’s nationalists gathered in Jakar-ta to declare independence. They included Sukarnoand Mohammed Hatta, who became Indonesia’s firstpresident and vice-president, respectively.

The new state was given five basic principles forits foundation – known as Pancasila. These are stillthe ruling state philosophy today, and include beliefin the unity of God; in a just and civilised humanity;in a united Indonesia; in democracy guided by theinner wisdom of unanimity arising from representa-tive deliberation; and social justice.

The precepts, rights and freedoms of Pancasilaare embodied in the constitutional and legal sys-tem, and derive from the traditions and customs of

A total of 15 parties are

expected to contest the

2014 elections, vying for

the votes of around 175m

potential voters, 67m of

whom will be voting for the

first time.

21


The five principles of

Pancasila, which are

embodied in the

constitution, include belief

in the unity of God; in a just

and civilised humanity; in a

united Indonesia; in

democracy guided by the

inner wisdom of unanimity

arising from representative

deliberation; and social

justice.

A crucial timeParliamentary and presidential elections are set for 2014


the Indonesian people. The 1945 Constitution of thecountry is based upon Pancasila.

The Dutch would not give up easily, however. Armedconflict spread across Indonesia between national-ists and returning Dutch forces, with more killed inthe country during that conflict than during thefighting there in the Second World War.

Finally, on December 27, 1949, under UN and USpressure, the Dutch transferred sovereignty of thearchipelago to the new, Republic of the United Statesof Indonesia (RUSI) – although the Netherlandsretained West Papua (then Dutch New Guinea) until1963. In August 1950 though, Sukarno declared RUSIwould be replaced by a unitary, Republic of Indone-sia (RI), with a new constitution. The first parliamen-tary elections were held in 1955, when Sukarno’sIndonesian National Party (PNI) came first, thoughwithout a majority. Also making a strong showing wasthe Indonesian Communist Party (PKI), while Islamistparties had widespread support as well.

Islam had first come to Indonesia in the 8th cen-tury CE, spreading to become the dominant religionin Java and Sumatra by the end of the 16th centuryand in all the other islands except Bali by the end ofthe 18th. Bali remains a majority Hindu island, whileanimism and Christianity are strong forces in certainareas, such as Kalimantan, Maluku, Papua and Sulawe-si. Currently, approximately 86% of the Indonesianpopulation is Muslim, 10% Christian and the resteither follow Hinduism or other faiths.

Two major Islamic organisations exist – the Sun-ni, modernist Muhammadiyya and larger, tradition-alist National Union (NU). Both organisations engagein social and educational activities, although Muham-madiyya did make a foray into backing the IslamistNational Mandate Party (PAN) in the 2000s, a moveit has recently backed away from.

In a Cold War world, Sukarno’s Indonesia was onein which the president attempted to pull the coun-try’s nationalist, communist and Islamist strands

together – a daunting and ultimately unsuccessfulambition. This led, however, to his proclamation of“Guided Democracy” in 1957, with seats in the Cab-inet for the PNI, PKI and other parties. In 1959,Sukarno followed this, however, by abrogating the1950 constitution, replacing the elected parliamentwith one appointed by the president and with a sin-gle, National Front party established.

Behind this now authoritarian state was a delicatebalancing act between the army, the PKI and theIslamic groups. This eventually unravelled in 1965though, when a series of coups and counter-coupsled to a takeover by the military, led by Major Gen-eral Suharto, and a nationwide massacre of the PKIand its suspected sympathisers.

Under Suharto, a new era, know as the “New Order”,began. Indonesia experienced rapid economic growthunder the rule of Suharto’s Golkar Party, up until theAsian financial crisis of 1997-98. The country expand-ed territorially with the invasion of East Timor in1975. In addition, Suharto implemented a transmi-gration programme, resettling mainly Muslim citi-zens from the islands of Java and Sumatra to less pop-ulated islands – later sometimes leading to violentethnic and religious-based clashes.

By 1996, support for Suharto had begun to erode,with the financial crash that followed leading to riot-ing and calls for his resignation. Suharto finallyresigned in May 1998, and was replaced by the vice-president, Jusuf Habibie.

This saw the beginning of the Reformasi periodand the return to democracy. Elections were held in1999, with the largest party becoming the Indone-sian Democratic Party-Struggle (PDI-P), led bySukarno’s daughter, Megawati Sukarnoputri. Withthe PDI-P unable to form a majority, however, the newparliament elected Abdurrahman Wahid, known asGus Dur, president, with Sukarnoputri as vice-pres-ident. He was ousted in 2001 following majorprotests, with Sukarnoputri then taking over as pres-ident until 2004. Elections in that year saw SusiloBambang Yudhoyono (known as SBY) assumed theoffice of president. SBY then won the 2009 election,completing his maximum allowed two terms. Now,in 2014, the electoral field is once more open.CONSTITUTION & ELECTORAL CHANGE: Under thecurrent constitution, the head of state, command-er-in-chief of the armed forces and chief executiveauthority is the president. Since 2004, the officehas been directly elected every five years with amaximum of two terms allowed per incumbent. Thewinner of the presidential election is the candidateachieving 50% of the votes, plus one. If no candidatepasses this mark, a second round of voting is thenheld. One other rule is that to become a candidatefor president (candidacies are dual tickets, for pres-ident and vice-president), the candidate’s party musthave won at least 25% of the vote for the lowerhouse of the legislature, the People’s Representa-tive Council (DPR), or hold a minimum of 20% of theseats there. This essentially rules out independent

22

The current president won elections in both 2004 and 2009

Following Indonesia’s

declaration of

independence in 1945,

armed conflict spread

across the country

between nationalists and

returning Dutch forces.

Finally, under UN and US

pressure, the Netherlands

recognised Indonesia’s

independence at the end

of 1949.

Under the current

constitution, the president

is the head of state,

commander-in-chief of the

armed forces and chief

executive authority. The

office is directly elected,

and presidents can serve a

maximum of two five-year

terms.



candidates and those without a significant, nation-wide party base. It also tends to mean the presidentand vice-president come from different parties, inorder that the candidacy can receive the necessarysupport in the DPR, where individual parties seldomcross the 25% threshold.

The president appoints a Cabinet, again usuallyconsisting of ministers drawn from a variety of par-ties, given the need for coalitions within the DPR.The president can propose bills to the DPR, issue reg-ulations in emergencies, can appoint the chief jus-tice, conduct foreign policy (although ultimately, theDPR’s approval must be sought for treaties andappointments) and grant pardons, after consulta-tion with the Supreme Court.

The bicameral legislature consists of the lower,DPR and the upper Regional Representatives Coun-cil (DPD). Most political power resides in the DPR,whose 560 members are elected for five-year termsvia an open-list proportional representation system,allowing voters to vote for individuals put forwardby the different parties in electoral districts ofbetween three and 10 seats each.

An electoral threshold is also in force, of 3.5% ofthe national vote. This tends to exclude regional andlocally based parties at the national level, and wasalso imposed in order to reduce the number of par-ties overall. In 2004 there were 17 parties represent-ed in the DPR; after the 2009 elections, there werejust nine; and some are suggesting fewer still are like-ly to be represented following the 2014 elections.In 2009, 38 parties contested the elections, withperhaps a dozen likely to do so in 2014. The DPRdebates proposed laws sent by the president, whileit can also propose legislation of its own. It mayquestion the president and government officials,and is also responsible for passing the budget.

As of year-end 2013, the nine parties in the DPRwere divided between six on the government bench-es and three in opposition. The six ruling partieswere led by SBY’s own Democratic Party (DP), with148 seats, followed by Golkar, with 106; the Pros-perous Justice Party (PKS) with 57; PAN, with 46seats; the United Development Party (PPP) with 38seats; and the National Awakening Party (PKB) with28. The PKS, PAN, PPP and PKB are all Islamist-based.

The opposition, meanwhile, consists of the PDI-P,with 94 seats; the Great Indonesia Movement Party(Gerindra), with 26 seats; and the People’s Con-science Party (Hanura), with 17 seats.

Parties must have offices in 75% of the provincesand 50% of the districts to register, meaning that amajor investment in infrastructure is required beforea party can run in the national elections.

The upper house, meanwhile, contains 132 seats,with each province electing four members for sin-gle, five-year terms. In addition, the DPD must beinvolved in any legislation affecting the regions,while it may also propose bills to the DPR. DECENTRALISATION: Since the Reformasi periodbegan, there has also been a drive towards decen-

tralisation of authority; in many ways this is a responseto over-centralisation under Suharto and Sukarno,while is also designed to address demands for localautonomy and undermine separatist groups.

At year-end 2013, Indonesia consisted of 34provinces, with Aceh, Jakarta, Yogjakarta, Papua andWest Papua enjoying different levels of autonomyfrom the rest. In 2009, for example, Aceh introducedsharia law, tightening this in 2013, while Yogjakar-ta is the only province still headed by a monarch.

In 2014 elections will also be held for 33 provin-cial assemblies (the DPRD I), and for their 508 sub-divisions, the regencies or districts (DPRD II).

Some 2112 seats are being contested at the DPRDI level and 16,895 at the DPRD II. Jakarta and thenewest province, North Kalimantan, will not havedistrict-level balloting.JUDICIAL MATTERS: Indonesia’s legal code is basedon civil law, with influences from Dutch, Roman andcustomary systems. Islamic law also plays a major rolein Aceh. The highest court is the Supreme Court,which presides over everything except constitution-al cases, which go to the Constitutional Court. TheSupreme Court is headed by the chief justice, whosince February 2012 has been MA Hatta Ali.

Beneath this court, the high courts consist of gen-eral, military, administrative and religious types, withsome 250 district courts then coming under these.The Supreme Court is the final court of appeal andcan also order the reopening of closed cases.

Meanwhile, a body often in the headlines thesedays is the Corruption Eradication Commission (KPK),a government agency that has had a controversialrecord. Nonetheless, the KPK has also accumulateda growing number of successful prosecutions andis generally widely respected.ASEAN: Indonesia was among the founding mem-bers of ASEAN in 1967, along with Malaysia, thePhilippines, Singapore and Thailand. Since then, thebloc has gained in stature, as well as in population

25


The country is divided into 34 provinces, several of which enjoy different levels of autonomy

In 2004 there were 17

parties in the People’s

Representative Council,

whereas after the 2009

elections there were just

nine. Some suggest that

fewer are likely to be

represented post-2014.

The bicameral legislature

consists of the lower

People’s Representative

Council and the upper

Regional Representatives

Council. Most political

power resides in the

former.


and economic importance. Brunei joined the organ-isation in 1984, followed by Vietnam in 1995, Laosand Myanmar in 1997, and Cambodia in 1999. Thebloc now has a combined GDP of around $2.3trn. Inthe past few decades, the region’s impressive growthrates have helped millions out of poverty and trans-formed what were once largely agrarian economies,such as Malaysia and Thailand, into centres for man-ufacturing and industry. The richer nations are nowlooking to develop more sophisticated service indus-tries and move up the value chain, while the bloc’spoorer members have taken their place in lower-lev-el manufacturing.

All this is putting more money into the hands ofordinary people and making more of them middleclass – with an annual income of at least $3000. InIndonesia, ASEAN’s biggest economy and the sourceof around one-third of the group’s GDP, some 163mpeople are expected to be middle class by 2020,equivalent to the combined population of Britainand Germany. ASEAN is now moving towards closerintegration of its markets, and 2015 has been set asthe target date for the launch of the ASEAN Econom-ic Community (AEC). Under the AEC, tariffs betweenthe bloc’s five founding members plus Brunei will bealmost entirely removed, while the later members willaim to adopt the same tariff levels by 2018 (seeanalysis). In addition to the AEC, ASEAN has alsosigned free trade agreements with other countriesin the region, including Australia, New Zealand, SouthKorea, Japan, India and China. OTHER AFFILIATIONS: In addition to its member-ship in ASEAN, the country is a member of the UN,the World Trade Organisation, the Asia-Pacific Eco-nomic Cooperation grouping as well as the Organi-sation of Islamic Cooperation. Indonesia was alsoone of the founding members of the Non-AlignedMovement, which was established in Belgrade in1961 as a group of nations not aligned with oragainst the US or the Soviet Union in the Cold War.

OUTLOOK: With the presidential election due inmid-July 2014 and DPR and DPD balloting on April9, the year is likely to be dominated by electioneer-ing and balloting – followed by political bargaining,as the new president seeks to build a coalition in theCabinet and in the DPR. Who that new president willbe, however, has been the subject of considerabledebate countrywide since soon after the last elec-tion in 2009. At the time of writing, the governor ofJakarta, Jokowi, was the frontrunner in the polls.

Jokowi was the PDI-P candidate when he won Jakar-ta’s top job in 2012, and in November 2013, it wasnot clear whether the PDI-P’s leader, the veteranpolitician Megawati Sukarnoputra, might not stilldecide to run – perhaps for the last time – on thePDI-P’s ticket. Jokowi had also only just begun totackle Jakarta’s formidable challenges.

A candidate who has long declared his candidacyis Aburizal Bakrie, chairman of Golkar and memberof the powerful business and financial family. A fur-ther candidate might come out of a coalition of par-ties unlikely to beat the 20-25% threshold in the DPRindividually. This “central axis” group may band togeth-er many of the Islamist parties with the DP, whichhas lost much ground since 2009.

On balance, SBY leaves a mixed legacy. His first termwon him considerable public support and good will,as he tried to tackle a number of major issues. Yetin his second term, he was often seen as far less effec-tive. In any case, SBY leaves his successor as presi-dent with a series of challenges. Abroad, Indonesiawill have to be ready for the introduction of theASEAN Economic Community in 2015, with manylooking to Jakarta to take a more active role in region-al and international politics. At home, economicgrowth and the distribution of its benefits remainthorny issues, as does solving the bottlenecks andimpediments thrown up by rapid expansion in adeveloping economy. Regional disparities and oppor-tunities are also still high on the agenda. A busy timeahead, then, for whoever wins the elections in 2014.

26

ASEAN is working to improve integration, with the bloc set to introduce a common market in 2015

SBY’s party is currently the largest in parliament with 148 seats

With DPR and DPD

elections in April 2014 and

the presidential vote in

mid-July, the year is likely to

be dominated by

electioneering and

balloting – followed by

political bargaining, as the

new president seeks to

build a coalition in the

Cabinet and in the DPR.



Xi Jinping, President of China

The Chinese economy has remained consistently strongas we focus on reforms and liberalisation, and we areconfident of maintaining this momentum going forward.

China and the Asia-Pacific share a symbiotic relation-ship. Both parties rely on one another for new jobprospects and economic growth. We hope to establishmore links with the Asia-Pacific in order to build a bet-ter and more prosperous future.

The global economic recovery will be filled with dif-ficulties and setbacks. In the Asia-Pacific region it is nodifferent, but let us not forget that we are on a goodstreak, and I believe that we will continue this trend forthe foreseeable future. Advanced and developingeconomies alike are seeking new channels for growth,which can only come from reform and innovation.

Growth rates have been steady across the board,which gives me a lot of confidence in the future of theChinese economy. We are committed to structuralreforms in order to sustain, and even increase, growthover the long term. We are not short-sighted insofarthat we might forego long-term benefits in exchangefor short-term satisfaction. If structural reforms arenecessary for long-term growth, then we will committo these. Any cause we undertake will require due atten-tion to both short- and long-range targets, taking intoaccount both immediate and long-term interests. Killingthe goose that lays the golden eggs and only consid-ering immediate interests and long-term effects is nota formula for sustainable development.

I am also confident because China has strong endoge-nous power. This includes ongoing urbanisation, a grow-ing generation of modern and professional talent, andbetter implementation of innovation-driven develop-ment. In addition, continuous expansion of domesticneeds and the consumer market, adherence to theprinciple of putting people first, and enabling morepeople in other regions to share the benefits of devel-opment, are also strong factors going forward.

The development prospects for the Asia-Pacific regionare very exciting. They are currently undergoing their

own technological industrial revolution. Economies inthe region have a strong capacity to fend off risksbecause of their increasing competitiveness.

We need to stay alert to potential obstacles and chal-lenges. China needs to comprehensively deepen reformand open its own economy to move forward.

The rainbow often only appears after the winds andrain. There is a saying that there is no mountain high-er than man, and no road longer than our feet. No mat-ter how high the mountain is, and how long the roadis, as long as we move forward with perseverance, therewill be a day when the end is achieved.

China is a member of the Asia-Pacific family. Oureconomic relationship is interdependent. China can-not develop without the Asia-Pacific, and the Asia-Pacific cannot prosper without China. The sustainableand healthy development of the Chinese economy willbring greater opportunities to the development of thewider region. China will firmly maintain regional peaceand stability, vigorously promote regional developmentand prosperity, and be committed to building a region-al cooperation framework that stretches across thePacific Ocean and benefits all parties.

Asia-Pacific is the space for our joint development,and we are all the sailing ships moving forward in thesea of the Asia-Pacific. China hopes to join hands withour regional partners to collaborate and build a strongerregion that will help guide global economic recovery.

In terms of development, the region should seekcommon goals, insist on openness, promote innovation,as well as seek interaction.

The business community is an important force inpromoting economic development and trade, and wewelcome and encourage enterprises of all economiesto invest in China. In 2014, China will host the Asia-Pacific Economic Cooperation Summit Leaders’ Meet-ing. We hope representatives from across the region-al business community will come to Beijing to discussthings together and collaborate to jointly witnessanother important moment in the region’s development.

27


Over the rainbowXi Jinping, President of China, on the Asia-Pacific’s ties with China

COUNTRY PROFILE INTERVIEW

Yasuo Fukuda, Yasuo Fukuda, Former Prime Minister of Japan

What are your projections for Japanese investments

in Indonesia over the next 18 months, and how

long can the bullish investment rate be sustained?

FUKUDA: In cumulative terms, since 1990 Japan hasbeen the largest investor in Indonesia after Singapore,with a particularly dynamic shift in 2011. In that year,foreign direct investment from Japan to Indonesia dou-bled from 2010, reaching $1.52bn and going on toreach $2.46bn in 2012. The 2013 figure had alreadysurpassed that by the end of the third quarter, at$3.64bn. Though I cannot predict whether Japanesecompanies can sustain such a bullish pace, I am confi-dent that such inbound investments will continue solid-ly in the coming years, since Japanese companies havean extremely positive view of Indonesia’s market poten-tial and political stability in the medium and long term.A testament to this sentiment is the 2013 report bythe Japan Bank for International Cooperation (JBIC) onJapanese manufacturers’ overseas operations, in whichIndonesia was evaluated as the most promising desti-nation for investment in the medium term (about threeyears) followed by India, Thailand and China.

At present, 70% of Japanese investment projects

are in manufacturing. How likely is a shift into serv-

ices and where specifically would this take place?

FUKUDA: After the success of investments in cars,motorcycles and electronic household devices, Japan-ese companies are now expanding into consumer goodssuch as cosmetics and beverages. This trend is a directreflection of the growth of Indonesia’s middle class,which accordingly requires more extensive investmentin services. From a Japanese perspective, we see serv-ice opportunities everywhere, but especially in retail,where we are seeing significant new investments.

UNIQLO opened its largest shop in South-east Asiain Jakarta in the spring of 2013. AEON is opening shop-ping malls in the country. Japanese regional banks areincreasing their cooperation, and Japanese insurers will continue to operate in the Indonesian marketplace.

To what extent are Japan and Indonesia collaborat-

ing on infrastructure realisation and where else

must Indonesia seek to make improvements?

FUKUDA: Infrastructure is obviously essential for effi-cient business activities, and its development facili-tates economic growth. The Indonesian government’sMasterplan for Acceleration and Expansion of Indone-sia's Economic Development, announced in 2011, is avery important step forward. To speed implementa-tion, Indonesia and Japan, among others, are cooper-ating extensively to strengthen the infrastructure ofJakarta and its neighbouring Jabodetabek area throughthe Metropolitan Priority Areas project.

Under this plan, the two countries have identified45 projects to be completed by 2020, at a total cost ofaround Rp411.3trn ($41.13bn). The five flagship proj-ects include the Jakarta mass rapid transit system, thedevelopment of Cilamaya port, expansion of Soekara-no-Hatta International airport, creation of new academ-ic research clusters and the Jakarta sewerage project.As for improvements in other areas, the JBIC reportsthat Japanese companies are facing challenges in theform of increased labour costs and legal uncertainties.

What affects, direct or indirect, will Japan’s new

monetary policy have on Indonesia, and how will

this affect their relationship?

FUKUDA: Japan’s new economic policy, often referredto as Abenomics, consists of three “arrows” and aimsto spur economic recovery by ending deflation andpromoting sustainable growth. The effects, most strong-ly brought on by the first arrow, are already showingthe policy’s merits. Confidence in Japan’s private sec-tor has visibly increased, and is further reflected in eco-nomic indices and encouraging signs at the Tokyo stockexchange. The recovery of Japan’s economy will doubt-less help stimulate the world economy, especially inAsian. Indonesia, with long-standing ties to Japan, isexcellently placed to reap the rewards of its recovery,which will see both countries prosper in the long term.

28

Good neighboursOBG talks to Yasuo Fukuda, Former Prime Minister of Japan


COUNTRY PROFILE ANALYSIS

ASEAN has set itself targets and deadlines in a binding “blueprint”

Indonesia continues to be the dominant nation inSouth-east Asia both politically and economically. Itsparticipation within ASEAN will likely determine theshape of regional integration, with the introductionof the ASEAN Economic Community (AEC) at the endof 2015 looming as the next major milestone.

The AEC is expected to create new opportunities forinvestors in a region that boasts not only some of theworld’s fastest-growing economies, but also a rapid-ly expanding middle class. “ASEAN and South-eastAsia are one of the few really bright spots in the worldeconomy,” said Teoh Kok Lin, founder of Singular AssetManagement in Kuala Lumpur. “We still have a youngpopulation so the demographics are positive. We alsohave a huge emerging middle class. It’s a sweet spot.”A GROWING BLOC: In the past decade the economiesof emerging Asia have expanded by more than 7.5%a year, according to the IMF. ASEAN’s combined GDPis already valued at $2.3trn and is expected to reach$10trn by 2030. The group, now home to an estimat-ed 609m people, was formed in 1967. The originalmembers – Malaysia, Indonesia, Singapore, Thailandand the Philippines – made economic growth a pri-ority from the very start. Historically, members havetended to compete in the same industries, focusingon the potential outside ASEAN rather than within theregion. Even today, intra-ASEAN trade is just 25% ofthe region’s total. The group’s 10 members competein areas such as food processing, telecoms, tourismand business services, while those with better stan-dards of English have tended to have an advantagein the global economy.

The original five are now at the core of what hasgrown into a highly diverse organisation. As well asdiffering political systems, there are also vast dispar-ities in economic management, culture and wealth.Singapore is the richest but also the smallest. Its percapita income might be 45 times that of Myanmar,but it has less than 1% of ASEAN’s population. Myan-mar, by contrast, is home to more than 60m people.

BACKGROUND: The AEC was launched in 2003 asthe region emerged from the Asian financial crisis. Fiveyears earlier, the collapse of the Thai baht ricochetedacross the region, triggering deep recessions andbringing an end to the rule of Indonesia’s PresidentSuharto. In the aftermath, leaders sought a way torebuild their economies on a more secure foundation.

“Asians did not draw the wrong lesson from theAsian crisis; they did not hunker down, pull up drawbridges or withdraw from the world,” Christine Lagarde,the IMF’s managing director, said in a speech in KualaLumpur in November 2012. “Asia’s economic founda-tions became safer, sounder and more resilient, butstill open to the world and open for business.”

The AEC is designed to transform ASEAN’s 10 mem-bers into a single production base, allowing for thefree movement of goods, services, investment, skilledlabour and capital. Initially set to take effect in 2020,the AEC is now expected to come into force on Decem-ber 31, 2015. ASEAN has also championed integra-tion as a way to bridge some of the developmentaldifferences within and among members, deepen theregion’s economic ties with the rest of the world andcompete more effectively with China.TARGETS: The group has set itself key targets anddeadlines in a binding “blueprint” that tracks each ofthe AEC’s four pillars and was agreed in 2007. An “AECscorecard” keeps track of each country’s compliance.Lim Hong Hin, the deputy secretary-general withresponsibility for the AEC, notes that as of August2012, 72% of measures for 2008-11 had been imple-mented. Still, other than peer pressure, there are nopenalties for those countries that miss their targetsand no way to ensure measures take effect.

With the AEC built on the existing ASEAN Free TradeAgreement, it is perhaps not surprising that mostprogress has been made in trade liberalisation. Butefforts to integrate Customs procedures to create a“single window”, liberalise services, and harmonisecrucial regulations and standards have been slower.

In the past decade, the

economies of emerging

Asia have expanded by

more than 7.5% a year,

according to the IMF.

ASEAN’s combined GDP is

already valued at $2.3trn

and is expected to reach

$10trn by 2030.

29


The AEC is designed to

transform ASEAN’s 10

members into a single

production base, allowing

for the free movement of

goods, services,

investment, skilled labour

and capital. Initially set to

take effect in 2020, the

AEC is now expected to

come into force on

December 31, 2015.

Coming togetherLooking ahead to the introduction of the ASEAN Economic Communityat the end of 2015

COUNTRY PROFILE ANALYSIS

Local corporations, fearful of competition in theirhome markets and often politically well connected,have made it difficult for governments to effect thepolicy changes that the AEC demands. Indeed, a Glob-al Trade Alert report notes that in 2011 Indonesiaadopted more potentially restrictive trade measuresthan any other country in South-east Asia, ranking itamong the top 10 protectionist nations.TRACKING IMPLEMENTATION: Jayant Menon, theAsian Development Bank’s lead economist for tradeand regional cooperation, has been tracking the imple-mentation of the AEC. He doubts the core countrieswill meet their 2015 target for implementation –though they will declare the AEC in existence anyway– and admits that the poorer nations of Cambodia,Laos, Myanmar and Vietnam are even further behind,perhaps by as much as a decade. But he stresses thatthe 2015 target should be seen more as a “milestone”than a hard target. “One should not expect that in 2015to see ASEAN suddenly transformed; its nature andprocesses abruptly changed and its members inter-ests substantially altered,” he said. “2015 should beviewed more as a milestone year – a measure of a workin progress. The journey remains relevant even if thedestination takes longer to arrive at.” Menon esti-

mates the region’s core members will achieve AECimplementation by 2020, their original target. GLOBAL UNCERTAINTY: Officials are also mindfulof the region’s vulnerability to the uncertainty in therest of the world. “The intensification of global risksputs into question the credibility of globalisation andcasts some doubts on the region’s ability to manageits own integration,” Lim told delegates at a forum onthe AEC in September 2012. “Of particular concernare the potential pullbacks in trade and capital flowsinto the region as global conditions deteriorate, andthe possibility that some ASEAN countries may revertto protectionist measures and inward-looking poli-cies to protect their own domestic economies.”

The poorer nations, Cambodia, Laos, Vietnam andMyanmar, have, officially, until 2018 to reach theirtargets, but even richer countries have been able tonegotiate exclusions for what they deem to be “sen-sitive” industries. Indonesia and the Philippines are seenas among the most restrictive, concerned about open-ing their vast domestic markets even to regional rivals. RISING TRADE: Still, while data suggests policy imple-mentation has been slower in some areas than itshould be, trade between ASEAN and the rest of Asia,as well as within ASEAN itself, has risen sharply in thepast decade. The most recent data shows trade with-in the 10-member bloc rose to $520bn in 2010, com-pared with just $121m in 1998. There are signs toothat member states appreciate the benefits of con-vergence and cooperation.

Increasingly, electronics factories in ASEAN are mak-ing components that are then shipped to productioncentres in China for assembly and export to the widerworld. Japanese carmakers have taken advantage ofthe ASEAN Industrial Cooperation Scheme to set upan integrated region-wide production system. More-over, the importance of trade to the region is reflect-ed in the proliferation of free trade agreements eitheron a bilateral basis or between ASEAN and its majortrading partners, such as China, Japan and Korea.

Much then will depend on what happens in thenext two years, with many looking to Malaysia, whichwill take the ASEAN chair in 2015, to convince itsneighbours to embrace the common market andensure that ASEAN’s disparate members achieve theeconomic ambitions to which they have long aspired.

30

ASEAN-based electronics factories are exporting to the wider world

While data suggests policy

implementation has been

slower in some areas than

it should be, trade between

ASEAN and the rest of Asia,

as well as within ASEAN

itself, has risen sharply in

the past decade.

31

Trade & InvestmentRising trade volumes attest to the shift to value addedCommodities underpin exports, but manufacturing growsInflows of foreign direct investment expected to stay highPartnerships near and far support continued expansionImprovements to investment environment remain uneven

TRADE & INVESTMENT OVERVIEW

Streamlining of industries has helped reduce domestic bottlenecks

A significant actor in global trade and investment, anda member of the G20 group of the world’s largesteconomies, Indonesia has achieved a strong record ofattracting foreign direct investment (FDI) and rebalanc-ing its trade patterns toward high-growth markets. Theauthorities have developed new markets for exportswhile encouraging investment in import-substitutionindustries. Their key priorities heading into the 2014elections remain speeding up infrastructure develop-ment, improving labour flexibility, and bolstering tradeand investment policies. While challenges remain in theinvestment environment, efforts to streamline proce-dures and ease bottlenecks have attracted investmentin the natural resources and manufacturing sectors. Aspolicymakers worked to contain a current accountdeficit of imports of capital goods and intermediarymaterials in 2013, long-term direct investors appearedmore bullish than short-term portfolio investors. TRADE PATTERNS: Despite a 6.7% contraction in netexports in 2012, the value of Indonesia’s trade hasexpanded significantly over the past decade, with a dou-bling of exports between 2006 and 2011 to $203.50bn.Rising demand for Indonesia’s key commodity outputsfrom Asian markets has spurred a redirection of trade.Yet with most FDI flowing to sectors linked to con-sumption, trade has been a smaller growth driver thanhousehold spending. This comes despite ASEAN-widetrade liberalisation that has encouraged conglomeratesto expand their supply chains to Indonesia (see analy-sis). Japan was Indonesia’s top market in 2012, but itsshare of total exports fell from 22.28% in 2003 to15.86%, according to the Asian Development Bank(ADB). China and Singapore, the next two markets,grew from 6.23% and 8.84% of exports, respectively, in2003, to 11.4% and 9.02% by 2012. China’s significanceas a source of imports also grew, with its share ofIndonesian imports rising from 9.08% to 15.33% in2003-12, though it was third behind Singapore andJapan in 2012 imports, with 13.6% and 11.88%, respec-tively. The US, Indonesia’s fifth-largest market in 2012,

saw its share decline from 12.09% to 7.83% in the samespan, while exports to the EU dropped from nearly 18%to 9.3%. The largest increases went to India, whereexports doubled from 2.85% to 6.58% in 2003-12, andASEAN countries – exports to Malaysia rose from 3.87%to 5.94%, and to Thailand grew from 2.28% to 3.49%.

“We are seeing an intensification of trade and FDIflows in ASEAN, particularly between Indonesia, Thai-land and Vietnam in both directions,” Nick Gandolfo,HSBC’s senior vice-president of leading internationalbusiness in Indonesia, told OBG.ACCELERATED GROWTH: Trade with non-traditionalmarkets in Africa, the Middle East, Eastern Europe andLatin America has grown even faster, albeit from a lowbase. Growth in trade with Africa accelerated from14.42% annually in 2007-11 to 46.4% in 2011-12, whilethat with the Middle East rose from 7.7% to 43.23% inthe same span, according to data from the Ministry ofTrade (MoT). While traditional markets in Asia grew40.64% annually in 2007-11 and 63.13% in 2011-12, mar-kets in Europe and America contracted: annual tradegrowth with Western Europe slowed from 13.99% to -4.27% in this span, while that with North Americadropped from 10.69% to -14.83% (see analysis).

By the first half of 2013 the top 10 markets account-ed for 73.6% of Indonesian exports, according to theMoT, while roughly 70% of exports stay in Asia, as perfigures from private equity firm KKR. Although exportscontinued to contract into August 2013, with a 6.3%year-on-year (y-o-y) drop, a reversal of the oil and gasdeficit to a small surplus helped to offset contractingnon-hydrocarbons exports to a degree.

A 2013 report on trade patterns published by glob-al accountancy and professional services firm Ernst &Young forecast export growth rates of roughly 15%annually until 2020, driven by rebounding demand inemerging Asian economies. Annual increases in tradewith China, Thailand and South Korea were over 13%, stimulating demand for lower-value-added man-ufacturing exports – clothing and shoes in particular.

Japan was Indonesia’s top

export market in 2012,

with 15.86% of exports.

China and Singapore, the

next two markets,

accounted for 11.4% and

9.02%, respectively, of total

exports that year.

By the first half of 2013

Indonesia’s 10 largest

export markets accounted

for 73.6% of its total

exports, roughly 70% of

which stay in Asia.

32

In it for the long termInvestors are committing to the country for the long haul



TERMS OF TRADE: As Indonesia is the world’s largestexporter of crude palm oil (CPO) and tin, the secondsource of cocoa and a major exporter of nickel (fifth),gold (seventh) and copper (eighth), commodities area key earner, accounting for 62% of exports in the firsthalf of 2013, according to data from Statistics Indone-sia (BPS). Given its dependence on unprocessed com-modities, Indonesia benefitted from major priceupswings during the commodities super-cycle – with74% of the 28.98% y-o-y growth in exports in 2011 driv-en by increases in price rather than volumes, accord-ing to KKR – but it has also been affected by depressedprices since the first quarter of 2012. “The price indexof our goods exports declined by nearly 15% in 2012,mainly due to slower growth in our major trading part-ners, including India and China,” Luky Alfirman, head ofthe Ministry of Finance’s (MoF) centre for macroeco-nomic policy, told OBG. While CPO sales remain the sin-gle-largest export item with 13% of the total in the firstquarter of 2013, according to BPS data, manufacturedgoods have grown in importance, driven by exports ofmachinery, electronics, ships and aircraft parts. Shipexport sales grew 29.42% y-o-y in the first half of 2013,while footwear and ready-to-wear garments were up9.9% and 3.9%, respectively, in the first half of 2013according to data from the MoT.

Although these increases are significant, depressedprices for key commodity exports have dragged downsales values. Rebalancing of growth in China towarddomestic consumption has led to declines in CPO, rub-ber, and key industrial metals like tin and nickel, whoseprices declined 17% in the first half of 2013, and cop-per, which fell 12% in six months, while higher thermalcoal exports from the US given the rise in its shale gasproduction have pushed down coal prices. New exporttariffs of 20% on 65 unprocessed minerals (excludingcoal) introduced in 2012 have also squeezed exportvolumes, although the majority were suspended amidstthe August 2013 policy package from the MoF.RECORD FDI: Despite shocks to Indonesia’s commod-ity export earnings, the economy has continued toprove a draw for FDI. Investment, at roughly 32% of GDP,is the second driver of growth after household con-sumption. Inward FDI (excluding hydrocarbons andnon-bank financial institutions) rebounded from a lowof $4.88bn in 2009 to $16.21bn in 2010, the yearIndonesia overtook Thailand as the largest recipient ofFDI in ASEAN, and $24.56bn in 2012, when Indonesiaranked as the world’s 20th-largest FDI recipient, accord-ing to data from the UN Conference on Trade and Devel-opment (UNCTAD). Investment ratings upgrades byJapan’s JCR in 2010, and by Fitch and Moody’s at thestart of 2012, encouraged the higher FDI trend. Despitesignificant outflows in portfolio investment in 2013, FDIflows continued to grow, reaching $7.05bn in the firstquarter of 2013 and $7.17bn in the second quarter –with Indonesia on track to achieving $28bn in inwardFDI and Rp390trn ($39bn) in total investment, accord-ing to the Indonesia Investment Coordinating Board(BKPM). While FDI growth slowed slightly to $6.98bnin the third quarter of 2013, up 18.4% y-o-y, this was

largely compensated by surging domestic investment,up 33% y-o-y to $1.92bn.

In the first half of 2013, FDI accounted for 68.57%of total investment, while the total stock of inward FDIballooned tenfold in 12 years from 2000 to $205.66bn,according to UNCTAD. These record numbers were driv-en by greenfield investment, which accounted for 57.5%of all investment in the year to September 2013, whileexpansion of existing facilities accounted for 42.5%,according to BKPM. The four largest sources of FDI in2012 remained Singapore, Japan, South Korea and theUS with $4.86bn (19.8% of the total), $2.46bn (10%),$1.95bn (7.9%) and $1.24bn (5.1%), respectively, accord-ing to BKPM. Some uncertainty over official figuresremains, however, given an October 2013 report pub-lished by the American Chamber of Commerce inIndonesia (AmCham) that noted the under-valuing ofUS FDI: it found that total US investment in Indonesiareached $65bn in the eight years to 2012, rather thanthe official $7bn figure. This was due to the use of cor-porate entities in tax havens like Mauritius (which chan-nelled $1.06bn in FDI to Indonesia in 2012), the British

33


SOU

RCE:

UN

CTAD

FDI inflows & outflows, 2007-12 ($ bn)

0

5

10

15

20

25

OutflowsInflows

201220112010200920082007

Investment is the second growth driver after household consumption

In the first half of 2013, FDI

accounted for 68.57% of

total investment, while the

total stock of inward FDI

grew tenfold from 2000 to

2012, reaching $205.66bn.


Virgin Islands ($855.9m) and Cayman Islands ($8.5m)as well as Singapore and Hong Kong (see analysis).

Investor interest is expected to continue to grow.“Indonesia’s lower GDP projection will not deter for-eign investors,” Armand B Arief, president director ofUOB Bank, told OBG. “There is too much potential inthe medium- and long-term for investors to ignore theopportunity in Indonesia. After the recent FDI forumsin Indonesia, there has been a lot of follow up from for-eign investors, however, the government is making itdifficult because they can’t formally act on theseinquiries until the central bank makes it official.”BROADER FOCUS: Despite adverse terms of trade forexports, a growing share of FDI has focused on manu-facturing, domestic-oriented in particular. The share ofFDI in Indonesia’s secondary sector grew from 20.58%in 2010 to 47.9% in 2012 and 63.3% by the third quar-ter of 2013, while manufacturing and services combinedaccounted for 76% of all FDI in the first three quartersof 2013, according to BKPM. “We did not expect a sig-nificant drop-off in inward FDI in 2013, despite adverseportfolio investment flows during certain times in theyear, with a particular focus on consumer and retail,infrastructure and services,” Gandolfo told OBG.“Surabaya and Batam are probably the most active FDIdestinations outside Jakarta.” The secondary sector’sreliance on imports of capital goods and intermediarymaterials, which accounted for 20% and 73% of allimports in 2012, means that higher FDI in manufac-

turing has driven import growth and widened Indone-sia’s current account deficit (see analysis).

While disasters like the Fukushima tsunami andnuclear shutdown and the Thai floods in 2011 prompt-ed automotive and electronics manufacturers to expandproduction chains within ASEAN, the strong pull ofIndonesia’s vast domestic market and governmentmeasures to increase locally produced content both inmanufacturing and in commodity processing have alsoprovided impetus to growing investment. A full 15% ofall 2012 FDI went to transportation equipment andmachinery, according to KKR, a sign of value chainsbeing established in Java, outsourced from southern Chi-na. “We are seeing the shift of investment from natu-ral resources-based to value-added sectors,” incomingBKPM chief Mahendra Siregar said when the third-quarter 2013 investment figures were released.

The October 2013 report by AmCham found thatwhile US investment in oil, gas and mining grew 11%in eight years to 2012, growth in manufacturing invest-ment was nearly double that, at 21%. By 2012 52.2%of US FDI was in extractive industries and 46.1% in man-ufacturing. Significantly, the nature of firms investingincludes small and medium-sized enterprises (SMEs),particularly from Japan, South Korea and Taiwan, accord-ing to BKPM – a sign multinationals are expanding sup-ply chains to Indonesia.

“The growth in FDI from SMEs is largely because theyare subcontractors to larger multinationals that are

34

US investment in oil, gas

and mining grew 11% in

the eight years to 2012,

while manufacturing saw a

rise of 21%. By 2012, 52.2%

of US FDI was in extractive

industries and 46.1% in

manufacturing.


trying to fulfil government requirements to integratemore of their supply chains domestically,” DestryDamayanti, Bank Mandiri’s chief economist, told OBG.The largest deals by value in recent years have focusedon the manufacturing, automotive, electronics, phar-maceuticals and telecommunications sectors, accord-ing to research from the University of Indonesia. VALUE ADDED: Eager to transition to a higher-value-added production base, Indonesian authorities are striv-ing to streamline investment procedures and promoteinvestment to key sectors under the Masterplan forAcceleration and Expansion of Indonesia’s EconomicDevelopment (MP3EI) to 2025. Structured along sixgrowth corridors, the plan aims to develop sorely need-ed infrastructure to support expansion in key strategicindustries and jumpstart the country’s industrialisa-tion. Meanwhile, the MoT’s five-year strategic plan to2014 aims to increase non-oil exports, strengthen thedomestic market and improve the availability of basicproducts. Given Indonesia’s surging capital goods andintermediate materials imports, driven by growinginvestment in final manufacturing, the authorities areconscious of the pressing need to develop intermedi-ate industries. The Ministry of Industry’s industrialisa-tion plan focuses on 35 priority industrial clusters inbasic manufacturing, agro-industry, electronics and IT,transportation as well as creative and supportive indus-tries. “The regional context is conducive for Indonesiato develop its intermediate industries,” Ndiame Diop,lead economist and economic advisor for Indonesia atthe World Bank, told OBG. “As China rebalances thereis quite a lot of investment flowing south, and Indone-sia may be able to capture some of this.” RAW MANAGEMENT: The government has adopted acarrot and stick approach to improving value-added out-put. The WTO noted in its March 2013 trade policyreview that, “A number of measures... have recentlyraised concerns about the direction of trade and invest-ment policymaking.” The Heritage Foundation putsIndonesia’s trade-weighted average tariff at 2.5%, buttrade is constrained by non-tariff barriers (see analy-sis). The 2009 Mining Law allows only miners invest-ing in local smelters to continue exporting unprocessedminerals from 2012 and plans for a total ban on theexport of raw minerals from 2014, although investorsin downstream processing may be able to continuesuch exports given the loosening of export restrictionsin the government’s August 2013 policy package. Thestate also introduced progressive taxes on the exportof mineral commodities, CPO and cocoa, and sinceAugust 2013 requires the sale of tin through local commodity exchanges (see Capital Markets chapter).

Indonesia also placed import restrictions and quo-tas on horticultural and animal products in 2011, restrict-ing import licensing to a handful of importers and onlyfour entry ports. While these were also relaxed in April2013 due to rising food inflation, they elicited a num-ber of WTO complaints from the US (see analysis).Meanwhile, on the investment front, new rules on bankownership limiting single-owner (whether local or for-eign) shares to 40% of a lender from 2012 were seenas a means of halting Development Bank of Singapore’sattempted majority takeover of Bank Danamon, in theabsence of reciprocal access for Indonesian banks toSingapore’s market. This is prohibitive given the capi-tal charges applied to minority ownerships on bankscomplying with Basel III rules (see Banking chapter).

New rules on mining ownership introduced in 2012also require divestment to an 80% stake within six yearsof production (by 2018), and then 70%, 63%, 56% and49% every year thereafter – with local initial publicofferings not qualifying as divestment (see Miningchapter). In addition, as part of efforts to curb importsof intermediate materials and capital goods, the cen-tral bank has discouraged banks from lending to 10import-dependent industries including telecoms andautomotive manufacturing. “Bank Indonesia has encour-aged banks to support investments that will reduceimports, which in turn should have a positive effect onthe country's balance of payments,” Sheky Lemasoa,HSBC’s head of corporate in Indonesia, told OBG. “How-ever, these encouragements need to be clarified interms of enforcement.”

On the incentives front, in 2011 Indonesia rolled outtax holidays of 5-10 years (followed by 50% reductionsfor two years thereafter) and 5% cuts in income tax forinvestment over six years for firms investing over Rp1trn($100m) in one of the six MP3EI corridors in sectorslike base metal processing, oil refining, petrochemicals,renewables, telecoms equipment and machinery.Labour-intensive businesses – those employing morethan 100 staff – are also eligible for these incentivesfor investments over Rp50bn ($5m) in 129 sectors,including plantations, pharmacies and property. The gov-ernment plans to expand these incentives in the fourthquarter of 2013 to firms from countries with no taxtreaties with Indonesia and for those investing inresearch and development locally. In the two yearssince 2011 the government has only granted tax hol-idays to two investors: Unilever’s $133m oleochemicalpalm oil refinery and Chandra Asri Petrochemical’s$145m butadiene factory. While the approval processfor tax holidays is complicated – with BKPM assessingthe technical aspects and a committee including MoF,the Coordinating Ministry of Economic Affairs and theTax Office approving them – the two main criteria arethe amount of local content and jobs generated. NEGATIVE LIST REVISION: The 2007 Investment Lawintroduced greater clarity regarding which sectors areopen to majority FDI. In practice, however, this has ledto the publication of a “negative list” of sectors in whichFDI is capped – mainly high-value-added sectors suchas telecommunications towers, health care, pharma-

35


New rules on mining

ownership introduced in

2012 require divestment to

an 80% stake by 2018, and

further reductions to 70%,

63%, 56% and 49% every

year thereafter.

Labour-intensive

businesses – those

employing more than 100

staff – are eligible for

incentives on investments

over $5m in 129 sectors,

including plantations,

pharmacies and property.SOURCE: BKPM *excluding oil, gas, banking, insurance

2010 2011 2012 Q1 2013 Q2 2013

Primary sector 3.03 4.88 5.93 1.69 1.65

Secondary sector 3.34 6.79 11.77 4.55 3.46

Tertiary sector 9.84 7.81 6.86 0.80 2.07

Total 16.21 19.48 24.56 7.05 7.17

Value of FDI by sector, 2010-Q2 13 ($ bn)*


ceuticals production, courier services, small-scale retail-ing, creative industries and education – and thosewhere it is barred, mainly related to national securityand alcohol production. Investment restrictions varyfrom 45% to 95%, but there is no limit on the size ofinvestment, the source of funds or whether produc-tion is export- or domestic-oriented.

The list was last revised in 2010 and extends restric-tions to merged or acquired entities, with 20 industriesbarred from FDI, but the revisions also increased theFDI ceilings in sectors like courier services (from closedto 49%), health care (65% to 67%), large-scale con-struction (55% to 67%) and direct marketing (60% to95%). In addition, it relaxed ceilings for ASEAN investorsin areas such as marine transport and cargo handlingand hospitality. While another revision was widely antic-ipated by end-2012, and is expected to relax the 75%cap on pharmaceuticals production among others, thishas been delayed several times. OUTLOOK: Indonesia is on track to achieve anotherrecord year for FDI. The outgoing administration isintent on seizing on financial strains as an opportuni-ty to implement needed structural reforms. Notwith-standing the political transition, BKPM expects someRp450trn ($45bn) in new foreign and domestic invest-ment in 2014, a 15% y-o-y increase, while AmChampredicts some $61bn in new US FDI in the next threeto five years alone. While measures aimed at curbingthe current account deficit by reducing imports andexpanding value-added exports will take time to bearfruit, concerted efforts to develop the industrial baseare beginning to attract increased investment.Amidst the political debate, all the political parties agreeon the need for investment and to expand internation-al trade from its low base, although they will have toresist populist urges to impose restrictions.

While margins adequately compensate the risk forinvestors, authorities are conscious of the need to cutred tape, streamline burdensome regulations andimprove best practice across all regions.

“Indonesia is the least-unattractive country in theworld,” M. Chatib Basri, former head of BKPM and nowFinance Minister, told international newspapers in April2013. “Even though they have to deal with the prob-lems of bureaucracy and infrastructure, the returns arehigher than if you invest in Europe and the U.S. now.”

The government is steering improvements in itsinvestment climate through BKPM, which establisheda taskforce to that effect including the Tax Office, BankIndonesia and state power utility PLN. The aim is toreduce the time for connecting new businesses to elec-tricity, water and telephone lines. In early 2013 BKPMcut in half the number of documents needed to applyfor an investment licence and shifted to an online plat-form for processing applications. The Board is alsoseeking to coordinate across districts by establishingregional BKPM offices and operating best-practicecompetitions between districts.

The Customs service launched its electronic Nation-al Single Window in 2010 in order to streamline cross-border trading procedures. The enactment of the new‘eminent domain’ law for land acquisition linked to infra-structure projects in December 2011 is an encourag-ing step, although delays in toll-road developmentspoint to lingering challenges (see analysis) The centralbank is meanwhile encouraging significantly higherbank lending to SMEs in stages to 2017, which shouldfacilitate access to credit.

The administration has also sought to strengthenthe anti-corruption commission (KPK), which has ledcases against high-profile public officials including theDemocrat Party’s treasurer in 2011, the Youth andSports Minister in 2012 and the Constitutional Court’sChief Justice in October 2013. Yet anti-corruption offi-cials still do not hold subpoena powers that would sig-nificantly increase their power.

While improvements in the business climate are wel-come, investors must contend with above-average infla-tion in land prices and staff costs. An April 2012 studyby Japan’s External Trade Organisation (JETRO) foundthat the average cost of industrial land had nearly dou-bled from 2010 to 2012, to $196/sq m, while the avail-ability of land in the Greater Jakarta region was prob-lematic. Meanwhile, minimum wages increased by 18%nationwide in 2012 according to the ILO and as highas 44% in Jakarta. Although labour-intensive industriesaccount for only 9% of employment in Indonesia accord-ing to BKPM, the potential for knock-on effects on theentire pay scale is a concern for investors. The govern-ment is proposing reforms to wage negotiations pro-cedures in order to link wage increases to regionalinflation rather than political bargaining (see analysis).

36

Some $45bn in new foreign

and domestic investment is

expected in 2014, a 15%

y-o-y increase, while the US

alone is forecast to invest

$61bn directly in the next

three to five years.

TRADE & INVESTMENT ANALYSIS

Diversifying export markets is a central priority for the government

As part of its strategy of boosting non-oil exports tonew markets, the government is seeking to expand theavailability of trade finance for its exporters, particu-larly small and medium-sized enterprises (SMEs). “Ifwe want to prevent the ongoing volatility from disrupt-ing our export growth, then we should not focus onexporting goods only to the US and China; we must diver-sify our exports,” the minister of finance, M. Chatib Bas-ri, told a Jakarta seminar on trade finance in Septem-ber 2013. While exports to non-traditional markets inAfrica, the Middle East, Latin America and Central Asiagrew from $18bn to $24.6bn between 2008 and 2012,this growth has not offset weaknesses in the EU, USand China, and some 63% of exports remain commodi-ties. Indeed, given the global correction in commodityprices, Indonesia’s trade with unconventional marketsdropped 3.63% in value in the first half of 2013, accord-ing to data from the Ministry of Trade. Growing gov-ernment involvement in trade finance should facilitateaccess to international markets for smaller exporters. BANK FINANCE: Tight global credit markets in theaftermath of the 2008-09 financial crisis have prompt-ed European banks in particular to deleverage their Asiantrade finance operations. Traditionally dominant Frenchbanks like BNP Paribas and Société Générale have hadto repatriate capital onshore Europe to cover their posi-tions, leaving space for other banks, including Asian andregional banks, to expand their presence in Indonesiantrade finance. While major global banks like HSBC, Citi,Standard Chartered and Deutsche Bank are very activein Indonesia, their books remain weighted toward exportfinancing in a roughly 60:40 split to imports. Domes-tic banks like Mandiri and BNI play a more significantrole in imports, with roughly two-thirds to three-quar-ters of their books on import financing, although theyhave been expanding export funding for non-tradi-tional markets such as African and ASEAN in particu-lar. BNI, ranked as Indonesia’s best trade finance bankby the Asian Banker awards, has invested Rp100bn($10m) in upgrading its trade finance platform to cater

to more regional development banks and expects toboost trade finance volumes by 15% to 20% in 2013,to $25bn-26bn. While the availability of US dollar liq-uidity has tightened significantly since May 2013, withexporters hoarding foreign exchange to benefit fromthe rupiah’s 17% devaluation in the first three quartersof 2013, Indonesian banks have closely matched theircurrency positions, with the industry’s average net-open position (the currency mismatch in their balancesheets) at only 2% in September 2013, according to Fitch. GOVERNMENT SUPPORT: While larger exporters caneasily access banks’ trade finance facilities, the govern-ment provides additional trade support covering areasfrom which conventional banks traditionally shy away.While foreign export-import (EXIM) banks from theUS, Japan, Korea, China and others finance some Indone-sian imports from their home countries, the govern-ment has been expanding support for the country’sexporters. The state-owned Asuransi Ekspor Indone-sia (ASEI), established in 1985, provides export insur-ance for non-hydrocarbons trade covering commer-cial and political risks. The body covers up to 85% oflosses and has achieved consistent growth, albeit froma low base, in recent years: its assets grew 34.77% year-on-year (y-o-y) to Rp1.3trn ($130m) in 2012, while itsprofit grew 36.78% to Rp92.8bn ($9.3m). Yet export cred-it insurance premiums accounted for only 5% of ASEI’stotal premiums at the close of 2012, even if this totalexpanded rapidly from Rp7.8bn ($780,000) in 2008 to40bn ($4m) by 2012. The Indonesian EXIM Bank (IXMB),which replaced Bank Ekspor Indonesia in 2009 and hasRp4trn ($400m) in capital, provides pre- and post-ship-ment trade finance to clients in key sectors like palmoil, hydrocarbons, mining and textiles, although it aimsto expand support for rubber, cocoa, coffee, fisheriesand other key exports. IXMB is also expanding its financ-ing of infrastructure-related trade, in support of the gov-ernment’s Masterplan for Acceleration and Expansionof Indonesia’s Economic Development. In total, it dis-bursed Rp32.1trn ($3.2bn) in trade finance and export

Exports to non-traditional

markets in Africa, the

Middle East, Latin America

and Central Asia grew from

$18bn to $24.6bn between

2008 and 2012.

37


Foreign EXIM banks from

the US, Japan, Korea and

China finance some

Indonesian imports from

their home countries, but

the Indonesian government

has been expanding

support for the country’s

exporters as well.

Easing accessThe government helps to reduce bottlenecks in finance


guarantees in the four years to September 2013, gen-erally at lower interest rates than the commercial banks.In the first three quarters of 2013 the bank reportedroughly half of its financing to manufacturing, while theother half was spread across logistics, warehousing, plan-tations and mining. Trade support remains highly con-centrated amongst larger corporates, however, whichaccounted for 91.28% of IXMB’s Rp27trn ($2.7bn) inlending in 2012, while SMEs accounted for 8.72%.

The bank expects to expand lending by 30% in 2013,while its trade finance book (including letters of cred-it) is forecast to expand by 60%, according to a state-ment by the bank’s CEO in July 2013. It already achieveda 32.5% y-o-y rise in financing in the first half of 2013. EXPANDING ROLE: While lending has remained driv-en by larger corporates, the geographical spread ofIXMB’s financing has broadened considerably, withtrade finance with non-traditional markets accountingfor 23.37% of all lending in 2012. This reflects grow-ing government efforts to support exports to non-tra-ditional markets, with IXMB targeting new markets inAfrica, the Middle East, Latin America, Central Asia andEastern Europe. In 2012 the bank said it provided tradefinance facilities to exporters to 14 new markets suchas Algeria, Ghana, Taiwan, the UAE and Lebanon. Inearly 2013 the government expanded IXMB’s role tomatch that of larger EXIM banks worldwide, by allow-ing the bank to finance importers in target countriesrather than just Indonesian exporters. This expandedsupport allows Indonesian exporters to narrow theprice differential when selling to non-traditional mar-kets. “Due to higher risk, our businesses have to chargea higher price when they sell in such countries,” IsnenSutopo, a director at IXMB, told the Jakarta Globe in Octo-ber 2013. “Other countries cover these risks, allowingtheir product to be sold at lower prices.” The bank thusco-financed contractors on foreign projects like the KingAbdullah Financial District in Riyadh and gas pipelinesin Malaysia, Azerbaijan and Timor Leste. It has also pro-vided financing for the construction of smelters in

Indonesia: $65m for Indoferro’s iron smelter in Cilegonand $25m for Sulawesi Mining Investment’s nickelsmelter. To fund the expansion in its dollar-denominat-ed trade finance book, IXMB has turned to internation-al bond markets and private placements. Following its$500m five-year Eurobond debut in April 2012, thebank raised a $500m, three-year syndicated loan throughthe Bank of Tokyo Mitsubishi UFJ and other partners inMay 2013. IXMB said it is looking to add another $120min 2014. This funding comes on top of bilateral agree-ments with other EXIM banks: a $100m loan from Japan-ese sources in 2012, including $60m from Japan’s Bankfor International Cooperation and $40m from Sumito-mo Mitsui Banking Corporation. INITIAL IMPACT: While trade with non-traditional mar-kets has been growing apace, these increases are froma low base. “Indonesia’s export diversification effortshave started to bear results,” the International Institutefor Sustainable Development (IISD), a Canada-basedNGO, noted in a December 2012 report on Indonesiantrade policy. Exports to Pakistan grew 22%, to Myan-mar by 56%, to South Africa and Colombia by over 100%and to Brunei Darussalam by a record 222.4% in 2012,Indonesia’s top 10 export markets still accounted for73.6% of total exports in the first half of 2013, up from69.7% in 2012, according to the Ministry of Trade. Whilea slowdown in demand from key markets and a globalcommodity price downturn have weighed on the val-ue of exports, efforts to expand Indonesia’s trade withnew markets face competition from other key Asianexporters. “While we are seeking to diversify our exportsto new markets, such as in Africa and Latin America,through greater government support for trade finance,this will take time and we will compete with otheremerging economies like China and India as they seekto do the same,” Luky Alfirman, head of the Ministry ofFinance’s centre for macroeconomic policy, told OBG.

As investment in Indonesia’s non-commodity sec-tors continues to grow, the authorities will need toexpand access to credit and export finance for its SMEs– key to reducing Indonesia’s reliance on commodityexports, which have preserved stable trading patterns.New trade agreements will be important to integrat-ing Indonesia into global trade and expanding exports,but support from financial institutions and governmentleadership will be critical to leveraging opportunities.

Greater support for trade finance will be needed intrade policy as well, however. “The focus shall be to devel-op a long-term strategy for export development intothese markets by looking at current and future exportopportunities and complementarities in product and resource endowments and core competencies,”Canada’s IISD noted in its report in December 2012.

38

SOURCE: Asian Development Bank

2008 2009 2010 2011 2012

Exports, fob ($ bn) 137.02 116.51 157.78 203.5 190.03

Imports, cif ($ bn) 129.2 96.83 135.66 177.44 191.69

Trade balance ($ bn) 7.82 19.68 22.12 26.06 -1.66

Trade position, 2008-12

The government is seeking to expand the availability of trade finance for its exporters, particularly SMEs

Exports to non-traditional

markets grew rapidly in

2012: those to Pakistan

were up 22%; to Myanmar

by 56%; to South Africa and

Colombia by over 100%;

and to Brunei Darussalam

by a record 222.4%.


TRADE & INVESTMENT INTERVIEW

Muhammad Lutfi, Minister of Trade

To what extent will China’s economic slowdown and

lower commodity prices impact Indonesia’s goals?

LUTFI: China is an important trade partner for us as itis our second-largest partner in the world. Despite Chi-na’s economic slowdown, the growth in trade betweenour two nations continues to reach double digits andwe enjoyed about a 16% growth in trade in 2013. Ona wider scale, although Indonesia is maintaining a tradedeficit, trade with both traditional and new partners isgrowing. The trade balance with the US, for example,has gone from declining year after year to a positivebalance. Furthermore, the structure of trade betweenIndonesia and nations across the world is shifting.

While our exports in the past have consisted of com-modities and raw materials, with our new partners weare seeing high growth in trade featuring the preva-lence of finished goods. Our trade growth with theUAE, for example, was 116% over between 2012 and2013. Similarly high growth, with partners across Africaand Latin America, is being observed as well: 187%growth in trade with Peru; 117% with Nigeria; and 72%with South Africa, to mention a few.

A crucial point is that with these nations, our exportsmainly consist of finished or half-finished products:crude palm oil, cooking oil, detergent, or textile prod-ucts. Indonesia is very competitive in these productsegments. So while our relationship with our tradition-al trade partners in the Pacific remains important, rightnow we are more interested in seeing developmentwith non-traditional markets. It is clear that the Indone-sian economy is connected to the world economy andI am confident that both will prosper in coming years.

How will Indonesia ensure its readiness for integra-

tion into the ASEAN Economic Community in 2015?

LUTFI: The success of the ASEAN Economic Commu-nity (AEC) is particularly important to Indonesia as weare the largest economy in the region. The Indonesianeconomy comprises about half of ASEAN’s combinedeconomy and Indonesians account for about 40% of

ASEAN’s population. Some people are nervous aboutthe changes that ASEAN integration will bring and donot fully understand the aim of the AEC.

The foremost goals of the AEC are to create a singlemarket and production base, to develop a globally com-petitive economic region, to have equitable econom-ic development across the region and to integrate theregion into the global economy. These goals are con-ducive to the success of the Indonesian economy and,as the largest economy in the region, Indonesia has themost to gain. As for the increased openness of tradewithin the region, Indonesia is well prepared as we havelong been a champion of free trade.

The way I see it, our trade laws mandate that the gov-ernment empower trading parties, both national andinternational, without differentiation, and integrationwill truly serve to advance this goal. There are, howev-er, some areas of preparedness in which Indonesia hassome ground to make up, such as the ability of our work-force to speak English, which is a barrier to the nationin exporting its talent to the region and the world.

What measures is Indonesia taking to improve man-

ufacturing values, and what more can be done?

LUTFI: Although Indonesia has extensive resources,our exports lag behind some regional neighbours inindustry. We need more processing capacity in Indone-sia, but this is not going to come without infrastruc-ture and a sound regulatory environment. I think thatwe are taking the right steps toward this positive evo-lution of the nation’s manufacturing and processingcapacities. One change that needs to take place forIndonesia to achieve its potential is to improve the con-nectedness of the archipelago. We have 50m peoplein East Indonesia who are ready to become the nextmiddle class, but are prevented from doing so becausethey are not connected to production systems. Indone-sia needs to improve electrification and infrastructurein these regions to spur industry and create a produc-tion base catering to regional and international trade.

39


Increasing integrationOBG talks to Muhammad Lutfi, Minister of Trade


More FDI is expected to tap into the region’s growing prosperity

Growing prosperity, improved wealth distribution anda burgeoning middle class are set to fuel a rapid rise inprivate consumption within the ASEAN bloc countriesin the coming years, a trend that will be given furtherimpetus by the greater regional integration that will fol-low the launch of the ASEAN Economic Community(AEC) in 2015. According to a report by ratings agencyMoody’s from late 2013, the ASEAN economies shouldaverage growth of 5% in 2014, in part driven by firm-ing global demand. This rise in global economic growthwill impact countries that are more export oriented,specifically Malaysia, Singapore and Thailand, the reportsaid. However, the strongest force pushing expansionof ASEAN economies will be domestic consumption,which Moody’s projects will account for half or moreof GDP expansion across the bloc.

This growing consumer power within ASEAN is areflection of the rising strength of the member states’economies and the more even distribution of wealthwithin those economies. Over the past three years, theeconomy of the ASEAN region has grown by an aver-age of just over 6%, its net worth rising from some$1.8trn to $2.3trn. This increase is set to continue.ASEAN leaders set the ambitious target of all but dou-bling the bloc’s GDP to $4.4trn by 2030 and reducingthe rate of those who live in poverty within the regionfrom the present level of around 18.6% to 9.3% in the15 years following the launch of the AEC. If the GDPtarget is reached – and given the current compoundannual growth rate within ASEAN it could well beachieved – this would create a massive expanded con-sumer market within the bloc, which will also see itspopulation base increase over the coming decade. LEVELLING THE FIELD: While consumer purchasingpower is nowhere close to being even within ASEAN,with high degrees of disparity in income levels, nation-al economic development and even access to servic-es, the playing field is beginning to level out. In 2012,the average growth of Indonesia, Malaysia, the Philip-pines and Thailand was 6.21%, while average growth

in Cambodia, Laos, Vietnam, and Myanmar was 6.52%.Although there is not much difference here, this is setto change in the future. With the narrowing of the gapbetween national economic growth, consumers in thecountries on the second tier of the ASEAN ladder willbe better positioned to enjoy the benefits of the AEC,which should further promote growth within the bloc.

Not all ASEAN economies will grow at the same rate,however, and no economy is immune to peaks andtroughs. With the AEC in place, export surges in somemember states of the bloc can benefit all, with themain beneficiaries of demand in foreign trade. Inverse-ly of course, a sharp downturn in overseas trade forexport-driven economies within ASEAN can affect inter-nal trade and regional consumer demand, though thiswill likely be offset to a degree by the bloc’s own dynam-ics. Still, greater integration within ASEAN should smoothout some of the worst effects of future downturns. Intra-bloc trade already accounts for 25% of all exports bymember states, a figure set to climb as final trade bar-riers are lowered and increased localised investmentboosts the capacity of ASEAN members to meet region-al demand for products. RECOGNISING CONSUMER STRENGTH: Since 2008,foreign direct investment (FDI) inflows to ASEAN havetrebled to $111bn, with more than 8% of global for-eign investment being drawn to the region. Solid FDIgrowth is expected to continue into the AEC era as thebloc’s increasing economic strength and consumerbuying power attract more overseas businesses look-ing to tap into the region’s rising prosperity.

While the ASEAN region will face challenges on itspath to achieving a more advanced level of economicintegration, the overall result will be a net benefit tomember countries and the consuming public. Strongerintegration will cushion the region from global exter-nal shocks such as the 2008 financial crisis, while atthe same time developing the world’s largest emerg-ing market. Most of all, a more affluent ASEAN socie-ty will propel the further rise of the ASEAN consumer.

If ASEAN reaches its target

of increasing the bloc’s

GDP to $4.4trn by 2030 –

and given its recent

compound annual growth

rate this could well be

achieved – this would

create a massive regional

consumer market.

40

Consumer strengthA rise in spending power should promote ASEAN-wide growth



Le Luong Minh, Secretary-General, ASEAN

What challenges do ASEAN countries face before

inaugurating the Economic Community in 2015?

MINH: We have already accomplished many of thetasks on the ASEAN Economic Community (AEC) Blue-print and intend to track remaining priorities via theAEC Scorecard system. While we are currently at ahealthy implementation rate of 80%, as we approachthe 2015 deadline, enhancing the implementation ofthese measures will become more critical. By 2015 allASEAN member states should align their domestic lawswith regional agreements, ensure a free flow of serv-ices and capital throughout the region, and addressaccompanying challenges of implementation. To ensurea free flow of goods, ASEAN is working to eliminate non-tariff barriers in all member states by installing notifi-cation and monitoring mechanisms.

We have also focused our attention on the full imple-mentation of the ASEAN Single Window, in addition tosecuring mutual recognition arrangements to raisestandards and conformance in various key industries.

How many sectors will benefit from foreign direct

investment (FDI) inflows after the AEC starts up?

MINH: Intra-ASEAN FDI inflows have doubled follow-ing the AEC Blueprint’s adoption, from $9.7bn in 2007to almost $20bn in 2012. As for total FDI flows toASEAN, the share of intra-ASEAN FDI inflows increasedfrom 11% in 2007 to nearly 19% in 2012. Over half ofintra-ASEAN FDI inflows have gone into the services sec-tor – specifically financial services, trade and com-merce, and real estate - while around one-third goesto manufacturing. Recent surveys have indicated thatthe business community sees great regional expansionpotential in the oil and gas, retail, transport and stor-age, manufacturing, and banking and insurance sec-tors. Foreign equity rules in manufacturing are fairly openin the ASEAN region but more restricted in the agricul-ture and mining sectors. As for services, foreign equi-ty restrictions in telecommunications, transportation,electricity and banking are still prevalent in a majority

of member states. The ASEAN Comprehensive Invest-ment Agreement (ACIA) of March 2012 lent a usefulmeasure of coherence to existing provisions pertain-ing to investment liberalisation, protection, promotionand facilitation under a single investment agreement.However, ASEAN’s task must now be to effectively imple-ment the ACIA to ensure that the benefits are realisedby ASEAN and ASEAN-based foreign investors.

To what extent can ASEAN work to develop a com-

mon approach to the South China Sea dispute?

MINH: Tensions in the South China Sea could have far-reaching implications for the regional economy. It isworth noting that this is not solely about how to dealwith issues of territorial sovereignty involving ASEANmember states and China; it is also a matter of how toensure normal activity on one of the world’s most activesea lanes. ASEAN concluded the Declaration on theConduct of Parties in South China Sea (DOC) with Chi-na in 2002 and has ever since been actively engagingChina in dialogue with a view to ensuring its full andeffective implementation. The spirit of the DOC was fur-ther strengthened with the ASEAN-China Joint State-ment on the guidelines for its implementation issuedon the occasion of its 10th anniversary.

In 2012, in the face of renewed tensions, ASEANadopted its Six-Point Principles on the South ChinaSea, reaffirming the commitment of all member statesto achieving the full implementation of the DOC inaddition to the provision of guidelines for its implemen-tation and the early conclusion of the regional Code ofConduct in the South China Sea. This was based on ourrespect for the principles of international law, includ-ing the 1982 UN Convention on the Law of the Sea,and a commitment to the exercise of self-restraint byall parties, as well as the peaceful resolution of disputes.By firmly upholding these principles, ASEAN is doing allthat it can to maintain peace and stability in the region,with a view to doing everything that is possible to facilitate the community’s ambitious plans for growth.

41


Preparing for tomorrowOBG talks to Le Luong Minh, Secretary-General, ASEAN

TRADE & INVESTMENT VIEWPOINT

Sri Mulyani Indrawati, Managing Director, World Bank

The global economy appears to be moving into a newphase, in which output in advanced economies is firm-ing, albeit probably not as strongly as we would haveliked. Developing country growth appears to be slow-ing, including in the Asia-Pacific region. Our retreat, ofcourse, came in the wake of the decision by the US Fed-eral Reserve to defer its tapering of quantitative eas-ing (QE). It is a positive move in the short term for bothdeveloping and high-income economies. We know gov-ernments have now been given some breathing space.Clearly the risks and uncertainty about eventual taper-ing remain. But this is the time for policymakers to seizethe moment to address domestic vulnerabilities andreduce external financing exposures.

So what is the economic outlook? For the most part,the views of the World Bank Group are similar to thoseof the IMF. Global GDP is projected to expand about2.4% in 2013 and gradually strengthen to around 3.2%and 3.5% in 2014 and 2015. Asia-Pacific EconomicCooperation (APEC) emerging markets and developingeconomies are forecast to contribute almost 50% offuture world growth. Outside of India, the impact of theexpected accommodating monetary policy on the Asia-Pacific region has been limited so far.

After slowing down for several quarters in a row,growth in China is showing signs of stabilising at 7.5%due to external conditions and domestic policy aimedat rebalancing growth away from investment andexports. Despite gradual adjustment to tighter finan-cial conditions, expansion in other developing coun-tries is firming or holding steady. However, for manyAPEC economies, the balance of risk is once again onthe upside. As QE policies are withdrawn, interest rateswill likely rise further, which will increase debt-servic-ing costs and raise the cost of capital. On the positiveside, however, when tapering does happen it will sig-nal further recovery in the US. Weaker exchange ratesin developing countries will boost exports over time.

China’s moves to rebalance away from its depend-ence on investment and rein in credit growth could have

significant implications for developing countries. Slow-er investment growth, and consequently slower GDPexpansion, could call into question the profitability ofpast investments and associated loans, with potentialeffects in the region over the medium term.

Excess capital inflows from loose monetary policieshave fuelled asset-price inflation in neighbouring coun-tries, increasing the risk of property bubbles. Thus, asliquidity is restrained and interest rates rise, the taper-ing of QE could have serious consequences in the APECregion. In countries that have already recovered fromthe crisis, macroeconomic policy stances may need tobe adjusted to contain or prevent inflation, asset-pricebubbles and deteriorating current accounts.

The countries most vulnerable to swings in global cap-ital flows could continue to strengthen their balancesheets, by reducing their reliance on short-term andforeign-currency-denominated debt. The significanteffort throughout the region to develop local curren-cy bond markets is clear evidence that policymakershave understood and responded to this need.

I am convinced that countries in the Asia-Pacificregion need to make structural reform a priority inorder to extend their growth potential, which remains1 to 2 percentage points below pre-crisis levels. In orderto sustain faster rates of growth, developing countrieswill need to redouble their efforts to reduce bottlenecksby improving their investment climate, investing ininfrastructure, making better use of their labour poolsand boosting productivity.

The APEC Finance Official Process, under Indonesia’schairmanship, has rightly identified infrastructure financ-ing as one of the priorities for the bloc’s discussion in2013. In times of uncertainty, it is particularly impor-tant to focus on long-term and stable investment.

Maintaining economic systems that allow people tobenefit from growth has been a feature of the econom-ic development in the Asia-Pacific region over the pastdecades. This is vital to ending extreme poverty and boosting shared prosperity. We hope it continues.

42

Extending growth potentialSri Mulyani Indrawati, Managing Director, World Bank, on the region’seconomic outlook



Liberalisation of financial services under the AEC is set for 2020

Indonesian authorities are making moves to liberalisecommerce by leveraging existing bilateral and multi-lateral trade agreements and moving ahead with clos-er integration with traditional partners. While its tradepolicy has not always been consistent in its liberalisa-tion in recent years, eliciting complaints through theWorld Trade Organisation (WTO), the authorities seekto balance the priorities of import-substitution, pop-ulist pressures for protectionism and the opportunitiesof greater integration with global trade. A wave of newtrade pacts under deliberation, covering goods andservices and investment, should serve as bellwethersof Indonesia’s appetite for wholesale liberalisation. TARIFF & NON-TARIFF BARRIERS: As a founding mem-ber of the WTO, Indonesia grants at least most-favoured-nation (MFN) treatment to all trading partners, with anaverage applied trade-weighted tariff of 2.5%, accord-ing to the Heritage Foundation. Following a five-yeartariff harmonisation up to 2010, the average simple tar-iff dropped from 9.5% to 7.8% between 2006 and 2012,with average tariffs on industrial goods at 7.5% and thoseon agricultural goods at 9.5%, according to the WTO.

While some 85% of tariffs are now in the 0-10%range, a number of non-tariff barriers remain. Theserestrictions were relaxed in April 2013 following highfood-price inflation, but trading partners see suchattempts as symptomatic of inconsistent trade policy.Technical barriers like sanitary standards are an issue,though the main non-tariff measures hindering tradeinclude licensing and quota regimes, trade logisticsinefficiencies (including Indonesia’s high cost of logis-tics, which amounted to 27% of GDP in 2012, accord-ing to the World Bank), intellectual property, publicprocurement procedures and subsidies. Meanwhile,restrictions on investment in the services sector remainhigh: the OECD’s 2012 Index of Investment Freedomranks Indonesia as the second-most-restrictive of the55 countries reviewed. DISPUTES: Since 2005 Indonesia has been involved in13 trade disputes through the WTO, including five as

a complainant, four as a defendant and four as a thirdparty. A recent controversial example was the imposi-tion in 2012 of import quotas and strict licensing rulesfor importers of horticultural and animal products,restricting imports through four secondary ports, whichelicited a request-for-consultation by the US (the firststep toward a formal complaint) at the WTO in January2013. Other examples of restrictive trade practices byIndonesia include the 2009 Mining Law’s minimumdomestic sales requirement for coal producers (at a sub-market price), and rules introduced in May 2013 lim-iting the number of convenience stores and restaurantsthat a multinational company can operate in partner-ship with local investors.

Examples of Indonesian complaints under the WTOinclude cases against the US and Australia regardingexport restrictions on Indonesian cigarettes and arequest-for-consultation on EU anti-dumping meas-ures covering fatty-alcohol imports. TRADE AGREEMENTS: Despite such frictions, Indone-sia is party to six multilateral free trade agreements(FTAs) through ASEAN as well as bilateral FTAs with Japansince 2007 and Pakistan since August 2013. South-east Asia’s largest economy also has 63 bilateral invest-ment treaties and 17 other investment agreements,according to the UN Conference on Trade and Devel-opment (UNCTAD), which range from dual-taxationtreaties, the latest signed with Hong Kong in Novem-ber 2012, to sector-specific liberalisation efforts.

Accounting for some 40% of the bloc’s GDP, Indone-sia stands to benefit from the ASEAN Economic Com-munity (AEC), expected to take shape by end-2015 (seeCountry Profile chapter). While the ASEAN agreementcontains important exceptions for banks and financialservices, whose liberalisation is extended to 2020, lib-eralisation of trade in goods and services as well asinvestment within the region should support multina-tionals’ investments in expanding production and sup-ply chains regionally. This trend is already pronouncedin the automotive and electronics segments, for instance

The average simple tariff

dropped from 9.5% to 7.8%

between 2006 and 2012,

with average tariffs on

industrial goods at 7.5%

and those on agricultural

goods at 9.5%.

43


Indonesia is party to six

multilateral FTAs, as well as

bilateral FTAs with Japan

and Pakistan, 63 bilateral

investment treaties and 17

other investment

agreements.

Striking dealsLeveraging bilateral and multilateral agreements to boost trade


(see analysis). In the meantime, ASEAN has multilater-al FTAs in place with key Asia-Pacific countries, includ-ing China, India, Japan, South Korea, Australia and NewZealand. While these FTAs did not provoke a surge intrade in and of themselves, trade has grown consistent-ly over the past decade – Indonesia-China tradeincreased fourfold to reach $66.2bn in the seven yearsto 2012, for instance. China is intent on further devel-oping two-way market access. “In the immediate futurethe two sides must work to elevate the level of the Chi-na-ASEAN Free Trade Area by opening up our markets,”Chinese President Xi Jinping said.

The conclusion of these FTAs has brought tariffs withthose involved down to the 0.8-5.9% range, accordingto the WTO. The cost of applying for Certificates of Ori-gin (COOs), required to prove eligibility under the FTAsand ranging from 3% to 5% of the final cost of prod-ucts, according to the Ministry of Trade (MoT), meansthat larger firms and sub-contractors have benefittedmuch more than small and medium-sized enterprises.Nonetheless, the number of COOs under the variousASEAN FTAs surged from 26,085 certificates covering$1.9bn in trade (equal to 2% of total non-hydrocar-bons trade) in 2006 to 205,775 COOs covering $19.9bnin trade (16% of non-hydrocarbons trade) by 2010,according to MoT data. The government sees the poten-tial in FTAs. Indeed, the MoT expects an immediateimpact of an additional $100m in bilateral trade in thefirst year as a result of the Pakistan-Indonesia FTA, andan extra $1.5bn-2bn in trade in 2014. ONGOING NEGOTIATIONS: The MoT aims to expandmarket access for key non-hydrocarbons exports, plac-ing the highest priority on 10 products: textiles, footwear,rubber, palm oil, forestry products, shrimp, cocoa, cof-fee, automobiles and electronics. While these are estab-lished exports, the MoT plans to expand trade in goodswhere exports are marginal, like leather, medical appli-ances, medicinal herbs, essential oils, processed food,fish products, spices and handicrafts. Indonesia’s pref-erential market access under the Generalised System

of Preferences (GSP) with the EU, but also the US andEuropean Free Trade Association (EFTA) countries, isslated to end in 2014. As such, a number of new FTAsare under negotiation to replace the existing scheme.

After the failure of attempts by the EU to negotiatean ASEAN-wide multilateral FTA, the bloc has soughtbilateral trade agreements with individual ASEAN mem-bers since 2009, known as Comprehensive EconomicPartnership Agreements (CEPAs). Indonesia has also heldeight rounds of negotiations toward an FTA with EFTAsince 2010. “Political and private-sector support for aCEPA between Indonesia and the EU is there, althoughthe devil will be in the details of negotiations once theystart,” Oliver Oehms, senior advisor on trade and devel-opment at the Indonesian Chamber of Commerce andIndustry (KADIN), told OBG. “Negotiations since 2010on an FTA with the EFTA countries – Switzerland, Nor-way, Iceland and Liechtenstein – are ongoing, but withthe sectoral preferential market access conferred bythe EU’s GSP expiring in 2014 already, a new tradeframework with the much larger EU market is equally,if not more, important.”

In parallel, Indonesia is part of a 12-nation effort ledby the US for a Trans-Pacific Partnership (TPP), an FTAcovering 800m people and some 40% of global GDP.While exploratory discussions on bilateral FTAs withIndia, Chile and Iran are also under way, the most com-prehensive liberalisation efforts involve negotiationswith the EU and US, separately. Sectoral policies suchas Indonesia’s agricultural support schemes will be onedetermining factor, and the EU is intent on includingall so-called Singapore issues in the CEPA negotiations.These include rules on public procurement, intellectu-al property, e-commerce, the role of state-owned enter-prises and access for services and investment, a sourceof friction with most countries regionally. The TPP nego-tiations, which are secret but which the US trade rep-resentative hopes to conclude by end-2013, are saidto include all Singapore issues as well.

Despite the pressure exerted by the looming end ofthe GSP in 2014, the value of Indonesia’s trade withthe EU is overshadowed by the 70% of its trade focusedon Asia. While trade with the EU accounts for 9% ofIndonesia’s total trade, the bulk of this is with coun-tries or in sectors not covered by the GSP, accordingto World Bank estimates. RECIPROCITY: While Indonesia lags regional peers likeThailand and Malaysia in the number of trade pacts inforce, its authorities are conscious of the need to securepreferential market access to support the expansionof its non-hydrocarbons exports. This will require rec-iprocity from Indonesia. Whereas such trade deals aresignificant in lowering average tariffs, Indonesia mustwork on facilitating trade for smaller exporters (seeanalysis), but also in dismantling non-tariff barriers totrade. Improving the country’s business climate anddeveloping its trade logistics to seize opportunities willalso be crucial to helping monetise greater access. “Wemust end our logistical inefficiencies and increaseIndonesia’s ability to compete among ASEAN memberstates,” Suryo Sulisto, the chairman of KADIN, told OBG.

44

Indonesia is part of a 12-nation effort to consolidate 40% of global GDP under a single trans-Pacific FTA

The number of COOs under

ASEAN FTAs surged from

26,085 covering $1.9bn in

trade in 2006 to 205,775

covering $19.9bn in trade

by 2010.

The MoT is expanding

market access for

non-hydrocarbons exports

to diversify the mix, with

the highest priority on 10

products: textiles,

footwear, rubber, palm oil,

forestry products, shrimp,

cocoa, coffee, automobiles

and electronics.



Paul Wolfowitz, Former US Ambassador to Indonesia

While continuing on its path to reform, what key

areas should Indonesia focus on improving?

WOLFOWITZ: Indonesia has undertaken significanteconomic and political reforms since my time as ambas-sador there 25 years ago, and is now the world’s third-largest democracy. That it has done so successfully isnothing short of remarkable.

Just 15 years ago Indonesia was in the midst of anAsian financial crisis and the country’s real GDP hadfallen by some 14% in real terms in a single year. Today,however, economic growth is hovering under 7% annu-ally, with the country also looking forward confidentlyto democratic elections in 2014. While this is no smallaccomplishment, Indonesia cannot afford to sit on itslaurels, as the progress of recent years has only whet-ted the nation’s appetite for further progress.

Everyone seems to agree on at least two major chal-lenges facing the country. One is the need to confrontcorruption that is holding back economic growth andaffecting public confidence. To the government’s cred-it, efforts are being made to fight corruption and offi-cials are being prosecuted frequently, though lawenforcement alone is not the answer to the problem.What is needed might be called a “cultural change”, andthis cannot happen overnight. At the same time, a newgeneration of Indonesian leaders are also emergingwho understand the need to bring the country up toglobal standards of governance in this regard.

Second, is the need to improve the country’s infra-structure and traffic, particularly in Jakarta. This maybe a simpler problem to solve because it is not a cul-tural one, but there are significant legal and socialissues, in addition to the need for physical investment.

There is a third problem that concerns me, and Iknow that it concerns many Indonesians as well. Thatis the ability of extremist Muslim groups to operatewith apparent impunity, intimidating people they dis-agree with and even, in the worst instances, burningchurches and mosques of minority Muslim sects whichthey regard as heretical. I am not talking about terror-

ism. Indonesia has done a good job of fighting home-grown terrorists like the ones who perpetrated thebombing in Bali 10 years ago. But these violent extrem-ists are a problem. Even though they are still only a smallminority of Indonesia’s population, nonetheless theyare a blot on the country’s mostly well-deserved rep-utation for religious tolerance and more needs to bedone to bring them to justice when they break the law.

What role do you foresee for Indonesia in the wake

of moves by China and the US to further assert

themselves in the Asia-Pacific region?

WOLFOWITZ: China is looking for a greater role in theregion, while the US seems to be pulling back from for-eign commitments in general. Indonesia has, I believe,multiple roles to play in the unfolding future of theAsia-Pacific. First, the country is emerging as a leadingplayer in the ASEAN group – 10 countries with a com-bined population that is roughly half of China’s – whoseeconomies, for the most part have been growing steadi-ly. Second, Indonesia may be able to play a construc-tive mediating role on issues between other countries.Lastly, the country should try to play an active role inkeeping the US engaged in East Asia.

To what extent do you expect US trade relations in

the region to benefit from resolving the Trans-Pacif-

ic Partnership (TPP) negotiations?

WOLFOWITZ: The TPP negotiations are one of themost creative initiatives that the Obama administrationhas undertaken in the Asia-Pacific region. A success-ful outcome would benefit the US considerably, along-side the other countries involved in the negotiations.

The significant challenge, of course, is resolving thekey issues between the US and Japan. But I believe thata unified ASEAN approach could improve the chancesof success if the ASEAN member states recognise theneed to address protectionist forces in their own coun-tries. If, however, ASEAN becomes another protection-ist bloc, then that will not be beneficial for the TPP.

45


A key partnerOBG talks to Paul Wolfowitz, Former US Ambassador to Indonesia, andVisiting Scholar, American Enterprise Institute


Wishnu Wardhana, Chair, APEC Business Advisory Council 2013

How is ABAC prioritising the deepening of econom-

ic integration in the Asia-Pacific region?

WISHNU: First, I should highlight two important shiftswhich shape the way ABAC thinks today. In a globalmacro-economic context, we are now entering whateconomists call “the new normal”. Following the 2008-09 financial crisis our economic performance was basedon two factors: commodity prices and cheap moneystemming from the quantitative easing (QE) policy. Nowcommodity prices have fallen to new lows, and thetapering of QE is only a matter of time. Second, our cur-rent business model has evolved significantly fromwhen APEC was established 25 years ago, at a time whena particular product would be designed, produced andmarketed all in one country. Thus, in 2013 ABAC pushedto deepen economic integration through the promo-tion of a Foreign Trade Area of the Asia-Pacific, via boththe Regional Comprehensive Economic Partnershipand the Trans-Pacific Partnership.

How can access to finance for infrastructure proj-

ects be improved across Asia?

WISHNU: We have been discussing public-private part-nerships for a long time, yet progress is still below ourexpectations. In my view, there are three elements thatneed to be addressed by the public sector to catalyseprivate investment in infrastructure. First, the regula-tory environment for infrastructure must be eased, asprivate sector players want their investments to pro-vide adequate returns. Second, project readiness mustbe pre-confirmed by governments, so that projects arenot delayed and investors are not laden with unfore-seen costs. Third, while sovereign funds and multilat-eral banks are at the forefront of infrastructure financ-ing, long-term instruments like the Asian InfrastructureFund can be utilised, in addition to specific infrastruc-ture bonds, which can attract finance from commer-cial banks or pension funds. Indonesia has housed along list of promising infrastructure opportunities, butthe investment environment has tested such projects.

The poor utilisation of low interest money in the lastfour to five years can be viewed as a missed opportu-nity, but in truth, the central issue remains the tradi-tional problem of legal and regulatory uncertainty, inaddition to poor coordination between institutions andthe central and local governments.

How can small and medium-sized enterprises (SMEs)

gain better market access throughout the region

as well as better access to finance?

WISHNU: ABAC believes that SMEs should be betterintegrated into the global value chain and productionnetworks. SMEs are often limited to producing goods,while their potential to be part of the global produc-tion network is overlooked. We can learn in this regardfrom China, Taiwan and South Korea, which have nur-tured SMEs and integrated them into value-added prod-uct lines in segments like automobile components andIT products. We have made similar policy recommen-dations to the APEC economic leaders. There are alsoways to improve access to finance such as, for exam-ple, Bank Indonesia’s branchless banking programmeor mobile banking as a way to reach SMEs.

How will the 2015 ASEAN integration change the

landscape for foreign investment in the region?

WISHNU: ASEAN integration will change the landscapefor foreign direct investment because, within ASEAN,we have both synergy and competition. In terms ofcompetition, I tend to see it sector by sector. Singapore,for example, is obviously strong in services but not innatural resources. Hopefully, Indonesia will be able tocollaborate with the service industries offered by Sin-gapore, such as those in the logistics or financial sec-tors, to improve competitiveness. In agricultural, directcompetition between Indonesia, Thailand and Vietnamis clear, but this should have a positive impact on moti-vation. Overall, with the largest population, naturalresource capacity and human capital, Indonesia will remain the most attractive investment destination.

46

Competitive edgeOBG talks to Wishnu Wardhana, Chair, APEC Business Advisory Council(ABAC) 2013, and President Director and Group CEO, Indika Energy



FDI has sustained 22% average annual growth for the past six years

While foreign direct investment (FDI) has sustained22% average annual growth over the past six years,according to statistics from HSBC, the compositionof investment has broadened beyond the tradition-ally dominant extractive industries. As part of a region-al rebalancing of FDI, the focus of investment intoIndonesia is shifting from purely resource extractionto services and manufacturing, in both low-end, labour-intensive industries and end-stage production of auto-motives and electronics. Both Asian and traditionalWestern investors are expanding their regional pro-duction chains to include Indonesia, to supply thequickly growing domestic market, but also to build outexports. With Japan leading the way, overtaking Sin-gapore as the largest investor in Indonesia in 2013,foreign investors are leading the process of regionalintegration of production networks. Ranked fourthglobally as a prospective investment destination in theeyes of multinationals after China, the US and India,according to the UN Conference on Trade and Devel-opment’s (UNCTAD) “2013 World Investment Report”,Indonesia is attracting a broader set of investors to agrowing array of industries. Key to maintaining Indone-sia’s macro-economic balance will be steering invest-ment toward production of intermediate goods tosubstitute for surging investment-linked imports. PRIMARY SECTOR: Despite the broader focus of FDI,the primary sector remains a key driver of investment,rising 60.5% to $4.88bn in 2011 and another 21.5%to $5.93bn in 2012, driven primarily by investment inmining as well as food crops and plantations, accord-ing to the Indonesia Investment Coordinating Board(BKPM). Investment in mining and quarrying, whichincludes oil and gas, nearly doubled from $2.2bn in2010 to $4.1bn in 2012, and reached $3.37bn in thefirst quarter of 2013, 19.1% of all FDI and the largestsingle target sector. While mining’s share of FDI hasdeclined from the 23.2% it commanded pre-2008,according to the American Chamber of Commerce inIndonesia, a number of large projects have been

unveiled in recent years. Although the oil and gasindustry still faces regulatory challenges, players likethe US’s Chevron are expanding their investments, par-ticularly in natural gas. The Ministry of Energy and Min-eral Resources forecast $26.2bn in total investmentin hydrocarbons in 2013, led by France’s Total, Britain’sBP and Chevron, but also regional players like Thai-land’s PTT (see Energy chapter).

Despite new export taxes on mineral exports andrequirements for phased divestments to domesticinvestors over six to 10 years introduced over thepast two years, investment in mining and associatedprocessing facilities sustained a 23.8% year-on-yearrise in the first half of 2013. This includes a numberof cross-border acquisitions, such as PTT’s purchaseof a 55% stake in Sakari Resources for $1.15bn inAugust 2012, South Korean LG’s purchase of 60% ofGanda Alam Makmur for $224m in July 2012 and Aus-tralia’s Killara Resources buying 80% of Borneo EmasHitam in East Kalimantan for $26m in May 2013, allcoal producers. Indian investors have also made sig-nificant acquisitions in Indonesia, particularly since2009, when the FDI cap on mining investment wasraised to 100%. Tata Power’s 2007 acquisition of KaltimPrima Coal for $1.3bn was followed by purchases byAdani Group, Essar and GMR.SURGING DOWNSTREAM: With the government’splanned deadline for ending all unprocessed miner-al exports in 2014 approaching, investments in down-stream processing have also accelerated. The topthree investors in downstream mining are South Korea,Australia and the UK, according to BKPM. Chinesecompanies are backing at least seven nickel smelterprojects, including ones by China Hanking Holding,Tsingshan Group, Central Omega Resources and Chi-na Nickel Resources. Other newcomers include France’sEramet, which has committed to investing $5.5bnwith its joint-venture partner Mitsubishi in a nickelsmelter in North Maluku from mid-2013. Meanwhile,China’s Shandong Nanshan Aluminium Company began

47


The primary sector has

remained a key driver of

investment, seeing a 60.5%

increase to $4.88bn in 2011

and another 21.5% bump

to $5.93bn in 2012, with

much of this going towards

mining, food crops and

plantations.

Diversifying sourcesAttracting investors to a wider range of industries is a priority


developing a $5bn bauxite smelter in Bintan duringthe third quarter of 2013. However, while miningremains the key driver of primary-sector investments,agriculture and plantations are also key draws for FDI.

Indonesia’s agricultural land covers approximately30% of the nation’s total landmass, but there is sig-nificant scope for expanding output. The Ministry ofAgriculture reported some $12.4bn in cumulative agri-cultural investment between 2010 and March 2013,accounting for 13.1% of all investment during theperiod, driven by investors from Singapore, Taiwanand Japan. With some 6m ha of land cultivated forcrude palm oil (CPO) and a further 4m planned by 2015,palm oil is the largest draw for investment, butdepressed international prices have delayed someplans. Singapore’s Mewah International put on holdplans to invest $355m in a CPO refinery in East Java,saying it would revisit the plans in late 2014. The Mer-auke Integrated Food and Energy Estate project on2.5m ha has attracted investments from global com-modities firms Wilmar and Noble.

The US’s Cargill is investing $100m in a new cocoa-processing plant in East Java, while China’s New HopeGroup announced investments of $155m in early2013 to develop two feed mills and poultry breeding. SECONDARY INDUSTRIES: Indonesia has a well-established low-end, labour-intensive manufacturingbase, focused on textiles and footwear, but investmentsare now increasing and broadening to more con-sumer-related industries. FDI into the secondary sec-tor rose 102% to $6.79bn in 2011 and 73.4% to$11.77bn in 2012, driven primarily by investment infood processing, textiles, chemicals and pharmaceu-ticals, automotives and electronics, according to BKPM.

The $7.18bn invested in manufacturing in the firstthree quarters of 2013 accounted for 40.7% of all FDI,second only to investment in services. According toDeloitte’s 2013 Global Manufacturing CompetitivenessIndex, Indonesia ranks 17th, and is expected to improvein coming years, on the back of a “gradual shift in low-

technology or labour-intensive jobs from China toBangladesh, Vietnam and Indonesia”. More tradition-al industries like textiles still attract significant invest-ment, particularly from Chinese firms that have been outsourcing business components from their mainland bases. In 2012 the China Hi-Tech Groupannounced its plans to invest $6bn in a textiles com-plex and associated port located at Wonogiri, CentralJava, in partnership with the local firm, Sritex.

While significant investment is flowing into con-sumer-related sectors like packaging and food pro-cessing, the single largest investment in the past twoyears was in cosmetics, by French firm L’Oreal, whichopened its largest production facility in Cikarang, WestJava, in late 2012 at a cost of Rp1.2trn ($120m), with70% of output set to be exported. AUTOMOTIVE: Buoyed by booming domestic demandfor automotives, more capital-intensive manufactur-ers like vehicle assemblers are expanding their pres-ence in Indonesia. Japan has long led the way, withmajor producers like Toyota, Nissan, Honda and Suzu-ki increasing their investments. Toyota announcedplans in November 2012 to invest $2.7bn over the longterm, starting with $1.3bn over five years by expand-ing its existing Karawang facility by a fifth, develop-ing two greenfield plants (including one for subsidiaryDentsu) and its first local engine factory. Meanwhile,Nissan is investing $400m in a new factory, to be com-mercialised in 2014; Suzuki is spending $611m on afuel-efficient mini-car plant and $384m on an enginefactory; and Honda is investing Rp3.3trn ($330m) ina fourth Karawang motorcycle plant and $340m in asecond car assembly unit. Other Asian producers likeHyundai are expected to unveil plans in 2014, andWestern producers are following suit, with GeneralMotors investing $150m to reopen its Bekasi plant,Volkswagen spending $266m on a fuel-efficient carfactory to be built by 2015, and Caterpillar develop-ing a $150m mine-truck assembly plant in Batam.

The latest investment announcement came in Octo-ber 2013 when India’s Mahindra & Mahindra and itsSouth Korean subsidiary, SsangYong Motor, announceda $900m investment in a factory producing threemodels and six engines, over the next five years. Keyautomotive suppliers are gradually following assem-blers. While Indonesia has an extensive rubber indus-try and ranks as the world’s third-largest exporter,international investment in domestic tyre manufac-turing has accelerated in recent years. FollowingMichelin’s acquisition of 10% of South-east Asia’slargest tyre manufacturer, Gajah Tunggal, in 2004, thelargest investment was announced in 2012 whenSouth Korea’s Hankook unveiled $1.1bn investmentplans, including $353m in a rubber-processing facto-ry and the balance in its seventh tyre plant worldwidein Cikarang. Commercialised in September 2013, thetyre factory will boost output from an initial 4.3mtyres a year to 6m in 2014 – 70% of which for export.Meanwhile, a consortium of four companies, includ-ing Taiwan’s Cheng Shin Rubber Industry, which pro-duces Maxxis tyres; Apollo Tires; JK Tyre; and Shandong

48

The investment mix is steadily transitioning from a focus on extractive industries to manufacturing

The Ministry of Agriculture

reported some $12.4bn in

cumulative agricultural

investment between 2010

and March 2013,

accounting for 13.1% of all

investment during this

period.



Group, is investing some $1.28bn in a tyre manufac-turing facility in South Kalimantan. Electronics produc-ers are also taking note. Japan’s Sharp is investingRp1.2trn ($120m) in a factory producing 140,000washing machines and 220,000 refrigerators permonth, with first production set for end-2013. WhileSouth Korea’s Samsung is still studying local mobile-phone assembly plans, Taiwan’s Foxconn, a key Applesupplier, announced plans to invest as much as $10bnto build up Indonesia as its production base in South-east Asia. Investment is also flowing toward interme-diate industries from petrochemicals and steel tocement. The single largest investment comes from theworld’s second-largest steelmaker, South Korea’sPohang Iron and Steel Company (POSCO), which since2009 has partnered with Krakatau Steel to develop a$6bn, 6m-tonne-per-year mill in Banten, with the first3m tonnes of capacity set to be operational in 2014.While Krakatau’s 2012 agreement with Nippon Steeland Sumitomo Metal to invest $378m in a secondnew steel factory to supply domestic automotive pro-ducers has elicited complaints from POSCO, the SouthKorean firm plans for an additional $5bn in investmentby 2017 in cold steel, nickel smelters and energy proj-ects, including a 600-MW coal-fired power plant inSouth Sumatra. Also in heavy industry, Honam Petro-chemical Corp, a subsidiary of Lotte Group, plans toinvest $5bn in a naphtha cracker, having acquiredTitan Chemical Corp in 2010. South Korea’s LG unveiledplans in March 2012 to develop a $3bn petrochemi-cals complex adjacent to BP’s Tangguh in partnershipwith local oil and gas firm Duta Firza. The complexincludes two 3500-tonne-per-day urea plants, two2000-tonne-per-day ammonia plants and a methanolfactory, due for commercialisation in 2017. Chinesefirms are targeting the cement industry for significantinvestments: the State Development and InvestmentCorp’s $200m cement plant and associated seaportin West Papua is due to break ground in 2013, whileAnhui Conch Company has started construction on a$500m cement plant in South Kalimantan.SERVICES: Despite declining FDI in the tertiary sec-tor, which dropped 20.5% to $7.8bn in 2011 and 12%to $6.86bn in 2012, according to BKPM, Indonesia’sservices sector continues to draw investment, partic-ularly in transport and communications as well as infinancial services and retail. Although its share of totalFDI declined from 60.7% in 2010 to around 35.3% inthe first quarter of 2013, the sector has witnessed anumber of cross-border mergers and acquisitions andgreenfield investments in the past two years. USinvestors have targeted property and insurance plays,with Jones Lang LaSalle acquiring Procon Indah toform the largest property consultancy in Indonesia in2011 and ACE Insurance buying leading general insur-er Jaya Proteksi for $130m in 2012. Cash-rich Japan-ese conglomerates have also flooded into Indonesia,with Sumitomo Mitsui Banking Corp acquiring a 40%stake in Bank Tabungan Pensiunan Nasional (BTPN)from TPG Capital in May 2013 for roughly $1.5bn.Insurers have also made significant purchases, with

MSIG, Tokio Marine, Meiji Yasuda and Dai-ichi Lifeacquiring stakes in life insurers since 2011. SouthKorean investors are particularly active in bankingand insurance, with the presence of major banks likeHana Bank, Korea Exchange Bank and Woori Bank aswell as insurers like Samsung Fire & Marine. In retail,Ikea’s $100m investment in its first store in Banten ina joint venture with the Hero Group in 2013 is symp-tomatic of growing interest in distribution, followingin the steps of major retailers like Carrefour and Tesco.In addition, Indian investors are studying opportuni-ties in IT and business process outsourcing.

Buoyed by opportunities in the Masterplan for Accel-eration and Expansion of Indonesia’s Economic Devel-opment, investors are also participating in major infra-structure projects, mainly in power and transport.Chinese firms have invested $7bn in infrastructure overthe past decade, according to UNCTAD, with majorupcoming projects including a joint project by ChinaPower Investment Corp and Anhui Conch Cement fora $17bn, 7000-MW hydroelectric complex in CentralKalimantan announced in May 2013 and China Hua-dian Corp’s $630m power plant in Bali. Japanesebuilders Sumitomo Mitsui Construction, Obayashi andShimizu are participating in the partly JICA-fundedmass rapid transit railway in Jakarta, while Itochu andElectric Power Development are investing in the $4bn,2000-MW independent power plant in Java.

While Asian investors have led growing investmentin Indonesia, with Japan overtaking Singapore in 2013as the largest foreign investor, FDI is coming fromincreasingly diversified sources and targeting a broad-er array of sectors. Much of FDI in manufacturing isaimed at end-use production destined for the domes-tic market, although investment in intermediate indus-tries is gradually rising. The challenge for authoritieswill be to steer greater investment toward interme-diate and import-substitution industries to plug thecountry’s current account deficit, just as investorsare drawn to the growing pool of domestic consumers.

51


Retailers are flocking to Indonesia to capitalise on the significant potential of its large consumer base

Even though the tertiary

sector has seen a drop in

FDI, which fell 20.5% to

$7.8bn in 2011 and 12% to

$6.86bn in 2012, services

and infrastructure continue

to attract interest.

53

EconomyWorld’s 16th-largest economy with GDP of $824bnStrong fundamentals in place for long-term growthMaster plan to accelerate infrastructure developmentAuthorities take action to curb further growth in deficitMaintaining progress on unemployment a priorityEnabling greater foreign investment in key sectorsWorking to boost investment into East Java

ECONOMY OVERVIEW

GDP was $824bn in 2012, representing a fourfold increase in a decade

Following a decade of averaging 6% growth per year,Indonesia’s economy faced both external and inter-nal challenges in 2013. The world’s 16th-largest econ-omy with GDP of Rp8242trn ($824bn) in 2012, whichis a fourfold increase in a decade, and the fourth-mostpopulated with 247m citizens, Indonesia has strongfundamentals for long-term growth. While the sharpreversal of foreign portfolio investment (FPI) flows fromMay 2013 emphasised economic imbalances, author-ities are seizing on the sense of crisis as an opportu-nity for enacting needed structural reforms. With anelection year looming, however, the onus for rapidaction is on Bank Indonesia (BI), which adopted amonetary tightening stance that will slow economicgrowth and redress imbalances. “We know we willeventually return to a pre-quantitative easing world,”Luky Alfirman, head of the Ministry of Finance’s (MoF’s)centre for macroeconomic policy, told OBG. “We canno longer rely on high foreign portfolio inflows anda commodities super-cycle, so we are looking to read-just.” Despite external headwinds, its long-term growthtrajectory should put Indonesia among the world’s 10-largest economies by 2030, according to consultan-cy McKinsey & Company, with a 141m-strong middleclass by 2020, double its present size, according toBoston Consulting Group. Yet Indonesia needs tobridge gaps in its social and economic infrastructure,both hard and soft, to leverage a demographic divi-dend, as half of its population is below the age of 30. CONSISTENT: Indonesia has sustained a consistentgrowth record since 2003, the year its economy sur-passed the pre-Asian financial crisis peak of 1997.While growth slowed in the wake of the global finan-cial crisis that began in 2008, it remained a healthy4.6% in 2009, bolstered by high domestic consump-tion. Although growth cooled from a high of 6.8%year-on-year (y-o-y) in the fourth quarter of 2010 to6.5% in 2011 and 6.2% in 2012, this above-averageexpansion was sustained despite the country’s firstnegative export growth in 2012. Consumption has

grown steadily on the back of rising disposableincomes, with GDP per capita of $3596 in 2012. Butat only three-fifths China’s income levels and one-thirdof Brazil’s, per capita income growth is only midway,according to private equity firm KKR, which expectsa 40% aggregate rise in the five years to 2017. “Whilethe significance of GDP per capita approaching $4000is undeniable for the consumer marketplace, in Jakar-ta the level is probably nearer $12,000,” Rudy Tanoe-soedibjo, the president director of MNC Sky Vision, toldOBG. Rural-urban migration, which drove the urbanpopulation from 41.9% in 2000 to 51% in 2012, accord-ing to the UN Development Programme, has drivenproductivity growth and an expansion in the labourforce (see analysis). Despite its sizeable population,low credit penetration and lower-middle-income pur-chasing power mean Indonesia’s consumer industriesare in their nascent stages.

“Due to the rise of purchasing power of the Indone-sian public, we are seeing a lot of growth potentialfor consumer-driven industries including the automo-tive, retail and entertainment sectors,” Prem Harjani,the president director of Vivaces Prabu Investments,told OBG. As the middle class continues to expand from18% of the population in 2012 to 35-45% by 2030,according to McKinsey, the tertiary sector is boundto grow. Despite relatively high inequality, with a Ginicoefficient of income inequality that rose from 0.36to 0.38 in 2012, and 115m people living on less than$2 a day, the large domestic consumption engine hasinsulated Indonesia from volatility in world trade. Inthe coefficient, zero represents perfect equality, whileone represents inequality. FOREIGN DIRECT INVESTMENT (FDI): However, asan open economy Indonesia remains vulnerable to rap-id changes in global investor sentiment. The countryhas arguably been a victim of its own success: attract-ing record levels of FDI, reaching $24bn in 2012 ($32bnwhen including hydrocarbons and mining) targetingmanufacturing and consumption-related sectors, the

Bank Indonesia has

adopted a monetary

tightening stance that will

slow the pace of economic

growth and redress

imbalances.

55


Despite relatively high

inequality and 115m

people living on less than

$2 a day, the large

domestic consumption

engine has insulated

Indonesia from volatility in

world trade.

Tighten upThe authorities are taking the opportunity to enact structural reforms

ECONOMY OVERVIEW

current account has remained in a growing deficit sincethe fourth quarter of 2011. In the absence of a broadindustrial base, particularly for the production of inter-mediate and capital goods, rising FDI has spurredgrowing imports (see analysis). With FDI covering onlytwo-thirds of the value of the current account deficit,FPI has been crucial in insuring the balance of pay-ments. With FPI accounting for half of Indonesianequities and one-third of its bonds in 2013, sharpsell-offs have a destabilising effect on its currency andeconomy. While growth projections have been cut toa range of 5.2% (from the IMF) to 5.9% (from the MoF)in 2013 and 5.5-6% in 2014, this remains higher thanthe emerging markets average of 4.5% for 2013. STRUCTURAL DRIVERS: Key to this sustainablegrowth has been the economy’s diversified base.Although agriculture employs 35% of the workforceit accounts for just 15% of GDP. Since 2010 the serv-ices sector has become the major employer, andaccounted for 39% of GDP as of the second quarterof 2013. A sign of the diversified production base, man-ufacturing accounts for 23.8% of GDP, constructionfor 10.3% and mining for 10.4%. The global commodi-ties downturn caused contraction in the mining andquarrying sector of 1.2% y-o-y in the second quarterof 2013, and in oil and gas, which fell 4.7%. The sec-ondary and tertiary sectors remained key drivers ofgrowth, with manufacturing growing 5.8% y-o-y andconstruction 6.9%. In services, transport and commu-

nications expanded 11.5% y-o-y in the second quar-ter of 2013, while hotels and restoration grew at 6.5%,according to the World Bank.

Indonesia’s economy remains relatively insulatedfrom the effects of slow world trade growth. Exportsfell from 40.8% of GDP in 2000 to 29.9% in 2008 and24.1% in 2012, the region’s lowest, according to WorldBank figures, while that of household spendingremained constant at 57%. Despite strong creditgrowth in recent years, with above-20% growth inbank lending since 2010, the Indonesian consumerremains under-leveraged compared to regional peers,with household debt-to-GDP of a mere 10% in 2012,compared to Singapore’s 76%, Thailand’s 77% andMalaysia’s 81%, according to the Asian DevelopmentBank (ADB). Yet the combination of a fuel subsidycut, a consequent spike in inflation, higher domesticinterest rates and slowing growth temporarily affect-ed consumer confidence in mid-2013. “Consumerconfidence has been quite high in the past threeyears,” Ndiame Diop, lead economist and economicadvisor at the World Bank, told OBG. “We should watchthe extent to which the rupiah’s depreciation and theweaker outlook may affect confidence, and thus thepropensity to spend versus save.”REBALANCING: The Yudhoyono administration haspursued a fiscal rebalancing strategy over the pastdecade, aiming to reduce the share of unproductiverecurrent expenditure covering wages and social

56

Since 2010 the services

sector has become the

major employer and

accounted for 39% of GDP

as of the second quarter of

2013. The manufacturing

industry accounts for

23.8% of GDP, construction

for 10.3% and mining for

10.4%.

ECONOMY OVERVIEW

transfers, such as power and fuel subsidies, andexpanding investment in infrastructure development.Capital expenditure rose from 8.3% of central govern-ment budgeted spending in 2006, at the start of theadministration’s two terms, to 17% by 2012. While thecentral government budget expanded by 11.2% in2010, 24.3% in 2011 and 11.2% in 2012, capital expen-diture rose by 5.8%, 46.8% and 74%, respectively.Despite an infrastructure master plan published in2011, however, government spending on infrastruc-ture stagnated at 2.03% of GDP in 2012, lower thanIndia’s 8%, China’s 9% and Vietnam’s 10%, accordingto the World Bank (see analysis). SUBSIDIES: While the central government hasremained prudent in spending plans, a key variablestems from subsidies that have eaten a large share ofthe budget. Energy subsidies accounted for 22% ofthe budget in 2011 and 19% in 2012, with 55% of theseallocated to fuel sales. Despite fuel price adjustmentsin 2005 and 2008, the domestic sales price remainedwell below world prices at Rp4500 ($0.45) per litreand prompted spending on fuel subsidies to reachroughly $20bn in 2012, or 3.7% of GDP, while totalspending on subsidies reached Rp348.1trn ($34.8bn)in the revised 2013 budget, more than spending onhealth and education combined.

From 2013 the presidency regained authority forprice adjustments, whereas it depended on parlia-mentary approval in the previous two budgets. “Theauthority for setting fuel subsidies rests with the gov-ernment entirely in the 2013 and 2014 budgets,whereas in 2012, the government needed to meet athreshold set by the parliament before it was allowedto adjust the subsidised fuel price,” Luky told OBG. “Itis very significant as it gives us more flexibility.”

This allowed the government to raise premiumpetrol prices by 44% and diesel by 22% in June 2013,to Rp6500 ($0.65) per litre and Rp5500 ($0.55) perlitre, respectively. This cut allowed authorities to trimthe subsidy budget by 3.4% between 2013 and theproposed 2014 budget, to Rp336.2trn ($33.6bn).

The government is seeking to cap fuel subsidies atroughly Rp212trn ($21bn) in 2014, although given anoil price assumption of $106 per barrel, volatile glob-al markets could force spending to exceed this tar-get. Over the medium term the MoF is looking at waysto cap total subsidy payments – one option would beto set a subsidy ceiling per litre rather than an absolutedomestic price. Yet in the run-up to the 2014 elec-tions, economists do not expect significant furtherreform on this front.

Savings from the fuel price hike were shiftedtowards infrastructure investment, health and edu-cation, to which 20% of the central government budg-et is allocated, and targeted cash transfers of $900mto 15m low-income households. Provision of socialservices will attract a growing share of governmentspending in the next six years given the extension ofsocial security benefits, including universal healthinsurance for all Indonesians by 2019, which will cost up to $16bn a year, according to the World Bank.

DISBURSEMENT: Boosting capital spending has facedthe constraint of low budget disbursement. Whilecentral government budget execution rose from 84%in 2011 to 89% in 2012, disbursement of investmentfunds remained at 85%, according to the MoF. Withhalf of the budget decentralised to sub-nationaladministrations (provincial, district and municipal)since 2001, the execution rate for investment standsat below 50%. Coordination between the major tiersof government has proved problematic, while ineffi-ciencies between central government departmentsand in project-level execution, including land acqui-sition, have hindered full budget absorption.

The government has taken steps to improve spend-ing by introducing performance benchmarks for min-istries, accelerating the budget approval process tofrontload projects towards the start of the year andintroducing an e-procurement system that will be ful-ly implemented by 2014. “The new electronic pro-curement system rolled in for most agencies and localgovernments is improving both the efficiency andtransparency of our procurement process,” BobbyHamzar Rafinus, deputy minister for fiscal and mon-etary coordination at the Coordinating Ministry forEconomic Affairs, told OBG. FUNDING: In aggregate the government retains amplefiscal space. While the central government’s fiscaldeficit reached 2.1% of GDP in 2013, it remains belowthe legal limit of 3%. Gross debt has trended downfrom 95% of GDP in 2000 to 24% in 2012, of which

57


SOURCE: World Bank *Projected

2011 2012 2013* 2014*

Real GDP (annual % change) 6.5 6.2 5.6 5.3

Consumer price index (annual % change) 5.4 4.3 7.3 6.7

Current account deficit (% of GDP) 0.2 -2.8 -3.4 -2.6

Budget balance (% of GDP) -1.1 -1.9 -2.5 -2.3

Major trading partner GDP (annual % change) 3.6 3.4 3.4 3.9

Projections for key indicators, 2011-14

The Ministry of Finance is looking to cap total subsidy payments

The government has taken

steps to improve budget

execution, introducing

performance benchmarks

for ministries, accelerating

the budget approval

process to frontload

projects towards the start

of the year and developing

an e-procurement system.

ECONOMY OVERVIEW

44.4% is in foreign currency, according to the ADB.Despite high reliance on domestic bond financing,however, the government remains highly dependenton portfolio inflows given foreign investors’ holdingsof roughly one-third of domestic bonds outstanding.The sharp rise in bond yields from May 2013 pushedup the government’s cost of funding by 300 basispoints, while investors have proven increasingly dis-cerning on funding investment projects over unpro-ductive subsidies. TAX BASE: With the informal economy accountingfor 54% of employment and an estimated 24% of GDPaccording to the World Bank, Indonesia’s tax base islow, at 17% of the population, while tax take remainsonly 12% of GDP. The tax office has achieved somenotable successes in boosting collections, with tax rev-enues growing 16.7% in 2010, 20.8% in 2011 and 6.5%in 2012. Yet while tax compliance has improved, low-er revenues linked to commodity exports, whichaccount for 63% of foreign sales, have trended down-

wards in line with key commodity prices since thesecond quarter of 2012. “Although authorities intendto raise the tax ratio by 1 percentage point to 13%,this looks unlikely given the commodities downturn,”Anton Gunawan, Danamon Bank’s chief economistand executive vice-president, told OBG.BONDS: While its cost of funding has risen since May2013, Indonesia still has ample access to global anddomestic bond markets to finance its deficit – par-ticularly since its sovereign credit rating upgrades toinvestment grade in 2010 by Japan’s rating agenciesand at the start of 2012 by Fitch and Moody’s. Thegovernment has been a regular issuer of foreign cur-rency bonds, issuing two dollar-denominated bondsworth a combined $3.8bn and a Yen bond worth$692m in 2012. Coupons on bonds issued in 2013 haverisen, however, while 10-year and 20-year bonds worth$1.5bn each fetched coupons of 3.375% and 4.625%,respectively in April. A $1bn 10-year bond issue in Julywas priced at 5.375% and a $1.5bn 5.5-year issue inSeptember had a rate of 6.125%. That these issueswere over three times oversubscribed reflects thecontinued global appetite for Indonesian sovereigndebt, albeit at higher prices (see analysis). The gov-ernment also has standby contingency facilities worth$5bn (at 2.5%) from the World Bank ($2bn), Japan($1.5bn), Australia ($1bn) and the ADB ($0.5bn) thatit can draw on any time. INFLATION: A combination of higher energy pricesfrom June and increased food prices linked to horti-cultural and meat import controls spurred resurgencein inflationary pressure in mid-2013. Inflation hastrended downward from an average of 7.49% between2002 and 2007 to 5.49% from 2007-12, reaching alow of 4.3% in 2012 according to BI figures, within thecentral bank’s 3.5-5.5% target.

The impact of the falling rupiah, which droppedfrom an average of Rp8800:$1 in 2011 to Rp9400:$1in 2012, pushed inflation up to 5.5% y-o-y in May2013 and 5.9% in June. Annualised inflation jumpedto 8.6% in July and 8.8% in August, however, due to

58

The government has been a regular issuer of foreign currency bonds

With the informal economy

accounting for 54% of

employment and an

estimated 24% of GDP,

Indonesia’s tax base is low,

at 17% of the population.

ECONOMY OVERVIEW

the combination of fuel price increases and higherfood demand coinciding with Ramadan in July. “Ineach of the economic crises in 2005, 2008 and 2013one of main drivers of inflation pressure has been thelifting of fuel subsidies,” Iwan Wisaksana, senior vice-president at Kresna Graha Sekurindo, told OBG.Although full-year inflation projections range fromBank Danamon’s 8.7-9.2% to BI’s 9.2-9.8%, the subsidycut’s impact on inflation will only be short-term, giv-en previous experiences in 2005 and 2008. “We onlyexpect the direct and indirect impact of the fuel pricehike on inflation to last three months, although dueto the base effect we will only return to the trend 4.5-5% inflation rate by June 2014,” Anton told OBG. Indeed,by September 2013 month-on-month (m-o-m) infla-tion turned negative, falling by 0.35%, while the annu-alised rate cooled to 8.4%. Food inflation remained highat 11.4% y-o-y in September, although it started tofall with a m-o-m drop of 3.4%, while non-food infla-tion cooled to 6.9% y-o-y. DOMESTIC DEMAND: While inflation has exceededBI’s target band from July 2013, the central bank’s inter-est rate hikes appeared more directed to coolingdomestic demand to reduce the current accountdeficit rather than taming the on-off spike in infla-tion. “BI is able to accept some discrepancies in itsinflation-targeting framework when we see one-offinflationary shocks like that caused by the fuel sub-sidy cut in June 2013,” Bimo Epyanto, BI’s assistantdirector of investor relations, said. “Inflationary pres-sure in 2013 has stemmed from the government’sadministered price policies.” Nonetheless, the bankembarked on a sharp monetary tightening cycle fromJune, hiking rates for its overnight lending facility (FAS-BI) and benchmark interest rates by 150 basis pointsin three months to mid-September, and enacting aseries of macro-prudential measures aimed at cool-ing credit growth and curbing imports (see analysis).MANAGING IMBALANCES: Although Indonesia’s fun-damental growth story remains convincing to foreigndirect investors, the balance of payments came understrain in 2013, given significant portfolio outflows. ByJune major investment banks like Morgan Stanley hadcategorised Indonesia as one of the “fragile five”emerging markets with twin current account and fis-cal deficits, highly dependent on capital inflows tofinance these shortfalls.

Although portfolio inflows were sufficient to cov-er the deficit with some downward pressure on thecurrency from mid-2012 on – although the rupiahwas emerging Asia’s worst-performing currency in2012, with a 5.1% drop against the dollar – the starkreversal in portfolio investor sentiment initiated by theUS Federal Reserve’s indication in May 2013 of a slow-down in quantitative easing brought matters to ahead. As Indonesian credit default swap spreads rose60 basis points in three months to the end of July andforeign investors pulled Rp42.3trn ($4.2bn) out ofIndonesian markets in three months to September,pressure on the currency rose markedly. This stemmedfrom a combination of capital outflows by both for-

eign and domestic investors. “The capital outflow off-shore in 2013 was partly caused by a speculativeattack on our financial system by our own banks,” Pur-baya Yudhi Sadewa, Danareksa’s chief economist, toldOBG. Despite short-lived upticks in demand for equi-ties and bonds, the correction in Indonesia’s capitalmarkets continued into the fourth quarter of 2013(see Capital Markets chapter). STOCKING UP: Meanwhile, exporters preserved asmany foreign earnings as possible in dollars in antic-ipation of a continued slide in the currency. “Dollarliquidity is very tight as exports slump while importskeep growing to support local market demand, andexporters keep earnings in dollars, only converting intorupiah as and when necessary,” Nirmala Salli, HSBC’shead of trade in Indonesia, told OBG.

By late September the rupiah had become Asia’sworst-performing currency, falling 17% year-to-dateand breaking the Rp11,500:$1 mark, down from aver-ages of Rp8779:$1 in 2011 and Rp9384:$1 in 2012.The MoF readjusted its 2013 budget assumptionsfrom Rp9600:$1 to Rp10,200:$1 mid-year and fromRp9750:$1 to Rp10,500:$1 for the 2014 budget. Thisdeterioration in the current account deficit and theexchange rate prompted a swift response by BI and

59



Sector 2008 2009 2010 2011 2012

Agriculture 716.66 857.19 985.47 1091.45 1190.41

Mining 541.33 592.06 719.71 879.51 970.59

Manufacturing 1376.44 1477.54 1599.07 1806.14 1972.85

Electricity, gas & water 40.89 46.68 49.12 56.79 65.12

Construction 419.71 555.19 660.89 754.48 860.96

Trade 691.49 744.51 882.49 1024.01 1145.6

Transport & communications 312.19 353.74 423.17 491.28 549.12

Finance 368.13 405.162 466.56 535.15 598.52

Public administration 257.55 318.58 359.84 432.79 485.53

Others 224.3 255.54 300.52 351.19 403.14

GDP by sector, 2008-12 (Rp trn, 2012 prices)

There was a resurgence in inflationary pressure in mid-2013

While Indonesia’s growth

story remains convincing to

foreign direct investors, the

balance of payments came

under strain in 2013, given

significant portfolio

outflows.

ECONOMY OVERVIEW

a government package of policy measures in August2013 aimed at narrowing the deficit over the medi-um term (see analysis). Despite concerns over a pos-sible repeat of the 1997-98 Asian financial crisis,where corporates’ significant currency mismatchesprompted widespread bankruptcies as the currencydevalued sharply, Indonesian corporates remain muchbetter-placed to weather the storm in 2013.

Corporates most exposed to such mismatches,caused by rupiah-denominated earnings and foreignexchange-denominated debt, are in the property sec-tor, including larger developers like Lippo Karawaci,Alam Sutera and Kawasan Industri Jababeka, althoughFitch reported in August that over 80% of their forexexposure was hedged. Meanwhile, export-orientedcompanies in mining, energy and plantations are ableto sustain foreign debt burdens, although lower com-modity prices in 2013 have placed their earningsunder pressure. The banking sector is in a good posi-tion to weather any uptick in non-performing loansgiven high capital adequacy and liquidity ratios, whilethe banks maintained open currency mismatches

(net-open-positions) of just 2% in the third quarterof 2013, according to Fitch. CONSUMPTION: With little comfort expected fromexport growth, the onus for driving growth in thecoming year will fall on household consumption andgovernment investment.

While progress in disbursing funds under the gov-ernment’s infrastructure plan has been slow, it expectsto expedite key projects under its 2014 budget (seeanalysis). BI’s consumer confidence index dipped inJuly and August 2013 to its lowest level in 14 monthsdue to the impact of fuel prices on disposable incomes,before rebounding by 0.9% in September.

This was matched by a rebound in the manufactur-ing purchasing managers’ index compiled by HSBC,which rose from 48.5 in August to 50.2 in September,just above the 50 level indicating expansion in man-ufacturing output.

While consumption will remain constrained by high-er domestic lending rates and slower growth into2014, the run-up to presidential elections in July 2014will provide some offsetting effects. “We estimatethe election will add 0.2%-0.3% to GDP growth in2014, in the form of private consumption,” DestryDamayanti, Bank Mandiri’s chief economist, told OBG.“This spending typically goes to small and medium-sized enterprises and the informal sector.” These esti-mates are similar to BI’s, based on previous electionsin 2004 and 2009. While cash transfers to voters mayprovide additional impetus to private consumption,official party spending will stimulate the services sec-tor in particular. “Excluding money politics that couldgenerate more retail spending we expect the pre-election campaign to generate growth in sectors liketransport, hospitality and media,” Anton told OBG.OUTLOOK: While forecasting agencies – governmen-tal, multilateral and private sector – have downgrad-ed Indonesian growth forecasts significantly in 2013,they disagree on the timing of the slowdown. The IMFforecasts the slowest growth of 5.25% in 2013, downfrom 6.2% originally forecast, followed by a reboundto 5.5% in 2014, while the World Bank downgradedits 2013 growth forecast from 5.9% to 5.6%, and 5.3%in 2014, signalling a slower downturn. More opti-mistic, the MoF expects 5.9% and 6% growth for 2013and 2014, respectively, while BI is targeting 5.5-5.9%and 5.8-6.2% growth for the two years. Despite dis-agreements on the pace of the slowdown, growthremains higher than emerging markets’ average of 4.5%in 2013, and points to the resilience of long-termdrivers of economic growth. While policy continuityamid the political transition in 2014 will be an impor-tant factor in determining the pace of growth, theauthorities will continue to balance the need to sup-port domestic consumption growth with ensuringbroader macroeconomic stability and the confidenceof global investors.

This confidence game will be a tightrope walk, yetauthorities see in the short-term crisis an opportu-nity for enacting key structural reforms aimed at sustaining FDI flows and diversifying trade patterns.

60

Property corporates are the most exposed to currency mismatches

While consumption will

remain constrained by

higher domestic lending

rates and slower growth

into 2014, the run-up to

the presidential elections

in July will provide some

offsetting effects.


0

40

80

120

160

200

240

Value (Rp tn)

201320122011201020092008200720060

2

4

6

8

10

12

% of total spend

Gov't spending on infrastructure, 2006-13

SOU

RCE:

Min

istr

y of

Fin

ance

ECONOMY INTERVIEW

Dipo Alam, Cabinet Secretary

Following decentralisation, how can long-standing

bureaucratic inefficiencies be reduced, and what

safeguards might prevent abuse of power?

ALAM: Parliament passed many laws during the Refor-masi era, which followed the instability brought on bythe 1998-99 Asian financial crisis. GDP per capita fellto just $600 as a result and there was pressure, bothinternally and from the IMF, to begin decentralising tofill the power vacuum left after Suharto’s rule. Sincethen, our strategy for targeting bureaucratic inefficien-cy has been to limit the ability of regency heads or gov-ernors to make their own perdas (regional regulations).Accordingly, the home affairs minister has annulled3000 of the original 7000 perdas, prioritising those thatfacilitate, rather than obstruct, investment. Significantprogress in licensing has also been made: over 250 dis-tricts now operate the single window system, which cov-ers 75% of investment destinations. We are reviewingas well the regional electoral process, which is too cost-ly and corruption prone, and whether bupatis (headsof regencies) should continue to be elected directly.Remember, though, that per-capita income is up tonearly $4000, from $1200 before the 1998 crisis, andour government budget is nearly five times bigger thanin 2004. We are making progress.

What procedural improvements can be made to

boost investor confidence?

ALAM: One of the major campaigns that the govern-ment has been pursuing is to “de-bottleneck” all inef-ficiencies in governing. Through these efforts we canprovide better public services, including in the area ofinvestment promotion. We also launched the One-StopService (OSS) to better facilitate foreign direct invest-ment (FDI). Again, our fight against corruption is keyto increasing our competitiveness in attracting FDI. TheOSS is also aimed at streamlining the investment processthat at times is delayed by various local regulations. Atthe national level, a policy package has been launchedto improve the ease of doing business. No later than

February 14, 2014, all Indonesians who want to startup a business should enjoy a faster process. More con-ducive policies enjoyed by local business communitieswill, at the same time, benefit foreign investors. In manycases, foreign investors can gain the most from theirinvestment via partnership with local business actors.

International financial bodies question the wisdom

of subsidies in Indonesia. Are they still necessary?

ALAM: Indonesia is not a purely capitalist country; weare an archipelagic nation that needs targeted subsi-dies to keep moving. The question is how much and howto ensure they get to the recipient efficiently. Subsi-dies for fertilisers, which are liable to corruption, willin future be distributed by direct cash transfer. We areworking to improve Bank Rayat Indonesia, which canensure ATM presence in only 30-40% of villages, byintegrating a new satellite to cover 100% of them. Asfor the fuel subsidy, we feel that the amount and theway we distribute it has been clearly agreed on by par-liament and will remain stable in 2014.

What is the government’s focus for the rest of its

term? Any advice for future administrations?

ALAM: The central focus remains cutting unnecessaryred tape to ensure investor confidence. Future admin-istrations must continue to rigorously re-evaluate andrevitalise decentralisation laws. Corruption is a by-prod-uct of centralised power being delegated to the regionsin a short period of time, and we must face and con-quer this for the sake of national development. TheReformasi era induced an economic jump that exist-ing law was understandably unable to deal with. Now,reforming it must be our chief goal. Future administra-tions and parliaments must de-bureaucratise and de-regulate to spur investment. For this to happen, futureadministrations must continue to work hard and bemore efficient and effective. And this can be assuredthrough cooperation with parliament. For 2013, invest-ment will likely hit $38bn-$42bn, and in 2014, $46bn.

61


Tackling corruption and red tapeOBG talks to Dipo Alam, Cabinet Secretary

ECONOMY INTERVIEW

Jokowi, Governor of Jakarta

How are land acquisition hurdles being addressed

to accelerate government infrastructure projects?

JOKOWI: The land acquisition process begins with theso-called tax object sale value (NJOP). Problematical-ly, though, 99% of owners do not accept this price fortheir land. First appraisals are normally rejected, andonly about half of landowners accept the second. Thisbeing so, land acquisition from those who seriallyrefuse offers can last up to seven years. I go to peo-ple directly to arrange a solution, but if the price theydemand is unacceptable then sadly what follows isstalemate. On the outer South Jakarta toll road, weare dealing with some 140 landowners (and in theNorth, another 120), most of whom have not accept-ed our offers. On state-owned land, the process is fareasier, and we offer complete solutions to displacedresidents – usually including a local furnished apart-ment – to ease the process for them. The JakartaMonorail will be an example of success largely becausethe land was government-owned, but even that oncompletion will have taken 14 years.

Regulations from the central government must besimplified and NJOP and appraisal prices calculatedmore realistically, to reduce time-consuming andexpensive contestations. New regulations for landacquisition, implemented in late September 2013,should help further resolve these issues.

How has the Jakarta Health Card programme been

received by the public and by hospitals?

JOKOWI: The idea for this programme arose duringmy visits to kampungs (villages) where thousands ofsquatters and families, though acutely ill, were stay-ing at home with no money to pay for health care. As of its launch in November 2012, poor citizens with this card can get free treatment – including operations – at public clinics and private or govern-ment hospitals. I have already given out some 2.2mhealth cards, and the programme’s budget runs atabout Rp1.5trn ($150m), which is more than enough.

Though at first many hospital staff voiced concernsabout the higher flow of patients, of whom about510,000 were acutely ill, I have been addressing theseproblems daily. Hospitals had initially come understrain as new cardholders began to visit all at once,but the situation has since stabilised. Now, with thissystem here to stay, we can better serve the people.

How is permitting for businesses and construction

projects being made more efficient in Jakarta?

JOKOWI: We now have a one-stop service officecalled Pelayanan Terpadu Satu Pintu that we are test-ing in one municipality in East Jakarta. With suchlicensing offices we can serve the business commu-nity in a better and more transparent way, such as withcompany registration or trading permits. Not just inJakarta but all over Indonesia, it can take four to eightmonths to register a company or issue a housing con-struction permit. Now, the former takes three days;and the latter, two. This is our ambitious new idea and,if successful in East Jakarta, I will request its imple-mentation in all Jakarta municipalities.

Do you have a message for investors or business

people looking to operate in Jakarta?

JOKOWI: I would invite them to look at all of the dif-ferent projects we are undertaking, details of whichcan be found on our website. They include a 200-haland reclamation project in North Jakarta, new mono-rail lines serving Bekasi, Jakarta, Tangerang and the air-port (to be completed by mid-2017), and the North-South line of Jakarta Mass Rapid Transit (by 2019 atthe latest), better drainage systems (by March 2017)and other projects to improve inner-city congestion.All of this will increasingly have a positive knock-oneffect in the property market, and Jakarta will emergeas truly one of the best cities for investors in South-east Asia. The price of the property is still at a medi-um level, not yet in the same league as Singapore or Hong Kong, so there are still many opportunities.

62

Streamlining governmentOBG talks to Jokowi, Governor of Jakarta


ECONOMY ANALYSIS

Infrastructure remains a key constraint on Indonesia’s growth

Two years into the Master Plan for the Acceleration andExpansion of Indonesian Economic Development(MP3EI), progress has been spearheaded by govern-ment-led projects. Despite incentives and institutionsestablished to attract private investment to public-pri-vate partnerships (PPPs), projects have been hinderedby challenges in land acquisition and inefficient coor-dination between different tiers of government.

While MP3EI’s future remains uncertain followingthe 2014 presidential elections, the outgoing admin-istration is pursuing efforts to streamline key projectsand expedite progress in developing much-neededinfrastructure and accelerating Indonesia’s growth. TRACK RECORD: Infrastructure remains a key con-straint on Indonesia’s growth. Total government spend-ing on easing these bottlenecks has been a mere 2%of GDP in the past decade, less than half of Thailand’s3.6% and Malaysia’s 5.4% in 2012. Ranked 53rd of 160in the World Bank’s 2014 Logistics Performance Index,lower than the Philippines and Vietnam, albeit animprovement on the 75th place achieved in 2010,Indonesia’s substandard infrastructure adds consider-able costs to investment. Its logistics costs still accountfor 24% of GDP, compared to Vietnam’s 25%, Thailand’s17%, Malaysia’s 13% and Singapore’s 8%. While the gov-ernment has devoted a growing share of resourcestowards infrastructure development, rising from 8.2%of government capital expenditure in 2006 to 11.7%in the 2013 budget, a key plank of the MP3EI is privateinvestment, meant to account for 51% of the Rp4482trn($448bn) in spending to 2025. This includes 24.1% ofpurely private investment (Rp455.5trn, $45.6bn), 20.7%in PPPs (Rp390.9trn, $39.1bn) and 7.7% in hybrid proj-ects involving public, private and state-owned enter-prise investment (Rp144.9trn, $14.5bn). PRIORITIES: MP3EI provides a roadmap for transform-ing Indonesia into one the world’s 10-largest economieswithin 14 years. Premised on real annual GDP growthin the 7-9% range, the plan consists of six corridors ofeconomic growth leveraging natural resources and

existing industries on five islands. Roughly 41% of totalMP3EI spending, or Rp1888trn ($189bn), is earmarkedfor infrastructure development to support intra- andinter-regional connectivity, including in toll roads androads (23%), rail (13%), ports (8%), airports (2%), waterutilities (2%), ICT (10%), and power and energy (24%).The IMF has published even more ambitious estimatesfor Indonesia’s infrastructure requirements in the short-er 2012-17 period: assuming infrastructure spendingof 5% of GDP, requirements would be nearly twice ashigh at $363bn. Java, which accounted for 57.5% ofGDP in 2012, is set to receive 48.8% of MP3EI spend-ing on infrastructure, while Sumatra, with 23.6% of GDP,will receive 22.4% of funds. Commodity-dependentregional economies like Sumatra, Kalimantan and Papua-Maluku, which account for 4.8%, 9.5% and 2.2% of GDP,respectively, are to channel 9.9%, 8.8% and 6.4% of fore-cast infrastructure spending. The Bali-Nusa Tenggaracorridor, which contributes 2.4% of GDP, will receive 3.7%.

The plan is to establish clusters in eight industriesand 22 economic sectors, each specialising in a spe-cific segment. The northern Java coastline will focus onpetrochemicals and ship-building, while inland areas willbe dedicated to lighter industries like food and bever-ages. South Sumatra and Riau will focus on palm oil,and Papua will expand exploration and production inhard commodities like gas, gold and copper, alongsideagricultural plantations. Bali and Lombok will developtheir tourism and food production sectors. While theplan envisages pendulum-type shipping connectivitybetween the main islands, it has faced criticism. “TheMP3EI projects focus on creating growth poles linkedto their hinterlands,” Anton Gunawan, Danamon Bank’schief economist and executive vice-president, told OBG.“But we need a vision of interconnecting these poles,which are based on the past commodity boom.”PPP SOFT INFRASTRUCTURE: With private invest-ment expected to play a key role in the plan, the gov-ernment has rolled out incentives and new institutionsto provide guarantees, financing and coordination for

The government has

devoted a growing share of

resources towards

infrastructure

development, rising from

8.2% of government capital

expenditure in 2006 to

11.7% in the 2013 budget.

63


Shared responsibilityAttracting private investment is central to development plans

ECONOMY ANALYSIS

PPPs. Investors in a corridor are eligible for five- to 10-year corporate tax holidays from the start of produc-tion, followed by 50% cuts in tax for two following years.Incentives also include an annual 5% cut in income taxon investment for six years and an import duty waveron goods not produced in Indonesia, while foreigninvestors can take up to 95% ownership of infrastruc-ture and industries established in the corridors.

A new Infrastructure Guarantee Fund (IIGF) under theMinistry of Finance (MoF) was established in 2011 toprovide guarantees for government-related contrac-tors in PPPs, while a Viability Gap Fund (VGF) is beingestablished in 2013 to provide state funding for PPPsthat are economically feasible but not financially viable.Funded through the state budget, the VGF will providecash injections of up to 50% of cost during construc-tion phase to projects of over Rp100bn ($10m) wherefinal users will pay the principle of investment. TheVGF’s main focus is on water projects but could begeneralised to roads and railways, according to the IIGF.

The government has focused on easing bottlenecksin past PPPs. In 2011 a new land law streamlined acqui-sition procedures for projects linked to eminent domainand reduced the time and cost involved in expropriat-ing land, setting a 319- to 583-day timeframe for thewhole acquisition process. The government has alsoestablished coordinating and performance-trackingcommittees to expedite PPPs and government proj-ects. The MP3EI Implementation Committee (KP3EI)was formed in 2012 to resolve bottlenecks, while anew taskforce was established in 2011 to set and mon-itor key performance indicators for line ministries, in abid to improve budget disbursement. While the gov-ernment’s performance on expenditure has improved,coordination of PPPs has faced challenges due to dif-ferences in priorities between line ministries, state-owned enterprises and sub-national governments. PROGRESS: Despite this institutional backing, progresshas been slow. The Coordinating Ministry for Econom-ic Affairs (CMEA) announced in September 2013 that

a mere 14% of the total Rp4482trn ($448bn) in proj-ects by 2025, and 18% of the Rp3590trn ($359bn) inprojected spending to 2015, had been realised in thefirst two years. While 27% of government projects and21% of purely private projects planned by 2015 had bro-ken ground in July 2013, the rate of realisation for state-owned enterprise and PPP projects was much lower, at15% and 14.9%, respectively. The pace of ground-break-ing in fact slowed from Rp379.3trn ($38bn) in 2011 toRp232.7trn ($23bn) in 2012 and Rp35.4trn ($3.5bn)in the year to July 2013, according to the CMEA.

The government has forged ahead with roadupgrades, repairing 2800 km in 2012, 4500 km in 2013and plans for 4800 km in 2014. It is also midway throughits $3bn plans to upgrade 20 airports nationwide, open-ing Medan’s new Kuala Namu International Airport in2013, for instance, and in its plans for a parallel railwayfrom Jakarta to Surabaya, according to the Public WorksMinistry. Bottlenecks remain, however. The plannedTrans-Java Toll Road, while awarded to a consortium ofinvestors, has struggled with land acquisition issues,while the structure of the 2700-km trans-Sumatraroute remains unclear. The Jakarta provincial govern-ment has awarded six new inner city toll-roads how-ever, while new projects linking Serpong to Balaraja inJava and Medan to Kuala Namu were tendered in late2013. Given the lack of clear segregation betweenoperators and regulators in port and airport develop-ments, investments in both remains dominated by state-owned Pelindo I and II, and Angkasa Pura I and II. IndeedPelindo II has resisted the concessioning of KalibaruNorth and Cilamaya ports, according to the IIGF. Some10 PPPs are planned in airport developments, howev-er, including in Batam, North Bali and Yogyakarta.

In rail, the Central Kalimantan PPP railway faces struc-tural issues, the Jakarta-Soekarno-Hatta airport expressline is set to be tendered in 2014, while the East Kali-mantan railway proposed by Russian Railways has yetto break ground. Existing double-track projects in Javaare dominated by the state-owned Kereta Api, while theincoming Jakarta governor relaunched the capital’smass rapid transit and monorail projects as purely gov-ernment-backed in 2013. Meanwhile, the IIGF had onlyextended one guarantee by the fourth quarter of 2013to the Central Java Power Project, a PPP. MECHANISM OVERHAUL: In its 2014 budget propos-als, the government seeks to accelerate state fundingunder MP3EI and overhaul its coordination mecha-nisms. The main priority is to accelerate road upgradesand extensions, and expedite port and airport devel-opments. Meanwhile, the presidency aims to reform theKP3EI to reduce the number of stakeholder membersand create a clear order between state planning agencyBAPPENAS and the MoF. “We have a problem in termsof internal coordination between BAPPENAS and theMoF in determining the projects,” Luky Eko Wuryanto,CMEA’s deputy minister for infrastructure and region-al development, told a press conference in September2013. The MoF is also establishing a PPP Centre, whichwill identify a pipeline of bankable PPP infrastructureschemes and streamline projects on an ad hoc basis.

64

The acceleration of road upgrades and extensions is a high priority for the government

A Viability Gap Fund is

being established to

provide state support for

PPPs that are economically

feasible but not financially

viable. Funded through the

state budget, it will provide

up to 50% of costs during

the construction phase.

While 27% of government

projects and 21% of purely

private projects planned by

2015 had broken ground in

July 2013, the rate of

realisation for state-owned

enterprise and PPP projects

was much lower, at 15%

and 14.9%, respectively.


ECONOMY INTERVIEW

Suryo Sulisto, Chairman, KADIN

What sectors look to benefit most as Indonesia

transitions from being a resource driven economy

to one driven by industry and consumer demand?

SULISTO: I would say that the infrastructure and theagriculture sectors will benefit the most. Infrastruc-ture is something we lack across the board in terms ofroads, ports and airports. This must be improved toend logistical inefficiency and increase Indonesia’s abil-ity to compete among ASEAN members. We are still anet importer of food, but we have huge capacity toincrease domestic productivity, particularly staples suchas corn, rice and sugar. This area needs focus and pro-vision of the right incentives and stimulus for farmers.

I also believe that it is extremely important to builddomestic industrial capacity. As the affluent populationgrows, demand will follow. If you cannot satisfy demandwith locally produced goods, dependence will contin-ue to be on imports and the country will be subjectedto a bigger trade deficit and an increased amount ofmoney spent on the foreign exchange. Therefore, wemust look to empower our local industries which areproducing value added goods and commodities.

Given the vocal labour unions, which are petition-

ing for higher pay, how can the government balance

worker welfare and competitive compensation?

SULISTO: In terms of the management of labour unionactivities, the government must be more firm. Whiledemonstrating in an orderly fashion is acceptable, theopposite is happening in Indonesia and we must learnfrom countries like Japan where sensible conduct iseffectively enforced. As far as wage increases, we havecommunicated to the government the inability of com-panies using labour-intensive processes, such as thetextile and food industries, to absorb increased labourcosts due to small margins. The responsibility for find-ing a balance has to be taken on by provincial author-ities, who must liaise with unions, local government andrepresentatives of the private sector. In the regionssurrounding Jakarta, such as Bogor and Tangerang,

wage increases have been particularly steep, even inthe face of considerable objection by firms using labour-intensive processes. However, in the other regions thereis a more established consensus and wage increaseshave actually been very small. So, now we have a situ-ation where there is competition, in terms of findingthis balance, between regions. I think this is a positivedevelopment, as people are now seeking stability in theirwork and not just the highest wage they can find. How-ever, authorities in regions affected by labour union dis-ruption are starting to worry because there is going tobe a rechanneling of investment away from these areasif they cannot get the situation under control.

In terms of infrastructure development, how are

issues like land acquisition and financing being

addressed and what is the private sector’s role?

SULISTO: While the slow realisation of infrastructureprojects was previously due to extensive land acquisi-tion issues, I believe that the situation is now beingresolved via the new Land Acquisition Act, which givesthe government power to allocate land to any projectas long as they pay a sufficient sum to the elected ven-dor. These elected vendors of the land required forprojects are quickly realising the benefits of complyingwith the government, largely due to satisfactory remu-neration. Adequate financing for infrastructure projectshas also long been an issue, largely due to the limitedavailability of low-interest, long-term funding. KADINhas suggested the resurrection of a dedicated devel-opment bank to solve this problem, and we believe thiscould be achieved quite easily via utilisation of a statebank, however we are yet to hear any positive responseregarding this suggestion. Another prevailing issue isslow government bureaucracy. Everything takes far toolong, especially when compared to the private sector,which can move at twice the speed when it needs to.As such, we propose that the private sector should beutilised for all vital, time sensitive projects. The privatesector’s involvement is vital to complete these projects.

65


Paving the wayOBG talks to Suryo Sulisto, Chairman, Indonesian Chamber ofCommerce and Industry (KADIN)

ECONOMY INTERVIEW

Jusuf Wanandi, Co-founder & Vice Chairman, CSIS

Indonesia will face a number of economic chal-

lenges over the coming year. Which immediate pol-

icy actions should be taken and with what aim?

WANANDI: The government should prioritise domes-tic stability in an election year. Observers have in recentyears been euphoric about Indonesia’s impressive eco-nomic and rupiah strengthening before mass capitaloutflows took us back a step. This was somewhat fore-seeable because of the negative current account forthe last few years., but our response was uncoordinat-ed. Numerous well publicised lacunae in our econom-ic development – infrastructure, an actionable landacquisition law and labour inflexibility – have amplifiedshocks to the market. These challenges are related tothe wider development of our economy and are relianton the export of commodities. This has led to pressureconcerning the value of other currencies against therupiah, especially in light of the fact that we are alsovulnerable because we import 70-80% of our capitalgoods. While people talk about Indonesia being ableto achieve GDP growth of 6% with its eyes closed, thisis not the case. If various factors align in an unfortu-nate way then a serious economic upheaval could occur.

How would you evaluate the most pressing priori-

ties for the incoming administration?

WANANDI: The priority must be the total restructur-ing of the fuel subsidies that was almost completed byPresident Susilo Bambang Yudhuyono. We must alsodeal with the overly demanding labour unions, 80% ofwhich are connected to political parties. These links makecontrolling them a most contentious issue for govern-ment. However, we must confront them regardlessbecause they cannot keep asking for 45% wage increas-es every year. Many companies, particularly those inlabour-intensive industries, have struggled due to theensuing disruption and low levels of productivity. Kore-an companies have been forced to dismiss over 69,000Indonesian workers over the last two years due to suchproblems. The process of dismissing non-performing

workers is difficult, meaning companies often only hireworkers on temporary contracts of one year or less. Thisdetracts from the overall stability of the labour mar-ket. It also means that companies are unable to fore-cast labour costs, making it significantly more difficultto do business. While the ratio between wages andproductivity can never be entirely precise, companiesare well within their rights to expect at least some mar-ginal performance increases from their workers.

How can the country weigh the benefits of the

Trans-Pacific Partnership (TPP) and ASEAN Region-

al Economic Comprehensive Partnership (RCEP)?

WANANDI: The TPP is a very complex agreement andtherefore cannot be placed in the same category asthe RCEP. It represents too high a level of integrationfor Indonesia. There are also many problematic issues,such as the lack of competitiveness between state-owned and private enterprises, insufficient intellectu-al property rights and the need for labour unions toplay a greater role. Indonesia should be focusing on theRCEP, which has a more achievable level of integrationwhile being less complicated overall. It is based uponexisting bilateral agreements that will allow us to focusmore closely on integrating services, improving invest-ment instruments and boosting trade.

However, while domestic companies are no doubtfamiliar with the RCEP, they remain understandablyapprehensive. This is largely due to a failure on the partof our government to prepare them appropriately byfollowing the precedent set by the 1993 Bogor Goals,which had established clear objectives.

In terms of how Indonesia can benefit from ASEAN,while feasibility is very important, social and politicalelements are just as critical for the successful futureintegration of the region. Indonesia should follow theexample of the exchange programme between Germanyand France in which 30m students have visited oneanother’s country over the last three decades. Indone-sia would do well to replicate this approach in ASEAN.

66

Labour painsOBG talks to Jusuf Wanandi, Co-founder and Vice Chairman, Centre forStrategic and International Studies


ECONOMY ANALYSIS

Some 60% of the workforce is concentrated in Java and Bali

Despite having a large labour force of 121m people byFebruary 2013, Indonesia has achieved a consistentfall in official unemployment over the past decade.Growing investment in manufacturing and services hasdriven job creation, although the most labour-inten-sive sectors tend to be the lowest value-added. Withroughly half the 247m-population below the age of 30and 63% of working age, the labour market requiressustained rapid economic growth to keep pace withdemographic growth, which is seeing 2m Indonesiansenter the market annually. Despite the halving of unem-ployment from 11.2% in 2005 to 5.9% by February 2013,a 15-year low, 54% of workers are employed by the infor-mal sector, and the share of vulnerable employmentstood in the 60-70% range in 2012, according to theWorld Bank. As economic growth slows below 6%, wageinflation gathers pace and interest rates rise, the gov-ernment is enacting key measures to preserve employ-ment and sustain the gains of recent years. LABOUR:With the average 6% annual economic growthin the seven years to 2012 stemming primarily from thehigh-employment services sector, average annualemployment growth of 2.9% has outpaced the labourmarket’s 2.2% expansion, according to the nationalplanning agency BAPPENAS. Some economists arguethat faster growth is needed, however: “Our estimatesindicate that Indonesia needs at least 6.7% annual GDPgrowth to absorb expansion in the labour force,” Pur-baya Yudhi Sadewa, Danareksa’s chief economist, toldOBG. Since 2010 services have overtaken agricultureas the largest employer, accounting for 43% of employ-ment by February 2013, compared to 35% in agricul-ture and 22% in industry, according to the World Bank.“The shift from extraction industries towards consumer-related sectors is helping to drive employment, as theyare more labour-intensive,” James Castle, chairman ofCastleAsia, told OBG. Yet while unemployment has con-tinued to drop, productivity growth of 4.5% a year onaverage has lagged regional peers. Indeed, agriculturestill accounts for 35% of employment but only 15% of

GDP, while 90% of agricultural workers are low-skilled,according to BAPPENAS. A full 56% of the labour forcehad only completed primary school or lower in 2012.Youth unemployment in particular remained high at19.6% in August 2012, down only marginally from 20%a year prior, according to the International LabourOrganisation (ILO). Meanwhile, 60% of the nationallabour force is concentrated in Java and Bali.

The shift towards industrial and services jobs was sus-tained in the year to February 2013, with 13% year-on-year growth in construction, 4% in industry and 3.3%in trade, compared to a 3% drop in agricultural employ-ment. Small and medium-sized enterprises employing5-49 workers account for the bulk, some 90%, of man-ufacturing jobs, according to the International FinanceCorporation – a similar ratio to China, India, South Koreaand the Philippines. Yet with growing foreign directinvestment (FDI) in manufacturing, which accountedfor 48% of the $24.6bn in non-hydrocarbons FDI in2012, demand for skilled labour has grown. An Amer-ican Chamber of Commerce report on the last decadeof FDI in Indonesia estimated that every $1m in US FDIgenerated 242 jobs. This investment in manufacturingis going towards mechanised industrial segments, likeagro-processing, and capital-intensive manufacturingsuch as chemicals, rather than traditional industries nowin decline such as textiles, footwear and garments pro-duction, even if the latter remains the third-largestemployer. BAPPENAS forecasts the services sector willdrive employment growth over the next decade: it esti-mates the primary sector will require 7.8-8.3% employ-ment growth annually, compared to 12.6-13.1% in thesecondary and 13.4-13.9% in the tertiary sectors.WAGE INFLATION: The 2003 Manpower Act, whichimposes one of the highest severance packages, hasbeen a key constraint for employers. Companies havecircumvented restrictions by relying on outsourcedcasual labour, often for core functions. By May 2013the ILO estimated that some 80% of formally employedworkers did not hold a contract. In 2012 the Ministry

With half the population

below the age of 30 and

63% of working age, the

labour market requires

sustained rapid economic

expansion to keep pace

with demographic growth.

67


Just the jobThe government is enacting measures to sustain employment gains

ECONOMY ANALYSIS

of Manpower restricted the types of work eligible foroutsourcing to six non-core functions, and requiresfirms to shift temporary employees to full-time con-tracts. A number of uncertainties remain, including thepenalties for non-compliance. Employers have wel-comed greater clarity in employment rules but calledfor more flexibility in the main labour law to compen-sate. “Some tough decisions will need to be made onthe labour law to improve Indonesia’s competitivenessin the long term,” Stuart Dean, CEO of ASEAN at Gen-eral Electric, told OBG. “The specifics of the law will haveto strike a balance between labour rights and the abil-ity of employers to run their businesses.”

Alongside legal constraints, pressure from labourunions, led by the Confederation of Indonesian Work-ers’ Union, has driven wage inflation in recent years. Inthe greater Jakarta area alone, the municipal policereported a sharp increase in labour protests from 900in 2011 to 1050 in 2012. In November 2012 the Jakar-ta government raised the minimum wage, which is setat a provincial level, by 44% to Rp2.2m ($220), the high-est single increase on record. On average minimumwages were increased by 30% in 25 provinces and 18%nationwide, according to the ILO. Meanwhile, averagenominal wages grew from Rp1.41m ($141) in 2010 toRp1.53m ($153) in 2011 and Rp1.63m ($163) in 2012.

Though wages remain competitive in absolute termsrelative to peer South-east Asian economies, theirgrowth has outstripped productivity gains over thepast decade. A 2013 study by the Jakarta-based Cen-tre for Strategic and International Studies found thatwages increased by 5.5% annually from 2000 to 2011while productivity rose by only 3.4%, compared to Chi-na’s 7.2% wage inflation and 10.1% productivity growth.By 2013 the World Bank found the ratio of minimumwage-to-value-added per worker at only 0.42. The 30%growth in minimum wages in 2010-13 was the region’shighest. Concern over rising inflation in 2013, prompt-ed by higher fuel prices from June and food price infla-tion, has sustained higher wage claims of 50% and as

high as 68% in Jakarta. The impact of wage inflation onemployment levels is concerning, with the World Bankestimating in 2010 that a 10% minimum wage hike typ-ically spurs a 1 percentage point rise in unemployment,albeit with a lag of two to three quarters. FLEXIBLE REFORMS: The administration has soughtto cushion the blow of higher wages and employmentrestrictions by offering one-year renewable waiversfor labour-intensive industries, categorised as busi-nesses employing over 100 staff. “The combination ofa higher minimum wage and slowing growth couldhave an impact on unemployment,” Bobby Hamzar Rafi-nus, the deputy minister for fiscal and monetary coor-dination at the Coordinating Ministry for EconomicAffairs, told OBG. “This is why the government enact-ed deductions of tax instalments for preserving employ-ment and supports labour-intensive industries.”

A key pillar of the measures is support for labour-intensive industries. The measures provide for a 25-50%tax deduction for labour-intensive firms in sectors suchas textiles, footwear, furniture, confectionary and toys.They also allow bounded zones, where most labour-intensive light manufacturing plants are based, to sellmore of their output domestically – from 25% to 50%.

Large job-creating FDI projects, such as those byPOSCO and Hankook, can also apply for tax incentivesthrough the Indonesia Investment Coordinating Board(BKPM), although a tripartite commission involving theManpower, Finance and Coordinating Ministries final-ly approves these. The government is also seeking todevelop a higher-skilled labour force to meet the needsof higher-value-added industries. A $75m loan from theAsian Development Bank that was extended in 2012to 172 polytechnic schools, of which 140 are private,and a $38m National Skills Fund, is aimed at upgradingthe nation’s professional training capacity. “Indonesianeeds to move into a non-extraction economy, and todo this it needs knowledgeable workers,” Victor Hartono,the president director of Djarum Group, told OBG.NEW SYSTEM: Aside from tax incentives to preserveindustrial employment, the government also proposeda new formula-based bargaining process for minimumwage increases, to be announced yearly in November.The 2003 Act already requires provincial and districtgovernments to set minimum wages. “The responsibil-ity for finding a balance has to be taken by provincialauthorities, who must liaise with unions, local govern-ment and representatives of the private sector,” SuryoSulisto, chairman of the Indonesian Chamber of Com-merce and Industry, told OBG. Under the new rules, how-ever, the central government introduced district-levelcalculations for the cost of living and links minimumwage increases to local inflation, as well as proposingcaps on wage increases at 10% above inflation. Whilethe attempt to depoliticise the wage-setting processand shift to a more scientific basis may be challengingin an election year, the proposals should prove encour-aging to labour-intensive industries in particular. TheMinistry of Manpower also requires provincial and dis-trict governments to report on efforts to create employ-ment at the local level in a regulation issued in May 2013.

68

Greater clarity in employment rules has been welcomed

The administration has

sought to cushion the blow

of higher wages and

employment restrictions by

offering one-year

renewable waivers for

labour-intensive industries.


ECONOMY ANALYSIS

Total exports fell from $203.5bn in 2011 to $190bn in 2012

Pressures on Indonesia’s current account came to a headin May 2013 as portfolio investments reversed their flowand began leaving the country. Authorities have react-ed to curb further growth in the deficit. With BankIndonesia (BI) responsible for monetary tightening, thegovernment has followed with a series of measures tobalance the trade position. Although the impact of fis-cal measures will become evident only over the medi-um term, policies have yielded some early fruits. Overthe long term, however, only a coherent industrialisa-tion policy will sustain a balanced current account. WIDENING DEFICIT: With sustained growth in manu-facturing investment and continued reliance on com-modities for the bulk of its exports, Indonesia’s currentaccount has been under pressure since the fourthquarter of 2011, when it swung to a deficit of $2.3bn.With commodities such as coal, crude palm oil (CPO)and rubber accounting for 63% of total exports in 2012,according to BI, these have continued to fall since theirpeak of $57.76bn in the third quarter of 2011. This hasbeen largely caused by slowing demand in China, Indone-sia’s biggest export destination, and a drop in pricesfor key commodities. “The price index of our goodsexports declined by nearly 15% in 2012, mainly due toslower growth in our major trading partners, includingIndia and China,” Luky Alfirman, head of the Ministry ofFinance’s centre for macroeconomic policy, told OBG.Exports fell from $203.5bn in 2011 to $190bn in 2012.

Meanwhile, foreign direct investment (FDI) grew con-sistently from $19.5bn in 2011 to $24.6bn in 2012 androughly $14bn in the first half of 2013, 47.9% of whichfocused on the secondary sector and manufacturingparticularly, according to BKPM. According to BNPParibas, FDI covered 77% of the current account deficit(CAD) in 2012. With little production of intermediategoods, however, investment in the final stages of man-ufacturing has driven growth in imports: in 2012 amere 7% of imports consisted in consumer goods, while20% were capital goods and 73% intermediate and rawmaterials. As exports slowed from 13.6% growth in

2011 to a 6.6% contraction in 2012, imports contin-ued to expand by 13.3% in 2011 and 8% in 2012. AsIndonesia recorded its first annual trade deficit sincethe 1960s, of $1.63bn in 2012, its current accountswung from a small surplus of 0.2% of GDP in 2011 toa 2.8% deficit in 2012 and 4.4% by the second quarterof 2013. While the current account typically comesunder pressure in the second quarter given higherimports, firms’ debt servicing and repatriation of prof-its, the second quarter of 2013 witnessed the largestquarterly deficit given the run-up to Ramadan in July.The trade deficit reached its nadir of $2.3bn in July2012, according to Statistics Indonesia. With worsen-ing trade figures coinciding with a global outflow fromemerging markets caused by indications from the USFederal Reserve of possible tapering of its quantitativeeasing programme, portfolio flows reversed starkly andthe rupiah’s depreciation accelerated from June onwards.BI RESPONSE: The central bank’s response evolvedrapidly during the crisis. Initially it attempted similar moralsuasion as in past currency depreciations, in 2008 andin 2011, through open market operations and attemptsto steer the market through rate indications. This ledto an 11.5% drop in its foreign currency reserves inApril-August, from $104.8bn to $92.7bn, alongside awidening gap between BI-quoted exchange rates andthose offered by commercial banks and the Singapore-based non-deliverable currency forward market.Investors’ concerns over the domestic foreign-curren-cy liquidity and their ability to repatriate capital has exac-erbated capital outflows and preserved pressure on thecurrency. Although August reserves were sufficient tocover five months of imports and debt servicing, theirrapid fall prompted a revision of tactics. The central bankhad already tightened the overnight lending rate (FAS-BI) and its benchmark interest rate by 25 basis pointseach in June 2013, anticipating the fuel subsidy reduc-tion’s impact on inflation. From July, however, BI accel-erated its monetary tightening significantly: it hikedthe two policy rates by 50 basis points in late July, 50

The current account deficit

has been widening due to

the slowdown in exports

caused by lower demand

from Indonesia’s primary

trading partners and

reduced prices for key

commodities.

71


An active roleThe authorities have taken a range of measures aimed at securing thecountry’s long-term economic future

ECONOMY ANALYSIS

basis points in late August and another 25 basis pointsin both mid-September and mid-November – cumula-tive 175 basis point hikes in the FASBI (to 5.75%) andthe benchmark rate (to 7.50%) in the six months fromJune, the highest rates since early 2009.

This was combined with macro-prudential measuresto dampen domestic lending growth, as BI reducedbanks’ loan-to-deposit ceilings from 100% to 92% andraised their secondary reserve requirements, thosecovering banks’ holdings of government securities,from 2.5% to 4%. This contributed to a slowdown in lend-ing growth, which in turn helped curb imports (seeBanking chapter). BI also cut the minimum holdingperiod for central bank certificates (SBI) from six monthsto one month in a bid to attract more foreign investors.Furthermore, the bank introduced new measures to sup-port domestic foreign-currency liquidity by easing USdollar purchase rules for exporters, waving the require-ment for proof of underlying transactions to attract moreUS dollar liquidity onshore, lengthening its US dollar-denominated time deposit facilities to 12 months andreintroducing US dollar swap auctions from late July.

“The value of foreign exchange swaps by BI has mush-roomed since they were first introduced in July 2013,rising by over $3bn in September alone,” Helmi Arman,economist at Citibank Indonesia, told OBG. The centralbank has also suggested the idea of a US dollar-denom-inated SBI, a unique concept worldwide, to attract moredollar liquidity onshore. While the interest-rate hikeswere warranted given rising inflation prompted by thefuel price hikes implemented in late June – with y-o-yinflation accelerating from 5.9% in June to 8.6% in Julyand 8.8% in August – economists disagree on whetherBI has tightened too fast.

While foreign-linked economists argue the rate hikeswere warranted to preserve foreign investors’ yieldsamidst the currency correction and concerns over infla-tion and the CAD, most agree inflation will return tothe 4.5-5.5% trend rate by June 2014 given the baseeffect. “We are seeing a new form of monetary policy

from BI, targeting the current account rather than infla-tion,” Purbaya Yudhi Sadewa, Danareksa’s chief econ-omist, told OBG. “This is strange given that the CAD isa natural by-product of our success in attracting FDI,similar to our consistent CAD in the 1981-97 period.” FIREPOWER: While BI paused its tightening cycle inOctober, the bank increased rates by a further 25 pointsin November 2013. Although the bank shifted its mon-etary policy stance from influencing the direction tosmoothing out short-term volatility, it has also expand-ed its firepower by securing new forex-swap lines fromforeign central banks. Already a member of the ChiangMai initiative, a multilateral swap initiative involving 10ASEAN members alongside China, South Korea andJapan, BI also expanded bilateral swap agreements(BSAs). In August it extended a $12bn yen-denominat-ed BSA, with Japan indicating in October its readinessto increase the swap’s value if needed. In early Octo-ber China signed a RMB100bn ($16.1bn) yuan-denom-inated BSA with Indonesia, while South Korea signed a$10bn deal. While BI reacted swiftly, the governmentalso announced fiscal measures to address the crisis.“There is a perception gap between global investors,concerned about yields and calling for interest rateincreases, and what BI and the government are doing,”Anton Gunawan, Danamon Bank’s chief economist andexecutive vice-president, told OBG. “Indonesian author-ities must also look at liquidity in the banking sectorand the impact of rate hikes on employment – otherpolicy measures, including macro-prudential policies,are necessary aside from interest rate movements.”FISCAL MEASURES: Although the onus for short-termaction was squarely on BI in mid-2013, the governmentunveiled a package of measures in August 2013 thatare aimed at curbing imports, strengthening consump-tion and supporting investment in labour-intensive andexport industries particularly. “We are looking to re-adjust our current account by diversifying exports andcurbing excessive imports,” Luky told OBG.

The measures focus on four key areas. Those meas-ures concerning foreign direct investment (FDI) includethe streamlining of licensing requirements, removingbarriers on strategic investment projects and acceler-ating the revisions to the negative investment list,announced in late December 2013. Reforms aimed atcurbing the CAD include tax incentives for export-ori-ented industries, higher taxes on imported luxury goodsand raising bio-diesel fuel content to curb imports. Themeasures also include policies to preserve employ-ment, including tax incentives for labour-intensive firms,revisions to the minimum-wage negotiation process andeasing of some restrictions on bounded zones, dou-bling their domestic sales ceiling to 50% of output (seeanalysis). Finally, the government also sought to tamenon-fuel inflation by moving from import quotas toprice mechanisms for imports of beef and horticultur-al products, a suspension of prior policies that hadfuelled food-price inflation.

Economists have welcomed these policy measuresbut warn that their impact may be limited in the shortterm. “The government’s August package tried to

72

To help control lending and inflation, BI reduced banks’ loan-to-deposit ratios from 100% to 92%

In addition to its

membership in the Chiang

Mai initiative, in 2013 BI

signed three new bilateral

swap agreements – with

Japan, China and South

Korea – for a combined

value of $38.1bn.

In August 2013, the

government unveiled a

package aimed at boosting

FDI, curbing the current

account deficit, securing

employment and taming

inflation.


ECONOMY ANALYSIS

address the widening current account deficit, but thisis a medium to long-term package,” Fauzi Ichsan, Stan-dard Chartered’s senior economist, told OBG. “Withcommodities, mostly energy-related, accounting forover 60% of exports it is hard to see how they will growin the coming year, while the package did not addressthe issue of the US dollar liquidity gap.”

A higher CPO content for domestic fuel provides analternate outlet for high CPO production amidstdepressed global prices, helping curb refined fuelimports – given that roughly 60% of fuel consumptionis concentrated in Java and Bali, the measures will havea quicker impact. While politically-expedient, the high-er luxury tax will only have a limited impact on Indone-sia’s import bill. Meanwhile, measures to boost FDI willtake longer to manifest; however, the revision of thenegative list should help spur activity.

Addressing the structural causes of the CAD will takelonger, given the need to establish domestic produc-tion of intermediate materials and capital goods requiredby growing investment in manufacturing. “Some of themeasures enacted to curb the current account deficitare good, but they do not go far enough,” Anton toldOBG. “We would need to see a coherent industrialisa-tion vision to establish the necessary infrastructureand substitute some of the imported intermediarygoods that have driven the deficit’s growth.”PRELIMINARY IMPACT: Slowing economic growth,tighter domestic lending and reduced fuel imports,

stemming from higher domestic prices, started to grad-ually impact key indicators in September 2013. “Weexpect pressure on the current account to moderatein the second half of 2013, given lower imports of cap-ital goods, intermediate and raw materials, as well aslower fuel imports, as a consequence of the subsidycut in June 2013,” Luky told OBG. “We forecast an annu-al CAD in the 3-3.5% range.”

Indonesia’s trade balance returned to a small($132.4m) surplus in August, buoyed by weaker importsthat dropped 5.69% year-on-year (y-o-y) and 11.4%month-on-month (m-o-m) while exports sustainedtheir fall of 6.3% y-o-y and 12.8% m-o-m according toStatistics Indonesia – despite a 21.5% y-o-y rise inhydrocarbons exports. While lower fuel imports playeda role in curbing trade imbalances, imports of capitalgoods also fell 17% y-o-y in seven months to August.

The slight improvement in the third quarter of 2013provides some relief to Indonesian authorities, althoughthey admit the coming year will consist of a confidencegame with markets where they must demonstrate theyare ahead of the curve. Long-term, the government willneed to encourage investment throughout its produc-tion chain, focusing on developing onshore supplychains that can reduce pressure on imports of capitalgoods and intermediate materials. With no quick fix toIndonesia’s CAD, and amidst preparations for presiden-tial elections in mid-2014, the onus will continue to be on BI to preserve credibility with the global markets.

73

A coherent industrialisation

strategy will ensure that

Indonesia has the

necessary infrastructure

and intermediary

production facilities to

both boost exports and

reduce imports.

ECONOMY ANALYSIS

Domestic consumption is regarded as a key driver of the economy

With economic growth slowing, inflation rising andthe currency weakening, Indonesia has some toughmacroeconomic challenges ahead. However, the gov-ernment has responded to the situation with a vari-ety of monetary and fiscal policy tools, includingraising interest rates while at the same time rollingout fiscal stimulus measures.SLOWING GROWTH: In August 2013 the centralstatistics agency issued GDP figures for the secondquarter of 2013, showing that the economy hadexpanded by its slowest rate since the third quarterof 2010. Year-on-year growth in the second quar-ter eased to 5.92%, down from the 6.03% registeredin the previous three-month term, with the April-to-June result being the fourth quarter in a row thatthe rate of economic expansion had slowed.

The situation has been compounded by a fall inthe value of the rupiah, which had dropped more than20% against the dollar as of December 2013, and awidening of the current account deficit as exportgrowth has failed to keep pace with Indonesia’sappetite for imported goods.

The current account has been in the red for thepast six quarters, having previously been in positiveterritory – with the exception of 2008 – since 2005.While the current account deficit narrowed to $8.4bnin the third quarter of 2013, a drop from the near-ly $10bn deficit posted in the second quarter of2013, this was still the second-largest deficit in thelast five years. It is therefore likely to be some timebefore the deficit is erased in full.

The government has acknowledged that it may notbe able to meet its short-term targets. “We had seta 6.3% growth target for this year, but it may be dif-ficult to achieve this,” M. Chatib Basri, the financeminister, said in August 2013. “To achieve an eco-nomic growth of 6.3%, we should have 6.6% econom-ic growth [in September], which is difficult.”

In its August 15, 2013 meeting, the central bank,Bank Indonesia (BI), left its key interest rate

unchanged, a move seen as intended to foster growth,following a decision to raise rates to 6.5% in July, asinflation hit 8.61%, a steep climb from the 5.9% ofthe month before and the highest level in more thanfour years. However, in late August, BI reversedcourse, raising its benchmark rate to 7% in an attemptto slow capital outflow as the rupiah continued tofall. In the subsequent months, BI gradually raisedinterest rates to 7.5% as of November 12, 2013, withinflation slowing to 8.37% for the month. A HIKE IN RATES: While high interest rates shouldhelp curb inflation and slow the withdrawal of for-eign capital, they could also make it more difficultfor the government to achieve its target of above-6% growth, particularly with domestic consumptionseen as the locomotive of the economy.

In August 2013 Basri said that President SusiloBambang Yudhoyono favoured a “keep buying” pol-icy that would lift household consumption, the largestsingle contributor to the economy. “So, if consump-tion is high, GDP would be high,” Basri said. “House-hold consumption and government expenditure willboost the economy because investments are expect-ed to reduce, with no guarantee of export growth.”

In the short run, the government has said that itwill introduce a stimulus package, as well as tax hol-idays, in an attempt to reduce the current accountdeficit and boost growth. However, the marketresponded poorly to the plan, with stock and bondvalues, as well as the rupiah, declining in the daysfollowing the announcement. In the medium termthe 2014 budget could provide support to the econ-omy, with the state indicating that it will promotedomestic consumption, in addition to increasedspending on infrastructure construction and humanresource development, both of which are intendedto lift productivity. However, the effect of theseinvestments will take time to be felt. In February2013 Central Statistics Agency reported that Indone-sia’s GDP grew at an annual rate of 5.78% in 2013.

In the second quarter of

2013, the current account

deficit reached its highest

level in the last five years,

at nearly $10bn. This eased

slightly in the third quarter,

however, to $8.4bn.

Between July and

November 2013, the

central bank raised interest

rates from 6.5% to 7.5% in

an effort to curb inflation

and slow the withdrawal of

foreign capital.

74

Balancing growthThe central bank is taking action to ward off macroeconomic challenges


ECONOMY INTERVIEW

Edward Soeryadjaya, Chairman & Founder, Ortus Holdings

What are some of the biggest challenges that need

to be overcome for the economy to move forward?

SOERYADJAYA: The immediate priority is to reverse thecontinuing trade deficit, while the long-term challengeis to attract foreign investment. Exports have mostlybeen dependent on natural resources, which have expe-rienced a downturn for the past several quarters. With-out greater investment to spur the level and variety ofexports, the trade deficit will not be erased.

Short-term solutions via monetary policies will notbe able to solve the fundamental issues of our econo-my. Rather, what we need is foreign direct investment,which can drive economic growth. However, we firstneed to educate our stakeholders and the public aboutforeign investment and ownership. There can be goodand bad foreign investment. Good investment is thatwhich targets manufacturing and is export-oriented,or that which generates multiplier effects such as forroads, power, ports and other infrastructure. On the oth-er hand, bad investment includes short-term moneyplaced in the stock exchange or investments that erodenatural resources and have limited multiplier effects.For instance, while thousands of tonnes of copper andgold were extracted from Papua, infrastructure andeducation remains underdeveloped in that region.

Sustainable foreign investment will boost our com-petitiveness by creating new jobs, increasing employ-ment, developing infrastructure and nurturing a bet-ter workforce. Furthermore, the cost of doing businesscan be reduced, which, in turn will attract more invest-ment. Over time, wages will rise and the economy willgain momentum from higher domestic consumption.

How are external factors affecting fiscal perform-

ance and what can Indonesia do to support growth?

SOERYADJAYA: While the health of the US and EUeconomies is concerning, as together they constitutejust under half of the global economy, China and oth-er Asia-Pacific countries are currently on an upwardtrack. There are alternative ways for Indonesia to grow

besides through the influence of the US, as has beenthe case for some years now. Indonesia can prove itselfto be dynamic and robust with its Asian neighbours,such as China, Japan and South Korea.

For the long term, the government should embracethe concept of an integrated economy, which calls fornon-conflicting policies and a joined-up approach toeconomic planning. For instance, the newly implement-ed ban on the exporting of certain unprocessed metal-lic ores from Indonesia means that exporters of suchmaterials must first refine and process the ores into high-er grades. That is a fine policy; however, there has beena lack of integrated planning for the required support-ing industries and infrastructure to build the smelters,including supply of gas, power, roads, ports and humanresources. Red tape and site issues need to be ironedout. With an integrated approach, all related ministriesand stakeholders can work together and remove thehurdles, including huge numbers of permits at differ-ent levels of government, land usage for the infrastruc-ture and development of the fields, and incentives forreinvestments of the pre-tax earnings.

In what way can oil production be increased, and

how do domestic energy companies see the cur-

rent investment landscape?

SOERYADJAYA: Indonesia’s demand for energy, espe-cially in the medium to long term, is going to rise sig-nificantly. With priorities given to domestic operators,the government is hoping to see more multiplier effectscreated through oil and gas earnings. The governmentis taking steps to reduce red tape, in particular at theexploratory stage. Increased domestic financing forthe development of reserves on proven fields is alsounder way. Limited infrastructure in remote areas includ-ing roads, power supply and ports remains a challenge.Many industries could develop and improve markedlyif there were better roads, trains and organisationalstructures in place. Investment in this area could cre-ate positive spillover effects for the wider economy.

75


Attracting investorsOBG talks to Edward Soeryadjaya, Chairman & Founder, Ortus Holdings

ECONOMY INTERVIEW

Prijono Sugiarto, President Director, Astra International

How much is the revised economic outlook for

Indonesia’s GDP growth affecting corporations’

growth projections and expansion plans?

PRIJONO: A slowdown of Indonesia’s economicgrowth in 2013 was expected, following the sub-sidised fuel price increase, which sparked higherinflation and a 20% depreciation of the rupiah – duein large part to trade deficits. Despite this, I am con-fident in the medium- and long-term prospects ofthe country. On a global scale, the continued recov-ery of advanced economies such as the US will trig-ger higher demand in emerging economies, whichwill improve commodity prices and benefit Indone-sian exports. Furthermore, Indonesia’s macroeco-nomic fundamentals are still sound.

Tightening monetary policy is expected to bringdown inflation in 2014, and the trade balance hasbeen improving over the past months. Indonesiaalso has a very resilient consumer market, and ris-ing per capita income and a growing middle classmake the country a very attractive market for long-term investments. All of these factors, coupled witha smooth presidential election in 2014, will usher for-eign investment back into the country and boost theeconomy. Even with the tapering of US monetary pol-icy, I believe Indonesia will be largely unaffected andthat in the medium term foreign funds will return.Indonesia has actually only just started to enter itsgrowth phase and will experience much more robustgrowth in the future. Thus, companies are capitalis-ing on the country’s robust outlook and are contin-ually accelerating expansion plans.

As the economy is driven by domestic demand,

can Indonesian firms be encouraged to export

in order to improve the country’s trade balance?

PRIJONO: Currently, Indonesian companies are notsufficiently encouraged to tap export markets dueto factors including the lack of sufficient informa-tion on the export market, technological advantages

that make their products unique and competitivepricing to compete against products from otheremerging markets. To mitigate this, Indonesian firmsneed the government’s support to boost exports.

For Indonesian corporations to seriously consid-er the export market, we should look at incentiveslike subsidies, export insurance, and tax benefits forcompanies that build production bases and researchand development facilities at home, while also export-ing their products. A reduction in the cost of mate-rials used to produce exported products throughpolicy initiatives, including the reduction of importtaxes and duties, would also be beneficial. Theimprovement of sea and airports, as well as othertransportation infrastructure, would also reduce thelogistics cost of exporting. Lastly, a competitive andstable exchange rate for the rupiah needs to bemaintained in order to facilitate the interaction oflocal companies with the international market.

To what extent is the lack of infrastructure sti-

fling the Indonesian automotive sector’s growth?

PRIJONO: From a regulatory perspective it is quitelikely that regional governments may issue policies,such as limitations on car ownership, limitations oncar and motorcycle use in certain areas or duringcertain hours, and electronic road pricing. This mayimpact the growth of the automotive sector in regionswhere automotive growth is exceeding the pace ofroad infrastructure expansion and causing severetraffic congestion. This is mainly being experiencedin the greater Jakarta area and, to a lesser extent, inother large cities like Surabaya and Medan. There isroom for improvement in infrastructure develop-ment across the country, particularly in toll roads asthey relate to the automotive sector, which haveincreased a mere 778 km from 1978 to 2012. Thus,tangible growth in the nation’s infrastructure mustgo hand in hand with the growth of the automotivesector to support the full potential of the industry.

76

Delicate balanceOBG talks to Prijono Sugiarto, President Director, Astra International


ECONOMY ANALYSIS

Indonesia is planning to open 24 new airports by 2015

Slower growth in Indonesia may provide an impetus torealise a range of reforms that the government is plan-ning, changes that could open several important andattractive sectors to greater foreign investment. OnNovember 6, 2013 the Indonesia Investment Coordi-nating Board (BKPM) announced plans to allow for-eign investment in airports and ports, and to easerestrictions in the telecommunications and pharmaceu-ticals sectors. The announcement came just hours afterofficial figures showed GDP growth had slowed for afifth consecutive quarter, albeit to 5.62% – still impres-sive by global standards.LOOSENING RESTRICTIONS: The BKPM’s chairman,Mahendra Siregar, told reporters the government wouldallow foreign firms to hold stakes of up to 100% in air-ports, airport services and ports, while permitting 49%ownership of freight terminals. Currently, state-ownedfirms Angkasa Pura and Pelindo own and operate air-ports and seaports, respectively. With Indonesia plan-ning to open 24 new airports by 2015, private capitaland management expertise could help support expan-sion. Local press reports suggest that restrictions onforeign investment in financial institutions, tourism,health care and advertising could also be loosened.

However, Sofjan Wanandi, chairman of the Indone-sian Employers’ Association, told local press restric-tions could yet be imposed on retail and logistics, inwhich foreign ownership of 100% is allowed. Furtherdetails have yet to be released, but on December 5, 2013Mahendra told the press that President Susilo BambangYudhoyono had promised his advisers the reforms wouldbe finalised as soon as possible.

News regarding the reforms is long awaited. TheBKPM was due to revise the so-called negative invest-ments list (DNI), which sets limits on foreign ownershipof assets in various sectors, in 2013, but this had notbeen finalised as of early 2014. The list was last mod-ified in 2010, easing restrictions on investment in edu-cation, construction, health care, postal services andtelecoms, while tightening some other requirements.

SLOWING GROWTH: The renewed sense of urgencyabout the DNI revisions may be partly associated withthe upcoming parliamentary and presidential elections,but most media reports suggest that it is mainly driv-en by concerns over slowing growth. While GDP expan-sion of more than 5% may be high by global standards,Indonesia remains a relatively poor country with a largeand growing population, and the government wishesto continue delivering higher incomes and more jobs.One of the reasons for sluggish growth is lower invest-ment. In the third quarter of 2013, realised investmentsgrew 22.9% year-on-year, according to Indonesia Invest-ments. This may seem high, but it is low compared torecent performances – and realised investments grewjust 0.7% quarter-on-quarter in third-quarter 2013.CHALLENGES: A number of factors are acting as adrag on growth, including inflation, weak externaldemand, higher interest rates and a depreciation of therupiah. All are affecting investor confidence. In 2013the country saw an outflow from its financial marketsof $1.4bn to early December, compared to a $1.7bninflow in 2012. A recent survey by the British Cham-ber of Commerce Indonesia found that 60% of respon-dents remained confident about their business in thecountry, down from 83% in 2012, while the chamber’sease of doing business rating fell from 65% to 50%.

In an increasingly competitive environment, in whichmany emerging markets are seeking investment todrive growth, even Indonesia, with its large and grow-ing domestic market, ample resources and strategic loca-tion, cannot rest on its laurels. As the IMF said in anAugust 2013 report on the country, “More intensestructural reform efforts are needed to reduce supplybottlenecks, broaden the export base, and bolster medi-um-term economic and employment growth… the mainpriorities continue to be accelerating infrastructureinvestment, creating a more open and predictable tradeand investment regime.” Encouraging foreign investmentin key sectors such as transport and communicationswould be an important step in the right direction.

According to the Indonesia

Investment Coordinating

Board, recent reforms will

allow foreign firms to hold

stakes of up to 100% in

airports, airport services

and ports, while permitting

49% foreign ownership of

freight terminals.

77


A number of factors are

acting as a drag on growth,

including inflation, weak

external demand, higher

interest rates and a

depreciation of the rupiah,

with a resulting impact on

investor confidence.

Impetus for reformChanges are set to open new sectors to greater foreign investment

ECONOMY ANALYSIS

Agriculture accounts for around 16.46% of the province’s GDP

With the province’s GDP growth hitting 6.49% in thethird quarter of 2013, outpacing the national rateof 5.62%, it is clear that East Java’s commitment toboosting foreign and domestic investment is payingoff. To support investors, the East Java branch of theIndonesia Investment Coordinating Board (BKPM)offers a one-stop service, which allows businesslicences to be issued within just 14 days in 2013, downfrom 17 days the previous year. However, it shouldbe noted that this service is currently only availableto domestic companies; all foreign companies seek-ing to invest in East Java have to apply through theBKPM’s head office in Jakarta. LEADING FROM THE FRONT: To further maximisedomestic potential and mitigate the effects of theglobal economic slowdown, the East Java provincialgovernment is focusing on expanding inter-provincetrade and commerce via the establishment of 24representative offices across Indonesia. However,the government will also continue to look abroad aswell, focusing primarily on neighbouring Asian andOceanic markets through its existing offices in Japan,South Korea, China and Australia.

Given the province’s location, the developmentof multiple new port and shipping terminals remainsa goal, although the strategic focus of both the BKPMand the provincial government increasingly centreson connecting the second- and third-largest strandsof the local economy. According to Statistics Indone-sia, these consist of the manufacturing industry(26.79% of GDP) and agriculture (16.46% of GDP),whose mutual development should stimulate theentire economy and enfranchise the province of38.05m people’s young yet underutilised workforce.

With regards to agriculture, reliable production ofhorticultural commodities, particularly during thehigh-demand Ramadan and Eid Al Fitr periods, hasalso contributed to helping the province to reduceoverall inflation. In August 2013 East Java’s inflationrate was 8.06%, which is lower than the national

average of 8.79%, according to figures from BankIndonesia, the country’s central bank. HIGHER YIELDS: With aspirations of becoming acentre for agricultural activity, the government istargeting investment in compatible downstreamindustries, such as food and beverage factories,which will in turn have multiplier effects for the localeconomy. With an estimated 14% of the province’spopulation living below the poverty line at the endof 2013, the government is now committed to reduc-ing this at the ambitious but achievable rate of onepercentage point per year.

Cargill’s $100m investment in a plant in Gresik, EastJava, which is scheduled to start production in mid-2014, is a good example of the sort of investmentthe government aims to attract. The factory, whichis the first of its kind in Asia, will be capable of pro-cessing around 700,000 tonnes of cocoa beans annu-ally into products such as butter, powder and liquor.In terms of the positive effects that will be felt with-in the province, Cargill will double existing purchas-es from local farmers and also aims to train 1300

The government is

committed to reducing the

poverty rate and is

encouraging investment in

downstream industry,

including food and

beverage factories, which

will have multiplier effects

for the local economy.

78

Eastern promiseWorking to attract further investment into East Java


East Java’s GDP recorded 6.49% growth in the third quarter of 2013

ECONOMY ANALYSIS 79

Building on the province’s

surplus power capacity of

4250 MW, the authorities

are working to develop

alternative energy sources,

including geothermal,

which is largely untapped

despite a potential of up to

1500 MW.

The government aims to make East Java a centre for agriculture

smallholders by 2015 by setting up educational cen-tres, a move that is expected to improve cocoa beanquality, integrate best practices and boost yields.

Furthermore, state-controlled fertiliser companyPetrokimia Gresik has announced plans to set up anew ammonia and urea production plant in the samearea; the facility will cost an estimated $580m andshould be completed by mid-2016. The plant isexpected to have an annual production capacity ofaround 825,000 tonnes of ammonia and 570,000tonnes of urea fertiliser. Indonesia currently importsmore than 400,000 tonnes of ammonia per year, andit is envisioned that the plant will help to significant-ly reduce the country’s dependence on imports.

Cigarette manufacturer Sampoerna also openedits seventh hand-rolled cigarette factory in Jember,East Java in mid-2013, and it now employs 4500workers at the plant. The new factory joins the firm’ssix others in Surabaya, Malang, Probolinggo andLumajang, all of which are in East Java. PLUG & PLAY: A common obstacle for investorslooking to build downstream or value-added plantsin Indonesia is the shortage of power, but this is notan issue in East Java, as the province actually runs asurplus of around 4250 MW. While this is a definiteachievement in a country where shortfalls are com-mon, it also gives the province breathing room andan opportunity to further boost capacity by devel-oping alternative energy sources. This will likelyinclude the exploitation of its nascent geothermalenergy potential, estimated at around 1500 MW,which so far has been largely untapped. However,with the state-owned electricity provider, PerusahaanListrik Negara (PLN), estimating that Indonesia willneed to add some 5.7 GW of additional capacity peryear to meet the growing demand for power, theprovince cannot afford to rest on its laurels.INDUSTRIAL PARKS: Progress is being made on thedevelopment of much-needed industrial park areasas well. Located in Mojokerto outside of Surabaya,Ngoro Industrial Park, which is a joint venture betweendomestic developer Intiland Development and Tai-wan-based RSEA Engineering Corporation, will com-plete stage two of its expansion plan in mid- to late2014. With the current park spanning 220 ha, stagetwo of the expansion plan will increase land area by

another 223 ha; further augmentation to a final sitesize of 650 ha is planned over the course of the nextdecade. With 80% of the second stage of the devel-opment already sold in early 2014 and sales of stage-three space beginning at the end of the year, thedemand for such sites is tangible.

Wihardi Hosen, the general manager of NgoroIndustrial Park, told OBG, “70% of tenants are for-eign direct investors. While Jakarta increasinglyappears as a portfolio investor destination, Surabayais a location where genuine foreign direct investmentis being realised in the form of downstream facto-ries and processing plants being developed.” He wenton to cite the early 2014 completion of a 20-haUnicharm factory as one such example. HOME OF INDUSTRY: In line with such expansionefforts, Surabaya appears ready to welcome large-scale industrial investment with open arms. The city,Indonesia’s second largest, was rated “intermediateplus” in a financial management assessment conduct-ed by Standard & Poor’s in 2011, which identifiedthe city as “one of the best among South-east Asianlocal governments that Standard & Poor’s assessed”.

Subsequently, PLN has begun to champion theprovince as a site for the wave of new smelters set

ECONOMY ANALYSIS

to be built over the next three years. The controver-sial 2009 Mining Law, which took effect in January2014, bans exports of unprocessed ore and requiresore to be processed domestically. The availability ofpower and economic competitiveness have sincebeen cited as the key factors in the firm’s endorse-ment of East Java, with Nur Pamudji, the presidentdirector of PLN, emphasising his confidence in theprovince’s ability to provide enough power. He toldlocal press that, “Every day, around 3000 MW ofelectricity from East Java is transferred to Jakarta. Inthe near future, new power plants will also go on-stream in Paiton, Tanjung, Awar-Awar and Pacitan.”

Companies looking to comply with the new regu-lation include Freeport Indonesia, the local sub-sidiary of US giant Freeport-McMoRan Copper andGold, which formalised its commitment to supply-ing smelters in the province via a memorandum ofunderstanding signed with Indosmelt and IndovasiMineral Indonesia in August 2013. Indovasi’s $1.5bncopper cathode plant, which is to be located in eitherTuban or Gresik, is set to begin production in 2017with an output of 200,000 tonnes per year. At pres-ent, Freeport supplies 40% of its annual productionof 2.5m tonnes to Smelting’s Gresik-based smelter(of which Freeport owns 25%), which produces over300,000 tonnes of copper cathode. GETTING ATTENTION: Following a peak in invest-ment of $14.03bn in 2012 and a similar performance

in 2013, East Java continues to attract investor atten-tion both at home and abroad. While the forecastsfor 2014 for both investment and provincial econom-ic growth will likely be somewhat less rosy in light ofthe wait-and-see attitude being adopted by manyinvestors at present, the provincial authorities’ proac-tive and supportive approach is certainly encourag-ing. As such, it can reasonably be envisioned that anytemporary delays relating to the presidential andparliamentary elections scheduled for July 2014 willlikely be mitigated in the period which follows.

In the meantime, East Java must not lose sight ofthe importance of implementing measures to encour-age investment, including boosting the power sup-ply, pushing through infrastructural improvementsand strengthening links with investors. The need forfurther investment is clear: according to the minis-ter of national development planning, Armida Alis-jahbana, consumption accounts for 60% of growthin the province and investment less than 20%, against55% and 32% on the national level.

While new investments are gradually coming tofruition, significant challenges remain. Licensingprocedures in the province are arduous and privateland acquisition outside of the dedicated industrialparks continues to be a major obstacle. The prospectsfor Indonesia’s second-largest province seem bright,but only time will tell if it really is as easy to investin East Java as the provincial authorities suggest.

80

A new regulation, which

has been in force since

January 2014, prohibits the

export of unprocessed ores

and requires them to be

processed at local smelters.

East Java is well placed to

benefit from the expansion

of domestic smelting

capacity.

ECONOMY ANALYSIS

Indonesia’s logistics costs are estimated at around 24% of GDP

East Java is the principal gateway to eastern Indone-sia, and its transport and logistics network is crucialto the development of the province. With theSurabaya port of Tanjung Perak currently the coun-try’s second-busiest seaport, the completion of thenew multipurpose terminal, Teluk Lamong, is highlyanticipated and should help to reduce dwell times.INCREASING CAPACITY: The existing port of Tan-jung Perak has been consistently operating over itsgeneral cargo capacity of 3.57m tonnes per year,with volumes reaching more than 7m tonnes in 2012.The first phase of the new Teluk Lamong terminal,which began construction in 2010, will encompassa 500-sq-metre international yard, 450-sq-metredomestic yard, a 10-ha dry bulk yard and a 15.86-ha container storage yard. The second phase of theproject is planned to start in 2016 and is set toinclude development of a further 50 ha.

In addition to the marked capacity increases, state-owned operator Pelindo III has made good on itsaspirations to use environmentally friendly technol-ogy in the project, purchasing electrically poweredloading and unloading equipment from Finland-based manufacturer Konecranes.

Pelindo III and construction company Adhi Karyahave plans to begin work before the end of 2014 ona Rp2.5trn ($250m) automated container trans-porter, which will directly connect Tanjung Perak andthe new terminal to maximise efficiency. It is hopedthat improved connectivity between the two willcontribute towards realising the goals of the Mas-ter Plan for the Acceleration and Expansion ofIndonesia Economic Development (MP3EI) and helpmitigate Indonesia’s high logistics costs, which arecurrently estimated at around 24% of GDP, accord-ing to a recent World Bank report.

Upon beginning operations in 2014, Teluk Lamongwill become Indonesia’s largest international ship-ping terminal. Pelindo III plans to secure adequatepower supply for the terminal by collaborating with

state engineering company Rekayasa Industri in theconstruction of a 50-MW gas-powered electricityplant to serve the multipurpose terminal. NEW CONTENDER: While Tanjung Perak’s expan-sion remains a major topic of conversation in the sec-tor given the new terminal’s upcoming opening, setfor June 2014, the development of a 3000-ha sitein Gresik by chemicals and petroleum distributorAKR Corporindo is also attracting significant atten-tion. Expected to eventually become the country’slargest integrated port and industrial estate, thedevelopment represents a significant step forwardin easing the logistics bottlenecks of both East Javaand eastern Indonesia more broadly.

At an estimated cost of around Rp9trn ($900m)and developed in joint partnership with state enti-ty Pelindo III, the Java Integrated Industrial and PortsEstate (JIIPE) will feature a 400-ha deep-sea portwith a maximum vessel capacity of 18,000 twenty-foot equivalent units, as well as 1800 ha of indus-trial land and an 800-ha residential estate.

Furthermore, as the only private firm with a licenceto distribute subsidised fuel, AKR Corporindo was giv-en the right to distribute 267,892 kilolitres in 2013and will likely use the JIIPE to greatly improve itscapability to meet increasing private sector quotas.

Most importantly though, the developers havespecifically chosen the site to circumvent infrastruc-tural issues, such as the limited maximum channeldepth at Tanjung Perak (due to a pre-existing under-water electricity cable) and the poor road infrastruc-ture surrounding Tanjung Priok.

Around one-third of the 3000-ha JIIPE site hadbeen secured as of the beginning of 2014, althoughfurther development is likely to run into difficultieswith land acquisition. The entire project is expect-ed to be completed by 2023. PORT SUPPORT: While its inclusion within the MP3EIhas accelerated port expansion, the same cannot besaid of East Java’s surrounding shipyards, which are

81


The $900m, 3000-ha Java

Integrated Industrial and

Ports Estate will become

the country’s largest such

project and will help ease

the logistics bottlenecks of

East Java and eastern

Indonesia more broadly.

Linking upConnectivity plans are coming to fruition in East Java

ECONOMY ANALYSIS

not included under the direct infrastructural ambitof the economic acceleration programme. Thus, lit-tle attention has been paid to the likely parallelexpansion of the shipbuilding industry. Though thegovernment has made efforts to increase exportsin recent years, its regulation of April 2013, whichimplemented a 10% export tax, has hindered theability of domestic shipbuilders to compete interna-tionally. In addition, high borrowing costs, an importduty of up to 15% on raw materials and components,and a support industry whose products are unableto meet domestic certification requirements meanthat Indonesia’s ship production costs exceed thoseof regional competitors like China and Vietnam. Asa result, domestic shipbuilders are unlikely to meetthe government’s goals for developing high dead-weight tonnage (DWT) vessels by 2015.

Yance Gunawan, president director of Dumas Tan-jung Perak Shipyard, also highlighted the favourabletariffs and preferential tender treatment applied tosome areas of the country, such as Batam in theRiau Islands, telling OBG, “Domestic shipyards in EastJava have been questioning whether Batam is stillpart of Indonesia because it is subject to none ofthe taxes or challenges that we are.”

Batam currently possesses the only shipbuildingfirms that are capable of producing much-needed70,000-DWT vessels, while East Java’s capacityremains at 50,000 DWT. Although regulation andlocal conditions have dampened export prospects,it is not all bad news for shipbuilders in East Java. Theneed for more than 1000 new coastal ferries totransport passengers and cargo between the coun-try’s many islands has bolstered demand for localproducers to some extent. AIRPORT CAPACITY: Where air travel is concerned,Surabaya’s Juanda International Airport is theprovince’s main hub. Located around 20 km southof Surabaya, the airport handled some 16m passen-gers in 2013, double its capacity. A second terminal

planned under the MP3EI opened in February 2014to accommodate the increasing number of passen-gers. The new terminal at Indonesia’s second-busiestairport (after Jakarta’s Soekarno-Hatta Internation-al Airport based on passenger and aircraft move-ments) cost around Rp946bn ($94.6m) to build andhas the capacity to handle 6m passengers per year.It is dedicated to Garuda Indonesia, Air Asia, Man-dala Airlines and all international flights.

However, with a single runway of just 3000 metresaccommodating 378 flights per day on average,many commentators, including the IndonesianTourism Board, have highlighted expansion of the run-way as key priority. The airport’s operator, AngkasaPura I, has confirmed that it will construct a secondrunway, which it will develop in tandem with Termi-nal 3 to help accommodate the growing traffic.

Trikora Harjo, the general manager of AngkasaPura I Juanda, told OBG that with Terminal 2 becom-ing fully operational in early 2014, a new, 3600-metre runway and accompanying Terminal 3 wouldbe next on the agenda. The eventual aim is for theairport to be able to accommodate a total of 40mpassengers per year. Land acquisition for Terminal3 will begin in 2014 and construction is expected tocommence in 2015. Harjo also confirmed that, in lightof a lack of domestic human resources expertise inthe field, Juanda has been cooperating with SouthKorean’s Incheon International Airport on the con-struction and servicing of the new terminal, thesame South Korean partner used for the new Baliand Jakarta airport expansions. RAILWAY PROGRESS: While East Java continues totake steps to enhance its transport infrastructure,the expanding network is struggling to keep pacewith the ever-increasing flow of both people and car-go. However, projects are under way to address thisissue, including the Trans-Java double-track railway,which will connect Jakarta to Surabaya as part of theMP3EI. According to data from the Ministry of Trans-port, from 2011 through 2025 the country requiresa total of Rp320trn ($32bn) in investment to devel-op railway services on Indonesia’s five main islandsof Sumatra, Java, Kalimantan, Sulawesi and Papua.

At a cost of some Rp9.8trn ($980m), the 727-kmrailway line is set to cut intercity travel time from 13hours currently to only 8.5 hours, with completedtrack capacity allowing increased traffic from 64 to200 trains per day. Travel times have been lengthyas the railway connecting Cirebon and Surabaya isa single-track line. While the railway project was pre-viously scheduled to start operations in November2013, E E Mangindaan, the Indonesian minister oftransport, told local media in February 2014, “We arecurrently conducting the finishing process of theconstruction. We will officially open the double trackin March this year.” The completion of the projecthas been delayed mainly due to land acquisitionissues. While by no means the final piece of the infrastructure puzzle, the new double-track rail-way will do much to ease congestion on local roads.

82

Cargo volumes at Tanjung Perak exceeded 7m tonnes in 2012, well above its capacity of 3.57m tonnes

Surabaya’s Juanda

International Airport

handled 16m passengers in

2013, which is double its

capacity. To accommodate

the rising number of

passengers, a second

terminal was opened in

early 2014. A new, longer

runway and a third terminal

are next on the agenda.


ECONOMY INTERVIEW

Tri Rismaharini, Mayor of Surabaya

Surabaya is one of the most advanced cities in

Indonesia, but where is infrastructural investment

needed to bring it to the next level?

RISMAHARINI: In recent years many projects havebeen undertaken to develop Surabaya’s infrastructureand improve its accessibility, both from land and sea.New roads are continuously being built in the easternand western areas of the city, and we plan to imple-ment a mass rapid transit system in the near future. Thereis still work to be done, however, and we hope that thecentral government can help by building additionalaccess for logistical transportation by road and rail.

We are also developing access for a new port in theTeluk Lamong area. Surabaya’s ports play a key role inthe regional and national economy, as many in easternIndonesia rely on food, clothing and materials that orig-inate from Surabaya, so increasing our port capacity iscrucial. In preparation for Indonesia’s participation inthe ASEAN Economic Community and the ASEAN FreeTrade Area, the improvement of our ports is a must asthey are gateways to the region and the country as awhole. Projects are also under way to develop gas andwater resources for the people of Surabaya, to reducethe cost of living and improve their quality of life.

What is being done to encourage and assist foreign

companies looking to invest in Surabaya?

RISMAHARINI: It is very important to develop reliableand transparent access to information about investingin Surabaya so that foreign companies can have a clearunderstanding of the processes involved. We are work-ing to clarify the permit process and make the licens-ing process easier, making the city more attractive andaccessible to foreign companies. The Surabaya city gov-ernment also aids these firms by acting as a facilitatorand intermediary in dealing with permissions from thelocal population or building relationships with localcompanies with which they can partner. It is crucial forSurabaya to have these partnerships because thisincreases the quality of human resources in the city,

and our human capital must be ready when greaterregional economic integration takes place. At the sametime, foreign firms can get help from local partners inthe adaptation process and in the multicultural inter-action with local people. Strong cooperation betweenlocal and foreign companies is beneficial for all.

What must take place to ensure the sustainability

of Surabaya’s high growth rate in the near future?

RISMAHARINI: Of foremost importance is the devel-opment of our young population. We allocate 35% ofour regional budget to the improvement and develop-ment of our youth. There is free education in Surabayafrom playgroups all the way to high school, as well asscholarships for those who would be unable to obtainfurther education otherwise. It is also necessary to pro-vide facilities to ensure that these young people canget work after graduation, so this high level of invest-ment is vital as it is the only way to develop our youthto compete in the global workforce.

We are also working to develop informal educationby providing 972 libraries, as well as sports and artfacilities, language centres teaching English and Chi-nese, and courses on internet literacy. Surabaya has avery high level of connectivity to facilitate this, as thereis free Wi-Fi in all schools, libraries, hospitals, clinics,government offices and public parks in the city.

Furthermore, it is important to focus on the devel-opment of oft-ignored demographic groups which arenevertheless key drivers of economic growth, such ashousewives and mothers. Training for these groups isprovided to ensure that they can find work in the infor-mal sector, and we develop entrepreneurship skills byhelping them to sell their products in government-pro-vided malls, thus starting their own businesses.Surabaya’s recent economic development and growthis largely due to rising local consumption, so to ensurethat this growth is sustained or improves, we need topay special attention to the low-income populationand to raise incomes and living standards at all levels.

83


Continual improvementOBG talks to Tri Rismaharini, Mayor of Surabaya

85

BankingStrong fundamentals set to support long-term growthActivity concentrated among the five largest banksEfforts being made to extend services to rural areasAuthorities aiming to promote more lending to SMEs

BANKING OVERVIEW

The aggregate LDR reached a 15-year high of 88.68% by July 2013

Banking remains a highly profitable sector in Indone-sia despite being limited in its reach. Leading banks’average profits were the highest amongst majoreconomies in 2012, according to Bloomberg data,a remarkable feat in an era of falling bank profits glob-ally. Credit and savings remain marginal, however, withloans accounting for 32.85% of GDP and deposits39.13% by December 2012, according to the cen-tral bank, Bank Indonesia (BI). Although lending hasgrown by an average of 20% annually in the fiveyears to 2013, according to private-equity firm KKR,driven by strong consumer credit growth linked tothe emerging middle class, its contribution to theeconomy remains far shy of neighbours like India(55%), Malaysia (113.5%) and China (130%).

While well-capitalised and conservative, with verylow reliance on wholesale funding, Indonesian banksare constrained by slower deposit growth. As the reg-ulator seeks to expand banks’ intermediation to moreproductive sectors of the real economy, foreign insti-tutions’ appetite to tap into domestic growth hasgrown significantly in the past five years. Amidsttightening liquidity, banks’ and the regulator’s pri-orities are changing. “We are now more focused onstability than on growth,” Bimo Epyanto, BI’s assis-tant director of investor relations, told OBG.RAPID EXPANSION: Credit growth recovered quick-ly from its November 2009 trough – when it slowedto 5.5% year-on-year (y-o-y) amidst the global finan-cial crisis – reaching 24.4% in 2011 and 23.9% in2012 before moderating slightly to 20.7% in the firsthalf of 2013, according to BI data. Commercial banks’total assets, meanwhile, grew 17.08% y-o-y toRp4716.85trn ($471.69bn) by October 2013.

Lending to households was the key driver, espe-cially vehicle and housing loans. Sharia lending(through both dedicated banks and conventionalbanks’ windows) has also grown at consistentlyabove-market rates in the three years to 2013, sus-taining 24% annual asset growth compared to 11%

for conventional bank, according to PwC. “Islamicbanking is a relatively new industry in Indonesia andhas been growing faster than conventional banking,”Arviyan Arifin, president director of Bank Muamalat,told OBG. Although the rate of growth has beenimpressive, this has been from a low base – assetsreached Rp229.6trn ($22.96bn) in October 2013,4.82% of banking sector assets. OTHER INDICATORS: Such rapid credit growth hasoutpaced deposits, whose growth slowed from 19%in 2011 to 15.8% in 2012. As such, the sector’s aggre-gate loans-to-deposit ratio (LDR) has risen swiftlyfrom 72.1% in January 2010 to 83.6% by end-2012,reaching a 15-year high of 88.68% by July 2013according to BI. As liquidity dried up from late 2012onwards, loans denominated in local currencyreached a 89.7% LDR by October 2013. Amidst stronggrowth in dollar-denominated deposits in 2013 (asexporters delayed conversion to rupiah in expecta-tion of a sustained exchange-rate fall) and stable dol-lar lending, the system’s foreign-currency LDR hastrended upwards from 82.6% in mid-2012 to around89.5% by October 2013, according to BI. TAKING ACTION: As part of monetary tighteningmeasures that were announced in August 2013, BIis reducing its LDR ceiling from 100% to 92% byDecember 2013 to restrain credit growth. “The pri-ority now is to restrain domestic demand throughhikes in the benchmark interest rate and other instru-ments to constrain credit growth,” Epyanto told OBG.Only banks with capital adequacy ratios (CAR) ofabove 14% will be allowed to exceed this limit, giv-en their potential for additional wholesale fundingleverage to fund the excess.

“The reduction in the LDR ceiling to 92% will curblending growth for the more aggressive banks, whichI think is necessary after such rapid growth, and willhelp curb growth in the current account deficit.However, some banks may prefer to raise depositfunding rather than slow down their loan growth,”

Credit plays a modest role

in the Indonesian economy,

with loans amounting to

32.85% of GDP. This is

considerably lower than in

many neighbouring

countries, such as Malaysia

(113.5%) and China (130%).

Total credit has been

growing rapidly in recent

years, with a 24.4%

increase in 2011, 23.9% in

2012 and 20.7% in the first

half of 2013.

86

Strong fundamentalsThe sector is well positioned to experience sustained growth


BANKING OVERVIEW

Anton Gunawan, Bank Danamon’s chief economistand executive vice-president, told OBG. Banks expectlending growth to fall below 20% in 2013 for the firsttime in three years, while BI is targeting a 17% rate. INTEREST-DRIVEN PROFIT: Bank profits haveremained consistently high, with a return-on-assets(ROA) ratio of 3.03% in 2011 and 3.11% in 2012,moderating only slightly to 3.09% by October 2013.This is more than double the regional average of 1-1.5%. The key driver of profit remains net interestmargins (NIM) – the spread between deposit andlending rates – which have moderated only slightlyfrom 5.91% in 2011 to 5.49% in 2012 and 5.50% byOctober 2013. Relying on deposits for most of theirfunding – and especially lower-cost current accountsand savings accounts (CASA) rather than costlier timedeposits – banks have leveraged cheap funding tosustain high credit growth, although strains emergedgiven the rapidly rising LDRs.

While CASA deposits are short term in nature, theyhave historically remained a stable funding sourcefor the Indonesian banking sector. “The majority ofdeposits are still for one-month terms,” Julita Wikana,director at Fitch Ratings Indonesia, told OBG. “Butsince these tend to be rolled over, these CASAdeposits end up being quite sticky and are less cost-ly than time deposits.” Although higher interest ratesin 2013 will curb banks’ NIM further, consensus fore-casts expect these to remain above 5%.

Non-interest revenue growth, from the likes oftransaction fees, wealth management and bancas-surance, has remained more moderate, growing bysingle digits and accounting for less than 30% of bankincome. This may change, however. Agus Yanuar,president director of Samuel Asset Management,told OBG, “Interest rates used to be double digits andpeople placed their money in bank accounts, but now,with higher inflation and lower rates, people demandmore sophisticated investment products.”

The quality of assets has sustained its improve-ments since 2009, with the ratio of non-performingloans (NPL) to outstanding credit falling from a highof 7.6% in 2005 to 3.1% in 2010 and a historical lowof 1.9% by October 2013, according to BI. Banksmaintain prudent loan-loss provisioning to guardagainst any uptick in NPLs, according to Fitch.

Given the expected rise in NPLs up to 3% of totalloans in the coming year according to Mandiri, thesebuffers will be useful. As credit growth slows andbanks’ NIM moderates gradually, Moody’s forecasts

a greater focus on fee income in coming years, asbanks leverage their operations in order to cross-sell fee-generating products. CAPITAL BUFFERS: Despite the strains caused byrapid growth, Indonesian banks typically remain wellcapitalised and prudent. Although their CARs havetrended downwards from 21.2% in 2006 to 18.48%in October 2013, these remain significantly higherthan the BI floors – which stand at between 8% and14% depending on their risk profile.

The majority of these capital buffers consist of thehighest-quality Tier-1 capital, whose core capitalratio has risen from 15.48% to 16.66% in 12 monthsto October 2013. With only two banks issuing for-eign-currency debt, BNI and Bank Rakyat Indonesia(BRI), banks have largely been spared the strain fromthe rupiah’s depreciation since May 2013. Mean-while, banks’ net-open positions (NOP) – the levelof un-hedged foreign-currency exposure – remainslow at 2% of bank capital, according to Fitch in August2013, well below BI’s 20% ceiling.

While there are variations amongst banks, signif-icant linkages to foreign institutions can help min-imise the scope for systemic risk. “The highest for-eign-currency NOPs are maintained by banks withsubstantial foreign ownership like Bank Internasion-al Indonesia (BII),” Iwan Wisaksana, director at FitchRatings Indonesia, told OBG.LIQUIDITY: More worrying, the drying up of liquid-ity for many lenders caused the average liquid assetsratio to fall from 19.13% in May 2012 to 15.6% byJuly 2013. “While the big four banks have ample liq-uidity, smaller lenders face a liquidity shortage andhave started hiking deposit rates, sometimes abovethe 7% ceiling covered by the deposit insurancescheme,” Gunawan told OBG. In August 2013, BIenacted a second tightening measure by hiking thesecondary reserve ratio, which covers securities likeequities and bonds, from 2.5% to 4%. Although thishad limited impact, given most lenders’ holdings

87


SOURCE: JP Morgan

2010 2011 2012 2013 H1

Mandiri 28.80 32.80 26.60 16.00

BRI 56.98 31.50 22.80 16.00

BCA 24.60 27.60 8.30 19.00

BNI 65.00 42.00 21.00 30.00

CIMB Niaga 62.00 25.00 33.00 8.00

Danamon 88.00 16.00 16.00 -1.00

Profit growth by bank, 2010-13 H1 (%)

CASA deposits provide a cost-effective funding source, allowing banks to sustain high credit growth

Bank profits have remained

consistently high, with an

ROA ratio of 3.09% by

October 2013, which is

more than double the

regional average.

Although rapid growth has

put some strain on the

banking sector, Indonesian

banks continue to be well

capitalised, with a CAR of

18.48% in October 2013,

well above the BI’s floor.

BANKING OVERVIEW

above this level, it provides another avenue to injectliquidity into struggling banks. “The hike in second-ary reserve requirement strengthens the liquiditybuffer for small banks,” Helmi Arman, economist atCitibank Indonesia, told OBG. “By having ample gov-ernment bond holdings, they could better access BI’srepo liquidity facility if the need arises.”FRAGMENTED BUT SEGMENTED: Aggregate fig-ures obscure significant contrasts in Indonesia’sdiverse banking sector. Although the 2004 BankingArchitecture plan aimed to reduce the number ofplayers to as few as 30 in the longer term, the mar-ket still had 120 lenders as of October 2013, downfrom 124 in 2008. Accounting for 75.38% of totalfinancial-sector assets by end-2012, banks play akey role in providing financial access. These includea range of different institutions: four state-ownedbanks, 36 foreign-exchange commercial banks, 30non-foreign-exchange banks, 26 regional develop-ment banks owned by provincial and district govern-ments, 14 joint-venture banks involving foreigninvestors and 10 foreign banks.

A total of 1683 rural banks, some 190,000 savings-and-loans cooperatives, and over 600,000 microfi-nance institutions (both formal and informal) extendaccess to remote areas of the country, althoughtheir combined Rp75.5trn ($7.6bn) in assets is lessthan 2% of total commercial bank assets.

In November 2012, BI introduced new segmenta-tions of banks according to assets. As of October2013, the first group covers those with assets underRp1trn ($100m) and includes 11 lenders, which canoffer basic services but cannot build new branches,operate electronic banking or offer foreign exchangetransactions; the second, with assets under Rp10trn($1bn), covers 52 banks that are barred from off-shore transactions; the third group, with assets underRp50trn ($5bn), includes 35 lenders that can offerall products but must allocate 25% of their capitalto branch expansion including in remote locations;and the fourth group of over Rp50trn ($5bn) includes

22 banks able to offer all services and expand nation-wide. BI will also require conventional banks oper-ating sharia-lending windows to spin them off intoseparate subsidiaries by 2023.

In addition, the banking regulator is hoping toencourage banks to expand their networks to less-covered areas, given their high concentration insome regions. In 2012, for instance, state-ownedbanks such as BNI and BRI had over 40% of theirbranches outside of Java, while some private bankswere concentrated on the island – Bank Central Asia(BCA), for example, had 79% of its branches on Java. COMMANDING HEIGHTS: Despite the industry’sfragmented nature, the top 15 lenders dominate themarket, accounting for 71% of total sector assets in2012. Foreign investors play a major role in the toptier: Malaysia’s CIMB holds a stake in Indonesia’sfifth-largest bank, CIMB Niaga; the UK’s StandardChartered owns part of the eighth-largest player,PermataBank; Malaysia’s Maybank is part-owner ofninth-largest BII; and Singapore’s OCBC holds a stakein OCBC NISP, the 11th-largest bank.

Furthermore, foreign banks like HSBC, Citibankand Singapore’s UOB also feature amongst the largestbanks. Despite this sizable foreign presence, how-ever, the market remains dominated by local lenders.The “big four”, all publicly listed but three of whichare majority state-owned, accounted for 45% ofdeposits, 43% of loans and 43.9% of assets, accord-ing to a June 2013 report by Moody’s. MANDIRI: Bank Mandiri, the largest bank by branchnetwork and assets (Rp571.8trn, $57.18bn as of July2013), resulted from the merger of four failing banksin 1998 and is 60% state-owned. Traditionally awholesale bank, it has diversified into micro, smalland medium-sized enterprise (SME) and consumerlending, which together accounted for 30% of lend-ing and half of revenue in 2012, alongside insurance,securities, sharia and consumer finance operations.

Having completed a Rp11.69trn ($1.17bn) rightsissue in 2011, Mandiri delayed plans for a $800m

88

As of October 2013, the

sector had 120 lenders, as

well as 1683 rural banks,

190,000 savings-and-loans

cooperatives, and over

600,000 microfinance

institutions.

BANKING OVERVIEW

Eurobond in the second half of 2013 in favour of aforeign-bank credit line. The lender is seeking toshore up its CAR, which stood at 15.55% in the firsthalf of 2013, the top tier’s lowest. Although CASAaccounts for 64.67% of its funding, Mandiri had thebig four’s lowest NIM of 5.42%, but moderately highROA of 3.47% and ROE of 25.6% in the same period.

In the first half of 2013, Mandiri reported a 16%y-o-y increase in net profits to Rp8.29trn ($829m),which was driven by 20% growth in lending, a 19.4%increase in net interest and premium income toRp16.46trn ($1.65bn), and 13.8% growth in fee rev-enue to Rp6.5trn ($650m).

While Mandiri stopped accepting new loan appli-cations from August 2013, given its LDR of 82.75%,the bank is aiming for annual loan growth of 17-20%for 2013. Furthermore, for every one point increasein BI’s interest rates, Mandiri’s profit is expected torise 2.2%, according to Bahana. The lender sustainedits downward trend in its gross NPL ratio, reaching1.77% in the first half of 2013, while its NPL cover-age ratio stood at 117%. BRI: Originally established in 1895 as “the people’sbank”, BRI has traditionally focused on micro-lend-ing in rural areas through a network of over 4000rural units, covering 5.9m micro-borrowers by June2013. BRI is the oldest and second-largest bank byassets, worth Rp538.3trn ($53.83bn) in June 2013,and is 56.75% state-owned. In recent years, the lenderhas expanded to provide SME and consumer loans.

While BRI’s CASA to total funding ratio is lower thanMandiri’s, at 58.66% as of June 2013, BRI consis-tently records the market’s highest profitability giv-en the higher-yielding nature of its loan book – thebank’s policy is for micro and SME loans to accountfor 80% of its book. Its 33.05% ROE and 4.62% ROAin the first half of 2013 were market leaders, whileits 8.08% NIM was second only to Bank Danamon’s.In April 2013 BRI issued $500m in five-year Eurobondsto support further growth given its LDR of 89.25%.

The lender is targeting 20-22% loan growth for2013, having grown its loan book 28.5% y-o-y byJune 2013, with a 1.81% gross NPL ratio and a highNPL coverage ratio of 201%. The lender remainsmore exposed to the impact of interest-rate hikes,however, given the quicker impact on deposit rates,with Bahana estimating its net profit drops 2.5% forevery one point rise in benchmark rates. BCA: The largest private bank by assets (and thirdoverall), at Rp450.8trn ($45.08bn) in June 2013, BCAholds the market’s highest share of deposits. Estab-lished by the Salim Group in 1957, the bank wasnationalised in 1998 and sold to the Hartono fami-ly in 2002 (which currently owns 47.15%). BCA hasexpanded its market beyond the core focus on Chi-nese-Indonesian clients to the mass market. It hasalso diversified into insurance, securities, invest-ment banking and property. The bank has rebalancedaway from corporate lending since 2008 towardsSME and consumer loans, and boasts the industry’shighest CASA share, at 81.85% in June 2013 – the

only bank able to fund its entire loan book throughCASA according to Moody’s.

BCA is the largest payments bank, operating its ownclosed-loop payment system, and is the least exposedto interest-rate movements. Indeed, Bahana esti-mates that each one-point increase in interest ratesboosts BCA’s profits by 2.5%. The lender’s profitabil-ity remains lower than the top two, with a ROE of24.57% and ROA of 3.42% in the first half of 2013.Net profits grew 19% to Rp6.3trn ($630m), drivenby 24.1% y-o-y growth in lending to Rp280.4trn($28.04bn), a 22.5% rise in operating income and5.95% NIM. There is room for further credit expan-sion, as the bank has a low LDR of 73.2%, a grossNPL ratio of only 0.42% and LDR coverage of 384.5%.It aims to expand lending by 20% in fiscal year 2013. BNI: The fourth-largest bank by assets, at Rp329.2trn($32.92bn) in June 2013, is BNI. It has the lowest assetquality of the quartet, given its focus on SME lend-ing, which accounted for 28.8% of all loans in thefirst half of 2013, and this boosted NPL ratios above5%, according to Moody’s, higher than its aggregategross NPL ratio of 2.55%.

Originally established as Indonesia’s central bankin 1946, BNI was converted to a commercial bank in1955 and is still 60% state-owned. In addition to itsSME portfolio, BNI specialises in corporate and infra-structure business, which combined account for 74%of its lending. The bank achieved 24% loan growthin the year to June 2013, while its NPL ratio improvednotably from 3.44% to 2.55%. The bank achieved a

89



2009 2010 2011 2012

Demand deposits 413.67 483.88 568.44 661.96

Savings deposits 603.32 714.49 864.56 1026.13

Time deposits 894.28 1003.05 1121.96 1244.04

Domestic credits outstanding 1528.98 1896.68 2370.08 2907.43

Key deposit indicators, 2009-12 (Rp trn)

Of Indonesia’s five largest banks by assets, three are state-owned

The top banks have

pursued a range of

strategies, with some

focusing on SME lending,

while others have put more

emphasis on consumer

loans.

BANKING OVERVIEW

30.2% y-o-y rise in net income, with a ROA of 3.39%and a ROE of 21.78% in the first half of 2013, backedby 23% net interest income growth and 22% non-interest growth. BNI commands a stable low-costfunding base, of which CASA accounted for 67.9% inJune 2013, allowing the bank to increase its NIMfrom 5.8% to 6.2% y-o-y. The lender raised $500mthrough a Eurobond issue in 2012, while its CARstood at 16.27% in June 2013, second only to BCA’sof the big four. With a LDR of 84% in June 2013, thelowest of the state-owned lenders, BNI aims toachieve 19-21% loan growth in financial year 2013.Bahana estimates BNI’s profit rises 1.3% for each one-point increase in benchmark rates. CIMB NIAGA: While only 60% of BNI’s size, BankCIMB Niaga’s June 2013 assets of Rp202.2trn($20.22bn) place it amongst top tier banks in fifthplace, well ahead of Bank Danamon’s Rp158.1trn($15.81bn). The top five’s only foreign-owned lender,77.24%-owned by Malaysia’s CIMB Group, the bankresulted from the 2008 merger of Bank Niaga andBank Lippo. Following an initial period of rapid growthin consumer lending and sharia finance, CIMB Nia-ga slowed its credit growth in 2012 to 16% y-o-y, in order to shore up its liquidity and CAR positions.

With CASA accounting for only 33.7% of its fund-ing by June 2013, its LDR reached 99.17% and its CARimproved 0.82% y-o-y to 15.89%. While its loan growthfell to 10% y-o-y in the first half of 2013 and its NIMmoderated to 5.26%, the bank has sought to gener-ate fee revenue growth by leveraging its bancassur-ance and sharia lending arms. However, profit growthof 8% y-o-y to Rp2.13trn ($213m) in the first sixmonths of 2013 remains lower than that among thebig four, as does CIMB Niaga’s 19.54% ROE and 2.81%ROA. These 2013 values follow a 33% surge in netprofits in 2012, however, driven by a 29% increasein fee revenue and a 22% rise in net interest income.Given the bank’s focus on car financing and creditcards rather than lower-margin, low-income mort-gages, CIMB Niaga has successfully controlled itsNPL ratio, which was at 2.25% for the first half of2013, with a coverage ratio of 108.8%. M&A: The market has witnessed a few foreign-driv-en mergers and acquisitions (M&A) in recent years.The last majority-stake purchase was Qatar Nation-al Bank’s (QNB’s) acquisition of Bank Kessawan in2011. Since then only minority stakes have beensold, including the acquisition by Malaysia’s RHBBanking Group of a 40% stake in Bank Mestika Dhar-ma, due for completion at the end of 2013; Japan’sSumitomo Mitsui Bank’s purchase of a 40% stake instate-owned lender Bank Tabungan PensiunanNasional in May 2013 for roughly $1.5bn; and SouthKorean Woori Bank’s acquisition of a 33% stake inBank Himpunan Saudara 1906 in June 2013. The fol-lowing month, Bosowa purchased a 14% stake in therural-focused micro-lender Bank Bukopin, and inNovember of the same year, Bosowa suggested it mayaim to increase its stake to 40%.

Japan’s Mitsubishi UFG and China ConstructionBank also have expressed interest in acquisitions.Although BI has sought buyers for Bank Mutiara –the bank formerly known as Bank Century, whichwas bailed out in 2008 – buyers’ valuations remainbelow the bail-out cost and a deal seemed unlikelyin 2013. Forthcoming acquisitions appeared to beput on hold in July 2013, when Singapore’s DBS with-drew its offer to purchase a controlling stake in BankDanamon following BI’s objections at the lack of reciprocal access to banks in DBS’s home market.

90

A number of banks from throughout Asia hold stakes in the sector

Indonesian banks have

regularly been the subject

of M&A attempts by

foreign rivals. However, in

July 2013, the BI raised

objections to a pending

deal, potentially dampening

future foreign interest.

BANKING OVERVIEW

The ASEAN Economic Community could pose chal-lenges for local firms as foreigners enter the mar-ket in 2015. “Many overseas banks are eager to enterthe local market and the industry needs to enforceproper regulations and let the Indonesian bankskeep pace with their foreign competitors when thesingle economic union takes effect,” Armand B Arief,president director of UOB Bank, told OBG.SYSTEMIC REFORM: The failure of the DBS-Dana-mon deal marks a watershed in BI’s supervisorystance at a time of significant structural change.From January 2014, BI’s bank supervision functionswill be transferred to a new independent regulator,the Financial Services Board (Otoritas Jasa Keuan-gan, OJK), which has already been overseeing non-bank financial institutions in capital markets andinsurance since 2013. Some 1300 BI staff will trans-fer to OJK, which after initial years of governmentfunding – at Rp2.4trn ($240m) in 2014 – will levy acharge on bank assets (the level of which was stillunder discussion at the time of writing). “The OJKneeds to assert itself from the start and take con-trol, with transparency being particularly importantin order to remain impartial and separate from theactivities of competing political parties,” BienSubiantoro, president director of Bank BJB, told OBG.

In mid-2012, BI unveiled a range of reforms for its2004 Banking Architecture policy. Effectively repeal-ing its “single presence policy”, BI implemented newrules limiting single-group bank ownership to 40%for financial institutions (FIs), 30% for non-FIs and20% for individuals. Exceeding these limits is possi-ble for FIs demonstrating good governance and acommitment to lending for productive purposes,provided they feature amongst the 200 largest banksglobally with over 6% group Tier-1 capital ratios. InMarch 2013 BI imposed a five-year moratorium onincreasing stakes beyond 40%. This effectivelypenalises potential foreign acquirers: Basel III rulesin many foreign jurisdictions require banks holdingminority stakes of over 10% to deduct such stakesfrom their capital, meaning most foreign institutionsonly want majority stakes, for which no capital deduc-tion is needed. Given that Indonesia will not have toimplement Basel III until 2019 at the latest; howev-er, local acquirers are not constrained in this way.

A number of laws under consideration by theHouse of Representatives in the fourth quarter of2013 seek to safeguard against potential bank fail-ures in periods of tightening liquidity. The first, afinancial system safety net, aims to set operating rulesfor bank bail-outs, assigning responsibilities betweenthe Ministry of Finance, the regulator (OJK from2014) and the deposit insurance corporation, whichguarantees deposits up to Rp2bn ($200,000) belowfixed interest rates, which stood at 7% in October2013. Parliament was also considering rules requir-ing foreign banks to incorporate onshore, in a bid toring-fence potential contagion from problems at the group level, although, at the time of writing, itremains uncertain whether these measures will pass.

STRUCTURAL INEFFICIENCIES: While profitable,Indonesian banks have high cost-to-income (CTI)ratios that reflect structural inefficiencies and thedifficulty of providing banking services in a countrywith 6000 inhabited islands, where two-thirds ofthe population live outside of cities. Although costsremain high, financial access for both SMEs and theretail mass market remains low. In 2011, the WorldBank estimated that some 51% of the population waswithout access to financial services, 72% had nev-er received a loan and only 19.6% had a formal bankaccount. Although the bank industry’s aggregateCTI dropped from 85.4% to 74.1% between 2011 and2012, it is still worse than that of many of Indone-sia’s neighbours, which average 40-60%.

With personnel costs accounting for 50-60% ofoverhead, according to PermataBank, wage infla-tion and restrictions on foreign employment havekept costs high. While the interconnection of ATMsin June 2013 marks an encouraging step towardsincreasing infrastructure sharing, the establishmentof a national payments gateway in 2015 will be key

91


In some cases, personnel costs have exceeded 50% of total costs

Although profitable,

Indonesia’s banks have very

high cost-to-income ratios,

which is largely due to

structural inefficiencies

and the challenge of

providing services in a vast

archipelago with many

difficult-to-reach areas.

SOU

RCE:

Wor

ld B

ank

Non-performing loans to total gross loans, 2003-13 H1 (%)

0

2

4

6

8

10

2013 H12012201120102009200820072006200520042003

BANKING OVERVIEW

to improving the efficiency of clearing and settle-ment. Requirements for larger banks to expand theirnetworks to more remote locations may keep costshigh in the near term, however, BI expects thatlenders will expand in capital-light channels throughbranchless banking and generate higher fee rev-enue (see analysis).

Foreign bankers also see high costs as symptomaticof the central bank’s new restrictions on bank own-ership. “Indonesia will be a battleground betweenvested interests and the 250m people who wantcheap, high-quality banking services,” Fauzi Ichsan,Standard Chartered’s senior economist, told OBG.“Eventually high NIM will become a political issue.”LENDING CAPS: Alongside efforts to expand finan-cial access, BI is also seeking to cool the rapid growthof consumer lending and sanitise lending practices.It tightened loans-to-value (LTV) caps for motorcy-cles (to 75%), cars and houses (both 70%) in June2012 to improve credit approval standards and guardagainst excessive deterioration in asset quality.

“The new LTV caps on vehicle financing had a fargreater impact on motorcycles than on cars, sincelower-income clients are much more sensitive toprice and down-payments,” Saut Parulian Saragih,PermataBank’s head of strategy, told OBG. Sharialenders (both standalone and those operated assharia windows in conventional banks) were exemptfrom the rules until April 2013, allowing certainbanks to temporarily channel credit beyond thesecaps through their subsidiaries.

Despite a second measure limiting LTVs to 60% onsecond-house purchases of over 70 sq metres inearly 2013, growth in mortgages was sustained at16.5% y-o-y to Rp248.7trn ($24.87bn) in June 2013,according to BI, albeit from a low base – the valueof mortgages reached 5% of GDP in 2012, comparedto 16% in China and 32% in Malaysia as per KKR data.“The average maturity of mortgages has consider-ably lengthened since 2009, from an average of 5-10 years to 10-15 years and up to a maximum of 20

years,” Julita told OBG. “Private banks are also offer-ing longer fixed-rate teaser periods of up to fiveyears, longer than the average two.”

New rules were introduced in August 2013 thatshift risk from banks to developers by prohibitingmortgages for purchases of second homes in pre-construction phases and limiting disbursal of mort-gages according to the degree of completion. “Banks’mortgage-related NPLs are still quite low, with indus-try NPLs ratio at about 2.3%,” Julita told OBG. Mort-gage providers expect strong growth in 2013, albeitlower than 2012, with BNI aiming at 30-32% y-o-ygrowth and BCA at 20%, compared to 49% in 2012.

In light of a widening current account deficit, BIis also discouraging banks from lending to highlyimport-dependent sectors like telecoms, construc-tion and automotive manufacturing in a bid to coolcapital and intermediate goods imports.

“We feel that medium-sized loans can be a riskyarea for banks, particularly when you are dealingwith ambitious entrepreneurs who may put cautionto one side while eyeing expansion,” Bien Subiantoro,president director of Bank BJB, told OBG. “This is anarea which banks must keep a close eye on in 2014.”

While higher corporate bond rates may spur ashift towards bank lending in the near term, banksare tightening credit approval to comply with lowerLDR limits. “A tighter LDR ceiling will prompt a slow-down in lending in the second half of 2013 and firsthalf of 2014,” Haryanto Suganda, HSBC’s senior vice-president and head of business banking, told OBG.OUTLOOK: Following over a decade of high profitabil-ity and fragmentation, Indonesia’s banking sectorfaces the twin challenges of increasing intermedia-tion with the real economy and gradually loweringmargins. As larger, more efficient banks capitalise ontheir positions, smaller lenders will need to innovateand study potential M&A to sustain their positions.Over the medium term, as the banking system facesincreased ASEAN-wide competition, Indonesian banks will need to work at improving their efficiency.

92

In an effort to cool the

rapid growth of the

consumer lending market,

the BI reduced the LTV caps

for motorcycles (75%), cars

(70%) and houses (70%).

BANKING ANALYSIS

MSMEs account for 91% of jobs, 57% of GDP and 20% of exports

Accounting for some 91% of employment, 57% of GDPand 20% of exports by value in 2012, according to BankIndonesia (BI) statistics, micro, small and medium-sizedenterprises (MSMEs) form the backbone of Indonesia’seconomy. Yet the predominantly informal nature ofsuch companies has constrained their access to fund-ing and scope for growth. Although lending to the seg-ment accounted for roughly 18.63% of all outstandingloans by October 2013, aggregate figures obscure sig-nificant divergences between banks.

Amidst a raft of new regulations announced in Novem-ber 2012, the regulator unveiled ambitious new lend-ing targets for banks, requiring them to devote some20% of their balance sheet to MSME loans. While com-pliance is expected to be gradual in the five years to2018, rebalancing lending down the corporate ladderwill be challenging for joint venture and foreign banksin particular. Channelling such an increase in spendingwill require innovation in distribution strategies andfurther developments in the ecosystem for lending,including upgrading credit information systems. GRADUAL TARGETS: Implementing regulations forthe new lending targets were issued in January 2013and set a gradual pace for their introduction. Lendersare expected to expand their MSME books accordingto their ability in the first two years, but must have 5%of all outstanding loans to the segment by 2015. Thetargets then increase by five percentage points a year,reaching the 20% target in 2018.

The aim is thus to redirect growth away from non-productive credit – mainly consumer loans – towardsproductive lending. The central bank’s definition ofMSMEs is more restrictive than that of many lenders:micro firms are those with less than Rp300m ($30,000)in annual sales, smaller firms are categorised as thosewith under Rp2.5bn ($250,000) and medium firms asthose with under Rp50bn ($5m). This is compared to,for example, Standard Chartered’s classification ofsmall businesses as those with under Rp100bn ($10m)in turnover and medium firms as those with under

Rp375bn ($37.5m). While the targets may seem ambi-tious, they are in line with other Asian countries’ bank-ing policies during crucial stages of development. SouthKorea, for instance, set minimum lending targets of40% of the balance sheet during its developmentalphase in the 1980s, according to Danareksa’s head ofeconomic research, Purbaya Yudhi Sadewa.

Clarifying its approach somewhat, BI spokesman DifiJohansyah announced in January that lending to non-oil export-oriented industries would meet the MSMElending criteria, while lenders would also be allowed tochannel their lending through the country’s 26 region-al development banks. CURRENT LENDING: Under BI’s stricter definition, jointventure and foreign banks, whose balance sheets havetraditionally been skewed towards larger corporatelending and wholesale funding, devote a minimal 2.37%of their total lending to MSMEs as of July 2013. By con-trast, state-owned banks devoted 26.7% of their totallending to the segment, followed by foreign-exchangecommercial banks’ 19.7% and rural development banks’17.25% at the same point.

Total lending to MSMEs grew 13.86% y-o-y toRp487.92bn ($48.79m) in August 2012, with a non-per-forming loan (NPL) ratio of 3.94%, according to BI data,higher than the aggregate banking sector average ofnear 2%. Growth accelerated to 18.73% y-o-y toRp579.31bn ($57.93m) in August 2013, while the NPLratio fell to 3.61%. The bulk of this growth was drivenby state-owned banks and foreign-exchange commer-cial banks, which accounted for 49.49% and 41.45% oftotal outstanding MSME credit in July 2013. Lendingwas dominated by wholesale and retail trade, whichaccounted for 53.24% of all MSME lending, followedby processing (10%), agriculture (7.47%), construction(6.62%) and property (5.33%). Loans were mostly forworking capital, which made up 73.46% of the total, withinvestment loans accounting for the balance.

The best-positioned lenders as of November 2012included traditionally rural-focused institutions. These

In January 2013, the BI

introduced new rules that

required all banks to

devote at least 20% of their

balance sheets to MSME

lending by 2018.

93


According to the central

bank, MSMEs include all

firms with under Rp50bn

($5m) in annual sales. This

definition is considerably

more limited than the

guidelines used by some

other sector players.

Supporting SMEsEfforts are being made to improve access for smaller businesses

BANKING ANALYSIS

include state-owned microfinance bank Bank RakyatIndonesia (BRI) and Bank Bukopin, which devoted 43.1%and 30.1% of their balance sheets, respectively, toMSME lending in November 2012, according to JP Mor-gan. Private commercial banks Panin Bank and BankDanamon had also allocated 37.5% and 32.1%, respec-tively. The three other state-owned banks were rela-tively close: Bank BTPN’s MSME lending accounted for19.7% of all loans, and both BNI and Mandiri stood at15.9%. The five other top 10 banks will have to rampup lending, with Bank BTN reaching 16.6%, Bank CIMBNiaga (14.3%), Bank Internasional Indonesia (12.8%),PermataBank (12%) and Bank Central Asia (10.3%).

While some foreign lenders such as CommonwealthBank are already compliant with the near-term target,others like ANZ remain far off the mark. Given the par-allel requirement for top-tier banks to expand branchnetworks in more remote areas, the regulator expectsleading lenders to expand their reach both geograph-ically and by intensifying their lending. Indeed, the fiveprovinces with the highest lending to the segment –four of which are in Java – accounted for 57.84% of allMSME loans in October 2013, while the top 10 account-ed for 78.07%, according to BI.CHANNELS: With downward pressure on net interestmargins for corporate loans and slowing growth in con-sumer lending in 2013, banks are eager to diversifytowards riskier, high-yielding assets such as MSMEs. A2013 banking survey from PwC found that 44% ofbanker respondents named SME lending as the keydriver of growth, up from 31% the year before. Thebest-positioned lenders in the micro segment includeBRI with 7128 micro-lending branches in 2012, Mandiriwith 2212, Danamon Bank with 1562, Bank BTPN with582 and Bank BJB with 437, according to CLSA.

With a still high average cost-to-income ratio of74.1% in 2012, according to PwC, expanding branch-es and personnel to channel these extra funds will posechallenges to corporate-focused banks clustered inmajor urban centres. However, one potential avenue

for growth is illustrated by Mandiri’s rapid expansionin its micro-lending ledger, which grew at a compoundannual rate of 47% from 2009 to 2012, bolstered bythe bank’s cooperative subsidiary, Mitra Usaha, whichexpanded its micro-outlets from 610 to 2212 in the fouryears to 2012. In early 2013 Mandiri also partnered withpostal service provider Pos Indonesia and state-ownedpension fund Taspen to expand its reach further.

A second avenue will be for banks to collaboratewith affiliated multi-finance companies (MFCs) toexpand their leasing activities for SMEs, even thoughMFCs’ leasing revenues have declined from 17% of bankincome in 1998 to 11% in 2011, according to OECD data.While such moves have been limited in 2013, compe-tition between banks to tap such distribution channelswill increase in 2014 as the first deadline approaches. QUALITY: While most agree on the principle of chan-nelling more funding to the more productive segmentsof the corporate market, the challenges of preservingloan-approval discipline and containing potential NPLsare clear. “Corporates are very strong now and the NPLratio in this segment is very low, while micro-loans arerepaid on a daily basis, so we can see any issue and iden-tify as it develops,” Destry Damayanti, Bank Mandiri’schief economist, told OBG. “The fragile segment is SMEswith turnover of Rp500m-2bn ($50,000-200,000), asthey are very vulnerable to rising interest rates.” Indeed,the NPL ratio amongst MSMEs has historically beenroughly twice that of total loans.

While BI requires all SMEs with a turnover of overRp25bn ($2.5m) to conduct independent auditing oftheir accounts, smaller firms remain opaque. The cen-tral bank’s credit information bureau, established in2006, provides some information, although this isskewed toward consumer rather than commercial lend-ing, according to the OECD. The bureau only collatesinformation from banks and credit card firms, but notthe wider range of financial institutions. Enactment ofnew regulations in February 2013 by BI, with supportfrom the International Financial Corporation, allows forthe establishment of private credit bureaux, the firstof which is expected in 2014, which should help to pro-vide more complete information. Meanwhile, althoughtwo SME credit guarantee and insurance schemes havebeen in operation for cooperatives’ lending since 1971,the impact has remained limited.

The regulatory-driven expansion in banks’ risk assetsin coming years coincides with market pressure to scaledown the corporate market towards MSMEs. Yet withsignificant differences in capabilities between state-owned and certain local commercial banks on the onehand, and foreign-linked banks and wholesale lenderson the other, the industry faced significant uncertain-ty in late 2013 over how the rules would be enforced.

Balancing the priority of expanding financial accessto less formal and smaller companies, while also ensur-ing banking sector stability will be key for the regula-tor, particularly in a period of tightening liquidity forsmaller banks. Channelling such lending will requireinnovation in distribution channels and products, in addition to continued discipline in credit approval.

94

A 2013 survey of sector players found that 44% identified SME lending as a key driver of growth

Although SME lending has

the potential to provide

significant revenues, the

segment also carries higher

risk. Indeed, the NPL ratio

amongst MSMEs has

historically been roughly

twice that of total loans.


BANKING VIEWPOINT

Agus D W Martowardojo, Governor, Bank Indonesia

Infrastructure provision remains a big challenge, fromproject design and prioritisation through to financingand delivery. There is a need to boost investment in infra-structure to raise growth prospects, both in the short-term to insulate against a global slowing of growth andfor the long-term benefits of boosting the supply capac-ity of our economies. Infrastructure investment canalso help channel excess global savings – a more pro-ductive pursuit than short-term asset price specula-tion. To support this, we want the World Bank (WB) toprepare a comprehensive assessment of infrastructurefinancing, including provision of facilities, identificationof innovative sources of financing and technical sup-port to formulate bankable pipeline projects.

Many middle-income countries (MICs) in Asia, LatinAmerica and the Middle East have been in the middle-income trap for decades, struggling to remain compet-itive as high-volume, low-cost producers but unable tomove up the value chain and break into more advancedinnovation-based products and services.

Much more is needed for the transition to high-income status. Assistance is required not only on proj-ect financing, but also in the provision of technicalassistance and capacity-building to accelerate the struc-tural reforms needed to become – and remain – high-income economies. Rapid, sustainable growth requireshigh levels of investment. These investments will be inphysical and human capital, including roads, informa-tion technology and other infrastructure.

We especially appreciate the WB and the Interna-tional Finance Corporation (IFC) fostering a competi-tive private sector that has created new investment andemployment opportunities in MICs. A robust domesticprivate sector is critical to increased growth, which canbe linked to poverty reduction and improved standardsof living in MICs. We encourage the WB and the IFC toexpand their work to help provide small and medium-sized enterprises (SMEs) with greater access to finance.SMEs are critical for the economic and social develop-ment of MICs; play a major role in creating jobs and

income for low- and middle-income people; foster eco-nomic growth and social stability; and contribute to thedevelopment of a dynamic private sector.

Indonesia will continue to reform its business envi-ronment to attract more investment, bring opportuni-ty to a rising population and spur private sector growth.We want the IFC to work closely with Indonesia’s pub-lic and private sectors, offering global expertise andfocusing support for business reform.

These efforts would help Indonesia implement areform action plan to improve its rank on the WB’sannual “Doing Business Report”, as well as businesslicensing reform which aims to support efforts to reducethe costs and complications of doing business.

I reiterate our commitment to promoting financialinclusion as important to global economic develop-ment and poverty reduction. Indonesia strongly sup-ports this initiative. We are committed to the financialinclusion Peer Learning Programme in the G20 to fur-ther facilitate cross-country information-sharing andtechnical dialogue. We are also involved in internation-al fora to promote financial inclusion through the Glob-al Partnership for Financial Inclusion, the Alliance forFinancial Inclusion and the Asia-Pacific Economic Coop-eration Financial Inclusion Working Group.

We also view supporting low-income countries (LICs)as important, as they continue to face challenges insustaining growth. In this regard, the IMF can play a roleby continuing intensive policy support, engaging inlonger-term programmes and providing short-termfinancing. This will help LICs withstand external shocks,maintain macroeconomic stability, rebuild fiscal buffersand facilitate rapid recovery. We welcome the IMF’sdecision to distribute the remaining windfall gold salesprofits of $2.7bn, as part of a strategy to bolster sus-tainable resources for lending to LICs. While the legalrequirements and domestic processes in some coun-tries may not be straightforward, we are determinedto give our best effort to secure assurances and imple-mentation of this commitment in a timely manner.

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The way forwardAgus D W Martowardojo, Governor, Bank Indonesia, on how toencourage development in middle- and low-income countries

BANKING INTERVIEW

Alan Richards, CEO, HSBC Indonesia

What is your forecast for Indonesia’s banking sec-

tor, given the revised economic outlook? How

will it impact lending over the next 18 months?

RICHARDS: With GDP forecasts suggesting a slow-down in the economy – with Bank Indonesia (BI), thecentral bank, putting it at 5.5-5.8% – and interestrates still rising to stave off inflationary pressures,it is clear that BI is focused on financial stability.

As a consequence, BI is targeting a slowdown inbalance sheet growth for the industry as a whole,and we believe that the forecast of 15-17% in 2014looks reasonable. It is also worth mentioning thatlocal currency liquidity is expected to remain tight,and we are likely to see pressure in non-performingloan terms in sectors such as commodities. Overall,however, we remain optimistic for 2014, and thefundamental attractiveness of Indonesia’s economyremains unchanged.

How can Indonesia’s banking sector be brought

up to developed market standards?

RICHARDS: It has to be said that the banking sec-tor has made remarkable progress in the past decade,which is a compliment to the government, regula-tors and the market as a whole.

Indonesia is an active and responsible member ofimportant international bodies such as G20, theWorld Bank, the Bank of International Settlementsand so on. The regulators in Indonesia continue towork closely with their international counterpartson implementing global regulatory standards, suchas Basel II, and work is now beginning on Basel III.

There are a large number of international andregional banks in the country, which is positive. Ithink this has helped drive both competition and stan-dards for the benefit of consumers.

International banks have brought improvementsto banking products and technology, and most impor-tantly have helped in developing expertise and localtalent. With corporate governance standards improv-

ing, capital markets will continue to develop andcompetition will drive continuously improving stan-dards across the industry for the benefit of the econ-omy and society as a whole.

Based on what we have seen the last few quar-

ters, is the trade deficit a concern?

RICHARDS: Yes, it is a concern but it is not a sur-prise, given the resource-based nature of the econ-omy. The government is clearly focused on trying totackle the issue. The problem is structural and thelong-term solution lies in improving infrastructure,and ensuring that the economy moves downstreamand is better integrated.

Addressing the deficit will take time, but the gov-ernment and Bank Indonesia have listened to mar-ket players. They have taken bold and decisive actionsto control the deficit.

For example, back in November 2013, Bank Indone-sia unexpectedly raised Rupiah interest rates. It reaf-firmed that the central bank is well and truly awarethat the current account deficit was foremost ininvestors' minds, and that it would do whatever nec-essary to quell those concerns.

Infrastructure development has remained a crit-

ical challenge, including access to financing. What

does it take to spur infrastructure spending?

RICHARDS: I think everyone is frustrated with theslow progress, but the Masterplan for Accelerationand Expansion of Indonesia’s Economic Develop-ment sets out an excellent blueprint.

If roll-out and implementation can be expeditedin key areas such as roads and ports, the economywill benefit significantly. The land acquisition lawpassed in 2012 was another step in the right direc-tion, and if we can create an environment wherethere is more regulatory and legal certainty, I amquite confident that the financing necessary to sup-port infrastructure projects will become available.

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Financing the futureOBG talks to Alan Richards, CEO, HSBC Indonesia


BANKING ANALYSIS

In 2011, only 19.6% of Indonesians over 15 had a bank account

As banks seek to increase efficiency while expandingtheir reach, Bank Indonesia’s (BI) push towards mobilepayments systems holds potential in a country whoseunder-banked population is spread over some 6000inhabited islands and is largely rural. Mobile paymentshold the promise of cutting costs, expanding accessand driving banks’ fee revenue. While telecoms oper-ators’ e-wallet initiatives have met limited success, newguidelines in early 2013 hold promise to expand reachthrough networks of licensed agents.

By allowing various pilot schemes in 2013, BI’s flex-ibility will be key to supporting successful initiatives. “Giv-en the more sophisticated nature of existing retail bank-ing services in Indonesia compared to certain Africanmarkets, mobile payments systems will have a toughertime demonstrating their value,” Ivan Daniel Mortimer-Schutts, East Asia Pacific mobile and electronic bank-ing specialist at the International Finance Corporation(IFC), told OBG. “To capture enough volume, mobilepayments systems will need to complement and workalongside the existing banking system, rather than tryand go it alone.”PHYSICAL REACH: Although there were 18,114 bankand 4656 rural-bank branches as of October 2013,according to BI, penetration remains very limited. Amere 19.6% of Indonesians over 15 had a bank accountin 2011, according to the World Bank, compared to21.4% in Vietnam, 26.6% in the Philippines, 66.2% inMalaysia and 72.7% in Thailand. Over 60,000 microfi-nance institutions provide services to an additional50m people, according to the World Bank-funded Con-sultative Group to Assist the Poor (CGAP). In additionto limited branch facilities, the share of Indonesians witha debit cards is even lower, standing at around 11%,according to MasterCard.

With most commercial bank networks focused ondensely urbanised areas in Jakarta, Java and Bali, state-owned banks and microfinance lenders have the widestreach. Lenders like Bank Rakyat Indonesia (BRI) andBNI have over 40% of their branches outside Java, but

private banks are much more concentrated – BankCentral Asia (BCA), for instance, had 79% of its branch-es in Java as of 2012. BI’s November 2012 rules requir-ing large banks to open one branch in remote areas likeWest Papua, West Sulawesi, West Nusa Tenggara, NorthMaluku and Gorontalo for every three new branchesopened in Jakarta are meant to encourage wider reach.Yet banks’ concern over high costs and low profitabil-ity in rural areas may limit expansion. TELECOMS: Various mobile money platforms havebeen launched since 2007, although BI rules issued in2009 place strict limits on use. Unregistered users areallowed to keep up to Rp1m ($100) in e-wallets, whileregistered users (requiring only one form of identifica-tion, compared to two for bank accounts) can hold upto Rp5m ($500). Monthly transactions are capped atRp20m ($2000) and minimum payments are Rp10,000($1), while merchants receiving payments from e-wal-lets can only cash out through a bank branch or alicensed telecoms agent able to handle remittances.

By 2013 BI, had registered 13 e-money issuers includ-ing third-party platforms, according to Indosat, butdevelopments are dominated by the three largest sec-tor players. Telkomsel’s T-Cash, launched in 2007, claimedto have covered 8.2m users by 2012, although a 2010study by the IFC found that only 20% of accounts thenwere active. Indosat’s Dompetku followed in 2009 andXL Axiata’s XL Tunai in 2012. By end-2012, the Indone-sian Cellular Telecommunication Association reported12.6m e-wallet users and 50,000 cash-out points nation-wide, although only 6% of users were active. Some 95%of users were unregistered as of 2012, according toCGAP, meaning balances held in e-wallets were mini-mal. In February 2013, BlackBerry followed suit bylaunching BBM Money, a service providing real-time pay-ment between users who use the service to trade prod-ucts. Having registered 60,000 users in the first threemonths, it aims to reach 200,000 clients by end-2013.

The vast majority of transactions consist of mer-chant payments, in coordination with the Association

Although some state-run

banks have as many as 40%

of their branches outside

of Java, most of the private

banks are heavily

concentrated on the island.

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Mobile banking was first

introduced by telecoms

operators in 2007. Users

were provided with an

e-wallet, which could hold

up to Rp1m ($100) for

unregistered users or Rp5m

($500) for registered users.

Alternate channel growth Mobile payment systems promise to expand the sector’s reach

BANKING ANALYSIS

of Indonesian Provincial Governments, and bill pay-ments such as mobile top-ups, according to the IFC.

Regulatory constraints ranging from the inability touse third-party agents for cash-in/cash-out, to the lackof interconnection between the various platforms areseen as key barriers to the telecoms-led model’s growth.Operators have seen e-wallet schemes as add-ons toexisting service offerings, used as value-added servic-es to boost average revenue per user and to improveclient loyalty. Yet, in May 2013, the big three unveiledan interconnection between their platforms that allowsfor real-time transfers across networks for a fee ofRp2000 ($0.20). The existing e-wallet schemes pro-vide for low-value transactions between individualsgiven the reduced “know-your-customer” (KYC) require-ments, yet there is significant potential in scaling theseup as business payments systems. “The telco-led branch-less banking model seems to have the greatest poten-tial for market penetration,” Herani Hermawan, HSBC’shead of global payments and cash management, toldOBG. “Yet very low transaction ceilings limit the mod-el to customer-to-customer transactions, when thereal potential lies in business-to-business.”AGENCY GUIDELINES: To foster more experimentsled by banks, BI unveiled broad guidelines for branch-less banking in April 2013, allowing banks to outsourcecash-in/cash-out functions to third-party agents. Therules provide for both telecoms- and bank-led initia-tives, as well as hybrid models: agents are allowed toprovide basic services like account opening, deposit tak-ing, cash withdrawals and money transfers. The guide-lines do not include less onerous KYC requirementsthan for bank account opening, however. Basic bankaccounts – either e-money or savings accounts – canbe opened by providing two forms of identificationand one’s mobile number, while clients can withdrawcash from agents by showing a notification SMS, an IDand paying Rp2000 ($0.20). Agents do not require spe-cific remittance licences, but they are required to workexclusively with one partner (bank or operator) duringthe initial launch phase.

The pilot period, from May to November 2013,involved five banks and the big three telecoms opera-tors, and covered eight provinces: South and NorthSumatra; West, Central and East Java (but not Jakarta);Bali; East Kalimantan; and South Sulawesi. Each partic-ipant was only able to launch pilots in up to two provincesand three sub-districts per province, but had to includerural areas. The guidelines’ general nature, which do notspecify internal controls, give banks room for experi-menting, but the regulator requires close communica-tion to take stock of results.

“Payment providers are increasingly building theirbusiness case on new sources of value: big data, riskmanagement and enhanced sales experience,” the IFC’sMortimer-Schutts told OBG. “Use of digital paymentswill not be expanded by providers that hope to makea case primarily out of transaction fees: new paymentssystems will need to improve on serving particularneeds.” Following a review of these mobile paymentspilots, BI intends to issue more detailed regulations in

December 2013, providing for the scaling-up of suchschemes in three years to 2017. PILOTS: The five banks involved are Mandiri, BRI, BankBTPN, Bank CIMB Niaga and Bank Sinar Harapan Bali,a Mandiri subsidiary. The first to launch was CIMB Nia-ga with its “Rekening Ponsel” service in Bandung (WestJava) and Kebumen (Central Java). Investing someRp50bn ($5m) in the trial service, the bank hopes toenrol 500,000 new customers by the end of 2013.While clients still need to open an account at a CIMBNiaga branch, the lender is exploring collaboration withconvenience stores like Indomaret, Alfamart and 7-Eleven, as well as remittance handlers like WesternUnion, MoneyGram and Pos Indonesia.

Since 2008, Mandiri has rolled out an e-money serv-ice allowing clients to store up to Rp1m ($100) for toll-road and convenience-store payments. With 3.2m users,only 30% of which are Mandiri customers, the bank washandling roughly 9m transactions worth Rp150bn($15m) per month by early 2013. Building on this record,the bank rolled out its pilot branchless banking serv-ice, officially launching it in October 2013.

Initially the service will provide for deposit and with-drawals only, before being expanded to bill payments,as well as loan and insurance extension at a later stage.The bank is collaborating with both institutional agentslike Indomaret, Pos Indonesia and Taspen, and withindividual agents – it is using 60 such agents in the pilotto November. Sinar Harapan Bali was an early pilot forbranchless banking, enrolling six agents alongside PosIndonesia and Taspen outlets in the Gianyar and Tabanansub-districts of Bali to cover 145 new customers by Sep-tember. It recorded transactions worth Rp123.86m($12,386) in the three months to August.

BRI has focused on East and Central Java, piloting itsscheme in Banyuwangi and Kebumen. By September ithad signed up 11 agents charging Rp3500 ($0.35) pertransaction and handling a total of 200 transactionsdaily. It plans to expand to 12,000 agents nationwideonce it scales up and aims to begin offering loanapprovals early on. BRI is also cooperating with Telkom-sel in its T-Bank service. Finally, BTPN, co-owned by thegovernment and Japan’s Sumitomo Mitsui, has enrolled60 agents in West Java’s Bogor (in the Dramaga, Ciampeaand Cibungbulan sub-districts) and Bali (in Pekutatan,Mendoyo and Penebel). NEXT STEPS: Other leading retail banks like BCA, Per-mata and BTN are watching from the sidelines pend-ing detailed rules in December. Amidst overlappingexperiments by banks and telecoms operators, the IFCis working with a wide range of players – including con-sumer goods firms, banks, operators, the paymentsassociation and switching firms – to study what com-mon standards may be needed to support business-to-business payments systems for the retail supplychain. The issue of transaction costs will be a deter-mining factor in the success of agent and mobile bank-ing for individuals and businesses. Scaling up the branch-less initiative nationwide will require taking stock of thepilots’ results, expected in December, and close coop-eration between all players in the emerging ecosystem.

99


Five banks took part in the

mobile banking pilot, with

each of these focusing

their attention on different

regions. After reviewing

the results of the pilots, BI

is expected to provide

further guidance.

101

Capital MarketsLocal exchange led by consumer-related stocksIDX aims for market capitalisation of $750bn by 2015Upgraded credit ratings give a boost to bond market Government intends to establish global tin benchmarkSupporting growth of on-exchange derivatives trading

CAPITAL MARKETS OVERVIEW

In May 2013, the market capitalisation of the IDX exceeded $500bn

Over the past decade, Indonesia’s capital markets havegone from strength to strength, buoyed by the com-modities super-cycle, sustained economic growth anda resilient domestic consumption story. Long dominat-ed by foreign institutional investment, they remain vul-nerable to shifts in global emerging market risk appetite.“We are still in the structural bull market that startedin 2003,” Erwan Teguh, CIMB Securities’ head of research,told OBG. “Despite externally induced corrections in2008, 2011 and 2013, investors still seem to believe inthe fundamental Indonesian growth story.” Domesticparticipation has also grown steadily, although it remainsdominated by institutional investors. A diversified equi-ties portfolio has allowed growth to rebalance away fromnatural resources towards domestic-consumption-related stocks, with a steady stream of initial publicofferings (IPOs). While new instruments have beenslow to emerge, reform of the market infrastructure isongoing amidst the 2013 downturn.GROWTH: At its peak of over Rp5000trn ($500bn) inMay 2013, the market accounted for roughly 60% of2012 GDP – the region’s second-lowest, trailing Sin-gapore’s 224%, Malaysia’s 151%, Thailand’s 102% andthe Philippines’ 93% in 2012, but high by historical stan-dards of 50% in 2010, 45% in 2011 and 48% in 2012,according to Indonesian Stock Exchange (IDX) data.The Jakarta Composite Index (JCI) rebounded stronglyfrom its October 2008 trough of 1111 points to reacha May 2013 peak of 5214. The index’s year-on-year (y-o-y) growth cooled somewhat from 86.98% in 2009 and46.13% in 2010 to 3.2% in 2011 and 12.94% in 2012.Growth has been driven by the steady expansion of shareofferings, which rose from 396 in 2008 to 479 by theend of September 2013, and higher share trading thatwent from an average of 1.81bn shares worth $204mdaily in 2006 to 5.8bn shares worth $664m in the firstthree quarters of 2013. Trading remains concentratedin blue-chip stocks, with the top 20 most-traded equi-ties accounting for 49.35% of the total and 57.4% ofmarket capitalisation in the year to October 2013,

according to IDX. Indonesia’s market has been one ofthe region’s most consistent and strongest perform-ers since 2003, according to Credit Suisse, with fouryears when the equity market exceeded 45% growth. MAKE-UP: The market is dominated by financial sec-tor stocks, which made up 23.4% of market capitalisa-tion in September 2013, followed by consumer goods(20.9%); infrastructure, transport and utilities (13.5%);and trade and services (11.8%). This was not always thecase, however, as declining global commodity pricescaused mining, energy and agriculture stocks, whichwere the key growth drivers in the four years to 2012,to slump. “What is unique about the Indonesian mar-ket is its diversified offerings, since growth shifted fromnatural resources to consumer-related stocks and themarket kept growing,” Poltak Hotradero, head of researchat IDX, told OBG. Agriculture and mining stocks werethe worst performers in the year to June 2013, accord-ing to IDX, slumping 48.59% and 36.56%, respectively,while property and construction grew 44.45% and basicindustry and chemicals were up 41.33%. Trade, servic-es and consumer goods rose by a more moderate 12%and 10.59%, respectively, while finance and infrastruc-ture and transport stocks grew 4.76% and 4.7%.INFRASTRUCTURE: The exchange in its present formdates back to the 1987 deregulation encouraging com-panies to float and foreign portfolio investors (FPI) toparticipate, while the IDX was born from the merger ofthe Jakarta and Surabaya markets in 2007. Privatised in1992, the bourse is mutualised and owned by brokers,with membership costing Rp3bn ($300,000), while itsnon-profit status requires it to reinvest earnings drawnfrom membership fees, trading and issuance into mar-ket development. Although revision of the 1995 Cap-ital Markets Law has long been mooted as a way todemutualise the exchange, progress in parliament hasbeen slow. The new law is likely to allow IDX to demu-tualise, which could bring more efficiency and allow itto raise revenue from information alongside that fromtrading, issuers and members. Since January 2013 the

Growth in Indonesia’s stock

market in recent years has

been driven by the steady

expansion of share

offerings, which increased

from 396 in 2008 to 479 by

September 2013.

Once dominated by

commodities such as

mining, energy and

agriculture stocks, the local

market is now led by

consumer-related shares,

such as financial services

and consumer goods.

102

Eye on the long termWhile the markets are vulnerable to shifts in global risk appetite, thefundamentals supporting growth remain strong



Financial Services Board (Otoritas Jasa Keuangan, OJK)has replaced the Ministry of Finance’s former CapitalMarket and Financial Institution Supervisory Agency,overseeing capital markets, insurance and, beginningin January 2014, banking. Clearing and settlement,which are segregated between the depository andclearing agencies, takes place on a T+3 basis. IDX alsocomprises a bond-trading platform, with mark-to-mar-ket pricing provided by the Indonesia Bond PricingAgency, while two parallel commodity-futures exchangeshave emerged in the past decade (see analysis).INVESTORS: Despite $26.5bn in portfolio inflows from2011 to June 2013, according to Macquarie Securities,domestic investors’ share of trading has grown steadi-ly from a low of 19% in the second quarter of 2007 to44.2% by August 2013. Yet local institutions account-ed for 86.4% of this. The number of investor accountsnearly tripled from 160,000 in June 2009 to over 400,000by June 2013, of which 362,000 were retail accountsin 2012, according to Bahana Securities – roughly 0.15%of Indonesia’s population, essentially high-net-worthindividuals. Only around an eighth of these are active,according to IDX, which has pursued an outreach strat-egy designed to entice younger investors. “We are stillstruggling to raise retail participation on the market,”Poltak said. “We are thus establishing IDX corners atuniversities, more than 100 so far, leveraging their cur-rent knowledge to increase retail investment.” The mostactive local institutions are asset managers, pensionsfunds, insurers selling unit-linked policies and banksoffering wealth management services. Domesticinvestors typically do not rely on margin facilities, in con-trast to peer markets like Thailand. “There is very littleleverage in the system since most retail investors arehigh-net-worth individuals, while local institutions arenot allowed to leverage,” Erwan told OBG. “We offer mar-gin facilities but these are seldom used.”

While FPI’s share of total trading has declined in thepast decade, the type of investors has broadened tomore diverse institutions, including pension funds andregional investors like Malaysian mutual funds and Tai-wanese and Japanese investors, bolstered by Indone-sia’s investment-grade re-ratings since 2010. Higherglobal interest in Indonesian securities also spurred asignificant decline in yields on fixed-income securitiesissued by both the government and leading corporates(see analysis). Exposure to Indonesian equities throughoffshore-listed exchange-traded funds (ETFs) has alsogrown, with five Indonesian-only ETFs and a significantnumber of EM ETFs with around 10% exposure toIndonesian stocks. By August 2013 foreign institutionsaccounted for 67% of FPI and custodians (which includeboth institutional and retail) some 31%. The exchangeis seeking to broaden the pool of FPI and rebalancetowards Asia. “Up to June [2013] the most active for-eign investors were Japanese investors, like elsewherein ASEAN, but since we have seen significant outflowsdriven mainly by Western investors,” Poltak said. “Thisdemonstrates the need for us to diversify our sourcesof foreign portfolio investment towards Asia and ASEANinstitutional investors, since the region remains a net

capital exporter.” There is clear scope for growth, withless than 5% of cross-border investment into ASEANcoming from the region and with 40% of that locatedin the Malaysia-Indonesia corridor, according to CIMBand management consultancy Oliver Wyman.BROKERS: While 114 brokers are registered locally,with a minimum capital requirement of Rp50bn ($5m),the top 20 brokers (those with consistent research out-put) dominate trading by share of daily turnover. Thetop 10 brokers accounted for 34.7% of trading volumesand 45.96% of value in the second quarter of 2013,according to IDX. The largest brokers by trading valuecater to institutionals, although retail brokers likeMandiri, CIMB and Danareksa have been affected bycompetition from online brokers with narrower mar-gins, like e-Trading and IndoPremier over the past fiveyears. Conventional brokers have followed by launch-ing their own online platforms, including CIMB’s pan-ASEAN integrated platform, although they have had toadapt to lower fees. “We saw a war on commissions afew years ago, but this is now stabilising,” Poltak said.“Average retail commissions have fallen from the 25-30 basis points (on the buy side) range to 17, as a con-sequence of the growth of online brokers.”

The exchange’s fee stands at 0.054% of margins,while the sell side adds a 0.1% withholding tax. Institu-tional commissions are negotiable and slightly narrow-er, in the range of 10-15 basis points. The latest entrantswere Morgan Stanley in 2010 and Nomura Capital in2011. In 2013 certain brokers launched co-brandingwith global investment houses, including US-based Jef-feries with IndoPremier and Japan’s Daiwa with Bahana,which hopes to gain roughly 1% of additional daily mar-ket share in the process. “A growing number of localbrokers are co-branding to attract more foreign liquid-ity,” Harry Su, head of equities and research at Bahana,told OBG. “This allows foreign brokers offshore to gaina strong presence on the market and cut costs.”CORRECTION: Starting in late May 2013, a foreign sell-off of Indonesian equities sparked a correction in shareprices. This movement helped to produce a net out-flow of Rp42.3trn ($4.23bn) in the three months to Sep-tember, according to Bank Mandiri. Although the spark

103


SOURCE: Indonesian Stock Exchange

Q2 2012 Q3 2012 Q4 2012 Q1 2013 Q2 2013

Volume of share trading (bn) 271.72 215.89 310.59 375.97 383.62

Value of share trading (Rp trn) 287.69 252.99 297.03 376.05 482.35

Value of government bond trading (Rp trn) 398.04 550.40 472.38 389.89 545.67

Value of corporate bond trading (Rp trn) 43.46 32.72 43.63 42.19 57.60

Jakarta Composite Index high 4224.0 4262.6 4375.2 4940.9 5214.9

Jakarta Composite Index low 3654.6 3984.1 4236.3 4305.9 4418.9

No. of listed companies 445 454 459 464 472

No. of listed government bonds 90 91 92 92 93

Value of government bonds (Rp trn) 791.18 812.80 820.27 853.87 888.51

No. of listed corporate bonds 96 97 99 91 94

Value of corporate bonds (Rp trn) 167.47 171.32 187.46 196.44 205.37

No. of asset-backed securities issuers 4 4 5 5 5

Value of asset-backed securities (Rp trn) 1.25 1.15 1.98 1.89 1.70

IDX trading statistics, 2012-13

Domestic investors’ share

of trading has steadily

grown in recent years,

climbing from 19% in

mid-2007 to 44.2% by

August 2013.


for outflows came from the US Federal Reserve’s warn-ings of a looming tapering of its quantitative easing pro-gramme in May, concerns over macro-economic imbal-ances related to the persistent current account deficitand rising inflation driven by fuel and food prices com-pounded the sell-off in securities. While long-term val-ue investors like Hong Kong’s Jardine Matheson main-tained holdings of blue-chip stocks, portfolio managersflocked to the exits. “Long-end funds were the firstsellers in May as they were concerned about macroimbalances and what they saw as unrealistic valua-tions,” Erwan said. “They were then followed by Indone-sia-exposed offshore ETFs and hedge funds.”SETBACKS: The five Indonesian-focused offshore ETFstook the worst beating: in the third quarter of 2013alone, Market Vectors Indonesia Small Cap ETF fell29.2%, followed by Blackrock’s iShares MSCI IndonesiaETF down 24% and Market Vectors Indonesia ETF some20%, according to Bloomberg. Other ETFs with around10% exposure to Indonesian equities also fell sharply.With the rupiah breaking the Rp10,000:$1 barrier inAugust 2013 and benchmark interest rate hikes seenas endangering domestic growth, a second round ofsell-offs gathered pace with an outflow of Rp9.8trn($980m) that month alone. The JCI fell 22% to around4000 by early September 2013, although the market’saverage price-to-earnings (P/E) ratio was down onlymarginally from 21 times to 17.2 in the period, stillabove the MSCI EM Index’s average P/E of 11 in early

September. In rupiah terms, the share-price drop rankedfifth in Asia in the year to September, but compound-ed by the 17% drop in the rupiah versus the dollar, themarket ranked as the worst performer in Asia.VALUATIONS: Listed firms’ earnings growth has beenstrong in recent years, with return on equity (ROE)reaching 32.4% in 2011 and 32.2% in 2012, comparedto Thailand’s 16.5% and Malaysia’s 13.5% in 2012.Although annual growth in average earnings per share(EPS) has cooled from 27.5% in 2011 to 5.4% in 2012,Bahana expects earnings to bottom out at the turn of2014, with forecast 2013 EPS growth of 4.8% and 9.2%,excluding commodities. Lower earnings helped containfalls in price-earnings (P/E) ratios during the mid-2013correction, with average P/E ratios dropping only mar-ginally from 21.6 times in 2011 to 19.6 in 2012 and 17.2by September 2013. “We expect earnings to bottomout by the first quarter of 2014 and recover thereafter,”Joshua Tanja, UBS Indonesia's managing director andhead of equities, told OBG. “P/E ratios have not fallenthat much because earnings have also dropped.”

Domestic and long-term FPI investors rotated intodefensive stocks related to consumption, particularlyconsumer goods and telecoms. While the correctionhas been sharp in many sectors, P/E ratios for consumergoods stocks remained above 20 times on average.This drop in valuations has presented a buying oppor-tunity for investors who remain bullish on longer-termgrowth prospects. Crude forecasts for broader econom-

104

Listed firms have seen

strong earnings growth in

recent years, with ROE

levels standing at 32.4%

and 32.2% in 2011 and

2012, respectively.


ic growth should put a floor under the correction. “Weexpect nominal GDP growth of 11-12% in 2014, whichmeans the equity markets should theoretically grow byat least that much,” Anton Gunawan, Bank Danamon’schief economist, told OBG. “The swing factor is marketsentiment, which would require a credible signal fromgovernment, for instance.” Bahana Securities expectsgrowth in the JCI to rebound from a forecasted 3% in2013 to 14% in 2014.NEW SUPPLY: Although adverse market sentiment hasprompted delays in many planned IPOs, the exchangewas on track to achieve its goal of 30 new listings in2013, with 24 new listings by mid-September raising atotal of Rp14.2trn ($1.42bn). Encouraging new supplyis critical to IDX’s ambitions of becoming the region’slargest exchange by capitalisation by 2015, when ithopes to reach $750bn. The number of IPOs nearlydoubled from a trough of 13 in 2009 to reach 25 in2012, raising a total of Rp10.14trn ($1bn). The marketwitnessed roughly twice the amount of rights issues,with Rp22trn ($2.2bn) raised by 17 listed firms. The mostactive underwriter in 2013 was UBS Securities.

In recent years, the sectors yielding the most IPOshave been the transportation and banking industries.In value terms, the highest-yielding sectors over thisperiod have been banking and commodities. The largestIPOs in 2013 included automotive distributor MitraPinasthika Mustika, raising Rp1.5trn ($150m) in May;textiles producer Sri Rejeki Isman, investment firmSaratoga Investama Sedaya and state-owned SemenBaturaja raising Rp1.3trn ($130m), Rp1.5trn ($150m)and Rp1.3trn ($130m), respectively in June; retailerElectronic City, raising Rp1.35trn ($135m) in July; andSiloam Hospital raising Rp1.4trn ($140m) in Septem-ber. This has not scared off a pipeline of at least six moreIPOs in the fourth quarter of 2013, according to IDX:larger planned issues include herbal medicine produc-er SidoMuncul, which aims to raise Rp1.5trn ($150m),taxi company Bluebird’s delayed listing that would raiseup to Rp6trn ($600m) and auto-financer IndomobilMultiJasa, part of the Salim Group. BUY-BACKS: While average returns on IPOs in 2012reached 92%, the 2013 sell-off caused average returnsto slump to 26% in the year to September. Aiming toplace a floor under equity prices and demonstrate man-agement confidence, OJK enacted new rules in lateAugust allowing listed firms to buy back up to 20% oflisted shares without shareholder approval in periodsof high volatility. This rule, similar to one passed in 2008,defines high volatility as a 15% price-drop over threeconsecutive days, or by OJK’s unilateral announcement.“We are seeing a number of share buy-backs sinceAugust, driven by state-owned enterprises (SOEs), butwith some private operations as well,” Su told OBG. Thecash-rich nature of listed firms gave them ample capac-ity to fund the buy-backs. The SOEs involved includedTelekomunikasi Indonesia, toll-road operator Jasa Mar-ga, Semen Indonesia and coal-miner Bukit Asam, as wellas private firms such as MNC Investama, Media Nusan-tara Citra and Global Mediacom (all part of the MNCGroup), Panin Insurance and Intiland Development. Two

firms that staged IPOs in the first half of 2013 alsoannounced buy-backs: Electronic City, whose shareprice had slumped 24% below floating price by Sep-tember, set aside Rp150bn ($15m) for the buy-back,while Semen Baturaja, whose shares were trading 32%below IPO levels, budgeted Rp100bn ($10m). By Octo-ber 2013 over 20 firms had conducted buy-backs,although given the mid-cap size of most firms partic-ipating, the average deal size ranged from $5m to $20m,with buy-backs covering a three-month period toDecember 2013. Given the small deal sizes, the buy-backs had little influence on share prices, but diddemonstrate management confidence. REFORMS: IDX has pursued two reforms to its struc-ture aimed at boosting liquidity and encouraging moreretail participation. The first consists of reducing thenumber of stock-price fraction units, used in buy andsell bids, from five to three. The exchange has the high-est buy/sell spreads in South-east Asia at 80-90 basispoints, compared to a regional average of 30. By sim-plifying the fraction unit system, the aim is to narrowthis gap, permitting simplified algorithmic trading. Thesecond reform consists of reducing lot sizes from 500shares to 100, which will allow smaller investors to takepositions on larger-cap stocks. Yet given that mostshares trade at less than the equivalent of $2/share,minimum buy-in already ranks at a mere $1000. Both

105


IDX is pursuing reforms to boost liquidity and retail involvement

Encouraging new supply is

critical to the bourse’s

ambitions of becoming the

region’s largest exchange

by capitalisation by 2015,

when it hopes to reach

$750bn. The number of

IPOs nearly doubled from

13 in 2009 to 25 in 2012,

raising a total of $1bn.

SOURCE: Indonesia Stock Exchange *Year to Sept.

Volume (bn shares) Value ($ m) Frequency Market capitalisation ($ bn)

2006 1.81 204.07 19,880 138.40

2007 4.23 467.21 48,216 211.10

2008 3.28 469.05 55,905 98.31

2009 6.09 399.18 87,040 214.08

2010 5.43 529.70 105,790 361.67

2011 4.87 565.59 113,454 390.09

2012 4.28 483.95 121,712 426.78

2013* 5.77 664.14 162,684 377.21

Average daily trading & market capitalisation, 2006-13*


reforms were carried out on January 6, 2014. “Reduc-ing the price fractions from five to three will tightenour bid/ask spreads, which together with smaller lotsizes will encourage more liquidity and make it easierto manage portfolios,” Poltak said.

The transition to OJK, which will gain jurisdiction overbanks from 2014, will bring a more integrated approachto financial supervision and build on recent improve-ments to corporate governance and trading standards.In recent years the regulator enacted a new rule requir-ing the disclosure of beneficial owners of principalstockholders with over 20% stakes, stricter rules onannual reporting and restrictions on brokers’ collater-alisation of shares on behalf of investors. “Retail investorsare already much better protected than three years ago,”Erwan said. “Brokers are no longer allowed to collater-alise their shares, while IDX’s early warning systemsoperate well.” Although a new capital markets law andthe long-planned bankruptcy law were still pending inthe fourth quarter of 2013, OJK is forging ahead withpiecemeal reforms like establishing an investor pro-tection fund to guarantee investor compensation in theevent of counter-party default. INNOVATIONS: As part of its development plan, IDXaims to develop more hedging products, encouragemore retail participation, and enhance transparency andgovernance. Despite these efforts, new product launch-es have failed to attract significant liquidity of issuerinterest. Five equity ETFs have launched since 2011,starting with IndoPremier’s LQ-45 Index tracker, butIndonesian retail investors’ preference for active invest-ing or diversified mutual funds has constrained liquid-ity, while most major brokers have shied away from theinstrument. “At the moment about 7% of all the mon-ey in Indonesian financial services are dedicated tomutual fund products. This is still very small but we seethe appetite increasing every year for retail accounts,”Agus Yanuar, president director of Samuel Aset Man-ajemen, told OBG. According to Erwan, “Brokers whomarket ETFs onshore are those that don’t have activefund management affiliates. Most mutual fund investorsare quite risk-averse and prefer balanced funds thatare diversified across a range of asset classes.”

While new rules in 2007 paved the way for floatingreal estate investment trusts (REITs), the market has seenonly one such issue, in 2012. Further issuance will like-ly require changes in the tax code, unlikely given thegovernment’s drive to increase tax revenues. “While wewitnessed the first REIT launch, we do not expect a highpace of issuance until the tax office changes the taxstructure for REITs to that of a pass-through vehicle,”Poltak said. Leading property developer Lippo Grouplisted a REIT via its asset management subsidiary Cip-tadana in late 2012, with its Solo Grand Mall with aroundRp400bn ($40m) in assets underlying the trust. “TheLippo REIT is more of a conventional property fund,”Erwan said. “It has been used by Lippo to divest fromSolo Mall and they still have to pay dividend tax.” Theexchange also plans to develop more hedging instru-ments by introducing on-exchange securities lendingand borrowing (SLB) and re-launching single-stock and

index futures in late-2014 (see analysis). While SLB isavailable via the Indonesia Clearing and GuaranteeHouse (Kliring Penjaminan Efek Indonesia, KPEI) since2001, with a list of 91 eligible stocks, 98 clearing mem-bers and three custodian banks acting as market mak-ers, IDX plans to allow SLB in the secondary market in2015 once regulatory changes by OJK are enacted in2014. The lack of secondary-market SLB is seen as ahindrance to growth in ETF trading, given the inabilityto short-sell on the secondary market. KPEI recordedonly 139m such transactions worth a total of Rp309.1bn($30.9m) in the first three quarters of 2013. PRIVATE EQUITY: Falling equity prices may have a calm-ing influence on acquisition prices in private equity(PE) deals, which rose to 16.2 times earnings in 2012,according to a 2013 Boston Consulting Group report.The target sectors for PE funds – mainly consumer-relat-ed sectors like consumer goods, banking, infrastruc-ture and natural resources – have witnessed a total of$3bn in deals, of which $900m were in 2011 and 2012alone, according to research firm Preqin. Higher valu-ations are a function of strong earnings from consump-tion-related firms, as well as competition between agrowing array of PE players – with some 31 active fundsin 2013, according to the Emerging Market PE Associ-ation. Domestic players dominated by the big four –Saratoga, Ancora, Quvat and Northstar – account for$2bn of investment since 2007, while internationalplayers running South-east Asian funds, including majornames like KKR, Carlyle, Abraaj and CVC, account foraround $1bn. CVC’s $700m investment in retailer Mata-hari in 2010 accounts for $700m of this, however.

Global PE funds traditionally focus on deals above$100m. KKR made its first investment via its asset man-agement arm only in 2013, investing in a food produc-er, while Blackstone (operating out of Singapore) hadyet to close a deal by the fourth quarter of 2013. Thesector has witnessed several successful exits in bothtrade sales and IPOs, with Saratoga delivering success-ful IPOs in 2008, 2010 and 2012. Preqin estimated inearly 2013 that both types of funds aim to invest $8.2bncombined. Saratoga’s IPO in June 2013, the first for alocal PE fund manager, marked a watershed. Althoughthe market sell-off led its share price to fall 17% in thefirst day of trading, Saratoga followed the example ofmajor global fund managers like KKR and Blackstonein tapping public equity markets. OUTLOOK: Despite the challenges that have beencaused by global volatility, most investors have main-tained a bullish long-term outlook. Indonesia’s relianceon FPI to finance its current account deficit is a causefor concern. All the same, its consistent growth record,resilient corporate earnings and dynamic private sec-tor highlight its strong prospects for expansion goingforward. The coming year will be marked by governmentattempts to steady the pace of growth and to easestrains on the balance of payments. While short-termportfolio investment may be subject to temporaryswings, investors with an eye on long-term horizons willfind acquisition opportunities as the pricing of assetscorrects to more realistic levels over the coming year.

106

Listed firms have seen

strong earnings growth in

recent years, with ROE

levels standing at 32.4%

and 32.2% in 2011 and

2012, respectively.

As part of its development

plan, IDX aims to create

more hedging products,

encourage more retail

participation, and enhance

transparency and

governance.


CAPITAL MARKETS INTERVIEW

Muliaman D Hadad, Chairman, Otoritas Jasa Keuangan

How much progress has been made in terms of

easing cross-border restrictions within the ASEAN

banking integration framework?

HADAD: I think we’re already quite advanced in thisregard. It’s a long process, and we’re still discussingthe details of how we’ll proceed with this, but a lotof players would like to see a mutually beneficialintegration so that, at the end of the day, there arenot losers and winners. We’ve learned a lot from theeurozone experience. But I think, within ASEAN, wecan agree that our integration should create addi-tional welfare for all members.

ASEAN is really quite diverse, as there are fivemembers within the coalition who already have high-ly developed banking systems: Singapore, Malaysia,Thailand, Indonesia and the Philippines.

Then there is the second generation of ASEAN:Myanmar, Laos, Cambodia and Vietnam. There is adevelopment gap between these two groups. Thatis why we need to pay particular attention to howwe integrate our banking systems. The issue of capac-ity building is paramount for all of our members, butparticularly those who are still lagging in terms offinancial infrastructure development. Indonesia, forexample, must deepen its capital markets to staycompetitive with the region.

How is OJK planning to deepen the domestic cap-

ital markets and expand the investor base?

HADAD: We have to deepen our own market byincreasing the number of investors and improvingproduct development and variety. Also, the deepen-ing has to be managed on the demand side and sup-ply side. First, we have to increase our investor base,because the formal investors in the market are quitelimited and only around 400,000 people invest reg-ularly. Therefore, we need to grow the domestic retailinvestor segment. Another very important part ofour job is teaching financial literacy. We must beconstantly improving the financial literacy of our

people, because emerging markets are still strugglingwith this across South-east Asia.

Creating access to finance for all people is equal-ly important. In Indonesia, only 40% of people haveformal access to financial institutions; in terms ofthe supply side, we would like to add to the numberof listed companies in our capital market. At themoment, the timing and momentum are very good.I expect that 2014 will be a good year for the mar-ket because we expect higher economic growth andan increase in the number of initial public offerings.

Over the long term, what level of demand for

financial services do you anticipate in Indonesia?

HADAD: The room for growth in Indonesia’s finan-cial services market is quite significant. Indonesianper capita income has increased because of a steady6% economic growth for the last 5 years. Now, it isapproaching an average of $4,000 but the middleclass is also growing in very significant numbers.

We expect to have more than 100m people inIndonesia’s middle-income group within the nextfive years, and their income will be more than $10,000per annum. Therefore, demand for financial servic-es will grow quite significantly.

Previously, Indonesians were just relying on moretraditional banking services; however, now they areasking for insurance services as well because theyhave new cars and houses. Demand for financialservices is also becoming quite strong. For example,the increase of penetration of the insurance indus-try in Indonesia is quite significant.

Even today, Indonesia is still one of the least insurednations among the ASEAN countries, because ourinsurance penetration to GDP is still small and theratio of credit to our GDP is low compared to thatof our neighbours. I expect that the financial sec-tor has great room for growth given the increasingdemand and income per capita of the people, andit will be quite significant for the next 10-20 years.

107


Growing demandOBG talks to Muliaman D Hadad, Chairman, Otoritas Jasa Keuangan (OJK)

CAPITAL MARKETS INTERVIEW

Eko Yuliantoro, CEO, Bahana Securities

How are Indonesian capital markets bracing for

the tapering of the US’s quantitative easing pro-

gramme, and what is your 2014 outlook?

YULIANTORO: With regard to the Federal Reserve’stapering, I believe that most of the bad news hasmostly been priced into the market, in line with2013’s Rp25trn ($2.5bn) net foreign outflow in theIndonesian equity market. Additionally, based on ouranalysts’ recent road shows in Singapore, Hong Kongand Japan, most foreign fund managers are current-ly already underweight in Indonesia.

This is encouraging – if international players donot currently hold positions in the market, there isnothing to sell. In my opinion, this means there arelimited downsides for the market from current lev-els. I always feel much more comfortable asking for-eign investors to invest in our markets, particularlywhen the Indonesian rupiah has significantly depre-ciated. At this stage of the cycle, share prices are 25%cheaper in dollar terms.

Furthermore, the countries we visited were notcompletely risk averse to investing in Indonesia inthe future. In fact, in 2014 these overseas fund man-agers will be looking for encouraging signs to getback into this oversold market. Therefore, we havean index target of 5000 by the end of 2014, backedby some 15% market earnings per share growth.

What is your take on the 2014 elections, and

how will politics impact the markets?

YULIANTORO: In the lead up to the 2014 elections,the political climate could heat up. However, weexpect cooler heads to maintain stable conditions onthe ground. As the final term draw to a close for thecurrent president, Susilo Bambang Yudhoyono, thepolitical situation on the ground remains fluid withno significant domination by one political party.

There will be 12 nationwide parties and three localparties competing in the legislative election. Inter-estingly, we noted that almost 28% of voters in 2009

did not cast their ballots. The legislative electioncampaign started on January 11, 2014 and will rununtil April 5, 2014, with the election to be held onApril 9 of this year. Meanwhile, the presidential cam-paign will begin in June 2014, with the election tak-ing place on July 9, 2014.

It will be interesting to observe whether largepolitical parties will form coalitions in order to win.We believe that the new president will be market-friendly and pro-democracy, bringing reforms thatshould bode well for both growth and the markets.

With elections just around the corner, what sec-

tors and markets should foreign investors be

looking into for 2014?

YULIANTORO: Irrespective of the elections, Indone-sia’s consumer market is likely to see continued long-term burgeoning growth, given the pace of acceler-ated urbanisation, rapid growth in modern tradesand expanding fast-moving consumer goods sales.The country is the fourth-largest consumer marketin Asia – not including Japan – behind China, Indiaand Korea. In 2014 GDP per capita reached $4000,with a population of 253m. In the lead up to the July2014 elections, we expect consumer staple stocks –such as cigarettes, food and beverage, and pharma-ceuticals – to benefit from election spending, result-ing in well-supported domestic consumption, despiteBank Indonesia’s current tight monetary policy.

In addition, we are also positive about the poten-tial in the telecommunications sector due to a cou-ple of factors. First, we expect an upsurge in phoneusage as a direct result of the 2014 elections as itwill be necessary for political players to coordinatepolitical rallies and campaigns. This includes the useof prepaid cards or phone vouchers distributed bypolitical parties to potential grassroots voters. Sec-ond, we expect industry consolidation to continue,paving the way for continued rational pricing andimprovements in profitability. – January 13, 2014

108

Looking aheadOBG talks to Eko Yuliantoro, CEO, Bahana Securities


CAPITAL MARKETS ANALYSIS

Foreign investors have a preference for longer-term securities

Although Indonesia’s fixed-income market was onlyvalued at around 15% of GDP in 2012, compared to 45%for equities, issuance and investor appetite have grown.The government has sought to rebalance its debt pro-file towards domestic sources, and the value of out-standing local-currency government bonds has dou-bled from $41.2bn to $84.9bn in the eight years toAugust 2013, according to the Indonesian StockExchange (IDX). While still marginal as a share of totalissuance, outstanding corporate paper has tripled inthe same period, from $6.5bn to $19.6bn, enticed byrapidly falling yields. While risk-on/risk-off attitudesamong foreign investors have affected volatility sinceMay 2013, issuance should prove resilient and providehigher-yielding instruments. INVESTMENT GRADE: Major agencies’ re-ratings ofIndonesia to investment grade and greater globalappetite for high-yielding bonds have been key, thoughthey also expose Indonesia’s bond market to swings inglobal risk appetite. Since 2010 several credit ratingsagencies have upgraded Indonesia, unlocking moreinvestment from foreign institutional investors. TheJapan Credit Rating Agency upgraded Indonesia’s local-currency (LC) debt from “BBB-” to “BBB” in July 2010,followed by upgrades from Fitch in December 2011,Moody’s in January 2012 and Japan’s Rating & Invest-ment Information in October 2012. Only Standard &Poor’s has maintained its junk status on concerns overslow infrastructure development. “Japanese institu-tional investors really started investing in the Indone-sian market following JCR’s upgrade in 2010,” ErwanTeguh, CIMB Securities’ head of research, told OBG.Government bond yields fell significantly as a resultof higher investment, from around 16% to an aver-age of 6.5% in the eight years to 2013, according toCredit Suisse. While low by historical standards, theseyields remained in the higher emerging market tier.As a result, global emerging market bond indexesfrom HSBC, JP Morgan, Citi and Barclays have expand-ed their allocations to Indonesian bonds to between

10% and 12%, for fear of under-performing emergingmarket return benchmarks. INVESTOR APPETITE: Foreign investors’ share of totalgovernment bond holdings has grown consistently, ris-ing from 28.4% in June 2012 to a peak of 32.6% by theend of March 2013, the highest share in emerging Asia,before falling back slightly to 31% by August 2013. Theimposition of a six-month minimum holding period forBank Indonesia (BI) certificates (reduced to one monthin August 2013) also prompted a flow into governmentsecurities. The second-largest holders after banks, for-eign investors have diversified to include smaller fundmanagers. “We have seen some new foreign buyerscome to the bond market in the past few years – small-er names from Europe and the US,” Ali Setiawan, HSBC’ssenior vice-president of global markets, told OBG.

Foreigners have shown a preference for long-datedbonds, with some 44% of foreign-held governmentbonds at maturities of 10 years or more. While foreigninvestors have sold part of their holdings since May 2013,due to currency and macro imbalances, local institu-tionals raised their share of outstanding bonds. Banks’share of outstanding government bonds fell from near-ly 80% in 2003 to 36% by August 2013. Other majorholders of government debt include insurance firms,with 13% of bonds in August; mutual funds, 5%; andpensions, 4%. Local institutions dominate the less liq-uid corporate bond market, with pension funds hold-ing 29.6% of corporate bonds in August 2013; mutualfunds, 21.7%; banks, 21.14%; and insurance firms, 14.14%.GOVERNMENT CURVE: As the domestic stock of gov-ernment debt rose from 45% to 55% in the seven yearsto 2012, according to BI, local issuance has grown. Totaloutstanding LC-government debt grew 12.3% year-on-year to Rp888.5trn ($88.9bn) by June 2013, accordingto the Asian Development Bank (ADB), with a strongbias towards fixed-rate paper, which accounted for 71%of outstanding bonds in the second quarter of 2013.Sovereign issues have become more diversified, withthe first launch of a LC sukuk (sharia-compliant bond)

109


Foreign investors’ share of

local government bonds

rose from 28.4% in June

2012 to 32.6% by March

2013, before falling back

slightly to 31% in August.

A growing appetite Re-ratings and demand for high-yielding bonds are drawing investorsto the fixed-income market


and a 30-year conventional bond, both in 2007. By June2013 three main types of sukuks were in use: tradition-al sukuks, accounting for 1.9% of outstanding bonds;retail sukuks (4%); and project-based sukuks (2.7%).The government launched a dollar-denominatedonshore bond at end-2013 to increase onshore invest-ment options, while planning for bond-switches fromLC bonds to dollar-bonds to reduce refinancing risks.The pace of issuance was sustained through 2013,despite higher yields, to support the government’s full-year Rp231.8trn ($23.2bn) net issuance target.CORPORATE PAPER: While much smaller at 18.75%of outstanding bonds in August 2013, the corporatebond market has grown much faster, albeit from a lowbase. Leveraging on a liquid government risk-free yieldcurve, blue-chip corporates have increasingly tappedfixed-income instruments as an alternative to tradi-tional bank lending at lower rates and longer maturi-ties. Growth in corporate bonds reached 38.1% y-o-yin first-quarter 2013 and 23.6% in the second quarter,the fastest rate in emerging Asia, reaching Rp205.4trn($20.5bn) by end-June 2013, according to ADB. Con-ventional bonds accounted for 84.8% of outstandingbonds, with sukuks making up the balance, while aver-age maturities were shorter at between three and fiveyears. Although the values raised are typically smaller,at between Rp1trn ($100m) and Rp3trn ($300m), thecombined value of issues rose from Rp45trn ($4.5bn)in 2011 to over Rp60trn ($6bn) in 2012.

Newcomers such as commodity and consumer goodsfirms joined traditional issuers, including multi-financecompanies (MFCs), banks, property developers andstate-owned enterprises, although the latter still dom-inate issuance. The largest issues in 2013 included AstraSedaya Finance (raising Rp3trn, $300m), Bank OCBCNISP (Rp900bn, $90m), Bank Victoria (Rp500bn, $50bn)and Agung Podomoro Land (Rp1.2trn, $120m). Thethree issuers with the largest outstanding debt stockby second-quarter 2013 confirm this trend: state-ownedpower utility PLN had Rp14.2trn ($1.42bn) in outstand-

ing bonds, followed by Indonesia EximBank with Rp13trn($1.3bn) and Astra Sedaya Finance with Rp10.7trn($1.1bn). MFCs are regular issuers given their require-ments for working capital in order to fund lending.“Most MFC bond issuers in the first half of 2013 did soto generate working capital and manage their assets-to-liabilities maturity mismatches,” Iwan Wisaksana,senior vice-president at Kresna Graha Sekurindo, said.BEAR-MARKET ISSUANCE: Despite the hike in LC-bond yields of some 270 basis points between May andSeptember 2013 – ending at yields of 8.6% on bench-mark 10-year government bonds – the fixed-incomemarket will continue to see several forms of issuanceactivity. Although the government has expanded itsplans for foreign currency bond issuance from 14% ofissuance to 18-20%, with a $1.5bn sukuk issue lastingfive and a half years at 6.125% in September 2013, thegovernment is still issuing a combination of fixed-rateLC-bonds, retail bonds and Treasury bills.

In the corporate market, while planned issues by thelikes of CIMB Niaga and state-owned Kimia Farma havebeen delayed, traders expect continued issuance fromMFCs like Adira Dinamika Multifinance, who may havelittle other choice than to accept higher coupon rates.Given Bank Indonesia’s discouragement of banks fromlending to import-dependent sectors like telecoms andautomotives, some corporations may shift to the fixed-income market. “Despite the hike in coupons since May2013, we are likely to continue seeing some corporatebond issues due to their fixed long-term nature – bankborrowings tend to have floating rates,” Harry Su,Bahana’s head of equities and research, told OBG.Indeed, in October 2013 Adira announced a five-yearfixed bond at an 11% yield. These planned bonds, whichwould have shorter maturities of about three to fiveyears, would not be guaranteed by the central govern-ment and would therefore need to be backed by spe-cific, commercially viable projects.

As inflation cools and BI pauses its benchmark inter-est rate hikes throughout 2014, the pace of issuanceis expected to rebound. “While corporate bond issuancehas slowed amid rising yields, we expect these to resumeonce BI stops hiking interest rates and as inflationreturns to trend,” Purbaya Yudhi Sadewa, head of theDanareksa Research Institute, told OBG.PROSPECTS: Higher yields have raised the state’s costof funding and resulted in delays regarding corporateissues, but are a draw for institutions and high-yield-seeking investors that have returned to the marketsince late September 2013. The fundamentals of growthremain steady, as reflected in credit ratings agencies’reaffirming its ratings since the outflows from May2013. The government has space to issue more debt,while blue-chip corporates will return to market as theimpact of higher domestic lending rates sinks in.

While the correction has shown how fickle specula-tive foreign portfolio inflows are, it also reveals anappetite from long-term value investors. Although morevulnerable to changes in global risk appetite than oth-er Asian markets, like Thailand, Indonesia’s fixed-incomemarkets will continue to deepen in the coming years.

110

The value of outstanding local currency bonds doubled from $41.2bn in 2005 to $84.9bn in 2013

Growth in corporate bonds

reached 38.1% y-o-y in the

first quarter of 2013 and

23.6% in the second

quarter, the fastest rate in

emerging Asia, reaching

$20.5bn by end-June 2013.



In April 2013 Indonesia made up only 1% of Asian OTC FX derivatives

Despite the widespread use of hedging instruments off-shore, Indonesia’s derivatives market has been slow todevelop. Bank Indonesia (BI) regulations in late 2008following significant losses linked to onshore struc-tured products have restricted foreign-exchange (FX)and interest-rate derivatives to over-the-counter (OTC)trading between banks. A new exchange establishedin 2009, the Indonesia Commodity and DerivativesExchange (ICDX) introduced commodity and limitedFX futures that will benefit from new government reg-ulations requiring the sale of key mineral commoditiesvia onshore exchanges. While the Jakarta FuturesExchange (JFX) still struggles to introduce liquid con-tracts, the Indonesian Stock Exchange will reintroducesingle-stock and index futures in late 2014, followedby interest-rate futures. The G20 Financial StabilityBoard (FSB) requirements to migrate OTC derivativetrading on-exchange over the coming years will sup-port growth in exchange-based derivatives trading. OTC: In November 2008 BI issued new regulations bar-ring banks’ use of structured products, which hedge FXmovements, following losses by several banks. Thebiggest losses were recorded by Danamon, which sawa Rp800bn ($80m) loss, and Standard Chartered. “Thenew BI rules have ruled out structured derivative prod-ucts, although it is still possible for clients to buy suchtailor-made contracts through Singapore,” PoltakHotradero, head of research at IDX, told OBG.

In particular, the use of FX non-deliverable forwardsthrough Singapore-based banks has created a dynam-ic offshore forward market, with average daily volumesin the $500m-$700m range, according to HSBC esti-mates. By April 2013 Indonesia accounted for just 1%of total Asian OTC FX derivatives, according to manage-ment consultancy Oliver Wyman. “FX options tradingvolumes dropped significantly following 2009 rulesfrom BI,” Ali Setiawan, HSBC’s senior vice-president ofglobal markets, told OBG. “Banks like HSBC still quotedollar/rupiah rates, but these are only plain vanilla, so we are not seeing any development of this market.”

The majority of clients used such products to hedgeagainst financial risks rather than to speculate, a 2010survey by Gadjah Mada University found. Meanwhile,the regulator, Financial Services Board (OJK), requiresequity and commodity futures to be traded on-exchange.By September 2013 the ratio of OTC to on-exchangederivatives trading was 6:1, with only commodity andlimited FX futures listed. OVERSIGHT: The two are regulated by the Ministry ofTrade’s Commodity Futures Trading Regulatory Agency,which is separate from OJK. While aggregate monthlyturnover on JFX has grown from Rp152bn ($15.2m) in2009 to Rp3.99trn ($399m) in the first three quartersof 2013, no published turnover figures are available forICDX. Both commodity exchanges have developedfledgling storage capacity networks to standardiseproduct quality and delivery times, although moreinvestment will be needed as trading grows. “One ofthe key issues in developing a commodities futuresmarket is the infrastructure, mainly warehousing capac-ity that insures standardised quality,” Purbaya YudhiSadewa, chief economist at local financial services firmDanareksa, told OBG. “We are still far behind in ourexchange-traded derivatives development.”REFORM: As part of the G20, Indonesia is bound bythe FSB’s requirements to gradually shift derivatives trad-ing onto exchange platforms and to report OTC tradesto a central repository. A deadline was set for end-2013, by which all members must show concrete stepstowards central clearing and trade reporting. While BI’srules require daily reporting of OTC derivatives trans-actions, in 2011 the then-regulator, the IndonesianCapital Market and Financial Institution SupervisoryAgency (now OJK), expanded the definition of commod-ity futures to cover interest rates, foreign exchangeand equities, and introduced a new counter-party mod-el for OTC trading that allows derivatives to be tradedon-exchange or settled through a clearinghouse. However, full compliance remains distant as questionsover who would act as a central clearing house remain.

A new regulatory reform

requires that the sale of

key mineral commodities

take place via onshore

exchanges, such as the

newly created ICDX.

While structured derivative

products were banned by

BI in 2008, customers can

still buy these products

through Singapore, which

has led to an active

offshore forward market.

112

Hedging your betsRegulatory changes are set to support the growth of exchange-basedderivatives trading



“We are still some way off implementing G20 require-ments on derivatives,” Setiawan said. “The question iswho would act as the central clearing house for deriv-atives currently traded OTC, especially since banks arebarred from trading via the exchange.” BI introduced anew measure in mid-2013 that could spur more demandfor OTC products by allowing exporters to use FX-for-wards without underlying transactions as a way ofhedging currency exposures.

As part of the government’s strategy of increasingdomestic value added to Indonesia’s exported commodi-ties, the Ministry of Trade has pushed for onshoreexchange trading of key commodities, starting with tinfrom August 2013. The regulator has called on assis-tance from the Chicago Mercantile Exchange and theUS Commodity Futures Trading Commission to devel-op its onshore commodity trading in key hard and softcommodity exports. By requiring all 47 tin-ingotexporters to trade on a domestic exchange before ship-ment, the ministry plans to establish a new global tinbenchmark in Indonesia – the world’s largest produc-er with 40% of global supply – in direct competition tothe existing benchmark on the London Metals Exchange(LME). “The purpose of trading physical tin via thebourse for export is to make Indonesia the place forinternational tin-price discovery,” Sutriono Edi, head ofthe Commodity Futures Trading Regulatory Agency,told Bloomberg in October 2013. COMMODITY BENCHMARK: The only existing onshoretin contract is hosted on ICDX and backed by five tinproducers, including the world’s largest – state-ownedTimah. But although the government wants to cen-tralise tin trading on a single exchange, rival JFX plannedto introduce a tin contract in the fourth quarter of2013 with the backing of 18 smaller tin smelters. It wasstill awaiting CoFTRA approval in December 2013. TheICDX-listed tin contract was first introduced in 2012and relaunched in 2013 following lacklustre trading,which saw transactions trail off after 116 lots weretraded in 2012. Tin trading is available under five con-tracts during five seven-minute sessions, with five-tonne lot sizes of 99.9% purity. Physical delivery takesplace at four storage points in Bangka Belitung province,offshore East Sumatra, replacing the system of tin spotsales on global exchanges such as LME or in long-termsupply contracts with end-users. By October 2013, 24trading firms had joined ICDX, including major traderslike South Korea’s Daewoo. The new regulations prompt-ed Timah to declare a state of force majeure on itsexisting supply agreements. As a result, the tin produc-er cancelled its shipments, slowing tin exports to 786tonnes in September 2013, down from 9874 tonnes ayear earlier (see Mining chapter).

Prices jumped as a result. In that month alone, prompt-ed by the drop in shipments from Timah, LME tin pricesrose 21% year-on-year. Although it was unclear in Octo-ber 2013 whether JFX would be allowed to launch arival tin contract, its management argued more com-petition would benefit efficiency. “As the two com-modities exchanges strive to make their products moreattractive, we think the futures trading community will

benefit,” Lukas Lauw, head of the information technol-ogy and trading division at JFX, told OBG.STOCK & RATE FUTURES: Indonesia’s main stockexchange also plans to develop more equity and fixed-income hedging instruments. While the Jakarta andSurabaya exchanges once hosted single-stock futures(SSF) and stock index futures, respectively, they havebeen inactive since their merger in 2007. In late 2014,IDX aims to re-launch both types, starting with large-cap SSFs and a futures contract on the benchmarkLQ45, a capitalisation-weighted index of the 45 mostheavily traded stocks on the IDX. “The next step oncewe relaunch single-stock and index futures at year-end2014 will be interest-rate futures, using different matu-rity bond indexes published by the Indonesian Bond Pric-ing Agency,” Poltak said. IDX is conducting a study inconjunction with the Debt Management Office due forcompletion in 2014. The aim is to launch interest ratefutures based on one-, three-, six- and 12-month bondindexes published by the Indonesian Bond PricingAgency. As this trading infrastructure develops, investorswill welcome a wider range of instruments that allowmore flexibility for onshore-hedging.EXCHANGE TRADED: On-exchange derivatives aredeveloping at a faster rate. The JFX, owned by 29 futurestraders, opened in 2000, although trading only accel-erated from 2010 with its new trading platform. By2013 it offered 11 commodity futures contracts includ-ing olein, cocoa and gold (with three dollar-gold con-tracts), with plans for a tin contract in the fourth quar-ter of 2013. The rival ICDX, backed by 12 commodityfirms including major foreign buyers, launched in 2009and hosts four metal contracts, two palm-related, fivein energy, 14 agricultural commodities and 34 curren-cy pairs. The four market makers for OTC derivativesare the global custodians – HSBC, Standard Chartered,Deutsche Bank and JP Morgan – who must report trans-actions daily to BI. However, it will be vital for the author-ities to implement rules coherently, while exchangeswill need to expand infrastructure for physical delivery.

115


The Indonesian Stock Exchange will reintroduce single-stock and index futures in late 2014

As part of the government’s

strategy of increasing

domestic value added to

Indonesia’s exported

commodities, the Ministry

of Trade has pushed for

onshore exchange trading

of key commodities, starting

with tin from August 2013.

By requiring all 47 tin-ingot

exporters to trade on a

domestic exchange before

shipment, the Ministry of

Trade plans to establish a

new global tin benchmark

in Indonesia.


Temporary exemptions on the ban have been extended until 2017

While attempts since 1999 to establish a dynamic com-modity futures market have faced low liquidity andpatchy trading, the single most significant stimulus hascome from new government restrictions on the exportof unprocessed mineral ores since 2013. The TradeMinistry, which oversees the Commodity Futures Trad-ing Regulatory Agency (BAPPEBTI), has sought to buildIndonesia’s commodity spot-trading capacity to sup-port a ban on tin traded offshore. Although a full banon exports of unprocessed ores from January 2014onwards has been modified, providing exemptions tothose planning smelters locally, it should also driveinvestor demand for onshore commodity contracts. Asthe market deepens, with new commodity futures con-tracts planned in the year ahead, onshore contracts areset to become more liquid and the number of activetraders more diverse. As Asian platforms develop theirown pricing benchmarks for key commodities, Indone-sia will therefore be able to leverage its position as aleading producer of key commodities. EXPORT BANS: A key requirement of the 2009 Min-ing Law stipulates an increase in the local processingof mineral output and the development of onshorespot trading for such commodities. The first significantstep in this direction was enacted in August 2013 whenthe government required all tin exports to be first trad-ed through an Indonesian commodity exchange. Whilethe policy initially only covers tin ingots, it will be expand-ed to other products including solder from 2015. Indirect challenge to the dominant London MetalsExchange (LME), the tin contracts traded through theIndonesia Commodity and Derivatives Exchange (ICDX)were the only means through which tin could be secured.Although both producers and traders initially expect-ed the ban to be diluted given previous mining policyreversals, the government held steady. “We have thechance to be a price setter for tin,” Trade Minister GitaWirjawan told Reuters in December 2013. “If the ICDXsucceeds in keeping prices up, we can make it the basisfor other commodities.” The policy is also aimed at

curbing illegal mining, given the requirement of accu-rate documentation for all ores traded through ICDX,and to improve the transparency of price discovery.“With tin trading onshore there can now be more trans-parency in tin prices and in the way tin is traded,” MegainWidjaja, ICDX’s president director, told OBG. “We canalso coordinate research into pricing and evaluate theefficiency of Indonesia’s tin mining industry.”

In January 2014 the president signed new rules imple-menting the ban on exports of other unprocessed ores,requiring minerals like bauxite, nickel, tin, chromium, goldand silver to be fully refined prior to export and thoselike copper, iron ore, lead and zinc concentrates to bepurified or semi-processed. New export taxes were alsopassed to act as disincentives for semi-processed min-eral exports. While the government was required by the2009 law to enact the ban, it did move to dilute require-ments somewhat. Purity requirements of the initial tinexport ban were cut, with the minimum lead contentraised to 300 parts per million, higher than initiallyplanned. Despite the softening of the export ban, thegovernment has viewed such policies as a blueprint forother commodities, both hard and soft. PROCESSING COMMITMENTS: Temporary exemptionson the total ban on unprocessed ore exports wereextended until 2017 for 66 firms with plans to devel-op smelters locally. Given past policy reversals andexcess global smelting capacity however, miners havelagged in developing domestic smelting capacity.

“The market may have taken a complacent stand onthe law, taking a chance that it would not be imple-mented in its original writing,” Jens Nærvig Pedersenof Danske Research wrote in a January 2014 note. Withover 4000 firms holding mining licenses, many small-er producers lack the financial capacity to develop theirown smelters. Indeed, a 1m-tonne-per-year aluminiumsmelter requires a roughly $1.5bn investment, a highcommitment amidst falling commodity prices in 2014.Larger miners like Freeport McMoRan and NewmontMining, which account for 97% of Indonesia’s copper

In January 2014 the

president signed new rules

implementing a ban on

exports of unprocessed

ores, requiring minerals like

bauxite, nickel, tin,

chromium, gold and silver to

be fully refined prior to

export.

A key requirement of the

2009 Mining Law stipulates

an increase in the local

processing of mineral

output and the

development of on-shore

spot trading for such

commodities.

116

Commodities exchangeA ban on unprocessed ore exports should drive demand for onshorecontracts



output at the Grasberg and Batu Hijau mines, respec-tively, process roughly a third of their output throughIndonesia’s only copper smelter. Amongst over 100nickel miners, only Antam and Vale Indonesia processtheir ore locally. While China refined 565,000 tonnesof nickel in 2013, Indonesia refined only 16,000 of the271,000 tonnes it produced, according to ICDX.

With larger miners arguing that the production ofsemi-processed copper concentrate accounts for themajority of value-added in the copper chain, the exemp-tion of unprocessed exports until 2017 favours largerminers with local smelter plans. Smaller producers willbe expected to either upgrade their facilities or sell theirunprocessed ore to feed larger smelters. Of the 66firms licensed to continue exporting unprocessed ore,the Energy and Mineral Resources Ministry (EMRM)reported in January 2014 that 25 had almost complet-ed construction of their smelters, 10 were still in con-struction, 15 had just broken ground and 16 had sub-mitted their environmental impact assessments togovernment for approval. These smelters are predom-inantly copper and nickel processing facilities, givenIndonesia’s global production lead, while bauxite min-ers, predominantly Chinese, are developing mines inWest Africa as alternatives to Indonesia. TRADING INFRASTRUCTURE: Mineral refiners havelong sold their output through long-term supply con-tracts with end-users in the region, such as Singapore,Malaysia, China, South Korea, Taiwan and Japan, or

through global commodity exchanges in London andNew York. Although there are two commodity bench-mark exchanges in Asia – Tokyo’s rubber futures andMalaysia’s palm oil futures markets – the vast majori-ty of commodities are traded through Europe and theUS. Asian consumers have increasingly established theirown trading platforms however, with China launchingan iron ore contract through the Dalian CommodityExchange and a gold contract through the ShanghaiFutures Exchange for instance. Since 2009, Indonesiahas played host to two competing commodityexchanges: ICDX, founded by 11 gold and palm oil pro-ducers, and the older Jakarta Futures Exchange, estab-lished in 1999. Starting with gold and palm oil contracts,the two have struggled to attract significant liquidityuntil the 2013 tin ban (see analysis).TRADING TINS: After an aborted launch on ICDX in2012, the tin contract of five-tonne lot sizes of 99.9%purity was re-launched in 2013. Volumes have grownsignificantly, from a low of 795 tonnes in September2013 to 7440 tonnes in November and 8245 tonnesin December, according to Bloomberg. While this wasstill lower than the 929,105 tonnes of tin traded throughthe LME in October 2013, the rapid growth on ICDXreflected the government’s steadfastness in challeng-ing the global benchmark.

Indeed, by December ICDX had attracted 31 tintraders, including 14 buyers and 17 sellers out of atotal 47 domestic tin ingot producers. An additional 16

117

Although there are two

commodity benchmark

exchanges in Asia – Tokyo’s

rubber futures and

Malaysia’s palm oil futures

markets – the vast majority

of commodities are traded

through Europe and the US.


applications that were still under consideration byBAPPEBTI in January 2014.PRICING POWER: While the JFX had planned to launchits own tin contract, the Trade Ministry has maintainedthat contracts for a commodity would only be licensedthrough one exchange, in order to establish a singleonshore benchmark, and refused to license the JFXcontract. “It will be difficult to take a price reference ifthere are two exchanges or more that trade the samecontract,” BAPPEBTI chairman Sutriono Edi told Reutersin December 2013. “ICDX will keep trading tin becauseit has been successful.” Although 22 tin smelters hadbacked the JFX contract, they have gradually shifted totrading through ICDX – the Serumpun Tin group of 18smelters joined ICDX in October 2013 for instance.Global commodity traders are also taking note, with JPMorgan’s application for an ICDX license in late 2013lending credence to the exchange’s challenge to LME.While ICDX plans to launch tin futures contracts, JFX,for whom gold accounts for an average 60% of trad-ing, will launch new contracts of its own in an effort todrive 50% growth in turnover in 2014. The bourse isadding arabica and robusta coffee bean and rubber con-tracts from December 2013 and coal, soybeans and newgold futures in 2014 to add to its existing gold and oleincontracts. In particular, JFX hopes to leverage Indone-sia’s role as the world’s largest thermal coal producerto establish a local benchmark for coal prices. Theexchange also plans to grow the share of multilateraltrades, between numerous buyers and sellers, from6.9% in October 2013 to 30% in the next two years ina bid to boost liquidity. ICDX launched a dollar-denom-inated palm oil contract in late 2013, hoping to createan alternative benchmark to Malaysia’s ringgit-denom-inated benchmark market. While the initial focus is ontin, coal and palm oil, Indonesia hopes to expand onshorespot trading to other commodities both hard and soft.“Indonesia is one of the major producers of crude palmoil, cacao beans, rubber and coffee beans. So why don’twe set the reference prices using the exchange prices?”Deputy Trade Minister Bayu Krisnamurthi remarked at

a commodities conference in November 2013. WhileIndonesia holds pricing power in commodities like nick-el, tin, coal and potentially palm oil, its sway on morecommon ores like bauxite faces challenges from oth-er producers, particularly in West Africa. While gold andsilver are already refined locally, the ban will only affectpart of Indonesia’s coal output – that produced undermining business licenses, not contract of work.BUILDING BENCHMARKS: Confident that downstreamprocessing capacity will come online soon, authoritieshope to build local benchmarks for key commoditiesin a bid to place a floor under prices that have fallenthroughout 2013. Efforts to develop price discoverymechanisms closer to the locus of production and con-sumption in Asia are part of a broader trend, however.China alone launched futures contracts in coking andthermal coal, bitumen, iron ore, short-grain rice and eggsin 2013. While the pricing of commodities continuesin dollars, the growing role of Asian platforms in glob-al commodity markets reflects the evolution of globaltrading patterns. “Sooner or later there will be an Asiantime-zone price because it's natural, all the consumersare here,” Michael Syn, head of derivatives at SingaporeExchange, told Reuters in December 2013.

Indeed, global exchanges are following suit and driv-ing global integration of commodities markets, follow-ing the growth of trading in Asia. In November 2013,the Intercontinental Exchange Group announced its$150m takeover of Singapore Mercantile Exchange,while Hong Kong Exchanges & Clearing bought theLME for $2.2bn in 2012. In addition to this, the TokyoCommodity Exchange has been engaged in discussionswith CME Group since 2013 about the establishmentof the first global liquefied natural gas futures market.Of the utmost importance now will be for fledglingcommodity exchanges like ICDX and JFX to create the links necessary to establish a liquid benchmark.The management of Indonesia’s two exchanges haverecognised this and, aside from denominating key con-tracts in dollars, are engaged in the pursuit of partner-ships and linkages with foreign exchanges and traders.

118

ICDX launched a

dollar-denominated palm oil

contract in late 2013,

hoping to create an

alternative benchmark

to Malaysia’s

ringgit-denominated

benchmark market.

Share analysis & data provided by Bahana Securities

CAPITAL MARKETS SHARE ANALYSIS

THE COMPANY: Austindo Nusantara Jaya (ANJT), estab-lished under the name Austindo Teguhjaya in 1993,engaged in financial services, health care, agrobusinessand energy prior to 2012. In that year, ANJT restruc-tured its business to focus on palm oil and sago, as wellas engage in power generation from geothermal andbio-gas. Growth in palm oil (93% of revenue), sago,tobacco (3%) and renewable energies (4%) will be sup-ported using IPO proceeds amounting to $41m.

Owned by the Tahija family, who are well known forshareholder-friendly histories with listed Bank Niaga andPearl Energy, ANJT has solid corporate governance andno related-party transactions. Some 23 years of plan-tation experience and a conservative managementapproach have led to a total conservation area of 12,000ha. Coupled with excellent community relations, this inour view translates to a low operating risk and allowsfor sustainable growth going forward.

Currently, ANJT owns and operates four oil palm plan-tations located in North Sumatra, Belitung Island andWest Kalimantan. ANJT also has three oil palm planta-tions that remain unplanted and are situated in SouthSumatra and West Papua. Thus, ANJT’s seven oil palmplantations total 96,773 ha plantable land bank withplanted area of 40,852 ha, of which 78.2% are maturedoil palms aged more than four years, while the remain-ing 21.8% are immature and aged less than three years.DEVELOPMENT STRATEGY: With an unplanted landbank of 56,000 ha, ANJT plans to plant new palm oilestates amounting to 5400-7000 ha per annum throughto 2015. ANJT has finished land clearing and infrastruc-ture preparations in the newly acquired land bank inKalimantan as well as nursery and seedling activities.

Apart from expanding through its owned land bank,ANJ is also seeking acquisition opportunities in the sec-tor. Apart from the palm oil segment, ANJT will experi-ence strong production growth from sago and newenergy segment expansions. ANJT’s initial sago devel-opment is targeted at 15,000 ha plantation within a peri-od of five years. Following a lengthy negotiation process

since 2007 with local communities, ANJT finally receivedfull support from surrounding Papua tribes to developa sago starch industry in a sago concession area. As aresult, ANJT is now developing canals for sago log trans-portation, water supply chain networks, a sago millwith a monthly starch capacity of 3000 tonnes (expand-able to 5000), and other related infrastructures. Full-scale sago starch production will be in the region of70,000 tonnes of native starch per annum, dependingon market demand. ANJT is ready to move into down-stream processing with strategic partners.

ANJT has one of the most efficient cost structuresin the sector, at a cost of $397 per tonne, 8% lower thanthe sector average, resulting in a high EBITDA marginof 25% in 2013. This is partly due to the implementa-tion of several new technologies, initiatives and mech-anisations, allowing ANJT to operate more efficientlythan its peers, as reflected by higher employee produc-tivity of 8 ha per person (compared to the industryaverage of 5 ha per person). With ANJT increasing effi-ciencies, its future cost structure will remain manage-able in our view.FORECAST: ANJT, with a planted area of 41,000 ha,plans to expand into the sago business and biogas-basedpower plant businesses in 2014. Following the com-mencement of its Papua-based sago business, ANJTwill open palm oil plantations in Papua New Guinea. Pro-duction in 2014 should recover to 195,000 tonnes, up9% year-on-year (y-o-y), while additional contributionsfrom 6000 ha of harvested sago area and one operat-ing power plant should help support the overall top lineto reach $175m, up by 14% y-o-y. As we expect 2014earnings to recover to $37m, up 64% y-o-y, on higherproduction and lower labour cost growth, valuation iscurrently attractive on 2014 PE of 11.6x, 38% discountto its Malaysian counterparts. ANJT is one of our favouredtop small cap picks, with a target price of Rp1600($0.16), based on 2014 PE of 12.4x, translating to 32%discount to its Malaysian peers. Therefore, we expectits 15% market outperformance since its IPO to persist.

119


ANJT price & index relative performance

May-13 Jul-13 Sep-13 Dec-13

0

300

600

900

1200

1500

1800Price

0

1000

2000

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6000 IndexPrice (Rp)

12M high (Rp)

12M low (Rp)

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PERFORMANCE

MARKET RATIOS

ANJT market ratios

Data as of December 30, 2013

1M 3M 12M

Avg daily price (Rp) 1458 1328 1316

Avg daily vol (Rp bn) 0.9 0.9 1.4

Reuters code: ANJT

1490

1500

1180

5.0

Austindo Nusantara JayaAgriculture



THE COMPANY: Established in 1961, Bank Pembangu-nan Daerah Jabar Banten (BJBR) was the first districtdevelopment bank, known as Bank Karja Pembangu-nan Daerah Djawa Barat. In 1992, the bank changedits legal status to become a foreign exchange commer-cial bank, with limited scope for operations in the EastJava and Banten regions.

Following its IPO of 2.4bn new shares, which raisedapproximately Rp1.5trn ($150m) in July 2010, BJBR iscurrently owned by several local governments: the WestJava provincial government (with a 38% stake), Javaregency government (18%), Banten regency (6%), Javacity government (6%), Banten provincial government(5%) and Banten city government (2%) while the pub-lic controls the remaining 25%. The bank is currentlymonitored by five commissioners, namely Ir H Muhadi,Achmad Baraba, Klemi Subiyantoro, Yayat Sutaryat andRudhyanto Mooduto.

It is managed by a team of professionals with exten-sive experience and knowledge in the sector headedby Bien Subiantoro as the bank’s president director. BJBRhas laid its long-term strategic move from a regionalto a leading national bank. The two principal objectivesof geographical diversification are to overcome limit-ed growth opportunities in the regional market and toincrease its competitive edge amidst an intensifying busi-ness environment. The bank has diversified its geo-graphical presence by opening branches in several loca-tions outside East Java, including in Jakarta, Semarang,Surabaya, Medan and Batam over the past few years,bringing its total number of units in the third quarterof 2013 to 413 (62 branches, 304 sub-branches and47 forex branches). The bank is also well supported by152 cash offices and 106 payment points. Some 1052ATMs have been in operation on top of the 49,000“Bersama” ATMs spread across the archipelago.DEVELOPMENT STRATEGY: BJBR, the largest region-al bank by assets under our coverage, plans to focuson consumer lending, primarily in its captive civil ser-vant market. Consumer loans are backed by employee

payrolls with superior assets quality, enabling BJBR tomaintain its consumer loan gross NPL at below 50 bps.Increased competition in this segment has forced BJBRto compete in pricing in the hope of maintaining thebank’s strong presence in loans to civil servants whilecontinuing to preserve its above-average industrygrowth. In addition to consumer loans, BJBR carriesexposure in commercial, micro and mortgages, whichaltogether account for the remaining 36% of its loanportfolio mix. Unfortunately, its aggressive penetrationin the micro segment, currently only around 8% of loanportfolio, via “waroeng BJB” (small outlets) in the pastfew years has ballooned gross NPLs, which reachednearly 9.0% and resulted in the management review-ing its strategic move in boosting high-yielding loans.We believe a more prudent expansion and credit con-trol are likely to slowdown its micro loan growth ahead. FORECAST: BJBR’s margin pressure arising from com-petitive leading pricing and the higher cost of fundingwould be offset by continued growth in consumer loansand an improved credit risk profile ahead. Apart fromits competitive lending rate, increased civil servants’wages, higher credit ceiling and longer credit tenureshould allow BJBR’s consumer loans to continue grow-ing, allowing its bottom line to move at least in line withthe industry average. Expected improvement in its cred-it risk profile has resulted in limited provisioning thatwould consequently support bottom-line growth.

For the years 2014 and 2015, we project BJBR’s EPSgrowth to be 11-12%, allowing the bank to produce ROAEof around 22%. This should result in the bank’s contin-ued high dividend payout as part of its corporate div-idend policy. Note that the bank declared a 2012 DPSof Rp68 ($0.007), or equivalent to 8.2% yield.

Similarly, we would expect generous yields to mate-rialise in BJBR’s 2013 books. Concurrently, the sharesare currently trading at the undemanding 2014 P/BVof only 1.1x vis-à-vis the industry’s average valuationof 2.1x. Based on 2014 P/E, BJBR is also attractive on5.1x vis-à-vis the industry’s average valuation of 10.1x.

120

BJBR price & index relative performance

Dec-12 Apr-13 Aug-13 Dec-13

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BJBR market ratios


1M 3M 12M



Reuters code: BJBR

890

1300

740

8.6

BJBR


Banking



THE COMPANY: Established over 60 years ago, Garu-da Indonesia (GIAA) is the country’s first carrier andthe only premium airline serving the local market, withan extensive network including 22% of domestic mar-ket share and 38% market share in cargo.

On the international front, GIAA is also a marketleader with a market share of 15.5% for departingflights. GIAA was in charge of operations for 131 air-crafts as of the end of September 2013. GIAA has anintegrated business with four subsidiaries: Aero Wisa-ta (travel, transportation and catering), GMF Aero Asia(maintenance), Gapura Angkasa (ground handling),Abacus Distribution systems (computer reservationprovider), and Aero Systems Indonesia (IT provider andsolutions). These companies have paved the way forGIAA to build a strong brand and cater to its customers.In 2005, the management team undertook a compre-hensive debt restructuring programme, paving the wayfor GIAA to go public in early 2011.DEVELOPMENT STRATEGY: To maintain their marketshare from Lion Air as well as other airlines, and at thesame time cater to Indonesia’s expanding middle-classincome earners, GIAA established Citilink, its low-costcarrier (LCC) subsidiary, in 2001. Although currentlystill losing money, Citilink is expected to be profitablein 2014, helped by the government’s plan to increasethe ticket ceiling price for LCCs and a positive spillovereffect from GIAA’s passengers as load factor increas-es. Additionally, Citilink’s plan to expand within theregion as a whole by flying to Singapore, Malaysia andThailand, an expected stronger IDR and subdued fuelprices should all assist future performance. Going into2014, GIAA will expand its routes to the eastern partof Indonesia with the help of Bombardier CRJ 1000and ATR turbo prop aircraft. Therefore, as part of theirrejuvenation plan, GIAA will also add Boeing 777-300ER, which have first-class seatings, and also Airbus 330-200 and 330-300. On the LCC front, Citilink will add Air-bus 320-200 to their fleet. This will result in GIAA’s fleetaverage age to decline to five years in 2015, from 12

years in 2008, allowing for a greater competitive edge.GIAA is also likely to benefit from increased domesticflights on the back of political campaigning in 2014across the archipelago. This should help offset highcosts due to their rapid fleet expansions. On the inter-national front, GIAA is expanding routes with codesharing agreements with other international airlines toincrease penetration into Europe and the Middle East,while joining the Skyteam Alliance will help in provid-ing travel access to routes currently unserved. In an effortto further penetrate the overseas markets, GIAA willalso fly the Jakarta-London route in the second quar-ter of 2014 and increase route frequencies to Australiaand the Middle East. The GIAA has also signed an agree-ment with Aeromexico to tap the Latin American routes.

In line with the company’s rejuvenation plan, GIAAhas cooperated with two major flight schools in Indone-sia (BIFA and Curug Flight School) to provide themfuture pilot requirements. With new fleets and routeexpansions, GIAA is estimated to require 200-250 pilotsper annum. With the help of their own internal train-ing facility, GIAA will have no problem securing therequired cabin crews of 800-1000 per annum.FORECAST: Continued fleet rejuvenation and routeexpansions helped by code sharing agreements shouldresult in a 2012-15F EPS CAGR of 13% and Indonesianpassenger five-year CAGR of 17.5%, higher than theworld growth at 4.7% and Singapore’s 7.4%, which willbe supported by domestic flights. This is likely to sup-port demand growth going forward, facilitated by expan-sions of major airports and new terminals in five majorcities under Angkasa Pura I and II from 2013 to 2016.

On the capacity front, GIAA is planning to add 32 fur-ther aircraft up to 2014, with a total of 163 aircraft andcreating a higher ASK of 49,318 and RPK of 37,728. GIAAis trading on an attractive 2014F adj. EV/EBITDAR of6.2x, at around 30% discount to its regional peers. OurRp750 ($0.075) target price, reflecting a 50% upsidepotential from the current level, is based on a 2014FEV/EBITDAR of 6.9x, a 25% discount to the region.

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Garuda IndonesiaTransport



THE COMPANY: Established in 1997, Malindo Feedmill(MAIN), which is involved in the production and distri-bution of poultry feed, has become a rising star with-in the growing poultry sector due to a low penetrationrate. MAIN was formerly known as Gymtech FeedmillIndonesia, a subsidiary of two listed Malaysian compa-nies, Leong Hup Holdings Berhad and Emivest Berhad.In 2000, MAIN acquired a feed mill processing plant withan installed capacity of 150m tonnes per annum (tpa)from Subur Group and changed its name to MalindoFeedmill. To add production capacity, MAIN continuedto acquire more facilities and eventually gained suffi-cient size to list on the Indonesian Stock Exchange(IDX) in 2006. MAIN is Indonesia’s third-largest poultrycompany both in terms of size and market capitalisa-tion. Its business divisions include poultry feed (9M13:70% of revenues; 8% market share), day-old chicks(DOC, 19% of revenues; 9% market share), broiler chick-en (8%), processed chicken and others (duck breedingand aquaculture, 3%). In 2010, MAIN added one feedmill with a capacity of 450,000 tpa, two DOC farms witha total capacity of 15m chickens per annum, and onefarm GPS with a capacity of 720,000 PS. The companyhas a feed mill capacity of 900,000 tpa, DOC capacityof 181.8m per annum, broiler chicken capacity of 19.4mtpa, and processed food capacity of 9000 tpa.DEVELOPMENT STRATEGY: In 2013, MAIN commencedfood processing under the brand “Sunny Gold” chick-en nuggets and sausages, with a capacity of 9000 tpa.In 2013, the division, having only produced around 500tpa, was still making a loss due to its lack of economiesof scale. In 2014, we expect processed food produc-tion will be increased to around 1500-2000 tpa, beforejumping to 3500-4000 tpa, allowing the division togenerate profit. The management has been proactivein cutting marketing expenses by promoting its prod-ucts through direct marketing and traditional markets(65%). MAIN also supplies chicken nuggets to the likesof 7-Eleven and Lawson. Leading up to the elections in2014, we believe chicken consumption will increase as

most of the political parties have the tendency to pro-vide meals with chicken for campaign attendees.

To anticipate the increase in consumption, MAINplans to raise its feed mill capacity by 420,000 tpa to1.32m tpa by 2014, expanding their feed mill in Makas-sar by 240,000 tpa and Central Java by 180,000 tpa. MAINalso plans to increase their breeder farm capacity by15m-30m DOC per annum and set aside aroundRp100bn ($10m) for the purpose of capex expansion.As we estimate the prices of DOC (4Q13 average:Rp3900, $0.39, up 85% year-on-year), broiler chicken(4Q13 average: Rp18,300, $1.83, up 24% y-o-y) and feed(up 20% y-o-y) to remain strong in 2014, MAIN shouldsee operating support going forward.FORECAST: Driven by Indonesia’s low per capita chick-en consumption compared to neighbouring countries,there is a huge potential consumption which will sup-port MAIN’s long-term promising growth. On a per capi-ta basis Indonesians only consume 7 kg of chicken perannum, which represents only one-fifth of Malaysia’s37 kg of chicken per annum, whose income per capi-ta is twice the size of Indonesia’s. The Indonesian andMalaysian populations are mainly Muslim and do notconsume pork, pointing to greater consumption ofchicken as income per capita rises further.

As for costs, decreasing soybean oil and corn priceshave supported poultry players’ gross margins to remainattractive. Currency depreciation has recorded a largeforex loss (Rp150bn, $15m) in 2013 for Malindo as thecompany still imports all of its raw materials. MAINshould record negative earnings growth (-9% y-o-y) in2013, although the company’s top line growth remainspositive (+24% y-o-y). To anticipate forex fluctuations,MAIN plans to hedge their short-term loans ($22.3mas of September 2013, around 70% short-term borrow-ings). On valuation, however, MAIN remains attractiveon 2014 P/E of 12.6x given rapid growth, rupiah appre-ciation and also stable commodity prices. Therefore, atour target price of Rp4200 ($0.42), MAIN would tradeat 15.6x P/E, still some 10% discount to the sector.

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Malindo FeedmillPoultry




THE COMPANY: Indonesia’s largest integrated textilesmanufacturer, Sri Rejeki Isman (SRIL), popularly knownas “Sritex”, is currently enjoying the benefit of demanddisplacement from China as companies relocate toSouth-east Asia due to cheaper labour costs. Theupstream segment of spinning and weaving operatedby SRIL is more capital-intensive compared to the com-pany’s downstream segment (printing and garments),which has the propensity to be more labour-intensive.SRIL is predominantly an export-based company(around 60% of its revenues are to the overseas mar-kets) with South Korea, China and the US as the com-pany’s largest export destinations.

SRIL is globally competitive as it can secure DeutschePost DHL procurement through world bidding. Addi-tionally, SRIL is the only company outside of Europethat has obtained certification from the German armyprocurement department. We note that SRIL is wellknown for its high-tech military uniform productioncapability with orders from various countries thatrequire immediate production and delivery. Apart fromthe German military (since 1994), SRIL also has long-term and notable overseas clients, who depend onSRIL’s quality consistency and timely delivery. New cus-tomers include Uniqlo in 2013, when SRIL managedto obtain an order of $25m. By 2015, Uniqlo’s ordercould reach $100m-150m, or up to 46% of SRIL’s 2013top line, providing rapid growth ahead. On the localfront, SRIL should benefit from added military uni-form orders on improved government policy. DEVELOPMENT STRATEGY: In 2013-15, faster thanexpected growth should materialise from SRIL’sRp723bn ($72.3m) purchase of Sinar Pantja Djaja(SPD), an affiliated spinning company. Priced at 10times the 2014 PE, the SPD acquisition should seeenhanced earnings. This should expand spinning capac-ity by 210,000 spindles to 530,000. An acquisition ismore efficient than via a greenfield investment (at thecost of $800 per spindle), and allows SRIL to fast trackits expansion plans. SRIL has allocated $15m from its

IPO proceeds to double garment capacity by the firsthalf of 2014 from 8m pieces per annum to 16m, toproduce both fashion and army uniforms. Domestical-ly, army uniforms (100% of orders to SRIL) should beboosted by government plans to increase soldiers’quota from one uniform to two uniforms per annum,starting as early as 2014. We expect total garmentcapacity to reach 24m pieces by the end of 2015. Tofacilitate this process, SRIL plans to add more weav-ing and dyeing printing machines, to be operationalin 2015, costing $200m with the source of funding tocome from either bank loans or a rights issue at thestart of the project. SRIL expects to maintain net gear-ing at a maximum of 50% (9M13: 44%). Helped by itslong track record and experience in the industry, SRILis confident it has the expertise to run all of the newcapacities coming on stream as efficiently as possible.On its overseas sales, SRIL is seeing strong demandfor fashion garments on companies relocating awayfrom China and the global economic recovery.

In 2014, SRIL plans to expand its export markets,and we expect 2014F overseas revenue to contribute58.5% of total revenues. Given high-dollar incomesfrom exports, SRIL will emerge relatively unscathed inspite of the recent IDR depreciation adversely impact-ing the company’s predominantly dollar-based costs(some 80% of COGS are dollar-linked). FORECAST: We expect SRIL to record net revenue andnet profit of Rp4.8trn ($480m) and Rp467bn ($46.7m),respectively. This would pave the way for top and bot-tom line CAGR of 27.6% and 42.5%, respectively, in the2011A-2014F period.

On valuation, the stock currently trades on 2014 PEof 9.8x, 18% discount to the market. Our target priceof Rp310 ($0.03), with 27% upside potential, is basedon re-rating to average regional peers’ 2014 PE of 12xon the back of the company’s rapid growth ahead. Itis also worth noting that the management has men-tioned its intention to distribute interim dividends inthe first half of 2014, subject to shareholders’ approval.

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SRIL price & index relative performance

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Sri Rejeki IsmanTextiles



THE COMPANY: Total Bangun Persada (TOTL), one oftwo listed construction companies not owned by thestate, focuses on high-rise buildings for residential,office and commercial projects. Established in 1970,the company was listed on the IDX in July 2006, beforebeing included in the MSCI Indonesia Index in May2013. TOTL has built some prestigious buildings inIndonesia, including Bank Mega Tower, Trans TV, TheRegatta Apartment and The Pakubuwono Residences.As of September 2013, the company’s revenues main-ly stemmed from projects in Java and Bali (76%), fol-lowed by undertakings in Kalimantan and Sumatra (10%and 9%, respectively), with high-rise residential as thelargest revenue contributor (27%), followed by shop-ping centres (23%). Following TOTL’s entry into theproperty market through the creation of Total Persa-da Development (TPD), the firm has now establishedTotal Persada Indonesia (TPI), which deals in engineer-ing, procurement and construction (EPC) work, focus-ing on civil work in industrial building for oil and gas.Currently, TPI is working on Indocorsa, a tyre-makingplant, while TPD is finishing the GKM Tower develop-ment, a “green” office building in South Jakarta, con-sisting of 22 floors and three basements with land areaof approximately 5000 sq metres, building area of28,000 sq metres (with 14,900 sq metres for sale). Themanagement expects this development to be com-pleted by March 2014. TPD is also developing a con-dominium hotel in Tanjung Benoa, Bali, with expectedcompletion in March 2014. Despite this diversification,the construction segment continues to represent thelion’s share (85%) of TOTL’s revenues.DEVELOPMENT STRATEGY: Even with the slower eco-nomic growth expected in 2014, we believe TOTL willstill be able to increase new contracts, helped by high-quality products and timely product deliveries, whichrelate to high client satisfaction (repeat orders accountfor 75% of projects). This would not only allow for addi-tional repeat orders, it also would allow TOTL to con-tinue with current project developments without delays.

Going into 2014, the company’s top line should be sup-ported by revenues from new projects in 2013 (suchas Binus Alam Sutera, Menara BRI BSD, Neo SimatupangHotel). On the cost side, development of higher-endprestigious projects in Bali such as Ramada SakalaSuites & Condotel in Tanjung Benoa, Marriot Hotel inSeminyak and Holiday Inn in Tanjung Benoa, shouldensure gross profit margins in excess of 10%. To sup-port its performance growth, TOTL is participating intenders of office buildings amounting to Rp5trn($500m) and to be announced in early 2014, high-riseresidential Rp50bn ($5m), malls Rp300bn ($30m) andhotels Rp250bn ($25m). Related to the continuingdepreciation of the rupiah against the dollar, the man-agement of TOTL has stated that in 2014 the compa-ny will implement new contracts and will also createdollar contracts when the project’s construction mate-rials are mostly imported.FORECAST: On the balance sheet front, we believeTOTL’s net cash will not only support the company’sfuture expansion plans but also provide protection inthe event of possible liquidity crunch ahead. Prudentcash management implementation also supports TOTL’soperations. Its direct contract scheme translates intominimal inventory, allowing for lighter working capitalrequirements. The company only allocates 2014F capexrange of Rp20bn-25bn ($2m-2.5m). This will supportgrowth and allow TOTL to book revenue and net prof-it CAGR of 16.4% and 18.9%, respectively, in 2011A-2014F period. On valuation, TOTL trades on 2014 PE of8.1x, one of the most attractive contractors under ourcoverage, particularly as recent share price correctionprovides limited downside from current levels.

The dividend policy is attractive, with a payout ratioof 40% for net profit of between Rp50bn ($5m) andRp200bn ($20m), and 50% for net earnings aboveRp200bn ($20m). At our target price of Rp750 ($0.075),reflecting 50% upside potential, TOTL would still tradeat undemanding 2014F PE of 12x, more than 40% discount to the average regional construction peers.

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Total Bangun PersadaConstruction


125

InsuranceStarting from a small base, various segments on the riseFDI flows lead to market consolidation and competitionRegulator to institutionalise reporting requirementsGrowth in takaful market with the rise in underwritersNew health programmes to increase general coverage

INSURANCE OVERVIEW

Motor and property dominate the property and casualty segment

While still small compared to its potential, Indonesia’sinsurance market is attracting global underwriters andreinsurers. Only 6% the size of China’s market, accord-ing to SwissRe – at roughly Rp147trn ($14.7bn) in com-bined life and non-life premiums in 2012 – Indonesia’smarket has sustained annual growth of over 20% in pre-miums and 26% in assets over the past five years,according to the Jakarta-based credit rating agencyPefindo. Yet with penetration of only around 1.3% forlife and 0.47% for non-life in 2012 – according to theLife Insurance Association of Indonesia (AAJI) and theGeneral Insurance Association of Indonesia (AAUI),respectively – growth prospects are significant. Theglobal averages are 2.8% for life and 3.8% for non-life,according to accountancy Deloitte.SMALL BUT GROWING: The life segment, making uproughly two-thirds of premiums in 2012, is the mar-ket’s key growth driver with annual expansion of 25.6%in the decade to 2012, according to Japanese life insur-er Dai-ichi Life. Growth was sustained into the first halfof 2013 when combined life premiums and investmentincome rose 22.8% year-on-year (y-o-y) to Rp71.83trn($7.2bn), according to AAJI, while premiums alonereached Rp57.6trn ($5.76bn) in the first half of theyear, or 14.5% y-o-y growth. This makes Indonesia theworld’s 30th-largest life market and Asia’s eighth, exclud-ing Japan, according to Credit Suisse. Annual growth innon-life at the same time averaged 14.7%, rising 14.3%y-o-y in 2012 alone to Rp39.41trn ($3.9bn), accordingto insurance rating agency AMBest. Buoyed by risingcapital markets returns, investment-linked (unit-linked)policies account for nearly 60% of life premiums, withendowment policies contributing an additional 27%,according to Credit Suisse. The prevalence of unit-linked policies, mostly single-premium products, helpedshift investment risk to policyholders. “Unit-linked poli-cies have been the best selling over the past five to sev-en years, which minimises underwriters’ asset-liabilitymismatches,” Luc St-Amour, Sun Life Financial Indone-sia’s chief actuary, told OBG. “Yet Indonesians tend to

use cash in unit-linked policies as short-term invest-ment vehicles in a downturn, which is peculiar giventhe long-term nature of these for insurance products.”NEW GROWTH: While motor and property lines stilldominate the property and casualty (P&C) segment,accounting for 29.7% and 27.8% of premiums and grow-ing 13.3% y-o-y and 12.3% y-o-y in 2012, respectively,according to AAUI, growth drivers lay in smaller linesin 2012. For example, personal accident (PA) and healthgross premiums grew 33.4% y-o-y in 2012, followed bycredit insurance at 28.2% and marine hull at 25.8%.

While both life and P&C underwriters can competeon PA and health lines, health riders are dominated bylife insurers. The absence of compulsory third-partyliability insurance for drivers has limited the size of themotor segment to around half that in peer countries.“One of the main hindrances to growing the generalinsurance business is that the government has beenslow to make motor insurance compulsory for drivers,”Arizal ER, the president director of Asuransi Rama, toldOBG. State-owned Jasa Raharja runs a limited schemethat levies part of the motor registration fees and cov-ers third-party bodily damage, but proposals to start acompulsory commercial scheme have repeatedly beendelayed. Yet more new vehicle sales have sustaineddouble-digit growth in motor premiums. “Despite BankIndonesia’s (BI) higher down-payment requirementsfor vehicle financing since 2012, we have not seen aslump in car sales and expect recent motor premiumgrowth to be sustained in 2013,” Julian Noor, AAUI’s exec-utive secretary, told OBG. STILL FRAGMENTED: With 81 licensed P&C underwrit-ers and 46 life insurers by end-2012, the market remainshighly fragmented for its size. Despite the many play-ers, both markets are dominated by a handful: the topfive life insurers held 45% of in-force premiums in 2011,according to Credit Suisse, while the top five P&C under-writers held 39.5% of premiums, down only slightlyfrom their 41.5% share in 2009, according to AAUI. For-eign investors are allowed to hold up to 80% of an

Rising disposable incomes,

consumption growth and

sustained investment are

key factors in the sector’s

recent expansion and

future potential growth.

The life segment, which

comprised roughly

two-thirds of premiums in

2012, is the market’s key

growth driver. The segment

has seen annual expansion

of 25.6% in the decade to

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126

Growth modeNew opportunities and rising demand lead to sector expansion


INSURANCE OVERVIEW

underwriter in Indonesia, but in practice they can exceedthis by injecting additional equity and diluting the localpartner’s stake. Foreign players’ influence in the life seg-ment is more extensive than in P&C, with the foreign-controlled share of the life segment reaching 63.6% in2011, far higher than their combined 4.4% in China,according to SwissRe. Foreign insurers make up less than30% of non-life premiums, according to the reinsurer’sestimates. Four of the top five life insurers are foreignjoint ventures (JVs), listed in order of premium value:Prudential, AXA Mandiri, Allianz Life and AIA. In con-trast, all of the top five in non-life – Sinarmas, state-owned Jasa Indonesia, Astra Buana, Central Asia and TuguPratama (which is 65%-owned by state-owned Perta-mina) – are locally owned and linked to either banks,the state or major vehicle distributors. FOREIGN IMPACT: Although the number of playershas not fallen significantly, over the past three yearsforeign direct investment (FDI) has driven a wave ofmergers and acquisitions (M&A), likely to affect thepace of competition. Japanese investors have drivenmany acquisitions, taking advantage of their strongcurrency and high capital bases to buy into the Indone-sian growth story. Mitsui Sumitomo’s MSIG bought a50% stake in Sinarmas Life for $827m in April 2011;Mitsubishi’s Tokio Marine bought an 80% stake inMalaysian-owned MAA Life for $9.8m in March 2012,renaming it Tokio Marine Life; and Meiji Yasuda Life raisedits stake in Avrist from 5% to 23% for $100.3m in May2012. In June 2013 Dai-ichi Life bought a 40% stake inPanin Life for $340m and a 15-year bancassuranceagreement with Panin Bank, with integration expect-ed by December 2013. In P&C, NKSJ Holdings’ Nip-ponkoa Insurance bought Bank Permata’s 31% stake inAsuransi Permata Nipponkoato, raising its stake to 80%,in January 2011 for Rp63.47bn ($6.35m). NKSJ alsoholds an 80% stake in Sompo Japan Indonesia and hasannounced plans to merge the two eventually.

South Korea’s Hanwha Life acquired mid-sized Mul-ticor Life for $13m in October 2012, while Singapore’sUOB sold its life subsidiary to local investment firmBakhti Capital in October 2010 for an undisclosed val-ue. Western investors have also been active, withSwitzerland’s Zurich Life acquiring Mayapada Insur-ance (renamed Zurich Topas Life) and the UK’s Avivabuying Winthertur Life, both in 2010. In non-life, MandiriAXA Life acquired non-life Asuransi Dharma Bangsa for

Rp60bn ($6m), rebranding it Mandiri AXA, in May 2011.SHC Capital of Singapore bought 55% of non-life insur-er Parolamas in December 2011, followed by Switzer-land’s Zuellig Group’s acquisition of 80% in AsuransiIndrapura, a small insurer, in June 2012. The largestnon-life buy-out followed the same month when USinsurer ACE bought 80% of Jaya Proteksi, the ninth-largest non-life insurer, for $130m. PREFERENCE: Foreign investors’ strategies have clear-ly prioritised underwriters owned by banks and withstrong bancassurance channels as acquisition targets.With most major banks tied up in exclusive 10-to-15-year bancassurance deals, the appeal of bank-relatedinsurers far outweighs standalone underwriters. Thismakes the three planned life insurer sales all the moreappealing. Despite delays, in July 2013 Bank NegaraIndonesia (BNI) reiterated its aim to sell up to 40% ofits life subsidiary for as much as $500m alongside anexclusive bancassurance deal of up to 20 years. Althoughsuch valuations may prove prohibitive, Nippon Life, theonly major Japanese life insurer not present in Indone-sia, has shown general interest. Meanwhile, Malaysia’sCIMB Bank announced its intention of selling its 51%stake in its JV with Sun Life for up to $200m, while Sin-armas and CT Corp’s Bank Mega announced plans tosell an unspecified stake in their JV Mega Life to a for-eign partner – both announced in September 2013. PROFITABLE: Both segments have recorded strongprofit growth on the back of high operational marginsand investment income driven by rising valuations onboth fixed-income and equity markets. Life insurersare more exposed to fixed-income markets with some80% of assets invested in government securities andaround 5-10% in corporate paper, while P&C insurershave a higher exposure to equities and shorter-termtime deposits, which account for up to 60% of invest-ments. Life insurers, the third-largest holders of local-currency government bonds, near-doubled their shareof outstanding bonds from 8.1% in 2005 to 14% byMarch 2013, according to the Asian Development Bank.

127


Life premiums reached $5.76bn in the first half of 2013, a rise of 14.5% year-on-year

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and acquisitions that can

be expected to increase

competition.

SOURCE: AAJI

Prudential 25.0

AXA Mandiri 14.1

Sinarmas Life 6.2

Allianz Life 6.1

AIA Financial 5.3

Inhealth 5.1

Jiwasraya 4.8

Manulife 4.4

Bumiputera 1912 2.7

Cigna 2.7

Top life insurers by market share, H1 2012 (%)

INSURANCE OVERVIEW

NOT ALL LOST: Meanwhile, unit-linked sales have driv-en profitability. “Conservatively, margins of 30-40% onregular premium unit-linked policies are not surprising.Of course the margin depends on the risk discount rateused by the companies,” Indra Tan, senior vice-presi-dent of corporate planning and risk management atTokio Marine Life, told OBG. Both segments maintainmanageable loss ratios of 43.9% in non-life and 48.1%in life, although claims rose 16% and 34% y-o-y in 2012,respectively, according to the AAUI and AAJI. Despitesome Rp32trn ($3.2bn) in losses following Jakarta floodsin early 2013, Fitch estimates insured losses remaineda much lower Rp3trn ($300m). While this may causean uptick in 2013 claims, the rating agency expects P&Closs ratio growth in 2013 to remain limited.

The 78 reporting P&C insurers recorded 21.9% y-o-y profit growth in 2012 to Rp4.8trn ($480m), accord-ing to AAUI, driven by a 76% rise in operating marginsto Rp1.8trn ($180m) and 10.4% growth in investmentreturns to Rp3.28trn ($328m). New life premiums, whichaccounted for 70% of total premiums in 2012, grew11.3% y-o-y, while investments by life insurers grew15%. Aggregate figures obscure significant differencesbetween JVs and locally-owned life insurers, however.According to data from AIG, JVs’ revenue has grown 24%on average in five years to end-2012 compared to a mere8% for local underwriters, while profit margins havegrown from 4% to 8% for the former compared to a dropfrom 4% to 1.7% for the latter.

The profitability of smaller JVs in the P&C segmentreflects higher offshore reinsurance cessions, provid-ing some scope for transfer pricing of profits to tax-efficient offshore centres like Singapore, Bermuda andMalaysia’s Labuan. “The insurance sector’s risk reten-tion has not grown as fast as the industry’s capitalisa-tion in recent years, a phenomenon the regulator is try-ing to understand,” AAUI’s Noor told OBG. “Over half ofthis deficit is linked to oil and gas insurance.”REINSURANCE: Despite the presence of four localreinsurers, domestic capacity remains limited. The 1992

Insurance Law requires underwriters to retain at least10% of risk on their balance sheets and to cede 10%to local reinsurers. Three of these are part state-owned:Tugu Reasuransi Indonesia (TuguRe), backed by state-linked Pertamina-owned Tugu Group; Reasuransi Nasion-al Indonesia (NasRe), backed by state-owned small andmedium-sized enterprise (SME) insurer Askrindo; andReasuransi Internasional Indonesia (ReIndo), owneddirectly by the Ministry of State-Owned Enterprises. Thefourth, oldest and only publicly listed reinsurer is Maska-pai Reasuransi Indonesia (Marein), backed by foreignbanks like UBS, ABN AMRO and RBS Coutts.

The largest reinsurer, with close to 50% of the mar-ket, is ReIndo. TuguRe and NasRe account for slightlyabove 20% of the market while MareIndo is the small-est, with below 10% of domestically reinsured premi-ums in 2010. The agency estimates that some 90% ofdomestic reinsured risk is non-life, mainly in smaller lineslike marine, motor and liability risks. While all four haveraised capital above the new mandatory floor ofRp150bn ($15m) by end-2012, their combined Rp600bn($60m) would cover roughly two months’ working cap-ital at Indonesia’s largest mine, Freeport-McMoRan’sGrasberg, in Papua. The Finance Ministry has also estab-lished several insurance pools for earthquakes (run byMaipak), terrorism, domestic shipping and traditionalmarkets, which helps expand capacity. OFFSHORE: Offshore cession for non-life risk was 53%of premiums in 2012, according to Singapore’s AsiaCapital Re (ACR). Simpler risks like residential proper-ty are reinsured locally, but the lion’s share of complexrisks are ceded offshore. “For complicated risks like oiland gas, only around 5% is kept onshore,” Mira Sih’hati,director at Marsh Indonesia, told OBG. Some 25 rein-surance brokers were licensed as of 2012, but largerglobal brokers like AON Benfield, WillisRe and Howdendominate alongside smaller local reinsurance brokerslike IBS and TalaRe. With most risk ceded offshore isplaced on a facultative basis rather than annual treaties,the market remains fluid. AMBest estimates facultativereinsurance was 72.5% of offshore-ceded risk in 2011.

New rules from the regulator requiring underwrit-ers with proportional reinsurance treaties to secure

128

Risks for residential property are insured locally, but the majority of complex risks are ceded offshore

In the life segment,

revenue for JV underwriters

grew some 24% in 2007-12,

while local players saw only

8% growth. Profit margins

grew from 4% to 8% for JVs,

while dropping from 4% to

1.7% for the local actors.


SOURCE: AUUI

2011 2012 % change

Gross premiums 34.48 39.41 14.3%

Gross claims 12.96 17.80 37.4%

Net premiums 16.90 19.61 16.0%

Net claims 8.92 10.71 20.0%

Reinsured premiums 15.52 17.33 11.7%

Reinsured claims 5.21 8.80 68.9%

Total costs 5.0 5.58 11.7%

Operational result 1.03 1.80 75.3%

Investment income 39.21 47.10 20.1%

Non-investment income 30.69 33.95 10.6%

Assets 69.95 81.16 16.0%

Profit before tax 4.55 5.54 21.8%

Profit after tax 3.94 4.80 21.9%

Non-life insurance indicators, 2011-12 (Rp trn)

INSURANCE OVERVIEW

natural catastrophe excess-of-loss programmes from2013 will further stimulate demand for reinsurancecapacity. While major reinsurers like SwissRe, MunichRe,ACE’s TempestRe and the London Lloyd’s market havetraditionally attracted the lion’s share of risk, Singaporehas gained market share in recent years. Lloyd’s Asianplatform in Singapore now hosts 21 syndicates, whilemajor regional reinsurers like ACR and BestRe haveexpanded their share of Indonesian business. Thoughglobal reinsurers can attract complex corporate busi-ness from regional offices in Singapore, the world’stwo largest reinsurers, MunichRe and SwissRe, plan toincorporate locally in 2014. This will allow both to cap-ture more retail lines, where premium growth has beenstrongest, starting with life before expanding to P&C. BAPEPAM-LK TO OJK: Authorities are in the midst ofimplementing far-reaching regulatory reforms aimedat placing the sector on a sound footing for long-termgrowth. Similar to the oversight of other non-bankfinancial institutions, regulation of the insurance indus-try was detached from the Ministry of Finance, whichoversaw the previous regulator, the Capital Market andFinancial Institution Supervisory Agency (Bapepam-LK). Since January 2013 a new independent regulator,the Financial Services Authority (OJK), was given juris-diction over insurance and capital markets, before gain-ing oversight over bank supervision from January 2014.While the OJK will be funded from the government’sbudget for the first several years, the authority is prepar-ing plans to levy a charge (at 0.03% of assets) on insur-ance companies as a means of funding. Its budget isset to double to Rp2.4trn ($240m) in 2014 when itassumes BI’s regulatory role, and it recruited 500 newstaff in 2013 to fulfil its existing role. MACRO-PRUDENTIAL: This comes at a key time forregulation. Indonesia moved to a risk-based capital(RBC) framework with minimum capital levels based ontypes of risk in 2005, but has only required underwrit-ers to hold 120% of risk-weighted capital from 2012.The industry has been required to file reports compli-ant with international finance standards since the thirdquarter of 2012. Life insurers must now segregate theirreporting of investment returns from premiums, a sig-nificant change to their reporting of liabilities for thedominant investment-linked products particularly. Italso requires insurers to mark their securities holdings

to market rather than pricing them at maturity, whichcan alter their reported asset positions significantly –particularly for life insurers holding long-tenor bonds.“While the marking of assets to market and the seg-mentation of unit-linked from premiums, the move togross premium valuation on the liability side did not havea great impact when implemented. The mark-to-mar-ket caused some stress on RBC ratios once interestrates started to rise from June,” St-Amour told OBG.

Although a grace period was reportedly extended tomid-sized life insurers, the impact on reported incomeand assets may be significant. OJK withdrew severallicenses from smaller underwriters in 2012, but the high-est-profile case involved withdrawal of Malaysia’s MAA,a non-life insurer, in mid-2013.

The underwriter has also offered policyholders a 60%haircut on their policies, but the case has been trans-ferred to intra-government negotiations. In October2013 OJK gave life insurer AJB Bumiputera 1912 threeyears to raise its solvency to above RBC standards,threatening to restructure it from a mutual company toa limited liability company (LLC) and risk bankruptcy ifit fails to do so. Bakrie Life, while technically in breachof RBC rules, has so far been able to retain its licence,although it is now barred from writing new business.

129

New rules for underwriters should stimulate demand for reinsurance

In January 2013 oversight

of the insurance sector was

handed over to a new,

independent regulator, the

Financial Services

Authority, which will work

to help institute new

regulations for the market.

INSURANCE OVERVIEW

FURTHER REQUIREMENTS: Meanwhile, the regulatorstands mid-way in hiking the industry’s capital require-ments. Having raised the floor for underwriters fromRp50bn ($5m) to Rp70bn ($7m) and from Rp100bn($10m) to Rp150bn ($15m) for reinsurers by end-2012,OJK intends to enforce a higher Rp100bn ($10m) forunderwriters and Rp200bn ($20m) for reinsurers by end-2014. While some grace period may be afforded tosmaller underwriters, the move will prompt mid-sizedunderwriters to seek equity injections or M&A oppor-tunities. “If smaller insurance companies cannot com-ply with capital requirements then they shouldn’t becompeting. Proper enforcement of such requirementsis key in helping the insurance sector narrow the devel-opmental gap with the banking sector,” said FadjarGunawan, the president director of Panin Life.

A number of other new rules have been issued, includ-ing new “know your customer” guidelines in 2012requiring higher due diligence standards from under-writers, and a new consumer protection rule in July2013 requiring more transparency in explaining con-tracts and fees, protecting consumer data and insti-tuting a new complaints and dispute resolution mech-anism through OJK. The authority is also seeking totrain 1000 new actuaries in three years in collabora-tion with universities, to fill the gap in actuaries need-ed for RBC reporting. NEW ACT: More far-reaching changes are pending withthe passage of a new Insurance Business Act, whichwould replace the 1992 law, including new requirementsfor sharia-compliant insurance underwriting and oth-er reforms. The most contentious political issue is a pro-posal to reduce the FDI ceiling in the insurance sector,although it is unlikely to be retroactively applied ifenacted. Another item of discord is the proposal torequire all underwriters, including mutual company andcooperative structures presently allowed, to incorpo-rate as limited liability companies. The new regulatoris also implementing new rules on product pricing forP&C policies, focusing on the property class in partic-ular. OJK will establish a new rating and statistics agencyin 2014 to set price benchmarks for fire insurance. Thisis likely to contain any deterioration in property premi-um growth as a result of lower house sales in 2013.

“While we expect a slowdown in property premiumgrowth in 2013 due to tighter mortgage origination,

this will likely be offset by higher premium levels driv-en by more realistic pricing of risks and thus lower lossratios,” Noor told OBG. Meanwhile, the association hasissued standard motor and earthquake policies toattempt standardisation of policy pricing across under-writers, though adoption remains voluntary. MULTI-CHANNEL MIX: Regulations updating the 1992Act are needed given the shift in distribution channelsin the past five years. The share of agents and brokers,traditionally dominant distribution channels, has fall-en as banks have grown their share of new premiumssince first introducing such products in the late 1990s.This trend is particularly pronounced in the life segment,where bancassurance’s share of premiums overtook thatof agents in 2012 for the first time. Growth in bancas-surance life premiums averaged 38% in the three yearsto 2010, according to Ernst & Young, outpacing the 13%growth via other channels. By 2012 the bancassur-ance channel accounted for 41.5% of life premiums,up from 25% in 2007, and 12.5% of non-life premiums,according to market research firm Finaccord. The shareof investment-linked sales via banks, however, is high-er, at above 50%. Bancassurance deals come in bothexclusive and non-exclusive forms, though a majorityof major banks are now tied up in 10- to 15-year agree-ments, reflecting intense competition for such deals.

AXA Mandiri’s life underwriter commands the high-est share of bancassurance sales, followed by Manulifeand AIA. While AIA works through three bank partners,the other two have locked in exclusive partnerships.Manulife partnered with Bank Danamon in July 2012,following the expiry of Danamon’s 10-year deal withAllianz, which maintains non-exclusive agreements withCIMB Niaga and Bank Central Asia. Allianz Life mean-while signed an Asia-wide 10-year exclusive partner-ship with HSBC in October 2012. Products sold viabanks must not only be approved by OJK, but also byBI, and all bank branches selling investment-linkedproducts must have one certified agent since new rulesin 2010. With much of the banking sector’s command-ing heights locked up, underwriters are now compet-ing for more targeted deals with smaller regional banks. AGENTS: The agency channel remains significant, how-ever, both for life, where it accounted for roughly 39%of premiums in 2012, and also for non-life. Agents areonly allowed to represent one underwriter and in the

130

Bancassurance’s share of

premiums growth averaged

38% in the three years to

2010, overtaking that of

agents for the first time in

2012. Growth in other

channels averaged 13% in

the same period.

INSURANCE OVERVIEW

past three years have been certified by the relevant asso-ciation. By September 2013, some 16,210 non-life andover 260,000 life agents had been certified, accordingto both associations. The channel is particularly impor-tant for underwriters’ outreach beyond urban centres,but also in selling more complex life products and motorpolicies at the point of sale. Although Bapepam-LK hadset ceilings for commissions at 25% of premiums in non-life, these are routinely exceeded – up to 60% – by cat-egorising additional payments as miscellaneous costs.This practice has pushed Indonesian retail P&C ratesto among the lowest in Asia, according to AMBest.Underwriters have increasingly focused on developingdirect sales, both through branch expansion and tele-marketing. Manulife has made a particular push inexpanding its branch network, while life insurers likeAXA Mandiri, Allianz and BNI have focused on agencysales alongside bancassurance. Telemarketing saleshave been most successful for simpler PA and healthpolicies sold by both life insurers and P&C underwrit-ers like ACE and AIG, although first-year renewal ratesare reportedly below 50%. By June 2012 telemarketingaccounted for 2% of life premiums, according to AAJI. BROKERS: While brokers’ share of retail lines has beeneroded by bancassurance, they remain a dominantforce in larger corporate accounts and, according toresearch firm Axco, increasingly in the under-penetrat-ed SME segment. Despite the large number of licensedbrokers, the market remains dominated by a handful.“While there are 165 licensed brokers, only around 30are really active,” Sih’hati said. “The top 10 control 30-40% of the broker market.” The largest broker is Marsh,followed by AON, Howden and Willis; the first two dom-inate oil and gas insurance broking. Jardine Lloyd’sThompson, which specialises in property and marinehull business, acquired two local agencies in May 2013to expand its share of the employee benefits market.The largest local brokers include MIR, the oldest localbroker; SGU; Indosurance and KBRU. The latter, part ofthe Sinarmas group, commands roughly 70% of thecommercial property broker market. Bapepam-LK hadproposed new rules requiring each broker to have atleast two directors and two commissioners each, whichwould prompt consolidation in the fragmented sector. SCALING DOWN: While both segments have witnessedsustained growth in premiums, the number of policy-holders remains limited. The AAJI estimates that 87.2mIndonesians held life policies by June 2013, a rise of 54.5%y-o-y, of which 14.7% were individual policies, thoughonly 8% of households held any form of P&C insurancein 2012, according to financial services firm PwC. “Theaffluent and upper-middle-class segments are fairlywell covered by current distribution platforms,” St-Amour said. “The main area of competition will be forthe next 80m customers, where distribution will becrucial.” The key to expanding penetration will be scal-ing down policies, striking the right balance of afford-ability and cost-efficient distribution. With 53% ofIndonesians working in the informal sector in 2011,according to the World Bank, and 60% living on $2 a day, the potential for micro-policies is significant.

While new rules framing micro-insurance policiesare expected from OJK in mid-2014, some underwrit-ers already have rolled out low-cost and limited-cov-erage policies. Most have been credit life policies rolledout via micro-finance institutions (MFIs), like Allianz’sgroup life endowment and credit life policies sold in 66institutions in Java since 2010, and Jiwasraya’s credit lifepolicies sold via 200 partner MFIs in Java and Kaliman-tan. “Microfinance is an area of finance that is rapidlydeveloping. It is assisting people by providing accessto financial support from banking institutions, wherethey would not have previously been eligible for anysort of loans,” Antonius CS Napitupulu, the presidentdirector of Askrindo, told OBG.

Other underwriters like AIG, Prudential, Manulife andBumiputera 1912 are also rolling out PA and life poli-cies. The new OJK rules are expected to establish aninsurers’ pool for micro-insurance and could extend toa planned system of crop insurance. A pilot scheme isplanned under the 2014 budget where state-ownedJasindo will cover some 20% of Indonesia’s rice fields.The government will cover 80% of the Rp188,000($18.80) annual premium per ha starting in April 2014,while farmers will pay the remaining Rp36,000 ($3.60).Covers will extend to losses up to Rp6m ($600) per hafor farmers losing over 75% of crops. OUTLOOK: Despite rising competition Indonesia’s insur-ance sector is yielding profit growth in both segments.The country ranks eighth in AON Benfield’s global coun-try opportunity index, well ahead of India, Thailand andSouth Korea. Double-digit premium growth is expect-ed to continue in the coming decade: Japan’s Dai-ichiexpects above 15% annual growth in life premiums, whileMunichRe expects above 10% growth in non-life overthis period. Stricter regulations imposed under a com-prehensive framework by the new regulator will bol-ster underwriters’ financial and technical capacity togarner this growth, while growing affluence, risingawareness of natural catastrophes and the need forfinancial planning will be key drivers of long-term growth.

131


Brokers remain a dominant force in larger corporate accounts and in the SME segment

While both segments have

witnessed sustained

growth in premiums, the

number of policyholders

remains limited. The key to

expanding penetration will

be scaling down policies

and striking a balance

between affordability and

cost-efficient distribution.

INSURANCE DIALOGUE

David Beynon, President Director, Tokio Marine Life Insurance

How are life insurance firms tailoring their strate-

gies to attract Indonesia’s growing middle class

and what progress has been made?

BEYNON: With regards to capturing the middle class,we believe there is a universal sales model that willbe able to cater to all classes and would avoid theneed for such tailoring. This model is known as “sin-gle need-based selling”.

While many new firms adopt “product push” tac-tics that may initially have quick results, they areinefficient in the long run. At the other end of thespectrum, they offer full financial needs analysis,whereby prospective customers’ financial needs areintegrated into a report that is used as a basis forselecting products to sell.

In Indonesia this kind of selling is probably at least10 years away, leaving single need-based selling,which focuses on one of eight key financial needs,as the best option. While these needs are universal,the order of preference varies by country.KUAN: Based on published statistics, Indonesia willhave approximately 140m-150m people in the mid-dle class by 2050, according to World Bank and IMFreports. I think the middle class has grown over time,and alongside this growth, both social and conven-tional media have led to a heightened awareness ofinsurance. This is a strong foundation for growth, butthere is still room for more progress.

Companies are continually operating in this spaceand it has been effective, but the segment is still inits infancy. In a more general sense, companies shouldmake more of an effort to listen to the market in orderto design products that fit the needs of the coun-try’s new and expanding middle class.

We have heard that there is an increasingly height-ened awareness about the benefits of insuranceprotection. Life expectancy in this country is high-er than ever before, and it is important for peopleto have a steady and reliable plan in order for themto be able to enjoy their retirement years. Thanks to

medical advances, many illnesses and diseases aretreatable, particularly when caught early. However,the treatment is expensive, and this is where insur-ance must come in. Fortunately, the middle class isbeginning to recognise this fact.

What kind of role do you anticipate the bancas-

surance model playing in the coming years and

what opportunities exist in this segment?

KUAN: At present, the insurance industry’s channelsremain mixed between agency and bancassurancearrangements. However, at Prudential Indonesia thecustomers’ preference is skewed towards agency.

We do see tremendous opportunities for both ofthese channels to grow, but I think that the agen-cies will stay in a paramount position in the follow-ing years. This is in part because people still preferface-to-face sales. At the same time, however, weanticipate seeing rapid growth of the bancassur-ance segment in the coming years.BEYNON: Bancassurance is growing at a very fastrate; it comprises at least a third of the insurancebusiness and is by far the most effective way toincrease insurance penetration.

There are several ways to enter the bancassurancemarket. The primary strategy is to acquire shares inan insurance firm that is already owned by a bank:this is a growing trend. If this is not possible, an alter-native strategy is an “open architecture” distribu-tion agreement with a bank or to “pay to play”, bywhich one can secure a preferred provider positionwith a bank for a fee.

Otherwise, one can look outside of financialproviders at big conglomerates that have a largecaptive client base. By using a strong brand with anexcellent reputation, insurance companies can dis-tribute their products more effectively.

Returning to banking, the precedent of banksoffering exclusivity to insurance firms has changed.Regulators have quite sensibly recognised that one

132

A growing marketOBG talks to David Beynon, President Director, Tokio Marine Life InsuranceIndonesia; and William Kuan, President Director, Prudential Indonesia


INSURANCE DIALOGUE

insurer cannot provide everything that a bank’sclients need. As such, banks must now make at leastthree positions available for insurance partners,including a primary link for the preferred provider.This will always have the option of offering productson a first refusal basis, which can then be followedup by two further product providers.

To what extent can the sector continue on its tra-

jectory of rapid growth without compromising

on the quality of service that it delivers?

BEYNON: The sector can continue growing, and inmy view, this is largely due to the agency system. Ishould clarify that what we call the agency systemrefers to sales managed by independent agencieson contracts. Only one major international compa-ny is still operating “branch-based” selling in thecountry; all other insurance firms use agencies.

This preference can largely be attributed to theentrepreneurial flexibility of this model, which moti-vates sales agents and their staff. In fact, Indonesiaprobably has the most developed agency-sellinglandscape, giving it space to develop the capacity tokeep up with sector growth. With regard to firms hav-ing much success here, they have grown so fast dueto the dominance of the agency model as well asthe work ethic of the staff.

In terms of human capital, sufficient talent is avail-able within the country. Indonesians have been inthe business for up to 15 or 20 years. The numberof agents is not a problem, in part because insur-ance penetration is so low, but also because it is anincreasingly sought-after profession. However, it istrue that Indonesia needs to invest in its human cap-ital more generally to reach its full potential. KUAN: I am of the firm belief that it can; moreover,I think that it is imperative for companies to investmore heavily in developing talent. There is a lot oftalent throughout the country. The major challengemust therefore be to accelerate the development of

the sector’s human resources. I think the key tomaintaining such rapid growth without compromis-ing quality of service is people, systems automationand customer service.

In what ways is the entry of new foreign players

into the market affecting levels of competition

and what does this mean for local firms?

BEYNON: I think it is undoubtedly the case that for-eign players are returning to Indonesia and compe-tition is therefore increasing as a result. Back in 2004and 2005, there were some major international insur-ance firms that had started to move out of Asia inorder to focus on Europe. However, now they are com-ing to the realisation that they would benefit frombeing situated in Indonesia and are returning.KUAN: As the sector has become increasingly com-petitive in the last few years, it remains importantto remember that competition makes us better,sharper and more efficient. Indeed, tremendousopportunities exist for all firms to grow and existtogether in the sector, for three main reasons.

The first is GDP growth, which remains robust andis expected to remain at around the 5-6% mark overthe next three years, which, compared to markets inEurope and the US, is simply awesome. The secondfactor is the rapid emergence of the middle class,and the third is that insurance penetration in thecountry remains extremely low.

In terms of premiums to GDP, Indonesia is runningat around 1.2%. Compared to neighbouring countriessuch as Malaysia and Singapore, which are runningnearer 4% and 6%, it remains extremely low on allmeasures. These three factors are crucial in explain-ing why this market is attracting competition.

Opportunities are present for all companiesinvolved to benefit from growth. However, this in turn may present other challenges for smallerplayers as regulators push to ensure that best prac-tices and standards are adhered to by all in the sector.

133


William Kuan, President Director, Prudential Indonesia

INSURANCE INTERVIEW

Elvyn G Masassya, President Director, Social Security Agency

How do you assess the roll out of the new social

security system so far, and what remaining chal-

lenges will there be before full implementation?

MASASSYA: The new social security system was estab-lished at the beginning of 2014 and is set to be fullyoperational by July 2015. This new system will bring manypositive changes to the Indonesian public and, in fact,many of these improvements are already well under way.

One key goal is to encourage as many Indonesiansto enrol as possible. As such, we have to make the sys-tem user-friendly and attractive. While people previ-ously had to visit a local branch to register, this can nowbe completed via our website or app, greatly reducingthis barrier to entry, especially for those without con-venient access to a physical branch. This electronicexpansion is taking place not only for registration, butalso for payment and claims services. In addition, weaim to have a branch in each of Indonesia’s 497 cities.Another improvement is institutional cooperationbetween public institutions, which helps to provide afaster service in areas such as identity verification.

However, the transition is not without its challenges.There are ongoing discussions with the governmentrelating to various regulations, including for the pen-sion programme. This is difficult. An understanding hasto be reached between employers and employees inboth the formal and informal sectors. While social secu-rity previously covered 40m formal workers, we areexpanding this to another 70m workers in the infor-mal sector, thus increasing the total to 110m people.There are many unique factors to consider in the infor-mal sector, especially given that these workers arespread across Indonesia’s vast geographical area.

How many people are set to sign up for the new sys-

tem, and does the country have the infrastructure

to support this increase in membership?

MASASSYA: By 2015, social security membership is pro-jected to reach more than 23m people, and this figureis set to double to more than 47m by 2018. In order to

facilitate this growth, our budget as a public institutionis expected to rise from $15bn to $40bn over the nextfive years. In terms of infrastructure, the focus is onenhancing efficiency and delivering easier access toservice for our members. Not only are new branchesbeing opened, but also the social security system hasimproved notably in terms of electronic access. Betterinformation technology and databases will successful-ly support rapid growth in membership. Further, we areworking locally with governors to ensure that institu-tions comply with social security regulations regardingthe registration of workers, so that those in the infor-mal sector can have a degree of protection that wasnot previously available. Through these channels theIndonesian public will have access to a stronger, morefunctional social security system.

What impact will this programme have on Indone-

sia’s competitiveness in the labour market?

MASASSYA: It is certain that there will be a positivecorrelation between the new social security systemand Indonesia’s competitiveness, especially in terms ofproductivity. In both the formal and informal sectors,expansion in the coverage of social security means thatthe risks to workers are reduced. This will increase work-ers’ productivity, which in turn will boost the revenueof Indonesian companies as well as the income ofemployees. Social security also serves to curb socialunrest in terms of conflict between employers andworkers, in the process enhancing confidence amongforeign investors considering investments.

We also recognise that there is still a significant prob-lem in Indonesia in terms of income distribution inequal-ity, and the new programme seeks to deliver not onlybasic welfare for workers, but also to improve the sit-uation of those that are worst off through food andtransportation benefits. There is a sense of urgency forsocial security across the archipelago, and I am confi-dent that this new system can be a part of the engineof economic growth for the country in the years to come.

134

New and improvedOBG talks to Elvyn G Masassya, President Director, Social SecurityAgency (BPJS)


INSURANCE ANALYSIS

Takaful’s share of the insurance market could rise to 7.9% by 2018

In the world’s most populous Muslim nation where over85% of the population ascribes to the faith, Indonesia’ssharia-compliant insurance segment (takaful) remainsmarginal at a mere 3.9% of industry assets in 2012,according to a June 2013 report by rating agency Fitch.While proportionately small compared to neighbour-ing countries like Malaysia and Brunei Darussalam, themarket has grown rapidly since the first takaful under-writer – Malaysian-backed Syarikat Takaful – launchedin 1994. The entrance of more foreign insurers attract-ed by one of the fastest-growing frontier markets fortakaful should drive product innovation and diversifi-cation of distribution. Expected regulatory reform,details of which remain uncertain, should also encour-age consolidation and raise standards. “According togovernment data, there are about 120 insurance com-panies in Indonesia which will require $100bn in capi-tal in the coming years. Therefore, some consolidationmay be taking place in the short-term,” Slamet Riyadi,the president director of Jasaraharja Putera, told OBG.RAPID GROWTH: The segment’s growth since 2005has been over double the industry average, with a com-pound annual growth of 35% from 2005 to 2010,according to accountancy Ernst & Young. Gross taka-ful premiums grew nearly 10-fold in the five years to2011 (the latest year for which audited figures areavailable), reaching Rp4.97trn ($497m), according tothe Indonesia Islamic Insurance Association (AASI).Meanwhile, takaful underwriters’ combined assets grewmore than fivefold from 2007 to 2012, from Rp1.9trn($190m) to Rp11.4trn ($1.14bn), according to datafrom the Ministry of Finance.

While still small relative to the size of Indonesia’sinsurance market, the segment’s premiums overtookthose of Saudi Arabia and the UAE in 2010, accordingto SwissRe, the world’s second-largest reinsurer. AASIforecast in May 2013 full-year growth of 35-40%, whileFitch expects takaful’s share of the insurance marketto double to 7.9% by 2018. “We see strong potential forgrowth in takaful as the market expands to mid- and

lower-income segments of the population,” Indra Tan,senior vice-president of corporate planning and riskmanagement at Tokio Marine Life, told OBG. The seg-ment remains under-penetrated despite the rapidexpansion in the number of underwriters, ranging fromfully-fledged takaful underwriters to dedicated win-dows operated by conventional insurers. MARKET STRUCTURE: Both the Life Insurance Asso-ciation of Indonesia and the non-life General Insur-ance Association of Indonesia explain the rapid recentgrowth as driven by the expansion in underwritingcapacity in the segment. The number of underwritersoffering takaful products has grown from 30 in 2006to 43 by 2013, alongside three reinsurers’ dedicatedwindows. Only five of these are fully-fledged takafulunderwriters, however: three in life and two in non-life.The remainder are conventional underwriters operat-ing dedicated windows, segregating their sharia-com-pliant business by a Chinese wall. In line with rules forthe conventional market, underwriters must segregatetheir non-life business (umum) from their life (knownas family takaful, or keluarga).

Malaysian underwriters have led the charge since1994, when Takaful Malaysia, a unit of Bank IslamMalaysia, the only publicly listed takaful underwriter inthat country, launched Syarikat Takaful Indonesia (STI),in which it maintains a 56% stake as of 2013. The hold-ing operates a subsidiary each in family and general taka-ful underwriters. Its partnership with the 3000-branchBank Muamalat, the second-largest sharia-compliantand oldest lender in Indonesia, has driven the under-writer to the top position among takaful players, eventhough its contribution to the Malaysian group’s rev-enue remains below 15%. The group hopes to drive thisto over 20% by 2015. As a means of encouraging coop-eration with its bancassurance partner, STI plans to sella 19% stake to Bank Muamalat in 2014, raising its totalshareholding to 25%. A second leading Malaysian under-writer, Great Eastern Takaful, launched its Indonesianoperations in 2011 through a bancassurance deal with

Growth of the takaful

insurance segment has

been double the industry

average, at 35% between

2005 and 2010, and gross

takaful premiums grew

10-fold in the five years to

2011.

135


The expansion of the

takaful market is credited

to the rise in takaful

underwriters, which

increased from 30 to 43

between 2006 and 2013.

Frontier for takafulMaking space for a growing segment

INSURANCE ANALYSIS

the 400-branch OCBC Bank. With encouraging growth,the number of underwriters operating successful taka-ful windows has multiplied, led by foreign joint ventureslike Allianz, AXA, Prudential, Sun Life and others. AXA’sjoint venture with Bank Mandiri in marketing takafulproducts since 2003 has been particularly successfulgiven the wide reach of Mandiri Syariah, the largestsharia-compliant bank with over 700 branches. PRODUCTS & CHANNELS: The majority of productssold thus far have followed the wakala model, wherepremium is split between an administrator fee and apolicyholder fund to settle claims and share excessproceeds. The policyholder funds are placed in amudaraba structure where funds are placed on a risk-and profit-sharing basis. In the family (life) segment,which accounts for roughly 90% of takaful sales, accord-ing to Tokio Marine Life estimates, trends have mirroredthose in conventional products where unit-linked taka-ful has gained a commanding share of the market.

The rapid growth in sharia-compliant banking has gen-erated spin-off effects for takaful products sold throughbank partnerships. Allianz aims to double its marketshare in takaful by 2018 by capitalising on its bancas-surance relation with HSBC’s sharia-compliant divisionHSBC Amanah, as does Sun Life through its joint ven-ture with CIMB Bank Niaga. This greater emphasis onbank distribution is supporting the gradual shift fromsimple takaful protection plans to a diversified array offinancial planning instruments. In the past three yearsthe portfolio of takaful products available on the mar-ket has broadened to unit-linked policies, annuities,dedicated policies for women, child protection andhealth riders. Allianz has also led the way in marketingsmaller-premium takaful products, rolling out a taka-ful credit policy, with monthly premiums as low asRp3000 ($0.30), through 66 microfinance institutionsand rural banks with which it partners. AIG has also rolledout takaful micro-policies for health and personal acci-dent in 2012, partnering with Bank Muamalat’s non-profit microfinance subsidiary Baitulmaal Muamalat.

RETAKAFUL: While the array of sharia-compliant finan-cial instruments has expanded significantly in recentyears, with the launch of sharia bonds by Bank Indone-sia in September 2007, there have been more bondissues by sharia banks, and the Jakarta Islamic Index wasestablished in 2002, which in turn attracted a numberof sharia-compliant mutual funds. Yet while the typesof Islamic investment instruments has multiplied, if notalways in sufficient size to meet demand, domestic re-takaful capacity remains constrained. Three of the fourdomestic reinsurers operate re-takaful windows, withNasionalRe dominating the general segment and ReIn-do covering most family re-takaful.

Significant retakaful capacity is available regionally,mainly through the Malaysian offshore financial cen-tre of Labuan and Singapore. Since 1997 Asean Retaka-ful International, a unit of Takaful Malaysia, has ledLabuan’s development as a major retakaful centre glob-ally. The regulator, the Financial Services Authority, haslong held that takaful risk ceded to reinsurers shouldfirst be ceded onshore before seeking capacity off-shore. The Council of Indonesian Ulama, however, hasmaintained that risk should be ceded offshore if domes-tic re-takaful capacity is insufficient, rather than ced-ing risk to conventional reinsurers domestically. REGULATORY REFORM: The segment has flourishedunder a relatively laissez-faire approach by the regula-tor. Although authorities have not adopted as proac-tive an approach as Malaysia, where takaful policies aresubsidised for broader adoption, underwriters thus farhave not been forced to spin off this business as stand-alone companies. Although capital requirements forconventional insurers were raised to Rp70bn ($7m) in2012, the lower Rp50bn ($5m) was maintained forstandalone takaful operators and will only rise to Rp75bn($7.5m) in 2014, when conventional underwriters willneed to comply with a new Rp100bn ($10bn) require-ment. While standalone takaful underwriters will needto raise additional equity to comply in 2014, with play-ers like STI already announcing plans for additionalequity issues, more far-reaching reform is included inthe proposed Insurance Business Act in front of theHouse of Representatives in 2013. Although it is unclearwhether the bill will be enacted before the 2014 elec-tions, a key provision will require underwriters to spinoff separate takaful underwriters within three years ofthe bill’s enactment. This is far faster than Bank Indone-sia’s requirement for banks to spin off sharia windowswithin 15 years or once their assets exceed 50% of thebalance sheet. While it is uncertain when the new ruleswill be enacted, some players like Manulife have alreadyannounced their intent of spinning off their takafulbusiness as a separate subsidiary.

Despite the nascent stages of takaful’s developmentin Indonesia, the market presents strong fundamentalprospects for growth given the country’s large Muslimpopulation, increasingly diverse product offering andnew distribution channels. The regulator will need tostrike a balance between the priorities of domesticat-ing takaful risk and supporting the sector’s develop-ment, as well as the integrity of the takaful value chain.

136

The family, or life, segment accounts for roughly 90% of local takaful sales

While agencies have

traditionally driven takaful

sales, the rapid growth in

sharia-compliant banking

has generated spin-off

effects for products sold

through bank partnerships.

Growth in the number and

type of sharia-compliant

financial instruments

began with the creation of

the Jakarta Islamic Index in

2002 and the launch of

sharia bonds by Bank

Indonesia in 2007.


INSURANCE INTERVIEW

Tim Shields, President Director, ACE Jaya Proteksi

ter regulated because it is larger and longer estab-lished. The general sector must now try to rise to thatlevel. Too many small players in a marketplace drivesprices down, and this, by reducing margins, limits theservices companies can deliver.

What lessons can the younger and still-developing

general sector learn from the larger and older life

sector, and where is there the most opportunity?

SHIELDS: Over the last few years, the life sector hasstayed ahead of the general sector in product innova-tion, service quality and distribution. Such stellar devel-opment was further supported by adequacy of capitaland a sufficient supply of talent. The principal lessonto be learnt is that success is strongly linked to estab-lishing distribution levels across many different chan-nels. As for opportunity, one critical and now hotly con-tested area is multi finance. Another, for the future, willbe micro insurance as the government seeks to offloadresponsibility in this area to the private sector. A thirdis liability cover. Big industries in Indonesia understandrisk management, and as companies expand interna-tionally and executives and business teams travel moreabroad, spaces will open for more penetration.

How can penetration into small and medium-sized

enterprises (SMEs) be improved and deepened?

SHIELDS: Indonesia has a big potential SME market,as about 41m players made up nearly 58% of GDP in2012. Only a very small number, however, make the con-scientious choice to insure their businesses and prop-erty. There are a number of inherent barriers to pene-tration, such as the relatively low number of bankbranches that distribute SME insurance, and a lack ofawareness among SMEs as to the benefits of protect-ing their assets. There is still lots of room for buildingawareness, and branch networks are just one way ofdoing so. The key factors for tapping into SMEs, though,are a wide network of product distribution channels,innovation of new products and affordable premiums.

137


Investing for expansionOBG talks to Tim Shields, President Director, ACE Jaya Proteksi

To what extent is the insurance sector engaged in

a “war for talent” and how can this be mitigated?

SHIELDS: The financial sector, and particularly theinsurance industry, has experienced phenomenal growthin the last few years. This is clear from the sector’s dou-ble-digit growth and the bullish entrance of new com-panies, both domestic and international, into the mar-ket. In 2011, Indonesia’s non-life insurance penetrationwas only 0.6% of GDP compared with neighbouringmarkets such as Singapore (1.5%) and Malaysia (1.8%).At the end of 2013 the figure was still under 1%, sopotential remains enormous.

The industry’s biggest challenge has thus becomesourcing adequate human resources. While at the topmanagement level the landscape is fairly well served,lower ranks have evident shortages. The key is to investin the training and education of staff so that they canmeet the standards now required of successful play-ers. These demands stem both from unrelenting com-petition in the market and from the incoming CustomerProtection Law, although the law is likely to apply moreto smaller, local players. Graduate training programmeswill be crucial to this educational nurturing and muststart from the moment young professionals enter theworkplace. English-language skills must also improveas Indonesia becomes more of a diverse marketplace.If insurance companies are willing to commit to theirstaff, the talent will come to us.

What will be the immediate effects of higher cap-

ital requirements on insurance, and how could con-

solidations and mergers be seen as a positive thing?

SHIELDS: General insurance would benefit from hav-ing a smaller pool of higher-capitalised players, as thiswould help render claims and service provision moreuniform. Insurance is all about being able to pay thecorrect claims in a timely manner, no matter their size.The bottom third of the sector will be increasingly test-ed by such regulations, which will force smaller play-ers to either merge or dissolve. Life insurance is bet-

INSURANCE ANALYSIS

Life insurers have traditionally bundled health cover in life policies

As the government plans to begin reforming its socialsecurity system in 2014, private underwriters expectmore profitable growth in health insurance. While thereare five parallel schemes providing social security, some37% of Indonesians, or around 88m people, have nohealth insurance and faced spiralling out-of-pocketmedical expenses in 2012, according to the WorldHealth Organisation (WHO). Meanwhile, private healthpolicies are sold mainly as riders on life insurance,though intense competition on group health plans thataccount for the majority of premiums has constrainedmargins and caused high loss ratios. Following a pilotproject in Jakarta in 2012, however, insurers expect thenew system to face teething problems and promptmore individuals to buy private policies. “Universal healthinsurance will change everything in Indonesia. As morethan 100m people will be joining the system quickly,there will be supply gaps and the greater timeline is250m people by 2019,” Agus Benjamin, the presidentdirector of Lippo General Insurance, told OBG.EXISTING SCHEMES: Of the five social securityschemes, three provide some health coverage, but theirscope remains limited. The Askes scheme covers some17.2m civil servants, military and police officers and theirfamilies, according to the Ministry of Health. Jamsostekprovides some 5.6m formal-sector employees with cov-er for health, work accident, pensions and death ben-efits, funded by a levy of 5.7% on employees’ salaries:3.7% from employers and 2% on employee wages.Although Jamsostek membership is mandatory for firmswith more than 10 employees or with monthly payrollsover Rp1bn ($100,000), compliance has been uneven.Informal workers can also participate in the scheme vol-untarily, while formal-sector companies can opt out ofthe scheme if they contribute to a private health insur-ance scheme with better coverage.

A third scheme run by central and local governmentswas launched in January 2005 to cover the poor andnear-poor with basic health benefits. This third schemehas driven coverage from 16.5% in 2004 to 56% of the

population by 2012, with 76.4m people covered underJamkesmas alone. Yet the three schemes only extendto public hospitals, government health centres and alimited number of private hospitals that have soughtpatient volumes. The Jamkesmas scheme earmarksRp6500 ($0.65) per person per month, accounting fora quarter of the central government’s health budgetin the five years to 2010, according to the World Bank.Indonesia spent only 0.9% of GDP on public health carein 2011, according to the bank, compared to 1.2% inIndia, 1.4% in the Philippines, 2.7% in Vietnam, 2.9% inChina, 3.1% in Thailand, 4.1% in Brazil and 5% in Turkey. PRIVATE POLICIES: While both life and non-life under-writers are able to offer health insurance by law (theonly policies alongside personal accident (PA) whereboth can compete), life insurers have held an edge bybundling health covers in life policies. “Life insurersfrequently cross-subsidise losses on their health rid-ers with proceeds from their life business,” Peter Phe-lan, president director of Pacific Cross, a third-partyadministrator servicing health insurers, told OBG. “Mostof the market is corporate, where loss ratios can exceed75%.” The main providers include foreign-linked lifejoint ventures like AXA, Allianz, Aviva, Manulife, Pruden-tial and AIA. State-owned Jasindo bought significant mar-ket share in 2010 by offering discounts of up to 30%on premiums, but it has since curbed these excesses.

Premium growth figures in PA and health sales havebeen significant in recent years. Combined gross pre-miums near-doubled in the two years to end-2012,from Rp2.86trn ($286m) in 2010 to Rp5.17trn ($517m)by 2012, the year when growth reached 33.4%, accord-ing to figures from the General Insurance Association.Yet while health insurance rates are growing by about10% annually, medical costs are estimated to rise 10-15% annually, according to Pacific Cross. “While per-haps 7-10 % of the population has some kind of healthinsurance, most of which is provided by their employ-ers, and premiums are growing roughly 10% annually,we believe this is mostly driven by population growth

State-sponsored health

coverage in Indonesia is

administered by three

programmes that together

cover an estimated 99.2m

Indonesians.

138

Broadening health coverageExpanding the net and extending benefits


INSURANCE ANALYSIS

rather than an expanding market,” Phelan said. Whilethe market is dominated by group policies, underwrit-ers see potential in retail lines, particularly given theestimated 1.5m Indonesians seeking health care abroad,spending $11.5bn per year, according to the ministry. PLANNING UNIVERSAL: Wide-ranging reform wasenacted in 2011 when parliament passed Law 24 onsocial security providers, creating the Social SecurityOrganising Body (BPJS). The law requires all employersto provide five key benefits – health, workers’ compen-sation, pensions, provident funds and death benefits– to staff, while the government will extend coverageto all Indonesians by 2019. The new BPJS health depart-ment will integrate the health insurance componentsof Askes, Jamsostek and Jamkesmas, while the BPJSemployment office will provide the remaining benefits.The health scheme will be funded by premiums fromboth employers and staff, with the former paying 4%of salary and the latter 1%, while the government willcover the poor. Non-poor informal workers will makeflat monthly contributions. Despite initial proposals formonthly premiums of Rp15,000 ($1.50) per person,debate in parliament is still on-going for the final month-ly premium. Care will only be covered at public hospi-tals, with service and drugs for major diseases like can-cer and chronic conditions free at the point of service.

The government’s roadmap to 2019 expects some121.6m people when it is rolled out in 2014, including96.4m categorised as poor, 17.2m public employees and5.5m Jamsostek-covered workers, and 2.5m coveredunder other government-run social security schemes.“If we calculate how many people have health cover-age in Indonesia, it is relatively miniscule, which meansthere is great potential moving forward,” said Roy Ibrahim,the president director of Asuransi Jiwa InHealth.

The Ministry of Social Affairs will set criteria for thosecovered by the government and those required to maketheir own contributions. Foreign workers in Indonesiafor over six months will also be required to join. “We’vebudgeted close to Rp24trn ($2.4bn) in 2014 for theuniversal health care scheme, starting with the poorand government employees, although this will rise infuture years,” Luky Alfirman, director of the Ministry ofFinance’s centre for macroeconomic policy, told OBG.Indeed, the World Bank estimates the scheme will cost $13bn-16bn annually once it is fully implemented.

139

About $2.4bn has been budgeted for universal health care in 2014

A recent law created the

BPJS, which will integrate

the government’s three

current health coverage

programmes, and the new

scheme will be funded by

contributions from both

employers and staff.

PILOT: A pilot scheme was rolled out in the capital bythe provincial government, known as Healthy JakartaCard, from November 2012, with mixed results. Cover-ing some 4.7m people categorised as poor and expect-ed to cover all 10m residents by 2014, the scheme cov-ers care at third-class public hospital wards at roughly90 of the city’s 147 registered hospitals. This causedpatient numbers to spike by a quarter within the firstsix months at some main hospitals. With long queuesand scare stories of patient deaths due to refusal oftreatment, insurers see this pilot as a sign of the teethingproblems the nationwide scheme will face given inad-equate facilities and manpower. Indonesia has only sixhospital beds for every 10,000 people, according to theWHO, four times less than the global average. RETAIL PROSPECTS: Insurers are gearing up for stronggrowth in retail health insurance demand as a result.“The roll-out of the government’s universal health insur-ance scheme could actually stimulate retail demand forhealth policies as it could raise insurance awarenessand cater to more affluent people’s desire for top-upson the government scheme,” Luc St-Amour, Sun LifeFinancial Indonesia’s chief actuary, told OBG. Althoughit is unclear whether firms will still get to opt out of the public scheme, underwriters are eager to expand.

INSURANCE ANALYSIS

Total flood-related losses in 2013 reached an estimated $63.8m

As one of the countries most exposed to natural catas-trophes (NatCat) such as earthquakes and floods,Indonesia’s relatively low insurance penetration hashistorically meant that the government must shoulderthe lion’s share of losses. With earthquake and floodpolicies usually sold as standalone covers, a growingincidence of catastrophes has driven increased pene-tration, albeit from low levels. “Natural catastrophes likeearthquakes and tsunamis have been driving premiumsfor property insurance in Indonesia, as well as flood risksfor certain big cities such as Jakarta and Bandung inWest Java,” Arman Juffry, president director of JardineLloyd Thompson Indonesia, said in Zurich Insurance’sreport on strategic risk in Asia in 2013.

New regulations for property tariffs, including floodpolicies, enacted in 2014 should help sanitise compe-tition and ensure sustainable underwriting practices.Meanwhile, donor-backed efforts to establish a newindex-based earthquake insurance model under theexisting domestic NatCat reinsurer Maipark should sig-nificantly expand coverage when it is rolled out. FLOODS: While Indonesia has faced a growing inci-dence of natural disasters, the level of insured lossesremains low, reflecting a significant insurance gap,according to SwissRe. In total the country has sufferedRp100trn ($10bn) in NatCat losses in the decade to2013, according to Maipark, although the governmenthas covered most of this. Torrential rains in January2013 caused floods that were significantly more severethan similar occurrences in 2002 and 2007, accordingto Fitch. These affected the central business district,touching over 100,274 homes in 31 districts, includ-ing the Presidential Palace, according to the NationalDisaster Management Agency (BNPB). The floodingalso caused a total of Rp32trn ($3.2bn) in damages,although claims reached only Rp3trn ($300m), accord-ing to reinsurance broker AON Benfield.

Given that roughly half of non-life risks were placedwith reinsurers or retroceded, given non-life insurers’low capital base, the impact on underwriters’ balance

sheets was contained. The Association of General Insur-ance Companies reports that total flood-related loss-es in 2013 reached Rp638bn ($63.8m), of whichRp600bn ($60m) was for property policies and the bal-ance in motor. Although substantial floods occurredagain in January 2014, they were concentrated in areaswith lower insurance penetration, according to Fitch,which estimated that budgeted flood claims were notlikely to reach Rp1.5trn ($150m) as of February 2014,roughly half the amount paid out the previous year. EARTHQUAKES: Alongside regular flooding, Indone-sia is also exposed to significant, albeit poorly insured,earthquake risks. “Indonesia’s earthquake hazard expo-sure is among the highest in the world, both in termsof human mortality and economic losses,” Frans Sahusi-lawane, Maipark’s president director, said in an Inter-national Finance Corporation (IFC) press release inOctober 2013. This is in line with global trends as theincidence of NatCat events has tripled in the last 30years, according to Maipark.

Maipark estimates that some 12m Indonesians livein zones prone to earthquakes, representing a totaleconomic exposure of $79bn. This represents a signif-icant unhedged exposure for lenders, particularly small-er regional banks and microfinance institutions. Inmajor urban areas like Yogyakarta in Java or West Suma-tra’s capital Padang, the most-exposed lenders couldlose between 15% and 35% of their income, accordingto Maipark. Extrapolating from current rates of invest-ment in property and infrastructure, SwissRe estimatesthat the current $10bn insurance gap would rise to$28bn by 2023. Focusing on flood risks, the reinsurerestimates the flood insurance gap would reach thelower but still considerable sum of $23bn by that date.In the absence of adequate insurance cover, the unin-sured losses are either shouldered by public financesor written off as unrecoverable losses. PRICING NATCAT: Originally structured as the Indone-sian Earthquake Reinsurance Pool in 2003, AsuransiMaipark Indonesia is a domestic reinsurer incorporat-

Despite facing an

increasing incidence of

natural disasters, insurance

losses remain low and the

government has

shouldered the majority of

the cost.

An estimated 12m

Indonesians live in

earthquake-prone areas,

which represents a major

unhedged exposure for

lenders and a total

economic exposure of

$79bn.

140

Weathering the stormCreating the tools to handle natural disasters


INSURANCE ANALYSIS

ed in 2004 specialising in NatCat. Backed by all non-life underwriters and reinsurers as shareholders, thereinsurer sets a benchmark for earthquake insurancepolicy pricing, promotes discipline by selling such poli-cies as standalone covers, and has developed a data-base of hazards and exposures to build local capacityto manage such potentially large risks. Shareholders arerequired to cede between 5% and 25% of insured sums,with a ceiling of $2.5m per risk, and must follow theset earthquake premium tariff. From January 2014 themandatory cession was raised to 15% of all insuredsums with a higher single-exposure ceiling of $3.5m.

Depending on zone, location, form of occupancy andstructure, the tariffs range from 0.104% to 0.33% of theinsured sum. The reinsurer’s gross premiums have grownin line with the industry’s, albeit from a low base, at16.99% to Rp105.2bn ($10.5m) in the year to Septem-ber 2013, according to Fitch, which rates Maipark BBB+with a stable outlook. While the reinsurer’s exposureis set to rise in line with the legal cession increase, itsstrong risk-based capitalisation ratio of 1080% in Sep-tember 2013 gives it ample room for growth.

While Maipark regulates earthquake tariffs, stand-alone flood covers have been highly under-priced inrecent years, with policy discounts of up to 50%, accord-ing to Fitch, as the sector’s fragmentation has result-ed in intense competition. Over the first two monthsof 2014 the new insurance regulator, Financial Servic-es Authority (OJK), has introduced strict new tariffssetting floors and ceilings for premium rates on flood,earthquake, volcanic eruptions and tsunamis as partof its overhaul of pricing oversight for the property andmotor classes (see analysis). NEW MODELS: While OJK has focused on curbingexcessive competition between non-life underwritersin acquiring new business, particularly in flood covers,Maipark is working to establish new disaster risk mod-elling tools that should help drive penetration. In ear-ly 2014 the reinsurer is finalising the first stage of itsflood model for Jakarta, based on its 10-year databaseof NatCat risks. “With this model, we can contribute to

the regulators and insurance industries in enhancingour knowledge on flood handling, starting from Jakar-ta,” Sahusilawane told the Jakarta-based foundationDisaster Risk Reduction in December 2013.

Since October 2013 it has also partnered with theIFC to develop an earthquake index insurance (EQII) prod-uct as a hedging instrument for lenders in disaster-pronezones. The IFC’s Global Index Insurance Facility aims touse index insurance with parametric triggers for claimspayments to enhance risk management in disastersand agriculture. The project builds on the IFC’s experi-ence of rolling out such a product in North Peru in2011, which was sold through a leading microfinancelender (Caja Nuestra Gente) and provides pay-outseven before flooding based on weather patterns.

The EQII product in Indonesia aims to expand pene-tration and allow banks to hedge their loan-book riskand continue to lend in an area following an earthquake.“The project will increase the resiliency of [financialinstitutions] FIs to earthquake disruption and facilitatemore rapid recovery following a severe seismic event,”according to the IFC in October 2013. While independ-ent consultant GlobalAgRisk and AON Benfield will stillbe working on the product’s details in 2014, the mod-el will most likely involve a subsidised excess-of-loss fea-ture, before transitioning to the global reinsurance andcapital markets through issuance of catastrophe bondsfor instance. Once the product is rolled out throughMaipark, the IFC expects the product to provide coverfor a total of $5m in loans to individuals and small andmedium-sized enterprises by 2015 and $50m by 2019.

Indonesia faces a significant and growing insurancegap in coming years. While the regulator seeks to ensurefair competition amongst non-life underwriters,Maipark’s efforts to develop NatCat risk modelling toolsand standardised products will be key to expandingpenetration. Authorities, keen to transfer a larger shareof NatCat risk to market-based instruments, are key sup-porters of this trend. Government at all levels will alsoneed to enhance efforts at mitigating risks in the firstplace by consistently enforcing building regulations.

141

A new earthquake index

insurance product aims to

allow banks to hedge their

loan-book risks in certain

areas and continue to lend

in an area following an

earthquake.

INSURANCE ANALYSIS

New tariffs should ensure more sustainable underwriting practices

After taking over from the Indonesia Capital Market andFinancial Institution Supervisory Agency, the new Finan-cial Services Authority (OJK) is leading a regulatoryoverhaul of the sector. More aggressive than its pred-ecessor, OJK is implementing new governance rules forunderwriters and has set new premium tariffs and capson commissions for highly competitive motor and prop-erty classes – all ahead of a major overhaul of the exist-ing 1992 Insurance Act, which was under debate at theHouse of Representatives (DPR) in early 2014. Whilelegislative progress remains uncertain in an election year,the new insurance regulator is demonstrating its intentto sanitise business practices and set the sector on asolid path for sustainable growth. CORPORATE GOVERNANCE: Even before OJK’s estab-lishment in October 2012, the Ministry of Financeissued Regulation No. 152 on corporate governance forinsurance firms, requiring the new regulator to subjectall directors and commissioners to “fit and proper”tests. The rules require all directors and at least half ofa board of commissioners to reside in Indonesia, whileall underwriters and reinsurers must employ a minimumof three directors and three commissioners, of whichat least one must be independent. Directors cannot holdmultiple directorships, both in Indonesia and abroad,although they can act as commissioners at another firm.

The tests have also been expanded to controllingshareholders of insurance firms, defined as investorswith over 25% stakes in underwriters. By giving OJK ahand in board appointments, the rule significantlystrengthens the new regulator’s oversight of corporategovernance structures. However, following concernsraised by two insurance associations surrounding theexistence of multiple subsidiaries and alliances betweenunderwriters, OJK is revising its governance standardsto apply to the holding group level as well. SETTING TARIFFS: Aside from strengthening its over-sight of both life and non-life underwriters’ governancestructures, the regulator is moving to sanitise under-writing standards to bolster insurers’ risk management

and support improved pricing of key non-life risks. InDecember 2013 OJK issued long-awaited tariffs thatset floors and ceilings on premiums in the key motorand property classes. Although a 2003 Ministry ofFinance circular requires underwriters to set premiumrates according to their risk and loss profile for the pol-icy class over the previous five years, underwriters havetended to offer significant discounts on more compet-itive classes like property and motor through excessivecommissions to intermediaries and premium rebates.In a highly competitive and fragmented market whereinsurers extend up to 50% discounts on property ratesin certain areas through high commissions to productmarketers, according to ratings agency Fitch, mostinsurers see the new rules as a positive developmentfor the sector as a whole. The OJK’s move came aftera failed attempt by members of the General InsuranceAssociation of Indonesia, following significant floodsin January 2013, to set tariffs for the industry using threegeographic zones for different motor tariffs and flood-related property policies. Rates were set to fluctuatebetween a low of 0.04% of insured sums in low-risk zonesthat have seldom been flooded, such as East Jakarta,and a high of 0.52% in high-risk zones, such as NorthJakarta. Together, these new rates represented a 20-30% increase over 2012 pricing.

After Indonesia’s Business Competition SupervisoryCommission ruled it a breach of the anti-monopoly LawNo. 5/1999, which requires OJK to be the tariff setter,the OJK established 120 different zones according toflooding risk and varying rates for 120 types of build-ing construction. The new rules also require risks tomachineries to be spun off as standalone policies, andlimit marketing commissions at 15% of premiums forproperty and flood policies and 25% for motor insur-ance. Companies failing to comply with the new tariffsrun the risk of seeing their licence suspended.

Although the new tariffs will likely impose higherpremiums on policyholders to cover the same risk cov-ers, according to Fitch, they will insure sustainable

By giving the Financial

Services Authority (OJK) a

hand in board

appointments, new

regulations significantly

strengthen the regulator’s

oversight of corporate

governance structures.

OJK has established 120

different zones according

to flooding risk and varying

rates for 120 types of

building construction. New

rules also limit marketing

commissions to 15% of

premiums for property and

flood policies and 25% for

motor insurance.

142

Letter of the lawThe legal framework is catching up with sector growth


INSURANCE ANALYSIS

underwriting practices and insulate insurers from poten-tially unsustainable losses. “This could also help to cre-ate a balance between prices charged and risks takenby the insurers,” according to a Fitch update in Febru-ary 2014. Additionally, the development of new earth-quake index insurance products by the specialisedcatastrophe reinsurer Maipark should enhance insur-ers’ catastrophe underwriting capacities. Developmentof new products in general is essential for new play-ers. “The key is this market is how to establish qualityproducts and distribute them as quickly as possible, andin this sense local players actually have an advantagedue to a pre-established branch network,” said IndraVaruna, the president director of Adira Insurance.LEGISLATIVE REFORM: While these piecemeal reformsare effecting some change, a far broader overhaul ofthe sector covering areas as disparate as licensing, cor-porate governance, business conduct and consumerprotection was being debated in the DPR in early 2014.Revisions to the existing 1992 Insurance Act have beenawaited for several years, yet the establishment of OJKhas made the review pressing in order to define moredetailed functions for the new regulator, including cre-ating powers to issue regulations and implementing rulesfor the new act once it is passed. In March 2013 a draftbill was circulated to the DPR that included key pro-posals for wide-ranging reforms.

It would force insurers currently selling takaful, orIslamic insurance, through a window to spin off the busi-ness into a separate entity – Indonesia is currently thelast market to allow such windows. Underwriters willalso have to create the new position of controller, nom-inations for which must be approved by OJK. Controllerswill be responsible for determining the composition ofmanagement and key policies. Underwriters will alsobe mandated to create an in-house security fund to insu-late policyholders in the event of liquidation, as well asparticipate in a policyholder guarantee system operat-ed by the Deposit Insurance Corporation (LPS), whichcurrently administers the only bank deposit insurancescheme. Implementing regulations will be required bythe OJK to determine the make-up of the security fund,while the LPS will define the details of the policyhold-er guarantee scheme. Strengthening the enforcementpowers of OJK, the bill introduces much tougher sanc-tions under the regulator’s purview, ranging from warn-

ings and fines to rescinding registration and barringoffending individuals from key executive positions.

The bill also clarifies key ambiguities in the currentinsurance act. While the use of third-party administra-tors is not specifically covered in the 1992 InsuranceAct, the new bill allows insurers to use third parties toacquire businesses and provides for the transfer ofsome business management roles to operators outsidethe company. The new bill would also require OJK toestablish an independent rating and statistics agencythat would determine benchmarks for premiums, as wellas collating industry statistics. Aside from consumer pro-tection and governance provisions, there is concernabout implementing related laws on the ground. POINTS OF CONTENTION: While these provisions com-mand widespread support as they strengthen the reg-ulator’s enforcement powers and sanitise business con-duct, debate has focused on proposals to introduce newcaps on foreign ownership of insurance firms. Ratherthan easing caps on foreign direct investment (FDI)ahead of ASEAN-wide liberalisation in 2015, the billproposed new restrictions requiring foreign investorsto own stakes in underwriters only through public cap-ital markets, rather than direct unlisted equity stakes.Although some legislators had proposed reducing thecap from the current 80%, albeit not retroactively, thisis unlikely to be included in the final bill given the scopefor further FDI-financed mergers and acquisitions.

Debate over this issue, coupled with other legisla-tive priorities, has delayed passage of the bill, whichwas originally planned for 2013. While the draft was inits final reading at the DPR in March 2014, it remainsuncertain whether it will be passed prior to legislativeelections in April 2014. “Political manoeuvring will sure-ly increase in the run-up to the 2014 national elections;a close watching brief is needed for both current insur-ance regulation and political attitudes to possible futureregulation,” according to legal firm Clyde & Co.’s “Glob-al Insurance Legal Developments 2013” report.

Although legislative reform always runs the risk ofintroducing new restrictions on investment, particu-larly in an election year, the insurance industry remainsbroadly supportive of the broader effort to reform. Thenew regulator’s more assertive stance reflects a gen-erally recognised need to update rules that were definedprior to the significant growth in insurance after 1992.

143

A draft bill circulating in

the House of

Representatives would

mandate insurers currently

selling takaful through a

window to spin off the

business into a separate

entity.

145

EnergyDiversification continues amid hydrocarbons discoveriesGeothermal energy presents a viable renewable optionDemand growth is rapid and fuel subsidies may shrinkA raft of regulatory changes are being considered

ENERGY OVERVIEW

The nation’s reserve to production ratio was 11.1 as of 2013

The nation’s vast territorial expanse and establishedpresence of experienced, well-financed internation-al and domestic oil firms has led to the discovery andexploitation of a succession of sizeable oil and gas proj-ects across the country for more than 125 years.Lured by attractive production contracts, consider-able remaining reserves and strong energy prices, thecountry more recently has managed to mitigate thedecline of its maturing oil fields and even boost over-all energy output from 2007 to 2010, throughincreased natural gas production and a concertedeffort to maximise the efficiency of its legacy fields.

This trend took a turn for the worse in 2010 whenuncertainty over the interpretation of the regulato-ry framework of the sector came into question andthe lack of stability within the oil and gas sector as awhole began to give operators – particularly interna-tional ones – pause before making new large-scaleinvestments or even extending existing agreements.CASH FLOW: Despite efforts to diversify the econo-my, the energy sector remains very much a crucial con-tributor to government coffers. For 2012 the upstreamoil and gas industry contributed $34.9bn towardsstate revenues, exceeding the target of the Indone-sian Revised Budget of $33.48bn, according to the SKKMigas 2012 annual report. Petroleum sales account-ed for a whole 58% of the government’s gross rev-enue stream on the year. Upstream investment in the

sector continued to grow for the fourth consecutiveyear with 2012 inflows hitting $16.1bn, $2.1bn morethan the $14bn seen in 2011. The lion’s share of 2012funding, $13.7bn, was channelled towards activitiessuch as staving off production declines of maturingfields, leaving $1.4bn for exploration activities withthe remaining $1bn going towards administrativecosts, according to SKK Migas.OIL RESERVES: As domestic oil consumption contin-ues to outpace exploration, reserves continue todecline, with SKK Migas estimating proven oil andcondensate reserves at 3.59bn barrels of oil withanother potential 3.68bn barrels in the ground, as ofJanuary 1, 2013. The reserve replacement ratio (RRR)in 2012 was 52%, indicating that every barrel of oilproduced was replaced by half a barrel of new dis-coveries. The RRR for natural gas, by contrast, paintsa rosier picture, with a RRR of 127% and provenreserves of associated and non-associated gas of104.37trn standard cu ft (tscf) along with the poten-tial for an additional 48.38 tscf. These figures are sim-ilar to those published in BP’s “Statistical Review ofWorld Energy 2013”, which listed Indonesia’s oilreserves at 3.7bn barrels, down from 4.7bn barrels atthe end of 2002, and a reserve to production ratio of11.1. Natural gas reserves were estimated more con-servatively as well, at 103.3 tscf, compared to the 91.8tscf estimated at the end of 2002.PRODUCTION: Mirroring global energy compositionas a whole, Indonesia’s hydrocarbon output can bebroadly characterised as a continued and steadydecline of oil output from maturing fields offset byenhanced oil recovery efforts as well as an increasein natural gas production.

“Oil and gas exploration and production is shiftingfrom western to eastern Indonesia, from onshore tooffshore and the deep sea area. This means that wehave to provide more sophisticated and bigger horse-power vessels to serve these deeper sea operations.The funds that we will be able to raise to procure

As of 2013, Indonesia’s

total hydrocarbons

reserves reportedly

included 3.7bn barrels of

oil and 103.3trn standard

cu ft of natural gas.

147


In 2012 the reserve

replacement ratio for oil

was just 52%, while that for

natural gas was

significantly higher, at

around 127%.

Diversification under wayHydrocarbons remain a key contributor to the economy, but the energymix is steadily broadening

SOURCE: SKK Migas *(000 boe/day)

Oil Gas Condensates Total

2006 883.25 1367.86 122.74 2373.85

2007 836.01 1300.49 118.39 2254.89

2008 852.63 1332.13 124.15 2308.91

2009 826.63 1421.77 122.33 2370.73

2010 824.45 1581.59 120.45 2526.49

2011 794.30 1502.66 107.8 1610.46

2012 762.82 1455.27 97.09 2315.18

Production of oil, gas & condensates, 2006-12*

ENERGY OVERVIEW

these vessels will determine our capacity to grow andsupport our customers,” Eddy Kurniawan Logam, pres-ident director of Logindo Samudramakmur, told OBG.Yet in spite of efforts to reverse these trends, both oiland natural gas production have been in decline since2010 as new exploration and production efforts con-tinue to be outpaced by rising consumption. “With theamount of new discoveries occurring in deep waterand marginal fields, it becomes essential for Indone-sia to leverage technology and expertise from over-seas to develop these challenging fields economical-ly so to support the growth of the country,” R S Kumar,president director of Technip in Indonesia, told OBG.

While Indonesia is facing the challenges of increasedcosts of working maturing oil fields and the develop-ment of frontier, deepwater and unconventionalresources as well as a shortage of drilling rigs and asso-ciated manpower, the opacity of the country’s ener-gy regulatory environment is often cited as the pri-mary difficulty for companies operating in the sector.Excepting a one-off anomaly in 2008, domestic crudeoil output has decreased each year since the begin-ning of the millennium and has dropped from 1272thousand barrels of oil equivalent per day (mboepd)in 2000 to 762.82 mboepd – 860 mboepd includingcondensates – in 2012, according to SKK Migas. Theoverall curtailing of hydrocarbon production from2572.72 mboepd to 2315.18 mboepd over the sametime period has been blunted by higher natural gasproduction which increased from 1160.42 mboepd in2000 to 1581.59 mboepd in 2010, but has sincedropped off to 1455.27 mboepd in 2012.

This is slightly less than BP estimates, which pro-jected production at 918,000 barrels per day (bpd)in 2012, down 3.9% from 952,000 the previous year.For natural gas BP estimated domestic output of71.1bn cu metres (bcm) on the year, down 6.6% from75.9 bcm in 2011. The majority of this production wasderived from established wells, although two newcontract areas – Tonga and Pameran – did enter into

production starting in 2012 after securing the requi-site plan of development (PoD) approval from theMinistry of Energy and Mineral Resources (MEMR).According to the PoDs filed, the two new contract areas(CA) are projected to produce roughly 1500 bpd com-bined in 2013. Through September 2013, oil produc-tion averaged 202,000 bpd along with natural gasoutput of 260,000 boe/d, according to the state-owned energy company Pertamina.AFFECTING OUTPUT: A tailing off of output by majorinternational oil firms had a significant impact on thesector as output from ConocoPhillips Indonesia fellby 15,995 bpd (18.2% of production) from 2012 to2011 along with a 14,615 bpd drop from Total E&PIndonesie (down 17.9%) and a host of others includ-ing ExxonMobil Oil Indonesia (-12%), Pertamina HuluEnergi West Madura Offshore (-16.1%), PetroChinaInternational Bermuda (-15.2%), Chevron PacificIndonesia (-4.5%) and Chevron Indonesia (-3.8%). Alltold, only 15 active production sharing contracts(PSCs) increased their output from 2011 to 2012, ledby Hess (Indonesia-Pangkah) with an increase of 4951bpd, . Pertamina EP (3203 bpd) and JOB Pertamina-Talisman Jambi Merang (2891 bpd). Total productioncontinued to fall in 2013, with SKK Migas estimatingin July 2013 that total crude and condensate outputon the year would average 834,000 bpd, down frominitial target of 840,000 bpd. After averaging 831,700bpd through the first six months of 2013 productionis projected to pick up in the second half of the yearas the result of higher production from the WestMadura Offshore field.

A total of 308 oil and gas contract areas were activein 2012, divided into 75 tenements in the productionphase (60 producing contracts and 15 in developmen-tal stages) and 233 in the exploratory stage, accord-ing to SKK Migas. Of the production contracts, 36were located onshore and 24 offshore with the remain-ing 15 straddling both. These were further augment-ed by another 54 coal bed methane (CBM) contracts,nearly all located onshore. Another 18 contracts werein the process of being relinquished on the year. The308 CAs in 2012 bested the 287 CAs active in 2011(172 exploration, 73 production and 42 CBM), as wellas the 245 in 2010 (155 exploration, 67 productionand 23 CBM). As stipulated in the 2001 Oil and GasLaw, the split between the central government and

148

A total of 308 oil and gas contracts were active nationwide in 2012

Natural gas production

steadily increased from

1160.42 mboepd in 2000

to 1581.59 mboepd in

2010, before declining to

1455.27 mboepd in 2012.

In 2012, 96 new

exploratory wells were

drilled across the country

– 55 onshore and 41

offshore – up from 81 the

previous year.


Oil sales accounted for 58% of gross government revenues in 2012

ENERGY OVERVIEW

oil and gas contractors is 85% and 15%, respectively,for oil production, and 70% and 30% for natural gas.EXPLORATION: Indonesia is at a crossroads in itsfuture domestic production prospects. Looking at therecent history of exploration activity in the countrythere is reason for optimism as past efforts by the reg-ulator have yielded an increase in exploratory wellsdrilled each year since 2008 with a relatively consis-tent showing throughout the past decade. In 2012,96 new exploratory wells were drilled across the coun-try – 55 onshore and 41 offshore – up from 81 drilledthe previous year, according to SKK Migas. The resultsof the 2012 efforts included 60 wildcat wells, of which27 contained hydrocarbons: nine oil and gas discov-ery wells; 13 gas discovery wells; and five oil discov-ery wells. The outlying 36 wells are classified as delin-eation wells – supplementary wells drilled successivelyoutward from an original successful wildcat well inorder to determine the boundaries of the productiveformation. Investment in these areas reflected theincreased activity in oil and gas exploration in 2012,where investments of $1.4bn roughly doubled 2011levels of $719m and were well above the annual 2007-11 average of $605.6m. Although 2012 saw an increaseof exploratory wells drilled throughout the country,these efforts are attributed to the continuation ofefforts launched years before and are unlikely to con-tinue to be sustained as these programmes wind downand are not replaced by new activity.

The frequency of seismic surveys, for instance, hasdeclined over the past few years. After rapidly increas-ing from 11,775 km of 2D surveys in 2007 to 33,906km in 2010, these exploratory efforts plummeted tojust 12,549 km in 2011 and 13,995 km carried out by27 PSCs in 2012, according to SKK Migas data. Moreexpensive and more accurate 3D surveys have alsotailed off from 8900 sq km in 2010 to 8147 sq kmand 6165 sq km in 2011. Looking ahead, SKK Migasannounced in September 2013 details for the nextround of bidding for oil and gas contracts, which willinclude tendering out 18 blocks, with applications

due by January 27, 2014. The areas officered up forbidding – two through the regular tender processand 16 through direct offer – consist of both offshore,onshore and combined territory and are located pri-marily around central and East Java, Sulawesi andMaluku with other outlying blocks situated in southSumatra, Papua and south of Nusa Tenggara Timur.GAS: Among the most prolific LNG-exporting nationsin the world, Indonesia’s gas infrastructure has beentraditionally geared towards exploiting its domesticenergy reserves firstly to bolster government coffers,with domestic consumption coming second. In 2012Indonesia’s LNG exports of 25 bcm of natural gasshipped ranked it fifth behind Qatar (105.4 bcm),Malaysia (31.8 bcm), Australia (28.1 bcm) and Nige-ria (27.2 bcm), according to BP’s “Statistical Reviewof World Energy 2013”. As domestic consumption hasclimbed and oil production waned, this strategy isbeing reoriented to secure fuel for electricity gener-ation and industrial use. This shift has seen the vol-ume of domestic natural gas consumed in 2012 reach3.4bn British thermal units (btu) per day, up 262% from2003 when consumption was 1.5bn btu per day,according to SKK Migas data. Exports have declinedfrom 4.4bn btu to 3.6bn btu although exports spikedto more than 4bn btu in 2010 and 2011.LOCAL FOCUS: Outside of the domestic market obli-gations (DMO) written into PSCs, investors in the pasthad little motivation to sell on the local market whichis regulated at a substantially lower price than on theregional LNG market. This issue has been alleviatedin recent years by the regulator’s efforts to facilitatea renegotiation in domestic purchase price which hasbrought price levels closer to export parity along withconsiderations for transportation costs and possibleLNG investments. This trend continued into 2012 asthe average gas purchase price rose by 28.76%, fromthe 2012 APBN-P target of $8.23 per million Britishthermal unit (mbtu) to $10.59/mbtu, through therenegotiation of local gas prices and transfers of LNG

151


While 2D seismic surveys have covered less territory than in past years, 13,995 km were studied in 2012

The volume of domestic

natural gas consumed in

2012 reached 3.4bn btu

per day, up 262% from

2003, when it was less than

1.5bn btu per day.

LNG exports of 25 bcm of

natural gas ranked

Indonesia fifth in the world

for total LNG exports,

behind Qatar, Malaysia,

Australia and Nigeria.The local gas purchase price in 2013 was up 28.76% to $10.59/mbtu

ENERGY OVERVIEW

Tangguh Papua sales, according to SKK Migas. In spiteof these efforts, the average domestic gas priceretreated to $5.6/mbtu by mid-2013 while exportprices hovered at $14.5/mbtu according to SKK Migas,although the regulator indicated it was consideringincreasing the domestic price to at least $8/mbtu.

Ultimately, the development of new gas resourceswill be crucial in maintaining production as output hasfallen in each of the past three years, dropping from8857m standard cu feet per day (mmscfd) to 8415mmscfd and 8167 mmscfd from 2010 to 2012, accord-ing to SKK Migas. This decline reflects a fall in pro-duction from the country’s largest producers includ-ing Total E&P Indonesia, which saw productiondecrease by 442 mmscfd from 2011 to 2012 alongwith numerous other operators. To date, the country’skey gas producing areas are situated primarily in Aceh,onshore Sumatra, offshore West Java and offshore EastKalimantan with the largest reserves estimated at51.46 tscf and 24.32 tscf located in the South Natu-na Sea and offshore Papua.NEW PLAYS: With regards to recently added capac-ity, the gas deliveries from the Ruby field located inthe Makassar Straits, offshore East Kalimantan beganin October 2013. Operated by Abu Dhabi’s Mubadala

Petroleum subsidiary Pearl Oil, production of the fieldis projected to reach 100 mmscfd and be deliveredto Pupuk Kalimantan Timur’s fertiliser plant via a 312-km pipeline to Total's Senipah onshore gas process-ing plant. Other partners in the block are Total E&PSebuku (15%) and Japan's Inpex (15%).

Progress was also made by Mobil Cepu at its BanyuUrip field, with the project increasing the productionof oil from early production facility to 28,500 bpdstarting October 2013. This represents 6200 bpdincrease from the recent 2012 production levels anda total of 8500 bpd from its original design capacityof 20,000 bpd in 2009. Chevron Indonesia’s Indone-sian Deepwater Development (IDD) project is expect-ed to deliver an additional peak production of 924mmscfd of gas and 23 thousand barrels of conden-sates per day (mbcpd) from the Gendalo, Maha, Gan-dang, Gehem, and Bangka fields by 2017. Other proj-ects under way include the Adabi field being workedby Inpex Masela with reserves projected at 6-9 tcfwhich is scheduled to start its 30-year productionrun in 2017 and will include a 2.5m tonnes per annumfloating liquid natural gas (FLNG) plant; the Jangkrikproject, targeting 913 bcf of gas and 739 mbcpd ofcondensates within the Jangkrik and Jangkrik NE fieldsstarting in 2015, developed by Eni Muara Bakau; theBukit Tua field operated by Petronas Carigali Keta-pang II, with a 20,000 bpd and 70 mmscfd capacityproduction facility slated to begin operations in late2014; the Ande Ande Lumut (AAL) field operated byAWE (Northwest Natuna), the first project developedin the Northwest Natuna block with an estimatedpeak production of 25,000 bpd and initial output pro-jected for late 2014; the North Duri Field operated byChevron Pacific Indonesia, with a peak productionrate gearing up to 17,000 bpd of oil in 2017 after ini-tial flows begin in December 2013; the Kepodangfield operated by PC Muriah and expected to produce365 bcf of cumulative gas with a flow rate of 116mmscfd of gas for 12 years starting in October 2014.LNG: Building on its robust LNG export infrastructure,Indonesia is in the midst of a substantial expansioncampaign which will see a dramatic increase in bothshipping and receiving terminals across the country.As the country shifts its primary energy mixture awayfrom coal and oil, the flexibility achieved through the

152

Gas production continued to decline in 2012, hitting 8167 mmscfd

Indonesia has made

expansion of its LNG

export infrastructure a key

priority, resulting in

upgrades and expansions

at shipping and receiving

terminals nationwide.

ENERGY OVERVIEW

addition of regasification terminals as well as newliquefaction capacity will provide opportunities bothfor increased consumption of domestic gas as well asexport opportunities depending on how future domes-tic market obligation policies play out. While some pro-duction from existing LNG facilities such as Bontangand Arun is projected to tail off over the next decade,losses such as these are expected to be more thanmade up by the bevy of new LNG plants scheduled tostart up in the coming years.

One of the more interesting projects is the retask-ing of the country’s oldest LNG plant of Arun, whichat one time operated six trains of LNG capacity, intoa receiving regasification terminal by November 2014as local natural gas supplies are expended and the lastof its contracts expire. Existing distribution from thefacility will be extended through the Arun-Belawanpipeline totalling approximately 160 km in length. The2.5m-tonne third-party access Donggi Senoro LNGproject (DSLNG) which will source gas from the Senoro(producing 310 mmscfd), Donggi (50 mmscfd) andMatindok (55 mmscfd) fields is also under construc-tion and on schedule to begin operations in the fourthquarter of 2014. Located in southwest Sulawesi, theproject is being developed by a consortium that is ledby Sulawesi LNG Development (itself a partnershipbetween Mitsubishi and Kogas), with a 59.9% stake,along with Pertamina Hulu Energi with 29% and Med-co LNG Indonesia with 11.1%. Additional gas from theproject will be dedicated for use by Indonesia’s stateelectricity company PLN for electricity generation aswell as for feedstock in fertiliser plants. TRAIN GROWTH: Capacity at existing facilities is alsobeing boosted, with plans to add a third 3.8m tonnesper annum (tpa) LNG train to the Tangguh facility andboost the overall capacity of the plant to 11.4 mtpa.Construction on a new $12.1bn train is expected tobegin in 2014 with the project scheduled to comeonline in 2018. Operated by majority stakeholder BPwith a 37.16% share in the project along with MI BerauB.V. (16.30%), China National Offshore Oil Corpora-tion (13.90%), Nippon Oil Exploration (Berau) (12.23%),KG Berau/KG Wiriagar (10.00%), LNG Japan Corpora-tion (7.35%), and Talisman (3.06%), the plan calls for40% of the output from the third train be reservedfor PLN for use on the domestic market. With exportand domestic consumption of Indonesian gas nowroughly equal, the country is also moving ahead withplans to provide regasification terminals in order tocounter regional shortfalls in the main demand areasof Java and South Sumatra. In addition to the Arunproject and the Regas Satu terminal already in oper-ation serving West Java, floating storage and regasi-fication units are also projected to start operationsin East-Central Java and South Sumatra in 2014. DOWNSTREAM: Indonesia’s large population basecoupled with a rapidly expanding economy over thepast few years and substantial fuel subsidies has fos-tered strong growth in primary energy consumptionacross the board. This trend, along with minimal invest-ment in new refining capacity over the past few

decades, has resulted in an increase in importedrefined products for domestic demand.

According to a report by Wood Mackenzie in Sep-tember 2013, the growing shortfall will cause Indone-sia to surpass the US as the world’s largest importerof petrol by 2018 – 10 years after it surrendered itsposition within OPEC. The report estimates the Indone-sian petrol deficit will grow from 340,000 bpd toaround 420,000 bpd by 2018, while the US/Mexicomarkets will see their shortage dwindle from 560,000bpd to just 60,000 bpd. According to Eddy KurniawanLogam, president director of Logindo Samudramak-mur, “Going forward, Indonesian exploration and pro-duction has to grow faster to keep up with the everincreasing domestic demand.” DOMINANT PLAYER: In spite of the liberalisation ofthe sector in 2001, the downstream segment remainsdominated by state-owned Pertamina, which owns andoperates six refineries throughout the country, witha combined total capacity of just over 1m bpd. Theseinclude the Dumai-Sei Pakning refinery located inCentral Sumatra with a capacity of 170,000 bpd, thePlaju refinery in South Sumatra at 127,200 bpd, Cili-cap in southern Java (348,000 bpd), Balikpapan inKalimantan (260,000 bpd), Balongan in West Java(125,000) and Kasim in West Papua (10,000 bpd).Pertamina is also carrying out an upgrade project atthe cost of $7bn for its existing refineries. The proj-ect focuses on the Balongan, Cilacap, Balikpapan,Plaju and Dumai facilities, which is expected to boosttotal capacity to 1.2m bpd between 2015 and 2018.

153


SOURCE: SKK Migas

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Fertiliser 1.1 1.17 1.77 1.94 2.88 3.08 3.33 3.61 3.33 3.61

Electricity 1.18 2.28 3.17 4.41 6.25 6.94 7.01 7.59 7.01 7.59

Industry 0.1 2.7 4.1 4.2 6.15 10.07 10.18 10.34 10.18 10.34

Total 2.38 6.15 9.04 10.55 15.28 20.09 20.52 21.54 20.52 21.54

Volume of domestic gas contracts, 2003-12 (trn cu ft)

Construction is set to begin on a new $12.1bn LNG train in 2014

The growing shortage of

domestic petrol production

capacity will see Indonesia

surpass the US as the

world’s largest importer of

petrol by 2018.

ENERGY OVERVIEW

OVERCOMING SUPPLY GAPS: To bridge the supplygap, which currently requires importing up to 400,000bpd of finished products each year, the governmentis looking to add around a half million barrels per dayto its refining capacity – roughly half of Indonesia’scurrent capacity. As of 2013, new projects were stillin the early stages of development and had not pro-ceeded past the licensing stages for new refineriesto be located in East Java, South Sumatra, Lombok andSouth Sulawesi. In 2013 Pertamina has focused onjointly developing at least two new refineries withexperienced partners from the Middle East. The firstof the two 300,000 bpd refineries is to be built inpartnership with the Kuwait Petroleum Corporation(KPC) in Balongan while the second facility will bedeveloped in conjunction with Saudi Aramco AsiaCompany and located in Tuban, East Java, accordingto Pertamina. Although the Saudi and Kuwaiti firmsare signed on as technical partners, Pertamina has indi-cated that it still plans to carry out a tendering process

for the projects. The company announced a feasibil-ity study for the $6bn Pertamina–KPC project wascompleted in August 2013 following the Februarysigning of a memorandum of understanding for an$8bn refinery with Saudi Aramco for which feasibili-ty studies were still ongoing as of late 2013. In spiteof the progress made on these undertakings, both ofwhich could be scheduled to come online by 2018, anumber of significant obstacles still remain in theform of ongoing negotiations between the potentialpartners. The negotiations centre around the subjectof incentives for the projects, including of exemptionfrom corporate income tax, Custom’s tax and infra-structure development. Coordinating Economic Min-ister Hatta Rajasa also stated in September 2013 thatanother refinery project slated to come online by2018 was also under development that would bestate-funded and operated solely by Pertamina withcrude sourced from Iraq. Pertamina is also a partnerin developing the West Qurna-1 oilfield in Iraq, whichis anticipated to be a possible source of inputs. “It istime for the government, members of parliament andall of the country’s leaders to formulate the nation-al energy roadmap in order to optimise the country’senergy resources,” Logam, president director of Login-do Samudramakmur, told OBG.OUTLOOK: Although Indonesia may never be able toreclaim its OPEC status, which was forgone in 2008when it became a net importer of oil, both the coun-try’s untapped conventional and unconventionalreserves have the potential to significantly ease thecountry’s energy import bill. Exploring and exploitingnew oil and gas fields – including more expensiveplays such as shale gas, CBM, deepwater and frontierresources – will be increasingly important for both thegrowing domestic market as well as lucrative exportsas maturing legacy fields continue to decline in pro-ductivity. The success of these efforts relies not onlyon the technical capabilities of the oil and gas oper-ators in the country, but also on the creation of a sta-ble regulatory framework to restore their confidence.

154

A new refinery is set to be built to help reduce the growing fuel gap

The present supply gap for

finished petroleum goods

requires imports of

approximately 400,000 bpd,

which the government

hopes to eliminate by

adding 500,000 bpd of

refining capacity.

ENERGY ANALYSIS

A record for power generation was set in 2012, of 200,317 GWh

Rising domestic consumption brought on by organicpopulation growth as well as increased energy inten-sity from industrial and economic expansion is fuellingthe country’s drive to boost electrical power genera-tion capacity, which is targeted to double in size by2020. Delivering this new wave of electricity genera-tion will be crucial for the development of Indonesiagiven the fact that its current installed capacity ofaround 40 GW ranks it among the lowest in the region,far behind other nations such as Thailand, Malaysia, Viet-nam and the Philippines. While state-owned powercompany Perusahaan Listrik Negara (PLN) retains thebulk responsibility for power generation in addition toits role as transmission system operator and distribu-tor, independent power producers (IPPs) are also tak-ing on a larger share of power production, moving for-ward since their foray into the market following thepassage of the 1985 Electricity Law. GENERATION: Striving to keep pace with perpetuallyrising demand, 2012 marked another record year forpower production, which exceeded the 200,000-GWhmark for the first time. Of the 200,317 GWh produced,PLN accounted for roughly three-quarters of all gen-eration with 149,755 GWh compared with 50,562 GWhfrom IPPs, although losses and other technical aspectsput the total amount sold to consumers at 173,000 GWh,according to PLN data. The residential sector remainedthe largest single purchaser of electricity, accountingfor 41.5% of all power used, followed by the industrialsector with 34.6%, and commercial and public usageat 17.8% and 6.1%, respectively. Of this energy produc-tion 39,108.56 GWh (26.12%) was produced by natu-ral gas, 66,920.80 GWh (44.69%) was produced by coal,29,640.59 GWh (19.79%) by oil, 10,524.61 GWh (7.03%)by hydro and 3557.54 GWh (2.38%) by geothermal. Asthe largest single power producer, PLN operated 32,901MW of installed capacity in 2012, up 12.4% from the29,268 MW the previous year, as per PLN data. Of these,coal-fired steam power plants were the largest contrib-utor, representing 14,446 MW of capacity, followed by

more modern combined-cycle power plants fuelled byfossil fuels with 8814 MW, 3516 MW of hydropower,2973 MW of gas turbine capacity, 2590 MW of diesel-fired generators, 548 MW of geothermal, and less than10 MW of solar and wind power production. Two of thelarger private power producers selling electricity toPLN in 2012 included the Paiton Energy Company, whichsold 8514 GWh (18.34% of private sales) to the nation-al grid, and Jawa Power with 8450 GWh (18.20%). PLANNING FOR THE FUTURE: Given the prevalenceof the fuel spread throughout the country, it comes asno surprise that Indonesia’s primary power source willstay as coal for the foreseeable future. But while thecheap and plentiful carbon supply will remain a main-stay of the country’s energy mix going forward, improve-ments in technology and growing concerns about boththe environment and energy security have led the coun-try to explore and eventually employ a more variedenergy strategy. Recognising the need for diversifica-tion, various segments of the government have craft-ed related strategies, plans and legislation over theyears to further these goals in the form of Law 30 of2007 on energy diversification; Presidential RegulationNo. 5 of 2006, which calls for a eventual 17% contri-bution of renewable energy to the primary energy mix;and the Ministry of Energy and Mineral Resources’(MEMR) Vision 25/25, which outlines a plan to achievea 25% renewable energy contribution by 2025.To this end, Suriyanto, president director of EnviromateTechnology International, told OBG, “ASEAN integra-tion will boost the environmental sector in Indonesiaas nations in the region will have greater opportuni-ties to share technology and solutions.”

As a whole, these plans vary in their target goals andtimelines but all seek to reduce the role of petroleumwithin the energy mix, secure domestic energy needs,reform subsidies and develop new and renewable ener-gy sources. While delays have limited the expansion ofrenewables called for in these strategies, increasing theproduction and domestic use of natural gas has proven

The state-owned power

company had 32,901 MW

of installed capacity in

2012, up 12.4% on the

previous year. Coal-fired

steam power was the

largest contributor, with

14,446 MW, followed by

combined-cycle power

plants fuelled by fossil

fuels, with 8814 MW.

155


While carbon resources are

plentiful and will remain

the leading contributors to

the nation’s energy mix,

environmental and supply

security concerns have

prompted the government

to pursue a varied energy

strategy.

Fuelling growthWith demand surging, the government is adjusting to maintain supply

ENERGY ANALYSIS

more successful in the short term. Known as the “bridgefuel” between dirtier-burning coal and generally moreexpensive renewables, natural gas is playing a growingrole in the country’s energy mix, in spite of a heavyreliance on gas exports in the past. Since 2003 the accu-mulated volume of domestic natural gas contracts allo-cated for electricity production has increased from1.18trn cu feet (tcf) to 7.59 tcf by 2012, according toSKK Migas. In 2012 alone 17 new contracts were signedto provide 580.73bn cu ft (bcf) of natural gas for pow-er plants. These contributions could increase in thefuture as well, with new forays being made in terms ofunconventional natural gas plays including shale oiland coal bed methane, the latter of which has alreadyinitiated its first 3-MW demonstration power plant.

In the short term, the government has launched apair of fast track programmes (FTPs), FTP1 and FTP2,each of which calls for the construction of 10 GW ofgeneration capacity. Initiated in 2006, FTP1 was origi-nally scheduled to have new plants up and running by2013, but delays have meant that about one-third ofthese projects had yet to be completed by 2014. FTP2is expected to be extended to 2020, reflecting the pushfor energy diversity. The plan will consist of 49% geot-hermal, 30% coal, 17% hydro, 3% gas turbine and 1%combined-cycle power plants, with 63% of projectstaken on by IPP contractors and 37% by PLN. RENEWABLES: While the FTPs should, when complet-ed, provide the power supply stability needed in the shortterm primarily through the usage of proven, tradition-al hydrocarbons (geothermal projects not withstand-ing), lessening the country’s reliance on fossil fuelsremains a long-term goal for the government. In orderto reduce Indonesia’s vulnerability to price shocks inthe market, increase its domestic energy security andprovide more environmentally friendly alternatives,more renewable power will need to be developed.

While geothermal projects already make a notice-able contribution to sustainable power and have thepotential to have a serious impact on the sector (seeanalysis), another well-established power source with

untapped potential of some 75 GW is the hydropow-er sector. To date, investments have limited the sectorto 6.6 GW of installed capacity, due to a number of chal-lenges, including the remote location of potential sites,difficulty with connectivity to the grid and low tariffs.Financing also remains a challenge for long-term, large-scale investments, with sovereign guarantees onlyoffered for geothermal projects.

In spite of the creation of the National Energy Poli-cy in 2006, the Energy Vision 25/25 in 2010 and theaddition of a feed-in tariff (FIT) in 2012 payable for geot-hermal and small scale (under 10 MW) hydro and bioen-ergy, large-scale implementation of other renewablesstill faces significant financial and regulatory hurdles.

“In order to attract sufficient investment, the FITsimply must be adjusted so to incentivise developmentof renewable energy resources. For example, Indone-sia offers $0.09-0.12 KWh for biomass-generated elec-tricity while the Philippines offers $0.15 plus,” KK Ral-han, president director of power solutions companyKaltimex, told OBG. Hydro, solar and wind participationin the FIT scheme are still being finalised, and landacquisition also remains a concern for the land-inten-sive projects required for commercial-scale wind andsolar photo-voltaics as well. Charles Gobel, CEO of Bor-mindo, told OBG, “Land acquisition continues to be thesingle most problematic issue for the onshore indus-try and it has gotten out of control, as landowners havethe upper hand in negotiations and there is no clearlegal framework to solve these challenges.”INFRASTRUCTURE: The national electrification ratiohas climbed rapidly over the past three decades from8% in 1980 to 57% by 2000, and has continued this riseto reach 77.65% as of 2013, as per MEMR data. As of2012, Indonesia’s electrification ratio still lagged farbehind the Philippines (89.7%), Vietnam (97.3%), Thai-land (99.3%) and Malaysia (99.4%), according to Renew-able Energy Support Programme for ASEAN reports. Asof 2012, PLN operated a national grid totalling some38,096 km of 25- to 500-kV transmission lines, alongwith 741,957 km of low- and medium-voltage lines.

156

The country is seeking a

balance, using

hydrocarbons in the short

term to support industrial

growth, with plans to phase

in renewable power for

long-term sustainability.

ENERGY ANALYSIS

Geothermal enables construction of power stations in remote areas

Already the third-largest geothermal power producerin the world behind only the Philippines and US, Indone-sia is counting on tapping into more of this abundantrenewable power source to diversify its rapidly expand-ing power sector. Located along the infamous ring offire amidst the convening of the Eurasian, Australian,Pacific and Philippine Sea plates, the same geologicforces responsible for the constant menace of earth-quakes, tsunamis and volcanic eruptions also providea powerful and abundant power source ready to be har-nessed. Seismic surveys and other studies – many car-ried out during oil and gas exploration – have revealed299 potentially exploitable targets for geothermal pow-er stations across most of the country, from Sumatra,Java and Bali, to East Nusa Teggara and Papua.

As of August 2013, the country’s installed capacityof 1341 MW represented a fraction of total domesticpotential, estimated at nearly 29 GW by the IndonesiaGeothermal Association (IGA). Of this amount, a 2011Ministry of Energy and Mineral Resources (MEMR) sur-vey projects 16 GW of reserves, of which 2.28 GW wereproven, 0.82 GW probable and 12.91 GW possible, withthe outstanding 13 GW speculative. KEY ADVANTAGES: Like other renewable energy pow-er sources, geothermal power has the advantage of util-ising a virtually free source of fuel, once the initialinvestment and infrastructure are completed. Howev-er, unlike other renewable technologies, such as wind,solar or hydropower, geothermal power sources are notsusceptible to changes in seasonal or daily weather pat-terns, which can result in highly variable electricity out-put. Additionally, without the need for fuel transportinfrastructure, such as ports, roads or pipelines, pow-er plants can be established in more remote areas andeven in isolated regions not currently accessed by thenational electricity grid. The Indonesian geothermalindustry also has the advantage of a high profile andstrong lobbying sector – a product of an affiliation with the oil and gas industry with which it shares manycommon exploration and exploitation similarities.

EXPANSION PLAN: In line with the government’s Vision25/25 energy development plan which is targetingrenewable energy to comprise 25% of Indonesia’s pri-mary energy mix by 2025, geothermal power produc-tion is expected to take on an increasingly large shareof domestic electricity production with a total contri-bution of 5.7% (9500 MW) of all power production by2025. The most immediate geothermal expansion plancalls for the addition of 4925 MW through the Fast Trackprogramme II (TFP2) at an estimated investment costof $12.61bn, according to MEMR. Of this, 465 MW willbe derived from development of production of fourexisting geothermal work areas (GWAs), 1535 MWfrom new development within 14 existing GWAs and2925 MW spread over 22 new GWAs.

If successful, the FTP2 programme would help toalleviate the growing electricity supply crunch while atthe same time reduce carbon dioxide output by 400tonnes from 2010 to 2025. The largest of these is theSarulla 1 plant in North Sumatra with a projected capac-ity of 3 x 110 MW, although other large projects beingdeveloped in new GWAs such as the Muaralaboh andRantau Dadap in West Sumatra and the Rajababasa inLampung (all of which boast an installed capacity of 2x 110 MW) are further along in their development,having already conducted infrastructure preparation andentering into exploration stages. CHALLENGES: In spite of the push by the public andprivate sector to bring more of the country’s geother-mal potential online, a number of roadblocks in the formof high development risk and large initial capital expen-ditures are still slowing process on the construction ofnew projects. Although geothermal requires little in theway of unit cost and boasts a high capacity usage, theselonger term benefits are offset in the short term by high-er upfront expenditure which average approximately$3m-$4m per megawatt of installed capacity com-pared to around $1.5m-$2m per megawatt for coal-fired power plants. These costs differences are furtheraffected by the longer term of development required

Geothermal power is

expected to account for an

increasingly large share of

domestic electricity

production, with a total

contribution of 5.7% (9500

MW) of all power

production by 2025.

157


As of August 2013, the

country’s installed capacity

of 1341 MW represented a

fraction of total domestic

potential, estimated at

nearly 29 GW.

From the core Geothermal potential is high and projects are under way

ENERGY ANALYSIS

for exploration and construction time which general-ly averages around seven years from survey stages toproduction. Another financing issue relates to pur-chase power agreements (PPAs) for geothermal proj-ects which are signed before exploration and construc-tion begin, and thus do not take into account fullknowledge of the power plant potential prior to itscompletion and as a result are difficult to assess. Becausethe majority of new geothermal projects are beingdeveloped by independent power producers (IPPs) andnot PLN, financing is a key issue as the majority of IPPsare financed approximately 70% through loans. LAND CHALLENGES: Perhaps the greatest impedi-ment to the sector is the restrictions on land use whichcan draw out the permit and approval process for yearsor even block projects outright. The 1999 Forestry Lawand the 2007 Spatial Zoning laws generally regulateand restrict activities from being carried out in protect-ed forest areas, although subsequent ordinances suchas government regulation 10 (GR 10) of 2010 allowspecific projects including power generation to be car-ried out in protected forest if they are deemed “strate-gically important” while GR 28/2011 specifically allowsgeothermal projects in protected forests. A 2011 mem-orandum of understanding between MEMR and theForestry Ministry was also signed for the purpose ofaccelerating the geothermal permits process withinproduction, protected and conservation forests.Although there has been progress in acknowledgingthe disconnect between forestry policy and the devel-opment of geothermal resources – many of which arelocated within areas protected by law – solutions forreconciling these conflicts were still being hammeredout as of late 2013. Given these obstacles, IndonesiaGeothermal Association (INAGA) projects a maximumof 6638 MW of practical and achievable installed geot-hermal capacity by 2025, roughly two-thirds of the9500 MW target. This revision takes into account delaysalready incurred to the developmental timeline, whichwould require 4600 MW to be installed in 2014-16, about

triple the current installed capacity, and the five to sev-en years required to complete early stage developmentof each of the 51 GWAs. This figure could be revised,however, if the investment environment improves witha revised power pricing policy, financial support and clar-ity on development in national parks. MOVING FORWARD: In order to resolve these chal-lenges, the government and the private sector have cob-bled together a number of measures designed to facil-itate growth in order to meet developmental targets.A number of laws and decrees have been passed since2010 both mandating the construction of new geot-hermal power production, requiring state-owned trans-mission system operator and distributor PLN to purchasepower and sweetening the pot for investors through anumber of fiscal incentives. New feed-in tariff regula-tions were implemented in 2012, assuring geothermalpower producers (among other renewable producers)a minimum price for their off-take at a range of $0.10-0.185 per MWh depending on geographic location andvoltage. The Geothermal Fund was also established in2011 and received Rp2trn ($2bn) in funding at the endof 2012 for use by the government investment unit toestablish and disseminate high-quality, independentlyverified exploration data to investors during the ten-dering process of new work areas. Local news outletsalso reported in March 2013 that the fund will also beused to finance soft loans of up to $30m per project. FINANCIAL SOLUTIONS: To address the financing chal-lenges for these projects directly, the INAGA and thebanking sector have also suggested increased finan-cial incentives in order to counter the higher perceivedrisks and lack of ability to assess project feasibility whichhave restricted the flow of capital to geothermal proj-ects. Some of the options floated at the EBTKE ConnexRenewable Energy and Energy Conservation Conferenceheld in August 2013 in Jakarta include further reformsto energy prices to better reflect risk and market con-ditions, some form of cost recovery such as is presentin the oil and gas sector, further tax breaks, reconfig-uring of PPA structure and other measures.

Finally, many of the non-financial regulatory issuesare included in the new draft bill amending Law No. 27of 2003 on Geothermal Energy, which went to theHouse of Representatives in October 2013 and couldbe enacted by the government in April 2014. Amongthe key revisions are resolving cross-ministry conflictsby removing the mining classification of geothermalactivity, thus allowing development in conservationareas. Other relevant changes involve establishing pro-visions for shareholding in private geothermal powerplants; clarifying government authority to delegategeothermal exploration and exploitation for both state-owned and independent enterprises; confirming thestate’s prerogative to revoke geothermal licenses grant-ed by low levels of regional government; and establish-ing guidelines for regional governmental managementof geothermal resources (including an obligation forgeothermal concession holders to offer a 10% stake inpower plants to regionally owned enterprises or state-owned enterprises after it enters the exploitation stage).

158

Indonesia is home to 299 sites that could potentially be exploited by geothermal power stations

Taking into consideration

the obstacles currently

faced by the industry, it is

estimated that a maximum

of 6638 MW of installed

geothermal capacity is

achievable by 2025.


ENERGY INTERVIEW

Karen Agustiawan, President Director, Pertamina

How is Pertamina working to reduce Indonesia’s

dependence on the usage of conventional oil and

gas, and which energy sources will take priority?

AGUSTIAWAN: Priority will given to geothermal sources,because we have the potential to benefit from alter-native energy such as biofuels. At the same time, it isimportant to be realistic about developments within thisindustry. For instance, over the next decade, oil pro-duction will decline to 400,000 barrels per day (bpd) ifwe are unable to find another major source of oil andgas. Peak production can be maintained for the nexttwo or three years at most before beginning to decline.

We do have some resources in gas. However, theseneed to be optimised. My vision for the company is tohave all ships, buses and trucks in the country fuelledby liquefied natural gas or compressed natural gas. Thisshould take off over the next few years, with the aimthat Indonesia will no longer be dependent on oil.

Brazil attempted something similar with biofuel inthe 1970s. When Indonesia became a net importer ofoil and gas, it should have gone down the same pathas Brazil, but we regrettably missed this chance. Tak-ing into account the country’s deficit, we can live with-out massive exports of crude palm oil (CPO), but wecannot cope without our current imports of energy.

If we can replace a portion of these oil imports byreducing CPO exports and dedicating ourselves to bio-fuel it will help tackle the country's deficit. Of coursewe would have to find ways to compensate palm oil farm-ers as if they had the export price, but this would besmaller than the current subsidy for energy. If success-ful, this could reduce crude dependency to 30% of cur-rent usage. Any production site that has geothermalshould use it for electricity generation, while any sitethat has hydropower potential should use it for elec-tricity generation – and so on for biomass and solar.

We must avoid becoming dependent solely on Perusa-haan Listrik Negara (PLN) for power generation. Thisis where small and medium-sized enterprises can playa leading role in contributing to Indonesia’s economy.

To what extent can Indonesia replicate the US’s suc-

cess with shale gas exploration and production?

AGUSTIAWAN: While shale gas contains great poten-tial, we do not yet have the infrastructure in place totake advantage of it. Besides, we are still not sure howmany export licenses the US government will issue inthe short term. As a result, I feel sceptical that we willdevelop these fields. These are long-term investments,requiring as many as three decades to make sense froman economical point of view. If the domestic marketcould pay for the high prices of Indonesian gas thenwe could consider it, but I doubt this will be the case.

Which specific infrastructure projects would make

investing in exploration and production in eastern

Indonesia more attractive to energy majors?

AGUSTIAWAN: Pertamina is entering the Papua sideeven though we are not among the largest players.Therefore, we would like to see the government buildnew infrastructure there such as fertiliser and cementplants, and even invest in the food industry. It can alsobe very expensive at present to get products to Papuaowing to the costs incurred during transportation.

Therefore, while we do need to think about provid-ing energy security to eastern Indonesia, we cannot ofcourse also forget that we are a corporate structureseeking profit, and that we need an economic scale forus to have a stronger presence in the area.

How would you assess the progress that has been

made in negotiations to incentivise refinery invest-

ments in conjunction with foreign companies?

AGUSTIAWAN: The existing incentives are not suffi-ciently appealing for foreign investors to build refiner-ies at the present time. As a result, the government isrevising its plans with the intention of launching an inter-national bid. The goal will be to increase downstreamcapacity to 600,000 bpd by 2017 thanks to these twonew refineries. Having said that, we would also like tosee the construction of a third refinery in Indonesia.

159


Fuel for the futureOBG talks to Karen Agustiawan, President Director, Pertamina

ENERGY INTERVIEW

Nur Pamudji, President Director, Perusahaan Listrik Negara

To what extent does Indonesia’s generation

capacity match demand? How does PLN plan to

expand access to electricity across Indonesia?

PAMUDJI: Indonesia has sufficient power supply tomeet its demands, including a surplus in Java. In fact,we already have excess capacity of more than 30%in Java and have decided to build two 1000-MWunits there. As for additional power projects, PLN isfacing some challenges related to land acquisition,but I am confident that we will be able to overcomethese and build the necessary infrastructure.

In the rest of Indonesia, distribution is more dif-ficult because the electrical grid remains weak. Forexample, South Sulawesi has a capacity of less than1000 MW, North Sumatra has only 1600 MW andSouth Sumatra has less than 1500 MW. The grid inthese areas needs to be ramped up.

Other than the construction of new power plants,there will also be an interconnection from Sarawak,Malaysia, into West Kalimantan province.

Sarawak is due to sell its surplus hydropower toIndonesia from mid-2015, providing sufficient pow-er to West Kalimantan. As a result, Indonesia will nothave any capacity challenges.

Currently, 50% of Indonesia’s electrical power

comes from coal; what plans are there to diver-

sify this energy mix in the medium term?

PAMUDJI: Two years ago coal represented just 38%of the mix, and now it has increased to approximate-ly 50%. Soon this figure will increase to around 65%,which I believe will be too much. Of course, if we canobtain additional gas it will be more economical tobuild gas-fired plants – but this is not a feasibleoption in the medium term.

Our greatest challenge is boosting renewables.We have the largest geothermal potential in theworld but at the present moment we only have 1300MW in production. We have a 6000-MW geother-mal project under development, but it is possible that

only half of it will be actualised; the rest will bedelayed due to limited concession capabilities.

How much appetite has there been from domes-

tic financial institutions to fund PLN’s expansion

and what role do you see international capital

playing financing these projects in the future?

PAMUDJI: Compared to Indonesia’s strong demand,I believe local sources of funding remain limited. In2012, we sold $1bn worth of bonds; two years ago,we sold the same amount. That amount of moneycannot be absorbed locally: if it were, the country’sentire resources would go to PLN.

To avoid this outcome, PLN is aiming to sourcefinancing from outside of Indonesia, for example inHong Kong, Singapore, Europe and the US. Of course,we are aware of the risks of borrowing in foreign cur-rency, given the volatility of the exchange rate withthe rupiah. Accordingly, instead of bonds, we arenow looking to raise funds from banks, as it is cheap-er and we believe it is a viable option.

What measures are being taken to increase local

partnership in PLN’s operations?

PAMUDJI: PLN wants to purchase electrical equip-ment from local companies, so we encourage firmsto build manufacturing facilities here in Indonesia.PLN can work with companies to facilitate their entryinto the market. For example, if a new companydecides to build switchgear equipment, such as cir-cuit breakers, they can ask us to guarantee that PLNwill purchase this product. The company is a pioneerinvestor in this segment, so we can guarantee thatup to 49% of the equipment required by PLN will bepurchased from their factory for the next five years.

PLN has given this guarantee to allow the firm tobuild its manufacturing facilities in Indonesia, as wewant to build a close relationship with the suppliersof our equipment. These links will also optimise PLN’soperations by reducing the stock in our warehouse.

160

Taking charge of powerOBG talks to Nur Pamudji, President Director, Perusahaan ListrikNegara (PLN)


ENERGY ANALYSIS

Production sharing contracts are attracting global firms to the sector

Promulgated in 2001, Indonesia’s Oil and Gas Lawforms the backbone of the sector’s regulatory frame-work along with various supplementary governmentordinances and decrees. While the law ostensiblylays out a clear set of rules governing both state andprivate sector responsibilities, entitlements, liabilitiesand all manner of legal obligations, different inter-pretations of regulations by the state have resultedin uncertainty for the private sector. At their core, pro-duction sharing contracts (PSCs) outlined in the oiland gas law have provided sufficient incentives andrevenue splits to attract many of the world’s mostprominent players such as Total E&P, Chevron, Exxon-Mobil, ConocoPhillips and others. Inconsistent adher-ence to regulations and unilateral alterations to con-tracts has also caused consternation among players.

“The contracts themselves are fine, the problem isimplementation,” Richard Dinnie, the senior interna-tional legal counsel for Total E&P’s Indonesia legalaffairs division, told OBG. “The stability of the systemand the sanctity of contracts is the biggest issue fac-ing the sector at the moment,” he added. As a result,early stage exploratory efforts have tailed off inrecent years and operators of major oil and gas fieldshave become reticent to make new investments. RizalShah, the president director of Offshore WorksIndonesia, told OBG, “Regulation of the oil and gascontract tender process limits most service tendersto short terms – typically one to three years – withno guarantee on utilisation. This causes service firmsto focus on surviving and limits their ability to makelonger-term investments in advanced assets.”CONTRACTUAL OBLIGATION: Although the keyterms of PSCs are for the most part static in their appli-cation, supplemental adjustments made to articlesin these contracts can and have resulted in signifi-cant changes in the final profit share for each par-ticipant. Over the past few years such modificationshave come in a variety of forms such as changes incost recovery, income tax, PSC transfer procedures,

and domestic market obligations. In addition, con-tracts have historically been structured so that com-mercial operators and not the state bear the bruntof the risk for projects. One of the more controver-sial regulations exemplifying the differing prioritiesbetween the public and private interests is theissuance of government regulation (GR) 79 in 2010relating to cost recovery of PSCs and income taxtreatment for the upstream oil and gas sector. Cre-ated to clarify certain income tax matters, GR 79 stillposes a number of questions four years after it wasenacted. Chief among these are uncertainty as towhether the ordinance can be applied retroactivelyand how apparent conflicts between the measure andpre-existing tax legislation will be resolved. In an envi-ronment where production costs are escalating dueto maturing oil fields and related enhanced oil recov-ery methods being employed, as well as explorationof more expensive and challenging deepwater andfrontier resources, the issue of cost recovery is like-ly to remain a concern for the foreseeable future. LOCAL COMMITMENTS: Another significant provi-sion included in PSCs which has evolved over theyears is the domestic market obligation (DMO) clauseregulating how much oil and gas the contractor mustset aside for sale on the domestic market. The DMOhas evolved over time with the introduction of newgenerations of PSCs, but current contracts requirethe contractor to supply the domestic market with25% of both oil and gas production from the contractarea out of its own equity share.

Natural gas DMOs are a relatively new addition andonly became commonplace following the passage ofGR 35 in 2004 (and later GR 79 of 2010) and as suchhave not generally been put into practice yet as mostof the associated PSCs are still in the exploratorystages. How much leeway the government gives innegotiating and interpreting these issues and oth-ers – and more importantly how consistent they arein honouring contractual obligations – will go a long

161


While DMOs are still

evolving, current contracts

require the contractor to

supply the domestic market

with 25% of both oil and

natural gas production

from the contract area out

of its own equity share.

Colouring between the linesRegulatory challenges remain for sector players

ENERGY ANALYSIS

way in determining future interest in the country’soil and gas sector not only for new exploration butalso in the extension of existing PSCs.

A number of PSCs for major oil and gas fields areset to expire within the next few years including theMahakam Block operated by Total E&P Indonesiawhich expires in 2017. If contract extensions are notreached for any manner of reasons, state-ownedenergy company, Pertamina, is waiting in the wingsand has already made clear publicly that it would bemore than happy to take over expiring PSCs.

Another concern for the sector is the pursuanceof criminal rather than civil charges brought againstthree executives of Chevron Pacific Indonesia (CPI)in a bioremediation case. The case came to conclu-sion in July 2013 when a guilty verdict was handeddown by the country’s anti-corruption court in spiteof testimony from Ministry of the Environment (KLH)and SKK Migas officials indicating the bioremedia-tion project was in fact in compliance with the appli-cable laws and regulations of Indonesia. In responsethe Indonesian Petroleum Association (IPA) issued astatement in July 2013 condemning the verdict, stat-ing, “the criminalisation of the PSC is a very worry-ing development for both national and internation-al oil and gas firms. The PSC is a business contract,and the IPA’s position is to continually emphasisethat disputes arising from PSC project implementa-tion, when shown to have been undertaken in com-pliance with applicable laws and regulations, shouldbe governed by the dispute resolution process underthe terms of the PSC which are based on civil law prin-ciples, not criminal law.” This followed a February2013 decision by the regulator to not extend thework permit of ExxonMobil’s country manager. REGULATOR: These issues are further complicatedby the changes being instituted within the regulatoritself, which is responsible for critical tasks withinthe sector including awarding of PSCs and the saleof oil and gas from domestic stocks. Little more thana decade after being created in 2002, upstream anddownstream regulators BP Migas and BPH Migaswere declared unconstitutional by the IndonesianConstitutional Court and subsequently dissolved in2012. In its place SKK Migas was created using muchof the existing personnel and infrastructure and per-

forming essentially the same tasks although it will haveoversight from a commission appointed by the Min-istry of Energy and Mineral Resources (MEMR).Although the transition has been relatively smooth,questions still remain regarding the government part-ner party for PSCs as well as how the new body willhandle decisions regarding the impending expiringPSCs as of late 2013.

Complicating matters, SKK Migas chairman RudiRubiandini was arrested on graft charges involving$700,000 originating from Singapore-headquarteredKernel Oil by the country's Corruption EradicationCommission (KPK) just eight months in his tenure inAugust 2013. While the incident did not involvemalfeasance regarding upstream oil and gas con-tracts, the fallout could fuel negative perceptionsfor the regulator less than a year after its inception. THE WAY FORWARD: Looking to address these andother regulatory issues, the government is current-ly drafting a new, updated oil and gas law. Among themost pressing issues which are to be reworked in theupdated draft legislation are clarification of the divi-sion of government and regulatory authorities in theoil and gas sector, confirmation that the body of lawpertaining to oil and gas cooperation contracts takesprecedence over other more general bodies of lawas well as the possible creation of a new develop-mental body which will take on the state’s PSC rep-resentative role formerly carried out by the nowdefunct BP Migas. In addition, SKK Migas has indi-cated a willingness to sweeten the pot for oil and gasfirms with more favourable PSC splits. However, anymajor regulatory changes in the oil and gas sectorare unlikely to be made prior to the 2014 election.

The Ministry of Finance (MoF) has also moved toboost incentives with the enactment of regulationpassed in 2012 (MoF regulation 27) and 2013 (MoFregulation 70), providing a value-added tax exemp-tion for the import of goods in the upstream oil, gasand geothermal sectors for exploratory and exploita-tion development phases. “In terms of the energylandscape and accommodation of foreign entities,Indonesia has been so flexible for so long that itneeds to be careful about suddenly switching tooverly protectionist policies,” KK Ralhan, presidentdirector of power solutions company Kaltimex, told OBG.

162

With the upcoming

elections in 2014, many in

the industry do not expect

major changes from sector

regulators until 2015 at the

earliest.

ENERGY ANALYSIS

The most recent hike in fuel prices saw them rise 11.1% in 2008

With a population of some 240m citizens, Indonesiahas long been burdened by the conundrum of pro-viding relatively inexpensive energy to its populationat large while at the same time maintaining domes-tic purchase prices of oil and gas high enough as toremain attractive for upstream operators to contin-ue to search out and exploit domestic reserves. Caughtin the middle of these diverging price points is thestate, which has been facing an increasingly steep tabfor the country’s energy use in recent years.

This combination of policies and growth are put-ting the country on pace to become the world’s topimporter of motor fuel by 2018, according to a studyreleased in September 2013 by the consulting firmWood Mackenzie. The report estimates that the petrolshortfall will rise from 2012 levels of 340,000 barrelsper day (bpd) to approximately 420,000 bpd by 2018,while the combined US-Mexico market will see importsdrop from 560,000 bpd to 60,000 bpd over the sametime period on the strength of increased domestic pro-duction and refining capacity. FOOTING THE BILL: The government’s annual fuel sub-sidisation tab increased more than four-fold from2009 to 2012, from Rp45trn ($4.5bn) to Rp211.9trn($21.2bn). For 2011 and 2012 these costs exceededprojected costs laid out in the annual state budget(APBN-P), with 2011 subsidies totalling Rp165.2trn($16.5bn) compared to estimates of Rp129.7trn($12.9bn), and a larger gap in 2012 between theAPBN-P figure of Rp137.4trn ($13.7bn) and actualcosts of Rp211.9trn ($21.2bn). Projected costs for2013 are set at Rp199.9trn ($20bn), with first semes-ter costs at Rp98.2trn ($9.8bn), while the 2014 APBN-P targets a reduction of subsidies to Rp194.9tn($19.5bn). If the country is to meet these targets, itwill need to carry out politically difficult decisions toreduce subsidies in the face of rising energy prices.This situation is compounded by additional macroeco-nomic challenges that Indonesia is facing and whichpicked up speed in the summer of 2013. Inflationary

pressure as a result of fuel price hikes can exasper-ate an already escalating problem. When the govern-ment last increased fuel prices in 2008 and the priceof petrol was raised from Rp4500 ($0.45) per litre toRp6000 ($0.60) per litre (although prices were reducedagain starting in 2009), inflation spiked from 6.6% in2007 to 11.1% in 2008 according to central bank sta-tistics. Fuel price hikes in 2005 also contributed to asimilar hike in inflation of 17.1% for the year. Whilethis loss-making position was tenable, when the econ-omy was riding a wave of strong GDP growth, theexpense has been increasingly difficult to absorb withthe economic downturn and rising trade gap, whichexploded in mid-2013. The price paid by the govern-ment could increase more if the value of the rupiahcontinues to decline relative to the dollar. With theIndonesian rupiah valued at 12,153:1 US dollar (as itwas in late December 2013) instead of the 9750:1 rateposted as late as May 2012 initially projected in thegovernment’s budget, the country’s fuel subsidy billcould be 15% higher than projected according to esti-mates by the CEO forum, CastleAsia.SLASHING SUBSIDIES: With the ballooning cost ofenergy on national budget ledgers, the governmentmoved to slash petrol and diesel subsidies in June2013, in spite of popular dissent. The price hike wassimilar to a 2008 move, as the price of subsidisedpremium fuel increased 44% from Rp4400 ($0.44)per litre to Rp6500 ($0.65) per litre, while the priceof diesel was hiked from Rp4500 ($0.45) per litre toRp5500 ($0.55) per litre. Natural gas prices have alsobeen on the move, in spite of strong pressure fromthe industrial and power sectors to keep prices lowand attractive for industrial and residential use.

The unit price of natural gas paid by the country’slargest electricity provider, state-owned PLN, increasedfrom Rp39,867.31 ($4) per thousand standard cu ft(mscf) to Rp63,757.56 ($6.38) from 2011 to 2012, and has continued rising steadily, from Rp23,480.99($2.35) per mscf in 2007, according to PLN reports.

163


The government’s annual

fuel subsidisation tab

increased more than

four-fold from 2009 to

2012, from $4.5bn to

$21.2bn.

The price is rightSubsidies for petrol have been costly, but removing them presents newchallenges

ENERGY ROUNDTABLE

Andhika Anindyaguna, CEO, Sugih Energy Jon M Gibbs, President ExxonMobil Indonesia

Are regulatory changes and stringent anti-graft

measures having an impact on investor appetite?

ANINDYAGUNA: We are optimistic about the transi-tion from BP Migas to SKK Migas, as the regulatory bodyis totally controlled by the Ministry of Energy, estab-lishing a clearer chain of command, as well as a moretransparent and accountable regulatory body. This willbring numerous benefits for both the investors andcompanies operating within this sector. If reforms con-tinue, it will create a better political environment withthe potential to facilitate greater investment.GIBBS: Governments play a key role in the industry’sability to expand energy supply in an environmental-ly responsible way. Policies that provide a stable reg-ulatory and legal framework encourage the long-rangethinking and investment decisions that allow the indus-try to excel. Recent efforts to streamline the regula-tory environment in Indonesia are important steps inencouraging certainty in the business climate.LORATO: There has been reduced appetite to take onrisk, as regulatory changes have skewed the risk-rewardbalance. Established firms are striving to retain theirmarket share, but in the long run exploration costs arerising and incentives are not materialising as we wouldhope. Removing taxes from the exploration phase, forwhich investors bear the whole risk, would drive greaterexploration. For example, production-sharing con-tracts (PSCs) signed after 2010 carry the burden ofthe newly proposed land and building taxes.PRAMONO: Indonesia has a long, successful historyin oil and gas development. It was once an OPEC mem-ber, recognised as a centre of liquefied natural gas (LNG)development and a hub for international hydrocarbonsplayers. This recognition was not without reason, withtrust given to a stable regulatory environment, whichis key to investor confidence.

This stable framework has begun to lose its reliabil-ity, creating increased uncertainty, with the lack of fis-cal stability discouraging exploration. To illustrate thispoint, the GR79 government regulation created very

strong uncertainty for investors, as it not only violatesthe sanctity of contracts that are otherwise grandfa-thered under the 2001 Oil and Gas Law, but also oth-er laws, hence the filing of a judicial review by theIndonesian Petroleum Association against GR79.

While Indonesia is transforming to a clean govern-ment through corruption eradication, the industry hasalways acted in accordance with good corporate gov-ernance and integrity. The industry fully supports thegovernment’s anti-graft policy.MAHFOEDZ: Oil and gas development is a long-term,capital-intensive investment, requiring a legally stableframework. Current issues such as the cost recoverymechanism, the criminalisation of industry, and amend-ments to the existing oil and gas law are some of themajor challenges that are confronted by the industry.We support the implementation of the 3C principles(clarity, consistency and certainty) on all regulationsapplied to this industry, which are the key critical ingre-dients to attracting investors. Some industry concernshave been addressed by the government, such as theland and building tax on exploration, which we expectwill accelerate exploration activity in the future. We alsosupport stringent anti-graft regulations as we believethey would improve the governance and transparen-cy of the management of the oil and gas industry.

How would you interpret the steep decline in the

number of seismic surveys conducted since 2011?

PRAMONO: Over the last 10 years exploration resultshave been disappointing in Indonesia; there remainunder-explored basins and frontier areas that havesignificant potential, particularly in eastern Indonesia.The costs and risks of carrying out exploration in theseareas have risen dramatically, not to mention accessdifficulties and permitting hurdles, including for seis-mic work. Such challenges are reflected in the depar-ture of some exploration players from Indonesia. Thedisappointing results of the last bidding rounds demon-strate the need for a regulatory environment that

164

NOC and come inOBG talks to Andhika Anindyaguna, CEO, Sugih Energy; Jon M Gibbs, President,ExxonMobil Indonesia; Lukman Mahfoedz, President, IPA & President Director,


ENERGY ROUNDTABLE

encourages exploration. In addition to legal certaintyand stability of fiscal terms, irregular provisions suchas the land and building tax must be removed. Weneed to see the simplification and acceleration of allpermitting processes impeding exploration, and areduction in micro-management oversight, especial-ly in procurement processes. Finally, several countriessucceeded in revitalising their exploration bids throughthe creation of a corporate structure to pool resourcesbetween multiple PSCs operated by affiliates of thesame company. This opened the possibility of buyingseismic data as part of a commitment by PSCs toencourage more surveys. Without addressing thesechallenges to investor confidence, it will be difficultto replace Indonesia’s declining hydrocarbons reserves.GIBBS: Exploration is at the highest end of the riskprofile, so governments can encourage explorationinvestment by examining the most appropriate policyresponses to incentivise those activities that are crit-ical to finding new resources, such as encouragingseismic studies. As is evident from the fate of deep-water exploration over the last few years, without sur-veys such as these, results can be disappointing.ANINDYAGUNA: Indonesia’s fundamentals as an ener-gy investment destination are very strong. Yet there isstill too much complexity surrounding the regulatoryenvironment and the permitting process for onshoreoil and gas operations – specifically land acquisition– which prevents many from investing in essentialareas in the exploration process, such as seismic stud-ies. To optimise Indonesia’s vast oil and gas resources,and facilitate greater investment in hydrocarbonsexploration, we need to see greater synergies betweenthe government, regulatory bodies, international oilcompanies (IOCs), and domestic oil and gas firms. Allrelevant stakeholders need to work together to sim-plify regulations, and to make exploration a moreattractive and efficient activity for investors.MAHFOEDZ: This steep drop off was partly driven bycoordination issues among government institutions and

regulatory measures causing delays in land acquisition.The government plans to simplify the process by reduc-ing the number of permits that are required for explo-ration and production. It is important to accelerate thislong-awaited simplification.LORATO: It is a combination of revised contract termsand a lack of additional incentives when we are eval-uating more difficult basins. Removing taxes from theexploration phase would be a step in the right direc-tion, and there has been a positive engagement withthe government regarding these concerns.

How attractive do you think it currently is for IOCs

to explore eastern and frontier areas?

MAHFOEDZ: Indonesia has abundant oil and gasresources that are still undeveloped, most of which arelocated in the east of the country, and the governmenthas already facilitated a deepwater exploration pro-gramme. Given the technically challenging environ-ment, the risks are great, as are the investmentsrequired. Balancing economic return with risk andinvestment is very important. Consistent governmentsupport, particularly in the domain of technologyaccess and expertise, as well as more open data man-agement systems, will be needed to encourage moreexploration investment in such frontier areas. LORATO: Eastern and frontier areas hold an allure butthere are too many uncertainties. Recent examples oftaxation imposed on the exploration phase have hada very negative effect. This is why I hope that ongo-ing discussions with the government result in a posi-tive outcome for oil companies already facing numer-ous financial, geological and logistical challenges.PRAMONO: The era of the easy oil find is over, butIndonesia is an “old” oil country, as there remain under-explored basins and frontier areas that have seriouspotential, particularly in eastern Indonesia. Unlockingthis potential requires carrying out exploration in deepoffshore and/or remote areas, bringing challenges interms of costs, technology, logistics, permitting and

165


Lukman Mahfoedz, President, IPA & President Director, Medco Enerji

Medco Energi; Roberto Lorato, President Director, Premier Oil Indonesia; &Hardy Pramono, President & General Manager, Total E&P Indonesie

ENERGY ROUNDTABLE

ability to interact with communities not familiar withoil and gas activity. IOCs have a lead role to play in thisfrontier exploration, provided the business environmentremains competitive enough to attract investment.Domestic firms are not equipped to assume the risk.GIBBS: Exploration in frontier areas is challenging allover the world. The situation in Indonesia’s eastern fron-tier region is no different. For example, potentialresources are remote, and moreover there is very lit-tle infrastructure. However, I remain very confidentthat such challenges can be overcome if the govern-ment is able to promote an environment where indus-try can carry out long-term, visionary projects.ANINDYAGUNA: IOCs are attracted to offshore explo-ration in these frontier regions. After all, despite thehigher risks and costs of drilling in deepwater basins,firms are able to conduct operations without facingthe extensive local issues that they may encounter onland. However, despite the complexities of onshoreoperations, we believe that exploring proven basins inmature regions such as Sumatra is a preferable strat-egy for smaller oil and gas exploration companies.

What is the role of national oil companies (NOCs)

likely to be in the future? How do you think they

can best form partnerships with IOCs?

LORATO: The government wants to see the develop-ment of a more competitive domestic energy marketin all phases, and NOCs such as Pertamina, Medco andEnergi Mega Persada have demonstrated their abilityto mitigate uncertainties and volatility in the regula-tory environment which affect IOCs. Leveraging onthe combined strengths of NOCs and IOCs will be keyto unlocking new business opportunities for investors.MAHFOEDZ: The role of IOCs is important in bringingtechnology, expertise and financial capability, especial-ly in attempting high-risk investments such as deep-water exploration or unconventional hydrocarbons.There are numerous opportunities for both NOCs andIOCs to collaborate and achieve benefits for both sides.

166


It will be an important task for the host governmentto create a conducive partnership environment inwhich NOCs and IOCs can collaborate successfully.ANINDYAGUNA: For exploration to move forward weneed technology and capital, which is a challenge forsmaller Indonesian firms. The government must incen-tivise local companies and try to grant access for fund-ing via capital markets, banks and even a dedicatedpetroleum fund programme. We do, however, still needthe support of big players in Indonesia. Our nationalcompanies have begun to expand into the internation-al market, and they want to be treated well in othercountries where they operate. This is why we mustwork closely with IOCs operating within Indonesia.PRAMONO: It is fully legitimate for NOCs to grow theirbusinesses in the country. However, there are manyinternational companies that have been active inIndonesia for decades and employ nationals as morethan 95% of their workforce. It will therefore be animportant task for the government to create a con-ducive partnership environment in which NOCs andIOCs can collaborate successfully. All companies havea role to play in the future of Indonesian oil and gas.

Only a very limited number of Indonesian firms areactive in frontier exploration, where there is surely alarger role for them in the future. NOCs will need togrow their financial and technological capacity, as wellas their risk appetite and exposure to large projects.To that end, partnerships with IOCs are chances forthem to learn and develop. However, systematically pri-oritising NOCs in oil and gas is not desirable, as it maydivert investment from the country. The amount of rev-enue for the state under a PSC is related only to theperformance of the contractor, rather than where itsfunding comes from. That said, we welcome NOCsincreasing their role on a level playing field.GIBBS: One of the most effective ways to generatenew economic opportunities is by building internation-al partnerships that leverage different strengths. Forinstance, over the years, NOCs have demonstrated a

Roberto Lorato, President Director, Premier Oil Indonesia

ENERGY ROUNDTABLE

wide range of capabilities as strong partners in ener-gy development, including secure access to resources,detailed experience operating in specific environ-ments, and a first-hand understanding of the localand national governments’ regulations and require-ments. Meanwhile, IOCs have an unparalleled breadthand depth of experience of taking on energy chal-lenges around the world, developing new approach-es and best practices across a range of conditions thatcan be brought to new partnerships and countries. Aswe look at the energy needs in the decades ahead, itwill take our entire industry combining the strengthsof both NOCs and IOCs to meet growing demand.

What challenges are preventing gas from playing

a larger role in Indonesia’s energy sector?

PRAMONO: Gas is underutilised in power generation,mostly due to competition from cheaper fuel, such ascoal. Lack of infrastructure also represents a hurdle.Use of compressed natural gas or LNG for vehicles canbe a source of rising demand, but would require dis-tribution infrastructure and modifications to cars andtrucks, and this cannot happen overnight. Also, it isprobable that Indonesia will further develop its palmoil resources to produce biofuels. Commercial devel-opment of coal-bed methane (CBM) and shale gaswill need to be demonstrated, and such resources arein their infancy in Indonesia. Material contribution togas demand from unconventional gas is likely to be along-term objective, and in the short term I believeIndonesia will continue to rely on conventional gas,along with a growing share of LNG imports.MAHFOEDZ: The most pressing challenges are gaspricing policy and the availability of infrastructure, asgas resources are widely spread out in Indonesia. Thereare also other challenges, including access to technol-ogy and expertise in handling gas resources such asunconventional hydrocarbons, gases containing highlevels of impurity or stranded marginal gas. Socialissues and long processes for permit and land acqui-

sition may also hinder successful development ofunconventional gas, including CBM and shale gas.GIBBS: ExxonMobil foresees global gas demand ris-ing by 60% by 2040. By then we expect that naturalgas will account for more than 25% of the world'senergy, and will have overtaken coal as the second-largest energy source. The main driver of this growthglobally is from the power-generation sector, and wesee this same trend being replicated here in Indone-sia. When you consider that Indonesia’s electricitydemand growth rate is expected to be among thehighest in the region, with international energy agen-cies forecasting demand to nearly quadruple by 2040,there is little doubt that there is a strong and growingfuture for natural gas in Indonesia. Turning this poten-tial into a reality will require Indonesia to develop itsendowment of gas resources safely and economical-ly, and this will in turn require partnerships betweengovernment and industry to create the right businessenvironment for this to happen.ANINDYAGUNA: As Indonesia is one of the few coun-tries in Asia with favourable geology for potential shalegas production, we are optimistic for the future ofunconventional gas. However, we are still in the earlystages of unconventional gas development, as thisresource has not yet been proven in Indonesia. Effortsto monetise unconventional gas will require substan-tial investment in advanced infrastructure, specifical-ly for distribution and refining projects. This will requireclose cooperation between the government and play-ers across the oil and gas industry.LORATO: There is an understanding that oil and gasproduction is decreasing and, more worryingly, that thereserves replacement ratio is well below 100%. This mayeven call into question the ability of the oil and gassector to contribute to the Indonesian economy in thefuture. Indeed, particularly for gas, more flexible con-tractual terms and improved distribution infrastructurewill be required to attract more investment in theexploration for, and development of, new resources.

167


Hardy Pramono, President & General Manager, Total E&P Indonesie

ENERGY ANALYSIS

The government has reduced subsidies on fuel to curb demand

With oil and gas imports weighing on its trade bal-ance, Indonesia is taking steps to reduce domesticdemand for fuel and boost local refinery capacity.These moves come in the wake of the InternationalEnergy Agency (IEA) releasing a 2013 report project-ing that energy demand in the South-east Asian coun-try is set to nearly double over the next two decades.IMPROVING THE TRADE BALANCE: Imports of oiland gas from January to August 2013 amounted to$29.9bn, while exports stood at $21.4bn, accordingto data issued by the Statistics Indonesia in early Octo-ber 2013. This $8.3bn gap more than accounted forthe eight-month trade deficit of $5.5bn, a bill that couldbecome even more expensive if the rupiah continuesto lose ground against the dollar. Imports are alsotrending up, rising by 8.7% year-on-year, while exportearnings dropped by 17.3%.

Looking to reduce its foreign purchases of hydro-carbons, the government has implemented measuresto reduce domestic consumption of fuel. These includea regulation issued in August that raises the amountof palm oil blended into biodiesel, from 7.5% to 10%,a move that the deputy energy minister, Susilo Sis-woutomo, said was designed to cut spending on oilimports. The rate will be even higher for biodieselused by power plants, where the mandatory level ofpalm oil has been increased to 20%.

Perhaps more importantly, the government hasreduced subsidies on fuel, in an attempt to pull backdemand. The new prices went into effect in June 2013,with the cost of petrol rising by 44% and diesel up by22%. Indonesia still has some of the lowest prices inthe world, however, at Rp6500 ($0.65) per litre for pre-mium fuel and Rp5500 ($0.55) for diesel.

The reduction will nonetheless lighten the burdenon the state budget, with subsidies estimated to costabout $20bn a year. These funds could be used to investin increasing local refinery capacity, which stands ataround 1m barrels per day (bpd), less than the cur-rent demand of 1.4m bpd. This would reduce reliance

on imported refined petroleum products, whichaccount for around half of foreign oil purchases in val-ue terms. The expectation is that the cost savings tobe achieved from the reduction in refined importswould more than offset the loss in revenues fromforegone crude oil sales. However, realising this planwould likely require the redrafting of long-term exportdeals with countries such as Japan and Korea, anoption that the former trade minister, Gita Wirjawan,has said that Indonesia is studying.THIRST FOR ENERGY TO GROW: Even if Indonesiawere to re-negotiate these contracts, the additionaloil would be unlikely to meet domestic needs. Accord-ing to BP’s “Statistical Review of World Energy 2013”,crude production is off around 30% from its 2001levels, while local demand has been steadily increas-ing over the last decade, in parallel with economicgrowth. Moreover, continued expansion means thatthis imbalance will likely worsen. The IEA’s “South-east Asia Energy Outlook” report, published in late2012, says annual energy demand will nearly doubleover the next two decades, jumping from 190m tonnesoil equivalent (toe) in 2011 to 360m toe by 2035,with oil expected to account for around 95m toe.

Demand for oil and gas from both the industrial andtransport sectors is projected to rise steadily over thenext 22 years, with the IEA saying industrial usage willclimb faster than any other end-use sector. The biggestincrease in demand in the transport sector will comeas a result of higher private vehicle ownership, whichis set to more than double to approximately 20m by2035, up from roughly 9m in 2011.

While the increase in fuel prices means people maydelay their car purchases or perhaps choose to driveless, it is clear that Indonesia is facing an increasing-ly challenging situation in terms of meeting its grow-ing energy needs. With no obvious indication that oilproduction levels will increase anytime soon, it seemsthat the government is choosing the next best alternative, taking steps to reduce domestic demand.

Oil and gas imports

between January and

August 2013 rose 8.7%

year-on-year over the same

period in 2012, while

export earnings fell 17.3%.

Demand for oil and gas

from both the industrial

and transport sectors is

expected to increase

steadily over the next two

decades.

168

A balancing actGovernment takes action on rising domestic demand for fuel


ENERGY ANALYSIS

Coal bed methane deposits are estimated at roughly 453.3 tscf

The country’s reliance on natural gas, needed to playan increasing role in meeting both its own energy needsas well as its continued use as a cash-generating export,leaves little doubt that the country will need to use anyand all means available in securing new domestic sup-plies. While there are still substantial amounts of con-ventional areas to explore throughout the country,recent advances in techniques and technology arefuelling interest in unconventional reserves such asthose locked up in shale gas formations or coal bedmethane (CBM) deposits. In fact, unconventional gasresources are predicted to be substantially greater thanconventional reserves, with the Ministry of Energy andMineral Resources (MEMR) estimating shale gas poten-tial of approximately 574trn sq cu feet (tscf) along withCBM projections of 453.3 tscf, compared with provenand probable conventional natural gas reserves ofaround 150 tscf. Yet in spite of this potential, a num-ber of barriers to tapping into these energy sourcesremain in place including regulatory challenges as wellas the relatively more expensive extraction costs com-pared to conventional measures. PLAYING THE LONG GAME: “CBM takes time to devel-op, longer than conventional gas,” Christopher Allen,the CBM appraisal manager of Vico Indonesia, toldOBG. “There are different completion technologies,which require quite a learning curve that is only solvedthrough trial and error. As exhibited in the US with shalegas and in Australia with CBM, once the early stages oftrial and error have refined the process and created effi-ciencies, production is expected to proceed at anincreasingly rapid pace. The challenge for the Indone-sian CBM industry at the moment is how to push throughthese early risk and cost barriers in order to begin pro-ducing more efficient projects which are economical-ly viable enough to stand on their own.”

Some of this increased technical difficulty and high-er cost of production lies in the composition of the proj-ects, which, unlike conventional oil and gas fields thatgenerally tap into large contiguous reserves using few

wells, instead require numerous wells tapping differ-ent sources. As is the case in the shale gas trend sweep-ing North America, the multitude of wells requiredmeans that extraction and utilisation of the gas is onlyeconomically viable due to the associated convention-al oil also extracted from the site, and early efforts havealso been aided by government financial assistance. CONCESSIONS: As a result of the longer lead time, thesector will not –at least initially – be able to provideboth cheap gas and rapid progression in terms of sup-ply. The US solved this through tax breaks that allowedshale gas producers to drill thousands of wells withoutlosing money, thus developing expertise and scales ofeconomy which were able to sustain the sector afterthese tax incentives expired. In Australia the govern-ment required power producers to purchase natural gaswhich led to an increased demand in CBM as it was stillless expensive than imported liquefied natural gas(LNG). For its part, the Indonesian government hasmade its own concessions in a bid to jump-start thesector and has offered private companies a 45% pro-duction share for CBM projects which comparesfavourably to the usual 15% granted to petroleum con-tracts and 30% for conventional natural gas. Anothersolution could be to price CBM gas at or closer to par-ity for export pricing rather than at domestic levels.

With regional LNG priced higher than domestic gas,the country could benefit from paying more for CBMand still save, given international LNG costs. This strat-egy would also boost government coffers, which takea cut of production, as well as stimulate the local econ-omy through investment and employment. To com-pensate for long exploration periods and the dewater-ing phase, which can take years, the industry wouldwelcome an extension of the 30-year limit on CBM pro-duction sharing contracts (PSCs). CBM: Still in its infancy, the fledgling CBM sector’s out-put has so far been limited primarily to productionderived from dewatering and production test wells. In2012 a total of eight wells situated in the Sekayu, San-

Shale gas potential is

estimated at about 574

tscf, with proven and

probable conventional

natural gas reserves at

around 150 tscf.

169


The government has made

concessions to jump-start

the CBM segment, offering

private firms a 45%

production share in CBM

projects.

No stone unturnedExploration for new resources mitigates other supply challenges

ENERGY ANALYSIS

ga-Sanga and Muara Enim contract areas combined toproduce 0.98m standard cu feet per day (mmscfd), upfrom 0.27 mmscfd produced by two wells in two con-tract areas in 2011, according to SKK Migas. As of theend of 2012 there were a total of 54 active CBM PSCsaccounting for a little more than 16% of all PSCs in thecountry. Moving towards practical utilisation of the gas,Vico Indonesia began producing 0.5 mmscfd of CBMgas for the PLN power plant at Sanga-Sanga in 2013.

Although CBM PSCs call for the drilling of hundredsof exploratory and developmental wells over the nextfew years, the aforementioned economic and techni-cal hurdles as well as other regulatory barriers haveslowed progress in some areas. As is the case with oth-er extractive industries, the sector faces an uphill reg-ulatory battle with issues like land accessibility due toforestry regulations, protected areas, government over-sight and purview, rig access, lack of financial incen-tives, among others.

“In order to achieve the exploration commitmentsoutlined in the PSCs, the government needs to makethe projects financially viable, get rid of regulatory bar-riers, and sort out the land issues,” said Allen. “If theycan do those three things, we could see significantlymore development because the potential is really there.”Due to the challenges facing the sector, only three CBMPSC contractors succeeded in fulfilling their develop-mental commitments in 2012: Newton Energy Capital(which is working the GMB Kutai contract area), VicoCBM Indonesia (working the GMB Sanga-Sanga con-tract area operator), and Medco CBM Sekayu (work-ing the GMB Sekayu contract area). The combinedefforts of these firms resulted in 16 new core holedrillings, 14 exploration drillings, 10 dewatering-pro-duction tests and 33 G&G (geological and geophysi-cal) studies according to SKK Migas. While these effortswere an improvement, they represent just a fraction ofstated commitments from the industry. SHALE: A lesser explored option to date, activity inshale gas exploration has only recently begun to gath-er momentum in the past couple of years. Early stud-ies have indicated that the country’s potential shale gasreserves are located primarily in six basins around thecountry including the Baong, Telisa and Gumai shalebasins in Sumatra (with a combined 233 tcf) with addi-tional potential located in Java (48 tcf), Kalimantan

(194 tcf) and Papua (90 tcf) with the remaining 9 tcfdispersed among other areas, according to the Indone-sian MEMR’s directorate of oil and gas. While the 574tcf reserve is impressive along the project CBM totalof 453.3 tcf, the actual technically recoverable reserveswill undoubtedly be less than these initial projections.

Technology first refined in the well-documentedshale gas boom of the US could similarly be brought tobear in Indonesia, and Chevron Pacific Indonesia alreadyuses hydraulic fracturing (fracking) techniques in Duri,Sumatra — the country’s largest oil field — while Aus-tralia’s NuEnergy Gas also initiated fracking operationsat five new untested coal beds in West Java starting in2013. Pertamina has also stated that it would be work-ing with Canada’s Talisman Energy to tap into its pre-vious shale experiences in the US in the Eagle Ford andMarcellus shale plays although no formal partnershiparrangement has been announced.

Efforts to explore and exploit these resources are stillin the early stages with the government receiving 75shale gas development proposals for potential shalegas blocks in Riau and Central Kalimantan provincesthrough a direct offer procedure as of May 2013,according to the directorate. State-owned energy com-pany Pertamina is taking the lead in the sector and inkeda PSC for the Sumbagut block in North Sumatra in May2013. Sumbagut is estimated to contain shale gaspotential of 18.56 tcf, according to Pertamina, and thefirm is targeting initial production in year seven of thePSC, at 40-100 mmscfd for the $7.8bn project. Perta-mina’s move into shale comes on top of its substantialparticipation in the CBM sector where it holds 14 CBMPSCs located in Sumatra and Kalimantan in which it mostrecently completed the drilling of two exploration wellsin Tanjung Enim Block, while exploratory drilling of twoother wells in Muara Enim Block continues into 2013.

The agreement signed by Pertamina is the first of itskind in Indonesia to make use of the new GovernmentRegulation 5, issued in January 2013 which outlines pro-cedures for selecting and offering non-conventionaloil and gas contracts.

The regulation was created to address the higherinvestments requirements and risks association withunconventional oil and gas exploration from reservoirsformed with low permeability such as shale oil and gas,tight sand gas, coal bed methane and methane hydrate.

170

Early studies indicate that

potential shale gas

reserves are mostly located

in six basins: Baong, Telisa

and Gumai, in Sumatra

(233 tcf); Java (48 tcf);

Kalimantan (194 tcf); and

Papua (90 tcf).

ENERGY ANALYSIS

Hydrocarbons represented around 30% of total exports in 2013

Oil and gas commercialisation has been a linchpin ofIndonesia’s economic development for more than threedecades, accounting for as much as 80% of the coun-try’s annual exports and 70% of its annual revenues sincethe 1970s. While the country’s economy has expand-ed and diversified over time, aided by the inflow of for-eign currency derived from oil and gas exports, ener-gy exports still provide significant revenue to thegovernment’s coffers as well as private sector invest-ment. The nature of energy exports themselves havelikewise evolved over time, moving from crude oil-basedproduction and shipments to natural gas, while demandhas also shifted from the West towards an energy-hun-gry Asia. Formerly a net oil exporter in the Organisa-tion of the Petroleum Exporting Countries, Indonesia’sprimary energy exports are now liquefied natural gas(LNG) and coal as the country has become a net oilimporter. In spite of various internal factors (recent pri-oritisation of securing domestic fuel sources, inadequateinfrastructure and a complex regulatory environment)and external dynamics (regional and global economicturbulence and volatile energy prices) influencingIndonesia’s export policies, energy exports remain a cru-cial cog in the archipelago’s economic machine. BOOK VALUE: Indonesia, along with Brunei, Malaysiaand Australia, made the Asia-Pacific region the world’smost prolific LNG supplier until it was supplanted bythe Middle East in the mid-2000s. As of 2013, the Asia-Pacific supplied 30% of the global LNG stocks comparedto 45% for the Middle East. Although not the dominantexport force it once was, energy shipments remain acrucial source of foreign currency inflows and account-ed for nearly one-third of all Indonesian export revenuesin 2013. A combined $56.09bn worth of hydrocarbonsproducts were shipped out in 2013, representing 30%of the country’s $183.55bn total exports, according tothe country’s central bank, Bank Indonesia. This repre-sented a decline from 2012 exports of $67.4bn, or 36%of total exports. Of the 2013 export tally, coal exportsremained by far the largest earner with $26.64bn worth

of shipments on the year (see Mining chapter). Natu-ral gas ranked second with exports of $15.69bn, includ-ing $5.12bn worth of LNG shipments. The remainingcontributors included crude oil valued at $12.19bnalong with $3.85bn worth of manufactured oil prod-ucts and $10.54m of liquefied petroleum gas (LPG). GROWTH MARKET: Indonesia’s ample proven reserves,combined with ongoing exploration and productionefforts, ensure that the supply side of its energy tradewill be strong for the foreseeable future. However, thedemand side of the equation looks to be even morefavourable for the country due to its proximity to theworld’s largest and fastest-growing consumer marketsfor LNG. Of the 29 countries currently importing LNG,the top five receivers are all located in Asia, and accountfor a combined 61% of all shipments, according to theInternational Gas Union’s (IGU) “World LNG Report2014”. Japan in particular has upped its energy importsin the wake of the Fukushima nuclear accident in 2011and is now the largest purchaser of LNG in the world.The country purchased more than double the amountof LNG of its closest rival in 2013, with 87.8 tonnes, up0.5 tonnes on 2012. South Korea ranked second with40.9 tonnes, up 4.1 tonnes over the previous years’total, followed by China at 18.6 tonnes, India (12.9tonnes) and Taiwan (12.8 tonnes). Asia also led allregions in terms of consumption growth with China,South Korea and Malaysia alone increasing their LNGpurchases by a combined 9.5 tonnes as demand con-tinued to decline in Europe due to competition frompipelines and renewable energy. GAS: An early oil producer starting up in the 1870s,Indonesia’s natural gas export market did not begin tohit its stride until after the discovery of the substan-tial Arun natural gas field in Aceh in 1971 and the Badakdiscovery in East Kalimantan in 1972. Exploration andproduction followed soon after, leading to the firstexports in 1977 and 1978 from Badak and Arun, respec-tively. In the ensuing decades Indonesia rose to becomethe world’s premier natural gas exporter, a title it would

The Asia-Pacific region is a

leading global supplier of

liquefied natural gas,

accounting for

approximately 30% of

worldwide supply in 2013.

171


In terms of exports, natural

gas shipments brought in

$15.69bn in 2013, with

crude oil adding $12.19bn

and manufactured oil

products a further $3.85bn.

Trade windsHydrocarbons receipts continue to fill state coffers

ENERGY ANALYSIS

hold from 1977 until 2005, when it was surpassed byQatar. Indonesia’s peak export year occurred in 1998when it shipped 36.1bn cu metres (bcm) of gas withthe country still sitting on reserves estimated at morethan 100trn cu feet (tcf).

In 2013, Indonesia shipped 10.03 tonnes, account-ing for about 7% of the global LNG market, just off the18.12 tonnes of 2012, according to IGU data. The largestpurchaser of LNG at 6.22 tonnes delivered was Japan,followed closely by South Korea at 5.93 tonnes, Chinawith 2.68 tonnes, Taiwan (1.95 tonnes) and Mexico(0.26 tonnes). Although still a major player in the LNGexport market, Indonesia’s LNG exports have fallen by40% since their 1999 peak with Japan in particular cut-ting its purchases by half from 2010 to 2013. Increasedcompetition from other natural gas exporters, mostnotably Qatar, Malaysia and Australia, which have addedcapacity in recent years, has eroded Indonesia’s LNGmarket share, and the country has been building upregasification infrastructure in anticipation of futureimports as well as to transport gas domestically.

Liquefaction is currently carried out at three loca-tions throughout the county: Northern Sumatra (Arun),Kalimantan (Bontang) and Papua (Tangguh). Their com-bined capacity of approximately 1.5 tcf per year (tcf/y)will be further bolstered in the coming years by twoadditional plants being built in Sulawesi. The Donggi-Senoro and Sengkang plants will each bring another100bcf/y to market upon their completion in 2015and 2017, respectively, in addition to the 2019 project-ed start-up date of the 120-bcf/y floating Adabi liq-uefaction terminal set to be built in the Arafura Sea.

Complementing overseas shipment, Indonesia alsooperates a pipeline network connecting it to Singaporeand Malaysia. Current long-term contracts send natu-ral gas shipments to both countries, with 2012 deliv-eries of 7.9 bcm and 2.3 bcm, respectively, accordingto BP’s “Statistical Review of World Energy 2013”.COAL: While much of the world’s attention has beenfocused on the rise of natural gas, coal continues tofuel the majority of electricity production worldwide.Indonesia remains a leading player as the top exporterof thermal coal by weight, a title which it took from Aus-tralia in 2011 (see Mining chapter). Domestic produc-tion has far outstripped demand over the past decade,leading to roughly three-quarters of the fuel hitting glob-

al markets in 2013. Output hit 237.4m tonnes of oil equiv-alent in 2012, up 9% over 2011 levels in spite of Indone-sia holding just 0.6% of global reserves amounting to5.53bn tonnes (1.53bn of anthracite and bituminousand 4bn tonnes of sub-bituminous and lignite), accord-ing to BP’s “Statistical Review of World Energy 2013”.

Roughly 70% of this output was exported in 2012,destined primarily for regional markets, including Indi-an, the world’s largest importer, which took 27% ofIndonesia’s coal exports. This was followed by China witha 24% share, South Korea (11%), Japan (10%), Taiwan(8%), Malaysia (5%) and others, including Hong Kong,Thailand, and the Philippines. CRUDE: As with natural gas, Indonesia’s petroleumtrade is dominated by shipping, primarily as a result ofhaving no international oil pipelines and limited domes-tic pipeline reach. Due to falling domestic oil produc-tion and inadequate refining capacity, global trade isweighted towards imports, particularly petrol and dieselfuel. Indonesia imported more than 506,000 barrels perday (bpd) of crude oil and lease condensate in 2013,according to the Analysis of Petroleum Exports (APEX)tanker tracking service of Lloyd's List Intelligence.

Around one-quarter of crude imports were sourcedfrom Saudi Arabia, along with 15% each from Nigeriaand Azerbaijan, followed by the UAE (5%), Qatar (4%),Malaysia (4%) and Angola (4%). In terms of refinedproducts, imports totalled 466,000 bpd in 2013 and435,000 bpd in 2012, according to energy consultantFacts Global Energy. These are comprised chiefly ofpetrol, which accounts for 66% of refined imports,along with smaller quantities of gasoil for transport andpower generation, LPG and jet fuel. State-owned nation-al energy group Pertamina, which is tasked with acquir-ing subsidised petrol for distribution on the domesticmarket, purchased 228.81m barrels of refined prod-ucts from abroad in 2013, up from 226.47m barrels in2012 and 212.7m barrels in 2011. The group alsoimported some 122.47m barrels of crude and 5.14mtonnes of LPG in 2013, compared to 98.21m barrelsand 4.44m tonnes in 2012. By contrast, Indonesiaexported an estimated 455,000 bpd, primarily to region-al buyers, according to APEX. Japan was the largestpurchaser, with 28% of all shipments, followed by Thai-land with 17%, Australia (14%), Singapore (10%), SouthKorea (8%), China (7%), the US (5%) and Malaysia (4%).

172

Natural gas liquefaction is

currently concentrated in

three different locations:

Northern Sumatra,

Kalimantan and Papua.

Capacity is expected to

increase in the years ahead

as two additional plants

come on-line.

ENERGY ANALYSIS

Hydropower supplies 10% of Indonesia’s annual electricity needs

As Indonesia becomes reliant on foreign imports forits petroleum needs, with annual government energysubsidies of Rp200trn ($20bn), the need to commer-cialise cheaper domestic power sources is becomingkey for the country’s economic development. By far themost inexpensive solution in terms of cost per KWh ofelectricity delivered is hydropower, which currently sup-plies 10% of the country’s electricity each year. In har-nessing the water flow of Indonesia’s abundant rivers,public and private power generation units are alreadyproducing electricity at a fraction of the cost of otherpower sources with the added benefit of being immunefrom the politically and economically driven volatilityinherent in the global oil and gas trade. BY NUMBER: The average generation cost KWh for thecounty’s primary hydropower producer, state poweroperator Perusahaan Listrik Negara (PLN), amountedto Rp155.87 ($0.02) per KWh in 2012, considerablyless than the average generation costs of Rp1217.28($0.12), as per PLN figures.

Of the cost of hydro, the largest component wasdepreciation of equipment, accounting for Rp81.62($0.01) per KWh of total costs, followed by mainte-nance at Rp30.80 ($0.003), personnel at Rp18.09($0.002), fuel and lubrication at Rp21.29 ($0.002), andRp4.08 ($0.0004) in other costs.

By contrast, the next cheapest competitor, steamgeneration, was more than five times as costly, with anaverage generation cost of Rp810 ($0.08) per KWh. Thecosts of other power production technologies includeRp1001.8 ($.010) per KWh for combined-cycle power,Rp1121.5 ($0.11) per KWh for geothermal, Rp2362.99($0.24) for gas turbine and Rp3168.58 ($0.32) per KWhfor diesel power generation. As a result, the total gen-eration cost for PLN of its hydro-electricity output in2012 was 1%, or Rp1.64bn ($164,000), of total gener-ation costs of Rp160.30bn ($16.03m), even thoughhydro accounting for 5.25% of electricity produced. UNTAPPED POTENTIAL: Several factors have chal-lenged the development of hydropower, however, which

the Directorate General of New Renewable Energy andEnergy Conservation (EBTKE) estimates potential of 75GW. As of 2013, only 4078.24 MW of hydropower hadbeen installed in the country, along with 61.46 MW ofmini-hydro capacity and 6.71 MW of micro-hydro, asper EBTKE numbers. Of the active large-scale powerplants, PLN operates the bulk, with a portfolio of 216generation units and a combined installed capacity of3491.1 MW, in addition to 27 MW and 3.3 MW of mini-and micro-hydro capacity. Over half of this capacity isset up along the Cirata River in West Java, in the 701-MW Saguling hydropower plant and the 1008-MWCirata Hydroelectric Power Project, respectively.

Other important hydropower plants include the306.82-MW plant located in Java Tengah, Central Java;a 283.03-MW plant in East Java; a 254.16-MW facilityin West Sumatra; a 236.04-MW plant in Bengkulu; a148.5-MW plant in South Sulawesi; a 132.40-MW plantin North Sumatra; a 118-MW plant in Lampung, and a114-MW plant in Riau. A number of major hydropow-er plants are also operated privately by independentpower producers (IPP): a 187.5-MW facility in NorthSumatra, a 186.5-MW plant in West Java and a 195-MW plant in Central Sulawesi, along with smaller pow-er plants located in East Java and South Sulawesi, aswell as other hydropower stations built on-site to sup-ply energy to remote mining and industrial operations.The largest private hydropower companies operatingin the country are Inalum, which run facilities in Suma-tra and Bali, and INCO in Sulawesi.CHALLENGES: While hydropower is the largest renew-able energy contributor in Indonesia’s power portfo-lio, development of this subsector has been slowed bya host of challenges both economic and technical. Themost significant of these is the remote location of manyof the high-potential sites and the associated difficul-ties of connecting these sites to the national transmis-sion grid, as well as the issue of obtaining financing forthe capital-intensive projects. Unlike the geothermalindustry, in which the large-scale, expensive projects

The remote location of

several potential

hydropower sites creates a

challenge in connecting

these facilities to the

national transmission grid.

173


The average generation

cost for hydropower per

KWh is almost five times

less than for steam

generation, and

significantly less than for

combined-cycle power and

geothermal, among other

energy sources.

Hydro potentialA growing focus on diversifying the energy mix

ENERGY ANALYSIS

are made more attractive to investors through sover-eign guarantees, large hydropower projects are givenno such assurance. This has led to a financing gapbetween banks, which prefer shorter payback terms ontheir loans of three or four years similar to what a con-ventional thermal power plant would require, and hydrodevelopers, which require lengthy permitting and con-struction periods that often exceed eight to 10 years.

Some of the financing issues for smaller-scale hydroprojects are beginning to be addressed following theaddition of a feed-in tariff (FIT) in 2012 for payable small-scale (under 10 MW) hydro projects. Under revision sinceit was first implemented in 2012, as of March 2014,the FIT for a hydropower plant with a capacity of lessthan 10 MW was between Rp975 ($0.10) and Rp1378($0.14) per KWh depending on the voltage of connec-tion and geographic region of the project.

While this framework does provide additional incen-tives for smaller developers, progress has been stalledas a result of an ongoing disconnect between poten-tial developers and financiers.

According to the director of energy, telecommuni-cations and informatics at the National Planning Agency,micro- and mini-hydropower projects are in many cas-es not bankable. This is due to a lack of capacity bothon the part of project developers and on the part oflending institutions: the former often do not know howto prepare project proposals that will be acceptable toinstitutional lenders, while the latter may also be shortof the knowledge and experienced needed to assessthe acceptability of projects, according to a study onIndonesia’s renewable energy incentive scheme by theInternational Institute for Sustainable Development.

Finally, administrative hurdles can also be significant,with dozens of permits and approvals required for theconstruction of a hydropower plant, which is compli-cated by challenges in coordinating federal, regional,provincial and local authorities. THE NEXT STEP: In spite of these roadblocks, progressis continuing, with mandates laid out in the government’sNational Energy Policy as well as its Energy Vision 25/25,introduced in 2010. Application of these policies includesthe second phase of the governments fast-track pro-grammes (FTP), which were established in 2006 to addelectricity capacity in the form of two, 10,000-MWtranches. FTP1 includes mostly conventional fossil fuel-

powered capacity, whereas FTP2 has a greener focus.This is good news for renewable energy developers ashydropower is slated to account for 17% of new capac-ity, totalling 1753 MW, as well as 49% for geothermal.Most projects will be carried out by the private sectorthrough IPP contracts rather than by PLN. As drawn upunder the FTP2 plan, most of the new hydro capacitywill be in Java, where 1087 MW of power plant capac-ity is set to be built, along with 476 MW slated forSumatra and 190 MW for Sulawesi. Smaller-scale mini-and micro-hydro is also likely to expand in the comingdecades, particularly in rural areas where remote loca-tions create difficulties in connecting to the nationalgrid. Hundreds of individual generation units are set tobe installed, with a national combined capacity of 740MW planned by 2015 and increasing to 950 MW by2020, according to the government’s “Blueprint ofNational Energy Management 2005-25”.KEY PROJECT: One large-scale endeavour being pur-sued by PLN is the $800m, 1040-MW Upper CisokanPumped Storage Hydro-Electrical Power Project situ-ated on a tributary of the Citarum River in West Java.Funding for the project, which will house four 260-MWreversible Francis pump-turbines in an undergroundpowerhouse, is being provided in part via a $640m loanagreement with the World Bank sourced from the Inter-national Bank for Reconstruction and Development. Thepower company invited applications for pre-qualifica-tion to construct upper and lower dams, waterways, apowerhouse and a switchyard in December 2013. Thestate power producer also announced plans in 2012to construct three additional greenfield hydropowerplants totalling 1300 MW outside Java under a public-private partnership, and broke ground on a new 50-MW hydropower plant in Papua in August 2012.

Complementing these plans is increasing demandfrom the private sector, in particular from within themining industry, which is in the midst of a value-addedpush by the government to mandate onshore process-ing of minerals. One of the country’s leading operators,Vale, already operates three hydropower plants withinstalled capacities of 165 MW, 110 MW and 90 MW.If fully implemented, this could create new opportuni-ties for hydro developers as mining companies, whichoften operate in remote areas, seek new power sup-plies for energy-intensive industrial refining applications.

174

Hydropower capacity is

being increased through a

number of projects under

the government’s National

Energy Policy and its

Energy Vision 25/25.

175

MiningRising consumption to affect minerals productionTin and coal exports form the bulk of sector revenuesEfforts focus on clearer regulatory frameworkArrangements governing permits subject to changeMining companies keep a close eye on divestment rules

MINING OVERVIEW

Mining exports hit $33.94bn, or 20.88% of domestic exports, in 2013

Buffeted by volatile global commodity prices and leg-islative uncertainty at home, Indonesia’s mineral out-put has fluctuated considerably in recent years.

After recovering from a commodity price slump start-ing in 2008, the sector picked up steam in 2011, in partdue to rising demand from emerging economies, result-ing in higher levels of both prices and output for Indone-sia. These gains proved short lived, however, as pricesagain receded in 2012 (except gold), resulting in mostmining operations in the country taking a financial hitin 2012 compared to the previous year. This was inspite of higher output driven by strong production ofnickel in Sulawesi, and declines continued into the firsthalf of 2013. The environment was further complicat-ed by ongoing uncertainty regarding the future of thecountry’s regulatory framework, particularly foreigndivestiture requirements, domestic refining require-ments and export restrictions. In contrast the thermalcoal segment appears strong, recording productiongrowth owing to regional demand. The performanceof coal companies has been less bullish, however, aslower prices in 2012 cut into profits for coal operators.“Top-end mining companies are still performing well,but due to low commodity prices smaller mining com-panies have been suffering,” Dharma Djojonegoro, pres-ident director of Multi Nitrotama Kimia, a local produc-er of mining explosives, told OBG. “Maybe about 20-30%of the more marginal coal mines had to reduce or stopproduction because of the price drop in coal.”NUMBERS GAME: The mining sector has grown sub-stantially over the past decade, increasing in value fromRp205.25trn ($25.52bn), or 8.94% of GDP, in 2004, toRp1.02qrn ($102bn), or 11.24% in 2013, in currentprices. These figures also include oil and gas mining andquarrying, respectively, with the former accounting forRp401.14trn ($40.11bn), or 4.42% of GDP in 2013, andthe latter Rp141.81trn ($14.18bn), equivalent to 1.57%,according to the Indonesian Central Statistics Agency.Notwithstanding, the mining sector’s 2013 contribu-tion to GDP was down on the 11.8% recorded in 2012.

Led by its plentiful coal shipments, the sector playsa substantial role in the country’s export trade, withmining products accounting for around one-fifth of totalexport value from 2010 to 2012, according to the cen-tral bank, Bank Indonesia (BI). Mining exports totalled$33.94bn in 2013, accounting for 20.88% of the coun-try’s total exports, up slightly from $31.23bn, or 20.47%of the total in 2012. Of the 2013 figure, coal represent-ed the lion’s share at $26.64bn, or 16.39% of all exports,followed by copper ore at $3.38bn, nickel ore at $1.88bnand bauxite at $1.39bn.

Investment into the sector, meanwhile, increased byan annual average of 17% from 2010 to 2012, accord-ing to data from the Ministry of Energy and MineralResources (MEMR). The figure reached $4.23bn in2012, up 32.6% on $3.41bn recorded in 2011, and wassplit among contracts of work (CoW), coal CoW (CCoW),state-owned enterprises and mining services.HURRY UP & WAIT: Indonesia’s mining sector is gov-erned primarily by the Law on Mineral and Coal Min-ing passed in 2009, which replaced previous legislationdrawn up in 1967, along with its accompanying sec-ondary regulations enacted thereafter. The govern-ment has insisted that the new law is necessary torevamp its contract system in order to create a reliableframework for foreign investment as well as to retainmore revenue domestically from the mining value chain.The new framework includes a number of provisionswhich mark a departure from its predecessors in termsof displaying more resource nationalism. To this end,there are more restrictions on the export of raw mate-rials, more stringent domestic processing requirementsfor ore, domestic market obligations (DMOs) andincreased divestment requirements of foreign-ownedoperations. Even the traditional CoW framework gov-erning foreign investment and the separate miningrights, or kuasa pertambangan (KP), licensing systemfor Indonesian investors has been replaced by the newmining business licence, or izin usaha pertambangan

(IUP), system. With discussions ongoing between the

The mining sector

comprised 11.24% of GDP

in 2013, down slightly on

11.8% in 2012, but an

improvement on the 8.94%

recorded in 2004.

177


Coal contributed $26.64bn

(16.39%) to domestic

exports in 2013, followed

by copper ore at $3.38bn,

nickel ore at $1.88bn and

bauxite at $1.39bn.

Moving into gearKey changes to the legal framework buoy the sector’s prospects

MINING OVERVIEW

government and private sector regarding the merits andfeasibility of the new provisions, the former has takenthe decision to defend and review certain aspects ofthe Mining Law. As a result, a series of secondary meas-ures have been adopted altering the timeframe ofimplementation, exceptions and other changes. PLAYING CATCH UP: All in all, these actions have donelittle to enhance the sector’s profile, with Indonesiaranked last (96th out of 96 jurisdictions) behind Kyr-gyzstan, the Democratic Republic of Congo, Venezuelaand Vietnam on the Policy Potential Index (PPI), accord-ing to the Fraser Institute’s “2012/13 Survey of Min-ing Companies”. The PPI is comprised of survey resultsgathered through 742 responses covering exploration,development and other mining-related companies, to15 policy factors that affect investment decisions.Indonesia also ranked second behind only Mongolia inthe category of “room for improvement” and secondto last, behind only Egypt, in the category of “legalprocesses that are fair, transparent, non-corrupt, time-ly and efficiently administered”. By contrast, the coun-try scored fourth on “policy and mineral potential

assuming no land use restrictions in place and assum-ing industry best practices”, behind only Mongolia, theYukon (Canada) and Papua New Guinea.EXPORT BAN & DOMESTIC PROCESSING: Under theterms of the new structure, IUP and special mining per-mits (IUPK) holders are now required to carry out min-eral processing domestically or arrange to go througha third party that has a special production operationlicence for refining and processing. The implementa-tion deadline was set at January 14, 2014 for firmsalready in the production phase, with those in the explo-ration phase given a February 6, 2015 date and forthose in the construction phase, February 6, 2016. Inaddition to the domestic processing requirements, aseparate provision, MEMR Regulation 7/2012 wasissued in February 2012 which banned outright exportsof ore and raw materials. The original implementationdate for the ban set for May 2012 was pushed back toJanuary 2014, allowing companies to continue shippingunprocessed minerals abroad albeit with a caveat in theform of a new 20% export duty (Ministry of FinanceRegulation No 75/2012) on mineral and stone items,as well as mandatory export approval from the Min-istry of Trade (MoT), and registration as an exporter. CHALLENGES: Given the country’s limited refinerycapacity relative to its production, full compliance wouldrequire tens of billions of dollars of new investments.The country’s total copper smelting capacity is rough-ly 2.4m tonnes per annum (tpa), around one-tenth ofthe capability required to domestically process Indone-sia’s total output as per MEMR data. Nickel smelting ismore encouraging with a capacity of 19.18m tpa com-pared to a production of around 33m tonnes, while baux-ite capacity is 7.1m tpa, with production of 30m tpa.

One challenge for mining companies is that boththe truncated implementation timeline as well as largecapital expenditures for relatively small profit marginsmake compliance with the law all but impossible in thetime allotted and in many cases economically unfeasi-ble even in the long term. For minerals that Indonesiadoes not produce significant quantities of, such as sil-ver, obtaining enough feedstock to justify a smelterwould also be difficult. Other factors such as key infra-structure gaps also create additional hurdles to fullcompliance, particularly for electricity whereby thereis already a national supply shortage, something thatsmelters require a large and consistent supply of. CLEARER HORIZONS?: In response to sector concerns,the Indonesian Chamber of Commerce and Industry(KADIN) announced plans in October 2013 to set up ateam to provide the government with input and rec-ommendations particularly related to the raw mineralexport ban. According to KADIN, recommendationswould be made on several issues, including the crite-ria companies would need to fulfil to be exempt fromthe raw material export ban, the applicable transitionperiod for the full implementation of the ban, cooper-ation among big companies to develop processing facil-ities and possible supervision for companies claimingthe smelting plant projects. As of November 2013,strong indications were given by the government that

178

Production, export & consumption of coal, 2006-12 (m tonnes)

SOU

RCE:

Min

istr

y of

Ene

rgy

& M

iner

al R

esou

rces

0

80

160

240

320

400

ConsumptionExportProduction

2012201120102009200820072006

The export of ore and raw materials is subject to local restrictions

Special mining permit

holders are required to

undertake mineral

processing domestically or

arrange to go through a

third party that has a

special production

operation licence for

refining and processing.


MINING OVERVIEW

the law would proceed as planned, but that loopholesand exceptions could also be introduced in practice.Some of the key issues which will need to be addressedby the government include determining which mate-rials lend themselves to be refined domestically and stillbe profitable, and creating an efficient regulatoryprocess to determine those mining companies capa-ble and motivated to develop their own refining capac-ity. So far, these new export restrictions do not applyto holders of existing CoW agreements, which includeseveral large-scale operations in the country, includ-ing Freeport McMoRan Copper & Gold, Newmont NusaTengarra (PTNNT) and Vale. These firms are not immuneto the effects of the new framework, however, as con-tract negotiations for the mandatory transition fromthe old CoW regimen to newer IUPs are ongoing forthe majority of contracts (97 contracts outstanding asof May 2013). These negotiations cover a number ofissues surrounding old contracts and new require-ments, specifically the size of mining areas, contractextensions, amount of royalties and taxation structure,domestic processing requirements, divestment, andthe utilisation of local goods and services.

While this law has facilitated a flurry of interest insmelting, with dozens of plans for new smelting oper-ations filed by companies seeking to avoid immediateeffects of the ban starting in 2014, the governmenthas so far indicated a stricter interpretation of the law.In spite of filing memoranda of understanding (MoU)in 2013 to construct new smelters for their copper andgold operations, two of the nation’s largest miningcompanies – Freeport Indonesia and PTNNT – weretold by the Coordinating Ministry of Economic Affairsin August 2013 that the MoUs would not exempt themfrom the domestic refining law.

The country’s coal trade has not been immune to reg-ulation either, with the authorities implementing abenchmark pricing scheme for coal and mineral exports,in addition to ongoing discussions on draft regulationsprohibiting the export of low energy coal with a caloricvalue of less than 5700 kCal. This is on top of possiblecostly upgrading requirements for low rank coal. CLEAN & CLEAR: Another bureaucratic obstacle theMining Law was intended to address is overlappingusage rights and categorisation of land at the local,regional and federal level. “Land acquisition is problem-

atic primarily due to the complete absence of the ruleof law in some regional areas paired with the lack of acurrent land registry. This means that a landowner cansimply point at a piece of land and claim ownership,leaving little available recourse for mining companies,”Freddy Setiawan, chairman of mining specialists MegahPratama Resources, told OBG.

In a survey published in May 2013 by PwC in con-junction with the Indonesian Mining Association andthe Indonesian Coal Mining Association, the single mostsignificant concern about the local mining sector (outof a total of 17 options) was the lack of coordinationamong the central, provincial and regional govern-ments. This was followed by conflicts between miningoperations and forestry regulations, with confusionover the implementation regulations for the new min-ing law coming in third. Multiple contradictory claimson property along with significant areas of land cate-gorised as off limits for commercial resource extrac-tion purposes has led to a backlog of permit applica-tions and appeals processes causing gridlock in thepermit system. As a means of rectifying this backlog,the government has set about mapping the areas wheremining is permitted, which includes occasional com-peting interests of federal, local and regional govern-ments, as well as different types of extractive indus-tries. The process then sets about determining the“clean and clear” status of existing mining licencesunder the jurisdiction of the 2009 Mining Law, witharound half of the roughly 10,000 mining licences sort-ed through as of May 2013. NEW BASELINE: Ongoing progress and completion ofthis programme is key not only in clarifying the param-eters of existing operations and weeding out fraudu-lent, illegal, unworked or abandoned claims, but alsobecause no new mining licences (with the exceptionof converted KPs) can be issued until the culminationof the process. Although the task has taken longerthan anticipated, once completed, registry should pro-vide a reliable baseline for new projects to proceedwith a higher assurance of accuracy. Other recent ben-efits granted to investors include the tax allowance(GR No 52/2011) and tax holiday (ministry regulation130/2011) passed in 2011, as well as import dutyexemption from capital goods. The government has alsostated it may relax foreign divestment requirements, if

179

The government has moved

to address the backlog of

mining permit applications

and appeals processes by

establishing a clearer

picture of where mining

and extractive industry is

permitted in the country.

MINING OVERVIEW

they comply with local processing caveats, though nopolicy decisions or legislation have yet been made pub-lic. Changes to foreign divestment requirements firstoutlined four years ago were also recently crystallisedwith the passage of MEMR Regulation 27/2013 andwill have repercussions for current and future miningcompanies with domestic operations (see analysis). COAL: Indonesia remains one of the world’s leading coalproducers, ranking fourth in production in 2012 with237.4m tonnes of oil equivalent (mtoe), positioning thecountry behind only China (1825 mtoe), the US (515.9mtoe) and Australia (241.1 mtoe), according to BritishPetroleum’s “Statistical Review of World Energy 2013”.

Although Indonesia accounts for 6.2% of global pro-duction, proven reserves were estimated at just 0.6%of worldwide supplies in 2012, approximately 5.53bntonnes (4.01bn tonnes of sub-bituminous and ligniteand roughly 1.52bn tonnes of anthracite and bitumi-nous). The majority of these deposits are located in SouthSumatra, South Kalimantan and East Kalimantan, withvarious smaller pockets elsewhere on Sumatra, Java, Kali-mantan, Sulawesi and Papua.

Fuelled mostly by demand within the Asia-Pacificregion and the opening of the sector to foreign invest-ment in the 1990s, output has risen substantially overthe two past decades, up from 17 mtoe produced in1992 to 63.5 mtoe in 2002. More recently, growth of9% was recorded with 2011’s output of 217.3 mtoe(353m tonnes). The majority of mined coal consists ofa medium-quality type (between 5100 and 6100cal/gram) and a low-quality type (below 5100 cal/gram),and is exported primarily to China, India, Japan andKorea. Indonesia exported 304m tonnes of coal in 2012,up from 272m tonnes in 2011, while domestic consump-tion largely remained static at 80m tonnes in 2011 and79m tonnes in 2012. However, this ratio is expected toshift towards domestic consumption in the comingyears, as a host of new coal-fired power plants are setto be built over the next decade and the governmentis likely to increase export taxes.

Continued growth of overall production, however, isfar from guaranteed if market prices stay depressed andthe government inflexible in its plans to increase roy-alties and export duties on coal (as stipulated in the2009 Mining Law). Coal royalties currently range from2% to 7% for those companies that work under an IUP,

and 13.5% for those that work under joint coal-miningcontractors (PKP2B) and earlier generation CCoW agree-ments. Under the new regulations, which came into forcein January 2014, royalties for IUP holders (generallysmall and medium-sized operations) have increasedfrom 10% to 13.5% depending on the caloric value oftheir output. Similar to the minerals segment, resist-ance to the new regulations has been significant, andactual implementation of the law remains in doubt.Still recovering from a drop in commodity prices, small-er mining outfits have already been forced to curtailactivity or even shutter their operations, while largerplayers have ramped up output to lower unit costs inan effort to ride out the downturn.

A benchmark pricing system (MEMR regulations 11and 17) was established in 2012, along with the DMO(MEMR 34) in 2009, leaving other outstanding issuesso far unresolved. This includes the export ban for coalwith a calorific value of less than 5700 kCal, an issuewhich is not expected to be fully addressed until at leastafter the 2014 presidential elections. Under the DMOarrangement, the MEMR set the DMO requirements at74.32m tonnes for 2013, spread among 74 coal min-ing companies, which was equivalent to 20.3% of fore-casted coal output for that year. Regarding higherexport duties, at the time of publication in early 2014the government had not announced any specific details.

Contract specifications under the new system for coalcompanies are similar to those of mineral agreements:coal exploration IUPs and IUPKs are valid for sevenyears, while production is permitted over a 20-yearperiod, with two optional 10-year extensions. Licensedareas are smaller for coal, ranging in size from 5000 hato 50,000 ha during the exploratory phase, and reducedto a maximum area of 25,000 ha after three years. Pro-duction can cover a maximum of 15,000 ha. TIN: The world’s second largest producer of tin behindChina, Indonesia produced an estimated 40,000 tonnesin 2013 compared to 41,000 tonnes in 2012, accord-ing to US Geological Survey (USGS) figures. Recentpolicy decisions from both the government and by tinmining companies themselves have had significanteffects on tin commodity prices, with the industry firstpropping up slumping tin prices in mid-2012 by collec-tively curtailing sales, as well as later in 2013 when thegovernment enacted new purity and trading restrictions.

180

Key importers of

Indonesian coal include

China, India, Japan and

Korea, though the

expected rise in domestic

consumption is also likely

to affect demand and

production going forward,

with several new coal-fired

power plants set to be built

in the coming years.

MINING OVERVIEW

The most notable government regulation was a movein August 2013 to require all 47 registered tin ingotexporters to trade tin on the country’s domesticexchange before shipping material, which followed anearlier ruling in July of that year to increase purity stan-dards for exports to 99.9% purity. In response to thenew requirements, Indonesia's leading tin exporter,state-owned Timah, halted shipments and declaredforce majeure in September. Although the regulationshave boosted tin commodity prices substantially, Indone-sian shipments have fallen off as well, due mostly tothe regulatory restrictions. Refined tin shipments, forinstance, fell to an 11-month low of 6465 tonnes in July2013 after exporting 98,817 tonnes in 2012, accord-ing to MoT statistics. Decreased tin supply to global mar-kets has pushed up benchmark prices on the LondonMetal Exchange (LME) by 18% since the end of June2013 to $23,285 per tonne in late September, where-as tin contracts traded on the Indonesia Commodityand Derivatives Exchange rose from $21,500 at thestart of September to $23,285 by the end of the month. NICKEL: Even as global nickel prices continue to con-tract due to reduced demand from the world’s leadingimporter China, which uses the metal for stainless steelproduction in products such as cutlery, production con-tinues to accelerate as mining companies pursue astrategy of increasing economies of scale and reduc-ing unit costs. After remaining soft in 2012, nickel pricesdeclined into 2013 with three-month delivery nickel hit-ting $13,205 per tonne on the LME on July 9, 2013, itslowest level since May 2009 and down from nearly$19,000 in February. While this has affected the bot-tom lines of major nickel producers, including thoseoperating in Indonesia such as state majority-ownedAntam and Vale Indonesia (formerly Inco Indonesia),production continues to be strong. Sourced mainlyfrom Sulawesi, nickel mine production jumped from228,000 tonnes in 2012 to 440,000 tonnes in 2013,according to USGS data. Exports have also continuedtheir upward swing, increasing from 10.65m tonnes ofnickel ore in 2009 to 19.05m tonnes in 2010, 37.47mtonnes in 2011 and 47.06m in 2012, according to CB&I.In spite of the 25.6% hike in volume from 2011 to 2012,export receipts for nickel shipments increased just10.01% due to lower commodity prices, which droppedfrom $1.33bn to $1.47bn. Indonesia’s total nickel con-tent reserves are estimated at 3.9m tonnes by the USGS. BAUXITE: Interest in aluminium ore, which is also usedin the production of non-metallurgical products suchas abrasives, chemicals and refractories, and in baux-ite rock has grown in demand in recent years, spurringa corresponding spike in production and exports.Accompanied by other rare metals such as monazite,the bauxite is found almost exclusively in East Kaliman-tan, as well as on the Lingga Islands and Bangka-Beli-tung Islands, which are off the west coast of Java.

Exports of bauxite more than tripled from 11.56mtonnes to 39.64m tonnes between 2007 and 2011,before falling to 29.57m tonnes in 2012, as per CB&Idata. The country’s total bauxite reserves were estimat-ed by the USGS to be 1bn tonnes as of February 2014.

OTHER METALS: Along with the primary productionof gold, copper, coal, tin and nickel, several other met-als are recovered either as secondary output from oth-er mining operations or through single dedicated mines.Ferro and associated metals, such as iron, cobalt, man-ganese and chromate, are distributed across the coun-try with the greatest concentrations located alongWestern Sumatra, Southern Java, East and West NusaTenggara, South Kalimantan, Sulawesi and North Maluku,as per data from the Geological Agency of Indonesia.Precious metals such as silver and platinum are con-centrated in Western and Southern Sumatra, EasternJava, Kalimantan and North Sulawesi, while other basemetals, namely lead and zinc, often accompany cop-per and tin finds, which are also dispersed countrywide. OUTLOOK: In spite of the challenges, the country’svast potential resources still provide substantial growthopportunities. With mineral prices expected to sta-bilise as emerging economies increase their demandfor the country’s raw materials, both domestic and for-eign mining outfits should find further incentives withnew exploration and development plans, provideduncertainty around the legislative framework is resolved.In the meantime, the implementation of key compo-nents laid out under the Mining Law are unlikely to be resolved until after the 2014 presidential election.

181


SOURCE: Bank of Indonesia

2008 2009 2010 2011 2012

Mining products 13,878.59 19,946.48 25,546.86 34,288.81 31,231.47

Coal 10,305.21 13,765.09 17,801.23 26,924.58 26,177.96

Copper ore 2316.37 5380.29 6325.23 4706.93 2484.71

Nickel ore 503.86 291.55 574.68 1333.17 1466.59

Bauxite 202.49 240.06 453.95 767.14 633.94

Granite 52.63 22.65 42.80 35.79 15.60

Other mining products 488.26 236.17 339.25 505.11 439.54

Other sector products 9.77 10.68 9.71 16.08 13.14

Unclassified exports 445.45 588.46 724.03 995.05 924.0

Export value by commodity, 2008-12 ($ m)

Regulatory restrictions have had an adverse effect on some metals

While coal is the mainstay

of mining activity in the

country, Indonesia is also a

leading producer of several

other metals. Tin and nickel

output reached 40,000 and

440,000 tonnes in 2013,

respectively. Bauxite

reserves, meanwhile, are

estimated at 1bn tonnes.

MINING ANALYSIS

Copper production decreased to around 380,000 tonnes in 2013

Home to the world’s second-most productive coppermine, and the largest gold mine in terms of reserves,Indonesia has positioned itself strongly among theworld’s largest precious mineral producers. Althoughgold production across the archipelago has tradition-ally been extracted as a by-product from large-scalecopper mines, the revenues generated from gold salesare far from an afterthought. Almost one-third to halfof the country’s gold production, along with nearlyone-third of copper output, is sourced from FreeportIndonesia’s Grasberg mine in any given year, with BatuHijau copper/gold mine and Gosowong gold/silvermine, in addition to the recent acceleration of produc-tion at the Martabe gold/silver mine, also contribut-ing to the segment’s current performance. PERFORMANCE: After a strong performance in 2009and 2010, driven by higher commodity prices and steadyproduction, output of gold and copper in 2011 tailedoff for the year. By and large, this was a result of weak-er global demand for copper, as well as start up delaysand production problems for the country’s two majorgold and copper producers.

Gold output in 2012 reached 66 tonnes, down from78 tonnes in 2011, according to data from the Ministryof Energy and Mineral Resources (MEMR). However, esti-mates from the US Geological Survey (USGS) puts the2013 figure at 60 tonnes, up marginally on 59 tonnesrecorded in 2012. Data from Thomson Reuters GFMS,meanwhile, indicate that output dropped from 120.1tonnes to 89 tonnes from 2011 to 2012, with a fur-ther 7% decrease in the first half of 2013 to 42.6 tonnes.In terms of global gold production, the slowdown sawIndonesia fall from seventh to 10th in 2012, with Cana-da, Ghana and Mexico all moving ahead, according toThomson Reuters GFMS.

As per MEMR data, copper rebounded from 618,000tonnes produced in 2011, to 804,000 tonnes in 2012,an increase of 30.1%. This compares to 999,000 tonnesin 2009 and 878,000 tonnes in 2010. Data from theUSGS, however, shows a continued decline from about

543,000 tonnes in 2011 to approximately 430,000tonnes in 2012, a trend which aligns with the fallingoutput of the country’s largest copper producers. Pre-liminary figures for 2013 published by the USGS showproduction of 380,000 tonnes, with export restrictionsas well as other challenges including work stoppagesand working with lower quality material. All in all, Indone-sia has sufficient quantities of gold and copper to con-tinue production at a high level for decades to come.Despite mineral production tailing off in recent years,data from the USGA indicates healthy reserves of 3000tonnes for gold and 28,000 tonnes for copper.AN OLD HAND: Containing one of the largest copperand gold reserves in the world, the Grasberg mineralsdistrict located in Papua and operated by FreeportIndonesia (PTFI) continues to make up the bulk of cop-per and gold production in the country, in spite ofdeclining output in recent years.

In operation since 1967, the mine is now shifting itsfocus away from the Grasberg open pit mine, which cur-rently accounts for the majority of production, towardsdeveloping other large-scale, high-grade undergroundore bodies, as laid out under the Common Infrastruc-ture Project (CIP).

Between 2012 and 2017, development of the CIP,Grasberg Block Cave underground mine and the DeepMill Level Zone, will require average annual investmentsof around $715m and is expected to yield a combined240,000 tonnes of ore per day by 2017. While the minestill possesses high quality reserves – estimated by thecompany at 14.06bn kg of copper and 30.9m ouncesof gold in 2012 – production has slowed in recent yearsfollowing frequent shutdowns at the mining site as wellas the recent processing of lower grade ore. As a result,copper production declined annually between 2009 and2012, dropping from some 743.9m recoverable kg in2009 to 315.2m kg three years later, according to com-pany reports. Gold output has been similarly affected,falling each year over the same period from 2.98mounces in 2009 to around 862,000 ounces in 2012.

Home to the world’s largest

gold mine in terms of

reserves, Indonesia ranks

10th globally for gold

production, though output

has fallen in recent years.

182

Golden promiseMore transparent governance may encourage gold and copper activity


MINING ANALYSIS

The site’s most recent work stoppage, which lastedfrom May to July 2013 was due to a tunnel cave-in thatkilled 28 people. Prior to the accident, a string of secu-rity issues including protests and several incidents ofviolence targeting Grasberg operations and employeesresulted in a number of stoppages to operations. Thiswas in spite of increased security both from the Indone-sian government and the company itself. Between July2009 and mid-February 2013, there were a total of 37shooting incidents, which resulted in 15 fatalities and57 injuries in and around the Grasberg minerals dis-trict, many of them occurring along the access roadleading to the mining and milling operations. COMPROMISE: As of 2013, PTFI was 90.64% owned byArizona-based Freeport-McMoRan Copper & Gold,including a 9.36% stake in subsidiary Indocopper Inves-tama. Although the current Contract of Works regimefor the mine inked in 1991 runs through 2021, with anoption to extend the contract another 20 years, thefuture of the mine and its ownership composition isunclear beyond that timeframe, due to the majoritydivestment provisions included in the new Mining Lawof 2009. The new regulations require foreign compa-nies such as Freeport-McMoRan to divest a majority51% stake in any mining venture in addition to othernew obligations, including raw ore export restrictionsand limits on the size of mines.

As these new laws are in conflict with the parame-ters outlined under the pre-existing contracts, the gov-ernment and Freeport are currently in negotiations toreach a compromise satisfactory to both parties priorto the expiration of the current contract.

Freeport indicated in 2012 it would consider sellingits stake in Indocopper Investama to move closer to itsdivestment requirements, as well as stating in July 2013that it would list 5% of its shares on the Indonesian StockExchange, specifically through an initial public offer-ing, and sell another 10.64% stake to the Indonesiangovernment (which already holds a 9.36% share). ROUNDING OUT THE FIELD: The second-largest cop-per and gold operation in the country is Batu Hijauopen pit mine located on the island of Sumbawa, whichhas primarily been producing copper concentrate witha gold by-product since commencing operations in1999. Run by Newmont Nusa Tengarra (PTNNT), a sub-sidiary of Newmont, the world’s second-largest gold pro-

ducer, the mine is a joint venture between PTNNT, Japan-ese corporation Sumitomo and the Indonesian gov-ernment. Copper production decreased by 42% in 2012to 71,200 tonnes along with a 78% dip in gold outputto 68,000 ounces on the year, with the decline for bothattributed primarily to processing lower grade stock-piled material, according to company reports. Reservesare estimated by PTNNT at 1.59m attributable tonnesof copper and 3.5m attributable ounces of gold as ofDecember 2012, giving the mine a projected lifespanof at least 20 more years.

Like the Grasberg project, PTNNT has also been mov-ing forward with divestment plans in order to complywith the revised regulatory regime. Prior to 2013, theBatu Hijau mine ownership was made up of the NusaTenggara Partnership BV (NTPBV) partnership betweenNPC and the Sumitomo Corporation with a 56% con-trolling interest along with domestic minority partnersMulti Daerah Bersaing with a 24% stake, Pukuafu Indah(PTPI) with 17.8%, and Indonesia Masbaga Investamaholding the remaining 2.2%.

After agreeing in 2011 to sell a 7% stake of NTPBVto the government and reduce the company’s holdingto the required 49%, government wrangling as to whichgovernment vehicle would take control of the stakedragged the deal out until local government interestswon out over the central government in July 2013.

Located on Halmahera Island, the Gosowong mineis another significant gold producer, and is operatedby Nusa Halmahera Minerals as part of a 75/25 part-nership between PTNNT and Aneka Tambang, as since1999. Unlike other major gold operations in Indonesia,Gosowong contains gold and silver deposits ratherthan copper, of which it produced 312,711 ounces ofgold and 342,835 ounces of silver through the year end-ing June 2013, according to PTNNT.

The mine is estimated to hold 2m ounces of gold andanother 3.1m ounces of silver. The new Martabe minelocated in Batang Toru of the North Sumatra provinceadded more than 200,000 ounces of gold and almost1m ounces of silver to Indonesia’s tally since beginningoperations in July 2012.

Operated by Hong Kong-based G-Resources Group,the project has forecast annual output of approxi-mately 250,000 ounces of gold and between 2m and3m ounces of silver once operations are accelerated.

183

Mining companies and the

Indonesian government are

continuing with discussions

to establish greater

transparency in divestment

arrangements.

MINING ANALYSIS

Production IUPs cover a period of five, 10 or 20 years

As part of Indonesia’s push to ensure that more bene-fits from resource extraction carried out by miningactivity are preserved and reinvested domestically, thegovernment is revamping the framework regulatingmining contracts. This is aimed at facilitating greaterlocal participation in operations and securing a largerproportion of revenues for the state. The overhaul ofthe longstanding Contracts of Work (CoW) regime forforeign companies and the separate mining rights, orkuasa pertambangan (KP), system for local companies,which has served as the framework for mining contractsbetween the state and private companies, has pro-gressed under the unified new mining business licence(IUP) scheme created in 2009. As a result, existing CoWdeals are in the midst of being renegotiated and anynew mining operations – once issuances of theseresume – and will operate under the IUP system. NEW REGIME: The specifics established under the IUPsystem are noticeably different from the CoW in playpreviously, in particular in terms of both length of con-tract and concession size. The mines already operatingfor decades in Indonesia would not be possible underthe new system: metallic mineral exploration areas arelimited to between 5000 ha and 100,000 ha (to bereduced to a maximum of 50,000 ha after three years),with a production area no larger than 25,000 ha, andnon-metallic minerals exploration areas capped at25,000 ha (reduced to 12,500 ha after two years) anda 5000-ha production area.

In terms of duration, exploration IUP contracts forrocks, non-metallic minerals and metallic minerals arecapped at a maximum of two, three and seven years,respectively. Production IUPs, meanwhile, are limited tofive, 10 and 20 years. Rock and non-metallic mineralagreements may also be extended twice for a periodof five years each, while metallic mineral contracts maybe extended twice for 10 years. LEGAL: Of equal, or perhaps greater, importance to min-ing groups is the evolution of divestment requirementslaid out in the 2009 Mineral Law. Initially, implement-

ing regulations for the law was enforced through Gov-ernment Regulation No. 23 of 2010 (GR23) whichrequired a minimum divestment of 20% of foreign cap-ital in IUP holders following the fifth year of produc-tion operations. This proved short-lived, however, as thegovernment exercised its power – as stipulated in theMining Law – to independently set divestment levels,as well as raise divestment requirements to 51% by thecompletion of the tenth year of production. This waspossible through the issuance of Government Regula-tion 24 of 2012 (GR24) in February 2012 and, later, Min-istry of Energy and Mineral Resources Regulation27/2013 (MEMR 27). Under the revised timetable, for-eign investors in the sector must reduce their owner-ship to: a maximum of 80% six years after productionbegins; 70% after seven years; 63% after eight years;56% after nine years; and 49% after 10 years. Local,regional and then federal governments are affordedfirst rights of refusal for these shares at below marketvalue discounted replacement costs, creating an incen-tive to either participate directly in the operations ortransfer them to locally-registered third parties. WIDE IMPACT: Apart from the decreased revenue andcontrol of mining operations, exploration activity car-ried out by foreign mining interests could also be affect-ed as upfront investment in costly exploratory activitymay not necessarily be recouped once operations movefrom exploration to production phases where furtherdivestment is required. According to MEMR 27, reduc-ing ownership to 49% by floating shares on the Indone-sian Stock Exchange would not qualify as divestment,and the new regulations supersede any arrangementsincluded in existing CoW contracts, meaning that com-panies which have been operating for decades mustnow also comply with the law.

As it is currently unclear how, and to what extent,divestment requirements will be applied to pre-exist-ing CoW contracts, these last two provisions have beenthe focus points of ongoing negotiations between thegovernment and large mining players in the country.

Metallic mineral

exploration areas must be

limited to between 5000 ha

and 100,000 ha, with a

production area no larger

than 25,000 ha. Exploration

and production areas for

non-metallic minerals,

meanwhile, are capped at

25,000 ha and 5000 ha,

respectively.

Reducing ownership to

49% by floating shares on

the Indonesian Stock

Exchange does not qualify

as divestment under

Indonesian law.

184

Divesting interestNew framework for contracts and business licences


MINING INTERVIEW

Martiono Hadianto, President Director, Newmont Nusa Tenggara

From a regulations perspective, how will the ban

on mineral ore exports impact mining companies?

HADIANTO: There are several new commitments thatwe are being asked to make that would significantlyimpact our business. Firstly, mining companies are beingasked to commit to refining their mined productsdomestically. Currently, only about 20% of our productis refined in Indonesia, meaning that we would have tocommit to the remaining 80% also being refined herein the future. Further, we would have to build our ownsmelters. This is problematic simply because smeltingis not our business, as we are miners first and foremost.In addition, if we were to build smelters, the minimumsize for the operation to be financially feasible wouldbe at a copper cathode capacity of 200,000 tonnes peryear (t/y), which would represent nearly $1.5bn ofinvestment from our side. However, to process our cur-rent quantity of product, we would only need a capac-ity of 125,000 t/y, meaning that such a project doesnot make economic sense. Looking at the current glob-al smelter industry, China has around 40% of the world’ssmelter capacity for copper. Combined, the largest min-ing companies in Indonesia represent only 3% of thatsame capacity. From a numbers standpoint this sud-den mandate to build smelters creates a huge burdenfor us. The presence of large mining companies is keyfor Indonesia, and regulations should be evaluated tocreate an environment conducive to the sector’s suc-cess. While the country’s mining sector ranks highly interms of geologic attractiveness, it ranks poorly regard-ing investment attractiveness. Something is wrong.

In what way are negotiations between policy mak-

ers and mining companies being enhanced?

HADIANTO: I am optimistic about progress. As ourmines are located in Nusa Tenggara, our presence issignificant to the social and economic well-being of theregion. Given that 2014 is an election year, a disrup-tion in an industry as critical as mining in these regionscould result in social and political unrest. We do not

want regulatory disagreements to jeopardise the sta-tus of our operations and to negatively impact a regionin which we have invested so much. As such, both New-mont and other mining groups are in discussion withpolicy makers to resolve issues. For example, whereasmining companies are willing to try to assist the gov-ernment in building smelters, we need this to be donein a way that is financially feasible. Over the past fewmonths, there has certainly been a more positive atti-tude to the negotiations, and I am hopeful that a rea-sonable agreement will be achieved.

How could the incoming administration more effec-

tively manage the mining industry?

HADIANTO: There are four specific improvementswhose implementation would increase the level of dia-logue between mining companies and policy makers.

Firstly, there needs to be a clear definition of the scopeof the mining sector versus that of the industry sector,in particular to distinguish refining in the industry sec-tor as separate, rather than as part of the mining busi-ness. Even now, “refining” by legal definition falls underthe regulation of the Ministry of Industry, so why is itbeing regulated by mining laws? Secondly, the govern-ment needs to understand the additional investmentthat every mining company would need to make if allprocessing were to be done in the country. While thesepolicy amendments may be politically feasible, thereneeds to be more research done to understand andaddress the economic viability of these changes for com-panies. Thirdly, greater emphasis on promoting explo-ration is required. Without such activities, we cannotexpect further growth in the mining sector going for-ward. Thus, promoting exploration is something thatcan be included under mining regulation. Finally, allmining companies would agree that the different play-ers in the industry need to provide greater input on theseregulations. Our inclusion when considering regulato-ry policy changes would go a ways to improving dia-logue between the authorities and the mining sector.

185


Overcoming challengesOBG talks to Martiono Hadianto, President Director, Newmont NusaTenggara

MINING INTERVIEW

Arsjad Rasjid, Vice-President Director & Group CFO, Indika Energy

Is land acquisition still the main challenge for pri-

vate investment in power, mining and related infra-

structure? Where can the government assist?

RASJID:While the government policy is angled towardsdeveloping value-added industry, these new process-ing plants and accompanying infrastructure all requireenergy. In order to secure requisite private sector invest-ment, there needs to be far greater coordination amongdifferent ministerial departments.

The government should also start securing land forprivate sector investors in advance; this has been occur-ring successfully in China for many years. Acquisitionof dedicated land banks and a well-run infrastructurebank should be pursued in order to catalyse develop-ment. However, perhaps even more pressing is theproblematic state of bureaucracy which hinders not onlythe mining sector but also the entire energy sector. Thisis the most challenging and time-consuming elementmainly because there is no alignment among centralgovernment, provinces and regencies. The Master Planfor the Acceleration and Expansion of Indonesia’s Eco-nomic Development is a great strategy but alone it isnot enough. All departments involved must feel a senseof ownership over projects and an according respon-sibility to assist development in areas which will havea huge impact if executed properly. Structural reformmust also be undertaken to ensure such alignment bydividing liability between government departments.The government must do its best to create a systemwhich enables tangible progress to be made.

Are there any short-term government policy actions

that could breathe new life into the mining sector,

which has faced challenges in the past two years?

RASJID: The key is to create a policy that is honest. Wemust look upon ourselves and compare the currentIndonesian landscape to other parts of the world. Apoignant comparison is to Nigeria, where many Euro-pean and US mining companies are investing despitethe challenging security characteristics. While mining

policy can still reflect national interest to an extent, pol-icy must also be competitive and realistic.

Domestic policy makers must also understand theprocess such as supply chain management, includingthe differences between minerals and ores in relationto processing. What the government must understandis that clarity is key. This is why companies operate inNigeria in light of security constraints. If Indonesia fol-lowed such a regulatory example it would likely becomethe preferred destination.

What effect has China’s demand for coal had on the

Indonesian mining landscape, and how can this

relationship continue to benefit Indonesia?

RASJID: In 2013 China introduced two policies thatimpacted the global and Indonesian coal markets sig-nificantly. The first policy set a maximum exploitationlimit of 50% for domestic Chinese coal reserves whilethe second increased standard safety requirementswhich in turn caused higher production costs for Chi-nese companies. In fact, some mines were forced stoptheir operations to ensure that they are able to meetthese new standards. The combination of these twopolicies caused an immediate surge in demand for coalfrom Indonesia, demonstrating both that China willremain an important buyer of Indonesian coal and thetangible effect a policy change can have.

Today, while Chinese economic growth is slightly low-er, it is still growing and they have built so much coal-reliant power-generation capacity that the country willcontinually need to import. We also predict that in thefuture China will come overseas to further consolidatecoal supply in destinations such as Indonesia whichlacks infrastructure but has resources in abundance.

China has several mineral processing plants and,while it may be difficult to export Indonesian-sourcedminerals in light of regulation, this could well promptChina to build processing facilities here. We hope thatour pre-established partnership can be further consolidated upon in order to benefit both countries.

186

OBG talks to Arsjad Rasjid, Vice-President Director and Group ChiefFinancial and Operating Officer, Indika Energy


A stronger partnership

187

Industry & RetailAttention to under-utilised sectors to boost productionMinimum wage increases reshape retailers’ bottom lineForeign interest in developing local automobile sectorA large middle class helps to fuel consumption growthTraditional retail structures alongside modern outlets

INDUSTRY OVERVIEW

A depreciated rupiah has helped make local goods more attractive

Indonesia has all the makings of an industrial pow-erhouse: a young and talented population, relative-ly cheap labour and a large domestic market. Thecountry has the capacity and the conditions to devel-op industry, specifically export-oriented industries.Manufacturing is also vitally important to Indone-sia. Without it and without its growth, the countrywill have a difficult time addressing its currentaccount deficit, escaping the middle-income trap andtaking the edge off the commodity cycle. Buildingup industrial capacity is the answer to many of thecountry’s problems: it will provide both growth anda cushion from external shocks, but this will not beeasy to achieve. While the country is attracting con-siderable foreign direct investment (FDI) and isregarded generally as a good place to do business,various challenges and long-term issues work againstthis transition. Like many countries, Indonesia isdealing with wage pressures and a flood of importsthat are making it difficult to hold on to and build amanufacturing base. It also faces infrastructural chal-lenges that will slow industrial development.BEFORE & AFTER: Before the Asian financial crisisof 1997-98, Indonesia was well on its way to becom-ing much like its neighbours: a low-cost, exportmachine. According to a 2012 World Bank studyentitled “Picking Up the Pace”, non-oil and gas man-ufacturing comprised between 10% and 14% of GDPin the six years prior to 1997. However, between2001 and 2010 this rate plummeted into the 2-8%range. The country went from one building up capac-ity fast to one struggling to maintain it. Accordingto the study, export growth of non-oil and gas prod-ucts rose annually at a rate of 21% between 1990and 1995; that fell to 5.1% in the 2000-05 period.

Much explains this relatively poor performance ofindustry and the failure to increase manufacturingexport production. The particularly devastating crashthe country experienced after the run on its curren-cy destroyed confidence in the economy and that,

along with political instability and some violence,served to scare off investors and depress local con-fidence. However, this only partially explains thecountry’s experience, for neighbours like Thailandwere similarly affected and have managed to rebuildand, in fact, outperform expectations. MISSED STEPS: During its recovery, Indonesia failedto make several key investments, such as in trans-portation and power infrastructure, two segmentsthat remain weak. The lag in these areas has had amaterial impact on the growth of industry.

Indonesia ranked 120th in the World Bank's “DoingBusiness Survey 2014”, and 175th in the Starting aBusiness category out of 189 nations. Investors werewary of a market where electricity supply was unsta-ble and where it may be difficult to both ship in com-ponents and ship out finished products.

Home to abundant natural resources, Indonesiaencouraged and courted investment in mining, min-erals and oil and gas, to the possible detriment ofinvestment in and development of other productivesectors. World Bank statistics, for example, show along-term and persistent decline in manufacturedexports as a percentage of total exports, from a highof 53% in 1993 to a low of 34% in 2011. (For com-parison, Thailand has remained above 70% since1994.) As the global price of commodities rose, theratio of these goods compared to the total amountof goods traded increased. Still, resources did seemto impact manufacturing in Indonesia more than inregional competitors. TOO MANY IMPORTS: As Indonesia started to sta-bilise its politics and was in a good position to turnattention to manufacturing, another threat emerged:imports. The country found that as the economiesof the West remained weak, Chinese-manufacturedgoods flooded in and made it difficult for the localfactories to stay in business. In 2012 Indonesiarecorded a $22bn trade surplus, but a $5.6bn tradedeficit with China (its largest trade deficit with any

Following the Asian

financial crisis, non-oil and

gas manufacturing

declined, with its

contribution to GDP

falling from 10-14% prior

to 1997 to 2-8% between

2001 and 2010.

189


While the country is

attracting considerable

foreign direct investment

and is generally regarded

as a good place to do

business, various

challenges and long-term

issues work against efforts

to build up industrial

capacity.

Back on trackLeveraging strengths to resume upwards trends

INDUSTRY OVERVIEW

country) amid a flurry of dumping complaints. “Often,the companies cannot compete in terms of price,”Baari la Inggi, executive secretary at the IndonesianTextile Association of Greater Jakarta, told OBG. TRICKY TIES: Some blame trade agreements for theimbalance. The ASEAN-China Free Trade Agreement(ACFTA), signed in 2002 and made effective in 2010,was seen as creating the world's largest free tradearea, but Indonesia has found that the initiativeseems to provide China with much more access toIndonesia’s markets than the other way around.Cheap manufactured goods have poured in whileresources have flowed out of Indonesia to China,putting the country in the unenviable position ofbeing the provider of low-value added materials andthe consumer of finished goods. However, Ministryof Trade numbers suggest that the benefits of thepact have been on the whole balanced. Between2009 and 2012, Indonesian exports to China grew37% while China’s exports to Indonesia were up 31%.But the country’s trade associations argue that thesefigures obscure reality and that certain industries

have been especially hard hit, such as garment andfootwear. Revisiting the agreement, however, is dif-ficult, as it was negotiated between six ASEAN mem-ber states and China and would require all partiesto be involved in the talks. As for future agreementswith ASEAN, industry players warn that Indonesiamust be able to secure its own advantages. “Withincreased ASEAN integration in 2015, Indonesia willsee an increase in products entering the marketfrom our South-east Asian neighbours. Conversely,it is important for Indonesian companies to estab-lish themselves in these markets as well to remaincompetitive,” Edwin Sutiono, director of Indonesianpeanut manufacturer Dua Kelinci, told OBG. WAGES: What is putting the most stress on Indone-sian industry, however, is the rise of wages. Whilethe country was for many years one of the cheaperplaces in the region, recent labour demands haveclosed the gap and have led some to reconsiderIndonesia as a manufacturing hub. In 2012 the min-imum wage in the Jakarta area rose 44%, and unionsdemanded a 50% increase for 2013. Though they didnot achieve their demands – they were insteadawarded 11% – the pressure is still on. It was likelynot one jump in wages in 2012 that is the main prob-lem – as a one-time adjustment to move people toa living wage, it may have made sense – but the per-sistent demands for higher wages year after yearthreaten to eat away at the country’s cost advan-tage. “Wage increase is a challenging issue faced byall developing countries, and Indonesia’s attitudeneeds to change whereby they must accept that themajority of the workforce is unskilled and thereforedisproportionate increases cannot be tolerated,” Ted-ja Sukmana Hudianto, president director of SteelPipe Industry of Indonesia, told OBG. COMPETITIVE EDGE: According to the Centre forStrategic International Studies, wages in Indonesiahave risen 30% since 2010. That compares with 14.2%in Thailand, 8.4% in China, 6.7% in Vietnam, 5.2% inCambodia and 3.3% in Malaysia. Jakarta’s minimumwage is now about the same as that of Indonesia’smain competitor, China. At current exchange rates,the minimum wage in Indonesia is about $200 permonth, roughly the same as that of a worker in Bei-jing or Bangkok, but substantially higher than whata typical worker in rural China receives, which canbe as low as $140 per month. If wages continue torise at the pace of previous years, Indonesia will soonlose any competitive advantage it has price-wiseover countries in a better position in terms of logis-tics, utilities and regulations. “Increases every yearmake a problem,” Endang Susilowati, deputy chair-person of the legal and advocacy division of theEmployers Association of Indonesia, told OBG.

What is most worrying for the manufacturing sec-tor, however, is what does not show up in the offi-cial numbers. According to some industry advocates,certain more extreme elements within the tradeunions are making unreasonable demands and manyof the demands go far beyond the law. Endang

190

Production index growth of manufacturing, 2010-13*

SOU

RCE:

Sta

tistic

s In

done

sia

*(20

10 =

100

)

-5

-2

1

4

7

10Q4 AvgQ3 AvgQ2 AvgQ1 Avg

2013201220112010

In 2012 the monthly minimum wage in Jakarta rose 44% to $200

Indonesia must look for

advantageous foreign trade

agreements and ensure

that it is able to remain

competitive in terms of the

import and export trade

balance.


INDUSTRY OVERVIEW

explained that the headline number is bad enough,but unions are looking for as much as Rp3.7m ($370)in 2014. She goes on to explain that much moregoes on behind the scenes. For example, a strictseverance pay schedule is set by law: someone whohas worked for a firm less than one year gets onemonth pay if fired; over one year and less than two,they get two months, as so on. But when layoffsoccur, the reality is quite different. Endang says thatin the event, unions will use somewhat aggressivetactics to extract higher benefits. They will campout in front of factories and threaten managers. Sheadds that foreign firms are particularly good targetsas they are more likely to pay, which in turn ruins themarket for everyone. “If you are a foreign company,you pay what they ask to solve the problem,” Endangsaid. “If they get big money from a foreign compa-ny, it becomes a benchmark.”IT'S THE ECONOMY: The gutting of the low-wagemanufacturing sector has profound implications for

the overall economy. According to the US Depart-ment of Agriculture, textiles and textile-related man-ufacturing employ some 10% of the population andgenerate 1.56% of Indonesia’s GDP. About 6.5% ofthe country’s exports are textiles and related prod-ucts. The loss or even the stagnation of sales in thelow value-added sectors has the potential to weak-en the economy where it hurts most – employmentand exports. Loss of these jobs threatens instabili-ty among the poorest in society, as well as a weak-ening in the country’s current account position whenit can least afford it. With a growing and young pop-ulation and precarious balance of payments situa-tion, the manufacturing sector has an importancebeyond its contribution to the GDP. HIGHS & LOWS: The outlook is decidedly mixed.According to Statistics Indonesia, the manufactur-ing sector has been volatile in recent quarters. In thefirst quarter of 2013, manufacturing production fellsome 2.2% from the fourth quarter of 2012 and roseonly 1.12% in the second quarter of the year overthe first, and 0.15% in the third quarter over thesecond. Some sectors appeared to face considerableheadwinds. In the second quarter of 2013, textilemanufacturing was down approximately 6.99% on theyear, while food product manufacturing was up only0.22% in the second quarter of 2013 over the firstquarter. For full-year 2013, manufacturing growthslowed but nevertheless held up well overall. Accord-ing to Statistics Indonesia, non-oil and gas manu-facturing was up some 10% in 2013, in current localcurrency terms. That is down from 11% growth in2012 and 12% growth in 2011. The textile, leatherproducts and footwear industries grew 10%, up from9% a year earlier, while the food, beverages andtobacco industries grew 8%, down from 14% in 2012.Statistics Indonesia’s full-year survey of large andmedium manufacturing showed good growth, albeitslightly slower. For all companies in this category,growth was 5.64% for 2013. The worst showing was for textiles, which dropped 8.65% during the year.

192

Textiles manufacturing employs some 10% of the population

Indonesia’s manufacturing

production fell 2.2% in the

first quarter of 2013 on the

previous quarter, but

proceeded to rise 1.12% in

the second quarter and

0.15% in the third quarter.

INDUSTRY OVERVIEW

CHALLENGES: Concern is now growing in Indone-sia that the industrial sector is too small and that itis slowing just as commodity prices are falling, mean-ing that the natural hedge of industrial productionis not doing what it should. It is feared that two keycomponents of the economy are sputtering togeth-er and that an opportunity may have been lost. Whencommodity prices were high, the country shouldhave poured the resulting cash flow into infrastruc-ture and a manufacturing base. That would have leftit in good stead as the inevitable pullback in resourceprices occurred. While all nations have trouble man-aging this transition, some have been somewhatsuccessful. Thailand and Malaysia are good exam-ples of South-east Asian economies that have extend-ed beyond resource dependency in order to build amanufacturing and services future. Indonesia didnot so effectively recycle its commodity surplusesand has a half-finished manufacturing sector and anincomplete infrastructure one.

At the same time, while industry has been great-ly challenged by higher wages, a lack of investmentand intense global competition, it has also in someways been doing well. Indonesia, while neither theleast expensive nor the most competitive of region-al economies, occupies a safe and comfortable mid-dle ground that is proving to be a good place to beover time. Its factories have been working with cus-tomers for decades in some cases, and their quali-ty and productivity has been assured and maintained.While some of the frontier markets may be able tobeat Indonesia in terms of price, they are still verymuch untested. The relationships with customersare not as strong and they have not been as thor-oughly vetted as those in Indonesia. CHILD PROTECTION: Additionally, Indonesia hasmade good progress in child labour protection. Whileit is still regarded as a country of “extreme risk” inthe Maplecroft Child Labour survey, it has rankedhigher than Myanmar and Bangladesh, two countriesthat are serious competitors to Indonesia in termsof low-cost manufacturing. While issues persist inthis regard, many of the most egregious examplesof child labour are in the informal sector amongsmall, local factories, not at larger ones typicallyused by international brands which tend to operateat higher standards. This assurance of quality andadherence to the law has tended to encourageinvestors to choose Indonesia. “Buyers always meetwith our factories,” Endang said. “They don't wantto gamble with other countries.”

Endang added that Indonesia has another advan-tage over some other developing countries. It hasbeen through its political turmoil, in the late 1990s,and while that was a difficult time for the country,it is ahead of many competitors in terms of reform.Egypt remains unsettled, China has yet to experiencemajor liberalisations, Myanmar is just getting start-ed, but Indonesia is relatively settled. While the coun-try still sees some protests, they tend to be moreprotests of participation, attempting to influence

the system, rather than protests that threaten whatthe country has put into place.

Industry participants also note that the countryhas additional strengths. It may be low-cost relative-ly speaking, but Indonesia has a deep base of expe-rience and talent and substantial installed capacity.So while China is capturing quite a sizable portionof business and might be more advanced in certainregards, Indonesia still maintains resilience at somelevels. It can hold its own in some higher-end prod-ucts categories. “Regarding products from China,they are only competing at the low end. At the highend, they are not competing with us,” BinsarMarpaung, secretary general at the IndonesianFootwear Association (Aprisindo), told OBG.FALLING CURRENCY: But perhaps the greatestadvantage of Indonesian industry is the decline inthe rupiah. The country’s currency fell more than 20%in a year, and this has helped make manufacturingproducts cheaper against those from other region-al manufacturers, especially China. The rupiah fellalmost 24% against China’s renminbi. In December2014 Indonesian exports hit their highest point inalmost two years. Between January and November2013, non-oil and gas exports to China were upslightly on the same period the previous year, andmay have hit a record high for the full year.

While it is still too early to declare a trend, it appearsthat the country’s weak currency is beginning to

193


SOURCE: Statistics Indonesia

2008 2009 2010 2011 2012

Saloon/cars 5923 2367 4081 3231 4869

Jeep 4x2/jeeps 4x2 415,997 346,245 477,252 530,762 693,421

Jeep 4x4/jeeps 4x4 9503 3560 15,191 27,870 45,211

Bis/buses 2956 2328 4106 4142 5299

Pick-up/trucks 166,249 110,316 201,878 271,943 316,757

Sepeda motor/motorcycles 6,264,265 5,884,021 7,366,646 8,006,293 7,079,721

Domestically assembled motor vehicles by type, 2008-12

The fall in the rupiah has made local manufacturing less expensive

Industry faces challenges,

including higher wages, a

lack of investment and

intense global competition.

While neither the least

expensive nor the most

competitive of regional

economies, Indonesia

occupies a safe middle

ground.

INDUSTRY OVERVIEW

make Indonesian goods more attractive in foreignmarkets and to foreign investors. While a falling rupi-ah has the potential to lead to a paper loss for non-Indonesian corporations, it also makes labour andassets cheaper. Observers say that when multination-als should jump in is a delicate calculation to make,but many foreign corporations seem to be findingthis a good time to enter the market. Prices are lowand the domestic market is attractive. FOREIGN INVESTMENT: Realised FDI hit a record in2013, up 22% to Rp270.4trn ($27.04bn). The fourthquarter of 2013 was especially strong in terms ofcapital inflow, with FDI up some 25.4% on the pre-vious year. As is the case with exports, at time of printit was still too early to tell whether this is a sustain-able trend going into 2014, but all indications arethat foreign investors are looking favourably on thecountry. Manufacturing appears to be an especial-ly popular target for foreign capital. In 2010 thecountry received $2.3bn of FDI in manufacturing, or

26% of the total. In 2011 that number was $6.8bn,or 34.9% of the total, and the following year $11.8bn(47.9%). In 2013 total FDI in manufacturing hit$15.8bn, or 55.4% of the total.

Indeed, Indonesia has been experiencing some-thing of a rush. Car makers have been especiallyenthusiastic. In 2013 Toyota said it would build a$9.2m car engine factory in the country as Japan-ese manufacturers continue to move capacity toSouth-east Asia and away from China. That sameyear, General Motors reopened a mothballed assem-bly factory in Bekasi with a $150m investment. Hon-da opened its second factory in the country in ear-ly 2014, making a Rp3.1trn ($310m) investment.

The Ministry of Trade said that the activity in thesector would result in major investments by partsand components suppliers. Indeed, in 2013 Han-kook, the Korean tyre manufacturer, opened a $353mfacility in Indonesia and in early 2014 it said it wouldbe expending capacity there. Other sectors werealso quite active. In late 2013 Philip Morris Indone-sia said it would be investing $174m in kretek ciga-rette production. It will be expanding production attwo facilities and building a new factory in Karawang.OUTLOOK: Given the recent history of the sector,the outlook for Indonesian industry is decidedlymixed. Manufacturing is under stress given the inten-sity of global competition, the lack of domestic infra-structure and rising wages. That said, Indonesia alsohas several advantages that should help it surpassthese challenges: an abundance of raw materials,domestic stability, a well-educated workforce andcontinuing appeal as a destination for foreign directinvestment. Though national and presidential elections in April and July 2014, respectively, maybring some uncertainty for investors, on the wholemost indicators point to a year of expansion for theeconomy. The challenge for the industry sector at this point is to make sure that demands forincreased wages and a lack of infrastructure do notderail the return and rise of Indonesian manufacturing.

194

Several foreign car makers are expanding into Indonesia

The rate of FDI inflows into

Indonesia has increased

year-on-year, rising from

$2.3bn in 2010 to $15.8bn

in 2013, and the trend

looks set to continue in

2014.

INDUSTRY ANALYSIS

Some minerals are exempted from the new export restrictions

Indonesia has long pushed to move more of its indus-trial processing onshore to both protect and encour-age local manufacturing. At first, efforts to rectifythe situation were inconsistent. Regulations werepassed but not applied, or loopholes were built inthat seemed to water down what at first appearedto be draconian measures. When Indonesia success-fully intervened in the markets, as it has done in thetextiles sector, it did so carefully. The governmentmade sure it adhered to both the letter and spirit ofinternational obligations. It scrupulously avoidedexcessive subsidies and promotional efforts thatwould make the playing field less than level.

Many analysts believed the country would contin-ue on this course, the government would be prag-matic and business would remain largely unchanged.However, in 2013 and early 2014, Indonesia tookmeasures and passed laws that indicated it was seri-ous about developing more industry onshore and thatit would go to great lengths to do so. It drew a linein the sand on exports of raw materials and beganto put into place the legal infrastructure for a com-prehensive industrial policy. It insists it is meeting andwill continue to meet the terms of its trade agree-ments, but at the same time government officialshave said the country reserves the right to adjustfree trade when it serves the national interest.MINERAL BAN: In this vein, a ban on foreign salesof key mineral ores, including nickel and bauxite,came into effect in early 2014. The 2009 MiningLaw, which mandated all mining companies beginprocessing and refining their output before export-ing by January 12, saw some miners who failed tocomply with the new rules charged an export dutyfor processed minerals. Indonesia is a major globalsupplier of both nickel and bauxite, accounting for20% of bauxite production in the fourth quarter of2013. Nickel is used in the manufacturing of steelwhile bauxite is a component in the production ofaluminium. In the months leading up to January 2014,

there was some confusion in the marketplace, as thegovernment vacillated on implementing the restric-tions. The final regulation, issued by the Ministry ofEnergy and Mineral Resources, included exemptionsfor concentrates of copper, zinc, lead, manganeseand iron ore, if they meet specified purity levels.OTHER RESTRICTIONS: The limits on foreign salesof mineral ores came in the wake of major changesto the processed tin market, where Indonesia is alsoa global leader. In July 2013 the government imple-mented new rules that raised minimum quality stan-dards for tin smelters, followed by a requirementeffective August 30 that year that all tin ingot tradesbe handled by the Indonesia Commodities and Deriv-atives Exchange (ICDX).

Sector players’ response to the local trading rulehas been mixed. Some smelters reacted poorly, say-ing it would increase warehousing and trading costs.But Sukrisno, the president director of Timah, Indone-sia’s largest tin exporter, told Bloomberg in October2013 that the rule’s “objective is how we can createa reasonable price”. Tin prices have been at histor-ically low levels for a few years, leading Indonesia toidle some of its processing facilities in 2012.NOT WITHOUT RISKS: The recent moves by Indone-sia to limit its raw minerals exports could encour-age the development of a local processing industry,but the strategy has downside risks as buyers lookto alternative sources. The immediate effect of lim-iting trades to the ICDX was a slump in tin exports,although they recovered in the final two months of2013 as more traders joined the exchange.

However, major buyers have started to look else-where for their tin and other minerals. China is seeking tin suppliers in Bolivia, Japan and Malaysia,and has turned to Africa for its bauxite requirements.Moreover, the Asian giant has had time to stockpilein preparation for the new regulations. According to international press reports, China has sufficientnickel reserves to last through to the end of 2014.

A law that came into effect

in early 2014 bans the

foreign sale of key mineral

ores, a move that is

expected to help develop

the local processing

industry.

195


Building up metals processingNew policies help the sector advance

INDUSTRY ANALYSIS

The effect on Indonesia’s exports is potentiallysignificant, with the changes coming at a time whenthe country’s trade balance has worsened. In Decem-ber 2013 Citigroup said the ban on ore exports wouldcut the current-account position by 0.3% of GDP.The government has also conceded that the law willcost $1bn in export revenues in 2014, in addition tothe more than 50,000 mining jobs already shed andpotential company losses amounting to $3.7bn,according to KADIN, the national chamber of com-merce and industry.BOOSTING PROCESSING CAPACITY: While therecould conceivably be short-term costs to Indonesia’sexport segment, such as a hit to the trade balanceand government revenues, the larger question iswhether Indonesia will be able to reap the expect-ed longer-term gains. At present, processing capac-ity is not sufficient to handle local ore production,and a number of bauxite mines have halted opera-tions since the ban, as they lack access to smelters.

One factor that could slow the development of pro-cessing facilities is the significant financial outlayrequired to build such facilities. Nickel miner BintangDelapan is currently building a 300,000-tonne-per-year ferronickel smelter in Sulawesi at a cost of$1.2bn. Large-scale industrial projects also requireextensive infrastructure and utilities backing, whichare costly to the state and require time to put in place.

The government has a role to play in helping makethis happen. “Indonesian companies, especially thosethat are import based, must have a plan to ensurecompetitiveness in 2015,” Edward Low, the CEO ofArita Prima Indonesia, told OBG. “There needs to bemore government support for local manufacturers,and measures including tax deductions on exportswould greatly benefit local companies.”TRADE POLICY: The move with perhaps the great-est long-term consequences was a trade law passedin early 2014 that allowed the government to put inplace both export and import restrictions. Analysts

see the law as a culmination of efforts to create anindustrial policy piecemeal through the export ban,labelling requirements and import controls on foodproducts. The trade law brings it all together and givesthe government a legal framework to engage inlarge-scale economic coordination.

One clause included in the trade law will give thegovernment the authority to limit and even stopimports of products to protect domestic industriesand avoid conflicts that go against Indonesia’s nation-al interest. The law also requires the government toconsult the House of Representatives before sign-ing any new international trade agreements, and anew permanent secretariat will be established toreview existing agreements and future ones.

The law followed the passing of a new industry lawin late 2013. While the new law has extensive imple-mentation requirements – the government has yetto issue 19 government regulations, including pres-idential and ministerial regulations, to ratify the law– the intent is clear. Indonesia wants to protectindustries from competition, create national cham-pions as well as encourage downstream processing.While supporters say that the laws are in accor-dance with Indonesia’s World Trade Organisationobligations, some elements could face challenges,especially with ASEAN seeking to create a single eco-nomic market in 2015.

Some analysts have suggested that the govern-ment may try to scale back ore export restrictionsat least in the short run, both to boost export rev-enues and to give investors time to build process-ing facilities. Election rounds throughout 2014, withlegislative polls in April and the presidential vote inJuly, could also have an impact on foreign investmentdecisions, but the lack of clarity should dissipate bythe third quarter. An improvement in political cer-tainty would go some way toward calming investors’nerves when it comes to developing the costly downstream processing facilities that Indonesia needs to further realise its local industrialisation goals.

196

A trade law passed in 2014 includes export and import restrictions

Significant financial outlay is required to build processing capacity

Analysts see the new trade

law as a culmination of

efforts to create an

industrial policy via the

recently enacted export

ban, labelling requirements

and import controls on

food products.


INDUSTRY INTERVIEW

Irvan K Hakim, President Director & CEO, Krakatau Steel

What sort of difficulties do domestic steel man-

ufacturers currently face in Indonesia?

HAKIM: Industry players are optimistic that by 2015global steel markets will rebound. We believe thatthe economic recovery in Europe will propel higherdemand for Indonesian steel.

Also, we must not forget the Chinese market. Manyeconomists feel that China can quickly raise its GDPgrowth from the current 7.5%, which will impactworld steel markets. For instance, China currently pro-duces 50% of the world’s steel, which translatesroughly to 750m tonnes per annum. In Indonesiathere is a saying that when China coughs, we catchthe cold. This is the case for many other countriesas well, far beyond the Asia-Pacific region.

Of late, to counter weak demand, many industryplayers have moved to diversify their operations.This is essential to spread risk, just as any investorshould do. This will ensure that we avoid volatility inthe market place, and cover our backs through oth-er streams of income. As an example, many compa-nies are entering joint ventures to put to use steelwaste from production. These sort of diversificationplans will help buffer steel companies from the cycli-cal commodities downturns.

There are many bright emerging prospects inIndonesia, and these will only grow. Indonesia inmany aspects could be grouped with Brazil, Russia,India and China, although we are not quite on thatlevel as yet. The government cannot do this alone,and this must be private sector-driven growth.

What will be the main drivers of the Indonesian

steel market moving forward?

HAKIM: In the case of emerging countries, normal-ly the main drivers are construction and infrastruc-ture projects. In developed markets, automobilesand home appliances are the main drivers. Indone-sia is placing an emphasis on automobiles, as we seea service-based economy begin to take root. The

growth of the local automotive industry, along withthe introduction of low-cost green cars, will have apositive impact on local market demand. Also, theimplementation of the 2009 Mining Law in 2014will add value to new downstream industries, whichmany foreign investors are interested in exploring.

To what extent are labour costs having an impact

on the steel industry at the moment?

HAKIM: Wages are continuing to rise, which is prov-ing to be an issue with the private sector and athorny matter with the government. This will proveto be a challenge over the long term for the indus-try. Many firms are looking to reduce their perma-nent labour force by 25%. That said, capacity is alsoincreasing and so will efficiency. In 2017 our employ-ees will be able to double their productivity due tonew facility investments coming on-line and stream-lined processes. We must make our industry lean inorder to compete on a regional and global level.

Are there any other major challenges for com-

panies attempting to expand domestically?

HAKIM: The two issues in steel production are rawmaterials and energy. Electricity and natural gas arecostly and the steel industry is energy-intensive. Alack of energy infrastructure is preventing somemanufacturers from operating at full capacity.

However, we believe that by 2015 the industryglobally will begin to recover, and once more oper-ate at around capacity. In addition, we are hopingthat anti-dumping laws are enforced so that com-petition in the market is fair. It should be clear thatdumping refers to the legality of steel. These anti-dumping measures are in place for five countries andenforced under the WTO standard of law.

If the regulations are enforced legally and fairlyI believe investments will continue to enter Indone-sia. As a result, this will reduce our current accountdeficit and also strengthen our investment climate.

197


Showing its mettleOBG talks to Irvan K Hakim, President Director & CEO, Krakatau Steel(Persero)

INDUSTRY INTERVIEW

Klaus Lesker, Member of the Executive Board, Ferrostaal

What opportunities will Indonesia’s plan to become

a centre for automobile production create for man-

ufacturing and petrochemicals industries?

LESKER: Being the largest economy in South-east Asia,with strong and still increasing domestic consumption,Indonesia offers highly captivating business and invest-ment opportunities for those who wish to supportthese aspirations. One opportunity is the rising demandfor plastics and the raw materials needed to processthem. To be competitive in this segment, players mustsource low-cost raw materials – a prerequisite for theaccelerating domestic industrialisation. While the devel-opment of petrochemicals plants is integral, so too isthe establishment of accompanying services like sup-ply chain management. These services are stronglyrelated to the efficient assembly of industrial goods inthe automotive sector, amongst others. The channellingof valuable knowledge and experience by foreign firmsinto these areas of business is critical for launching thesenew industries and ensuring long-term success.

In what way must legal and transportation infra-

structure be addressed to ease the way for foreign

investment in large-scale industrial projects?

LESKER: For the energy sector, developments in ruralareas are often hindered because of infrastructure andlogistical burdens that are too often carried solely bythe investor. The government’s plans to improve thesituation through Master Plan for Acceleration andExpansion of Indonesia’s Economic Development(MP3EI) projects are commendable; however, they mustbring positive results for investors. For many, even at afavourable location with assured access to raw mate-rials and reliable power supply, legal certainty is neverassured. However, most export-oriented industries,such as mining operations, have comparably short pay-back times. Manufacturing and supporting industries,such as petrochemicals production, need a solid anddependable legal environment for long-term invest-ment, which in turn facilitates an adequate return.

In light of the incoming 2014 ban on metal-ore

exports, where do you foresee opportunity in the

value-added processing industries?

LESKER: A short- to medium-term strategy could beto satisfy the domestic needs first as there is no mar-ket necessity to convert all of the minerals productioninto refined products. There are sufficient quantitiesto make downstream industries more competitive andless dependent on imports. Considering the produc-tion of raw mineral materials on one hand, and themarket requirements to expand the manufacturingindustries on the other hand, the pre-conditions arefavourable. Raw materials appear to be widely available.The processing of minerals requires a solid business plan,starting from a long-term resource management ofthe mine through to the development of sufficientsmelter infrastructure. However, significant inroadsmust first be made towards tackling the principal obsta-cle of availability and distribution of power.

How can Indonesia’s industrial sector look to ben-

efit from the ASEAN Economic Community (AEC)

integration planned for 2015?

LESKER: The AEC member states continue to increasetheir stake in worldwide economic performance, whichis a promising base for the growth of Indonesia. Theexpectations of the country’s contribution to drivingexpansion within ASEAN are strongly related to the provision of raw materials and services to the indus-trial supply chains in neighbouring countries. Howev-er, Indonesia must also utilise its raw materials for itsdomestic manufacturing industries, as well as improv-ing power supply and distribution, which are all impor-tant for competitiveness. Indonesia will need to expandits industrial supply chain and develop highly skilledhuman resources. While striving for a higher degreeof industrialisation and knowledge-based industries,Indonesia’s strong foundation within the lower-incomeemployment sector must also retain a competitivelevel so not be overtaken by other AEC members.

198

Captivating opportunitiesOBG talks to Klaus Lesker, Member of the Executive Board, Ferrostaal


INDUSTRY ANALYSIS

Some 1.23m cars were sold in 2013, an increase of 10.2% from 2012

The automotive sector in Indonesia saw surprisinggrowth in 2013. Although industry players and analystshad largely anticipated a flat year, 1.23m units were sold,an increase of 10.2% from 2012. But despite the healthyrise in sales, concerns remain. The somewhat strongperformance comes after a run of exceptional growth– 25%, 17% and 57% in 2012, 2011 and 2010, respec-tively – and was achieved in part as a result of heavydiscounting and promotion. Like the general economy,the industry has been facing significant economic head-winds as the currency falls, inflation kicks in and wagesrise. It fought to keep 2013 from being a down year. INTEREST: There is much reason for hope, however, andit seems that toward the end of 2013, fundamentalsas much as gimmicks may have played a role in sales.Interest rates did not climb as high as expected, asfinancing companies held back on increases as long aspossible and the central bank itself held steady. BankIndonesia kept its policy rate at 7.5% throughout 2013and into 2014. It turned out that despite concernsabout the falling currency and potential capital flight,the economy is doing better than expected, and thatis feeding through to interest rates. It is also helpingconsumer confidence. Indeed, Indonesians were themost optimistic consumers in the world toward theend of 2013, according to market research firm Nielsen.

Auto sales will likely do well in this environment. Withthe cost of money under control and at a reasonablelevel, and Indonesians hopeful about the future, big tick-et purchases are very much a possibility. The economymay have done an about face, and if that is the caseand growth holds and inflation remains under control,the auto sector may continue to perform well. LONGER-TERM TRENDS: Along with the economy aresome longer-term underlying trends and efforts thatalso suggest a bright future for the Indonesian auto sec-tor. In 2013 the government started offering incentivesfor the manufacturing of a low-cost green car (LCGC).Under the programme, which became effective May2013, a reduction of the luxury tax which ranges from

25% to 100% on automobiles, would be offered forcars that are of a certain size and achieve a certain fuelefficiency. For cars that run 20-28 km on a litre of gas,the reduction is 25% and 50% for above 28 km to thelitre. Other vehicles with a fuel efficiency of at least 20km to the litre that meet the requirements of the low-cost green car programme receive a 100% reduction.Additional requirements are that assembly must bedone in Indonesia and 84% of the components mustbe local. The sense was that car makers would be ableto produce models for about Rp100m ($10,000), andthat major Japanese makers, and possibly others, wouldjoin to make LCGCs. The programme was a successfrom the start and increased auto sales. In the first fourmonths of LCGC manufacturing, over 50,000 units wereshipped. Some analysts say the programme was respon-sible for saving the sector from a flat or down year. MANUFACTURING: The other positive longer-termtrend in the sector is development of Indonesia as amanufacturing hub for automobiles. International carcompanies and suppliers appear to be focusing onIndonesia. Honda, General Motors, Toyota and Han-kook have all built, reopened or expanded facilities inthe country, with more on the way. In mid-2013 the Jakar-

ta Globe reported that Volkswagen would open a fac-tory in the country. According to the report, the plannedinvestment was €200m for a plant to be up and run-ning by 2015, and the firm was hoping to use it as amanufacturing base for South-east Asia. “The demandfor automobiles will continue to grow as mobility is apriority for the new middle class. By 2020 Indonesiashould have about 2.7m cars in production a year,” RudyKarimun, managing director of Robert Bosch, told OBG.

Indonesia is seen to be in a good position to becomea manufacturing hub. It has relatively low wages and alarge domestic market to act as a foundation for anexport-oriented industry. The timing seems right. Giv-en the problems in Thailand, with the floods and protests,and the push on the part of Japanese manufacturersto move manufacturing offshore, Indonesia is a very

The low-cost green car

campaign provides

incentives for the domestic

production and purchase of

locally manufactured

fuel-efficient cars. This

includes a tax break, which

ranges from 25% to 100%.

199


Revving up a sectorOn track to capture greater market share

INDUSTRY ANALYSIS

promising target. While the economy fluctuates anddemand is volatile, the hope that the auto sector willbecome more export oriented is maintaining optimism.Furthermore, the trend may serve to inspire the growthof other industries. “The tyre industry is evolving hand-in-hand with the automotive sector. As Indonesiansswitch from motorcycles to automobiles, tyre firms areadapting their product offerings,” Edwin W Ng, presi-dent director of Maxxis Indonesia, told OBG.

Japanese automakers are the main foreign manufac-turers. They control more that 90% of the market,though share within the sector has shifted given thenew capacity being brought online and economic volatil-ity. Toyota’s share fell from 36.4% to 35.4% in 2013,while Suzuki rose from 11.3% to 13.3% (with sales ris-ing 29.6% on year). Daihatsu was up from 14.6% to15.1%, Nissan dropped from 6% to 5.5%, and Honda wentfrom 6.2% to 7.4% (with sales rising 32%). Imports rose22.4%, from 125,873 to 154,014, while exports of com-pletely built up units rose 5.3% to 105,380.MOTORCYCLES TOO: The motorcycle sector has alsodone well, rebounding very much like the auto sector.Sales rose in 2013, up an estimated 9.6% to 7.1m, andlike the auto sector, motorcycles had a strong upticktoward the end of 2013. October 2013 numbers rose

a full 14% from the same period a year earlier. Butunlike auto, the motorcycle sector has yet to break newhighs. Sales were still lower than those achieved in2011, when 8m units were sold.

The motorcycle industry has been facing consider-able challenges in Indonesia. With the rupiah falling,the cost of imported components has been rising. Buy-ers have also seen tighter financing. In June 2012, theBank of Indonesia started to require a 25% down pay-ment on motorcycles, up from 5%. At the same time,the central bank started raising interest rates, lifting thepolicy rate from 6% to 7.5% in a five-month period, tofight inflation and to stabilise the currency. By mid-2013, the economy was showing signs of serious weak-ness and consumers were becoming more cautious.

As with autos, the motorcycle market picked up atthe end of 2013 as optimism returned. Also, the downpayment requirements were not as onerous as firstexpected. Motorcycles are cheap in absolute terms, sothe cash needed to buy them is not beyond the reachof even poorer Indonesians. Other factors also helped.The capital’s notorious traffic encourages people to buymotorcycles, as travel by car is slow and public trans-portation is either unavailable or unreliable. For many,the motorcycle is the only reasonable option. SUBSIDIES: Another major issue is the fuel subsidy. InJune 2013 the subsidy was reduced, causing the priceof fuel to rise 44%, though it remains about 45% undermarket rates. So far, the increase has not had a directimpact on the sale of vehicles; it is primarily a socialissue, as it affects the poor the most. But the fuel priceremains a political and fiscal priority due to the cost tothe government, and prices may rise further, whichcould lead cars and motorcycle sales to suffer.

While the basic idea of turning Indonesia into a man-ufacturing hub is sound, some analysts remain scepti-cal of the model. Indonesia has a large and growingdomestic market and it is set to become a major com-ponent supplier, though it lacks some things. Indone-sia’s exports are roughly one-tenth of Thailand’s, anddespite the problems with flooding in Thailand and thepolitical clashes there, it remains a preferred locationfor manufacturing, with Myanmar also increasinglyseen as a good location for the making of lower value-added components. Indonesia will pick up business,but it will be long before it becomes a major car exporter.

200

Motorcycle sales in 2013 reached 7.1m, a 9.6% year-on-year rise

Despite the rise in

financing requirements,

motorcycles still remain an

affordable and popular

vehicle for Indonesians.

Like auto sales, motorcycle

purchases saw a strong

uptick at the end of 2013.

INDUSTRY ANALYSIS

Affluent locals are likely to demand the best medicines possible

With the introduction of universal health care in Indone-sia on January 1, 2014, the pharmaceutical sector inthe country is set for a boost. While the roll-out of theprogramme will be slow, a much expanded proportionof the population will be able to receive increasinglyadvanced and innovative drugs for their ailments. THE BIG PROJECT: The World Bank has estimated thatthe universal health care programme will cost between$16bn and $19bn a year by the time it is fully imple-mented in 2019. From 2009-13, the compound annu-al growth rate of the sector was 12%. It is expected thatthis rate will hold steady through to 2017 and that theoverall market in pharmaceuticals will double in valuein the five years following the introduction of the pro-gramme. However, sector participation presents manychallenges. According to Decision Resources, a phar-maceutical advisory and research company, universalhealth care will lead to downward pressures on reim-bursement rates and pricing for medicines as the gov-ernment works hard to keep its costs under control.Decision Resources also believes that protectionism isa concern as the government seeks to promote thedevelopment of domestic industry. Decree 1010, issuedin 2008, requires foreign companies either to manu-facture locally or partner with local companies, whileforeign investors are limited to 75% equity in a local drugscompany. When Decree 1010 was passed, 23 of the 29foreign companies selling in the country had to restruc-ture their operations to meet this requirement in twoyears. More than 75% of the country's pharmaceuti-cals are produced domestically, while local companiesare firmly in control of the market. Kalbe Pharmaceu-tical, the country's largest drugs maker, has a 17% sharein generic drugs and 12% overall. The next five largestcompanies are local: Sanbe (with a 6% market share),Soho, Dexa Medica, Pharos and Tempo. Novartis comesin at number seven and GlaxoSmithKline at numbereight, both with market shares of 3%.OTHER CHALLENGES: Distribution is also a challengeowing to the geography of the archipelago, making it

difficult to get medicines to the market. Regulationshave also made the process more complicated than nec-essary. Under Decree 1010, local distributors are nolonger able to register imported drugs, becoming insteadstrictly distribution companies. In June 2011, furtherrestrictions were placed on the sector. Pharmaceuti-cal companies present in the country without manu-facturing capacity would only receive licences for fiveyears; they were previously licensed indefinitely.

The government has been tipping the scales in favourof local producers. The health care programme isrequired to use generics or biosimilars, making themarket less attractive to the holders of valuable patents.The country in general seems to have a natural biastoward generics, with many believing that brand namedrugs only have superior packaging and better promo-tion. In 2012, the government issued seven compulso-ry licences on hepatitis and HIV drugs, overriding exist-ing patents owned by Merck, GlaxoSmithKline andBristol-Myers Squib. It seems the government has mixedviews on liberalisation in the sector as well. In late 2013,the Investment Coordinating Board said that foreign-ers would be allowed to own 85% of Indonesian phar-maceutical companies, up from 75%. But once the 2013Negative List was finalised, the 10% increase was absent.STILL POSITIVE: However, the demand created by thecountry’s demographic and economic indicators will cre-ate new opportunities, while the national health careprogramme is sure to increase business for all partici-pants involved. As the market matures, the apprecia-tion for branded pharmaceuticals should rise accord-ingly. Private hospitals that cater to both affluent localsand foreigners are quickly developing, and are likely todemand the best medicines available on the market.

International pharmaceutical companies, recognis-ing these possibilities, have become increasingly activein the sector. For instance, Merck opened a packagingplant in the country in October 2012, while in 2013,Fresenius Kabi, a German company, signed a joint ven-ture with Soho to manufacture intravenous generics.

201


More than 75% of the

country's pharmaceuticals

are produced domestically,

while local companies

are firmly in control of

the market.

Pharmaceutical boomThe introduction of universal health care looks set to generate newopportunities for foreign drug makers in the long term

INDUSTRY INTERVIEW

Hiroyuki Fukui, Pres. Commissioner, Toyota Motor Manufacturing

What future role is there for Indonesia as an auto-

motive export centre, and to what extent will devel-

oping markets shape this direction?

FUKUI: We are optimistic about the country’s role andpotential going forward, especially for exports to devel-oping countries. For many years, we have exported ourvehicles to countries across the ASEAN region and,recently, we have also increased exports to the MiddleEast. Other destinations for Indonesian exports includeLatin America, Africa and Central Asia, all of which areshowing a rapid increase in demand. The total demandfor Toyota’s cars from developing countries now standsat 45% and we expect this figure to rise to 50% overthe coming few years, and this is where Indonesian-manufactured exports can come into play. Given thispotential, we are seeing more players enter the Indone-sian market and establish manufacturing bases. I amthus confident that the country’s role as an automo-tive export hub will continue to grow in size and scope.

What competitive advantages does Indonesia hold

in comparison to other nations in the region?

FUKUI: Firstly, manufacturing in Indonesia makes eco-nomic sense in terms of costs, which although rising,are still competitive when compared to other Asiancountries. Furthermore, from a production viewpoint,the depth and breadth of Indonesia’s supplier base isbecoming more and more robust.

Likewise, it is also important to consider the coun-try’s huge domestic market. Automotive players choosethe countries in which to set up manufacturing facili-ties not only to export, but also to fulfil domesticdemand. When you look at the leading countries inSouth-east Asia for car manufacturing, Thailand still out-paces Indonesia by a large distance. However, the arch-ipelago’s population is about three times larger thanthat of Thailand, with major potential here, given ris-ing income and the likelihood for people to switch fromriding motorcycles to buying cars. Automotive compa-nies recognise this and, indeed, we are already seeing

Indonesia close the gap on Thailand on the way tobecoming the top manufacturer in the region.

How can the country attract more foreign invest-

ment to incentivise automotive companies to set

up manufacturing facilities here?

FUKUI: If the government is able to improve the coun-try’s infrastructure, global suppliers will come and investhere, creating an even stronger supplier base. One spe-cific area where Toyota is looking for infrastructureimprovement is seaports. We are cautiously optimisticthat the new Cilamaya Port, which is being planned incollaboration by the Japanese and Indonesian govern-ments, can become operational by 2020. This wouldalleviate the infrastructure problems that many auto-motive companies currently face, particularly whentransporting vehicles to and around the country. Ofcourse, this entails a lengthy development process, butthese improvements are needed for Indonesia to main-tain competitiveness and ensure future growth. Labourand energy costs should also rise in tandem withimprovements in productivity. Firms will continue tomanufacture in Indonesia if they can expect an increasein output to compensate for the higher input costs.

In what way can the Low Cost Green Car (LCGC) pro-

gramme shape the automotive industry?

FUKUI: The success and impact of the LCGC will ulti-mately be determined by the customer. Again, we haveto look at the country’s significant base of potentialLCGC users. If owners of motorcycles – which is still theprimary means of transport in Indonesia – decide tobuy a car, the LCGC will be an affordable option. In addi-tion, there are positive contributions to the industry interms of safety, environmental friendliness and scala-ble fuel economy. Of course, there was a recently man-dated review of the programme by the Ministry ofIndustry, but we are ready to work with regulators andrespond to any changes in the regulatory environmentto reach a viable plan and ensure the LCGC’s success.

202

Firmly in controlOBG talks to Hiroyuki Fukui, President Commissioner, Toyota MotorManufacturing Indonesia


RETAIL OVERVIEW

More international brands are entering the local market

A fast-growing middle class in Indonesia means moremalls, products and higher sales. Recent numbersappear to demonstrate that this very dynamic, whichhas been heavily discussed and promoted over thepast few years, was in fact holding in the country.After some signs of weakness in the middle of 2013,the retail market came roaring back with a string ofstrong indicators: retail sales were up 11.4% year-on-year in September 2013, 12.9% in October, 1.9%in November and 26.6% in December. The momen-tum continued into 2014, with retail sales rising28.7% in January. But analysts and businesspersonscaution that the phenomenon of the rising middleclass is not as simple and straightforward as it wasfirst believed. While people are in fact getting wealth-ier and this is translating into growth that will in alllikelihood continue, the process will be complicat-ed and prone to significant set backs. FLUCTUATIONS: Indonesia is a large, diverse and, inmany places, still a very poor country. A great manyIndonesians are seeing their incomes rise and arepassing certain thresholds that usually trigger achange in consumer behaviour. However, the buy-ing capacity of the average consumer remains lim-ited and prone to shocks. While Indonesians will bepurchasing more, they remain careful and can beexpected to pull back at the first signs of econom-ic weakness. Still, some assert that the demograph-ics are encouraging. “All the basic key performanceindicators are positive in Indonesia: the number ofchildren per family; growing purchasing power ofthe middle class and a new generation of consumerseager to access better products,” Philippe Broiani-go, president director of Hero Group, told OBG.

The identification of an emerging middle class,many analysts found, was to a great extent a mar-keting idea that got ahead of itself. Consequently,consumers were surprised to find in 2013 that notthat much has changed; that they are on averageonly slightly wealthier than they were a few years

ago. Some Indonesian retailers are becoming morerealistic as they examine their prospects. They arebeginning to adjust their expectations as well. Whileglobal analysts like the Boston Consulting Groupestimate that the current cadre of the middle andaffluent class stands at 74m individuals – and isexpected to reach some 141m by 2020 – local retail-ers say that these figures are likely an over estima-tion, and that the total may be closer to 40m-45m.“There was a lot of hype that may not have been jus-tified. Indonesians were reading that they are the nextChina and India, and they were believing the public-ity,” Catherine Eddy, managing director at global mar-ket research firm, Nielsen Indonesia, told OBG. STILL STRONG: Over time, Indonesian consumers willremain a force. While GDP per capita slips over keythresholds for more of the population in the futureand the market could be volatile, this will not changethe fact that there is strength in the sheer size ofIndonesia’s population. “It’s a very exciting time forconsumer industries in Indonesia because 50% of ourpopulation is under the age of 30 and our middleclass is growing by 5m people, equivalent to the sizeof Singapore, every year,” Henri Honoris, presidentdirector of Modern Internasional, which manages 7-Eleven franchises in Indonesia, told OBG.

Global consultancy McKinsey estimates the aver-age growth of consumer spending at 7.7% between2010 and 2030. The fastest growing subsectors forthis spending, according to the consultancy, are:finance, growing 10.5% over that time; leisure, 7.5%;health care, 6.2%; and education, 6.0%. It also not-ed that Indonesians are some of the most engagedconsumers. They are extremely brand conscious,more so than any other nation at this stage of devel-opment, according to McKinsey. The figures suggesta country clearly biased toward spending, with house-hold final consumption expenditure at 57%, higherthan Malaysia (49%) or China (35%). “The middleclass is price sensitive but can still afford things like

Estimates of the growth of

the middle class vary, with

some projecting that it

could reach 141m by 2020.

At present the middle class

is estimated to include

between 40m and 80m

Indonesians.

203


According to one estimate,

consumer spending is

forecast to increase by an

annual average of 7.7%

between 2010 and 2030,

with the fastest growing

sectors being finance,

leisure and health care.

Middle class reconsideredNew highs and lows for both the sector and consumers

RETAIL OVERVIEW

basic health care and affordable goods as purchas-ing power increases every year,” Wendy Yap, presi-dent director and CEO of Nippon Sari Roti, told OBG.SURGE AHEAD: The strength of the market and theinterests of consumers can be seen in a recent BankIndonesia (BI) retail sales survey. The study, pub-lished in January 2014 and which covered 650 retail-ers in 10 major cities, revealed that retail sales surged14% year-on-year in November 2014, the fastestgrowth since July of that year. The market for infor-mation and communications equipment, for exam-ple, has exploded, with sales almost doubling in twoyears, and growing 70% year-on-year in January 2014.Other areas rapidly growing are clothing, up morethan 25% year-on-year in the four months to Janu-ary 2014, and cultural and recreational goods, whichwere up more than 30% year-on-year in the threemonths to January 2014. “Even with lower thanexpected GDP growth, Indonesia will not experienceany retail slowdown as the domestic market is still growing internally,” Nugroho Setiadharma, thepresident director of Supra Boga Lestari, told OBG.

WAGES & SALARIES: Underpinning growth in retailsales is the fast increase in wages. In 2012 the min-imum wage in Jakarta rose 44% to Rp2.2m ($220)per month. The following year, it went up to Rp2.44m($244), but protesters were demanding a 50% raise.The impact is mixed. Many of these individuals arestill living on wages barely enough for necessities,which are becoming more expensive due to of infla-tion, so the increase may not mean that much in termsof spending power. At the same time, retailers notethat they are being squeezed by higher wages, whichfeeds through to costs. However, minimum wageremains under pressure, and the labour groups arebecoming more militant in pushing for raises thatexceed inflation and allow workers to enjoy realimprovements in standards of living.

Kelly Services Indonesia’s 2013 salary report indi-cates that many jobs are commanding salaries thatallow for significant consumption. A financial ana-lyst with three to seven years’ experience commandsanywhere from Rp10m ($1000) to Rp25m ($2500)per month. A call centre manager with five to 10 years’experience can earn between Rp12.5m ($1250) andRp25m ($2500) a month. A compensation and ben-efits specialist with three to six years’ experience canearn between Rp8m ($800) and Rp25m ($2500).Anecdotally, managers say that they are paying themost senior of their hires global or Singapore rates,and it can still be difficult to find the right people. VARIOUS DEMANDS: Indonesia has many differentmiddle classes and they have a range of demands,different levels of resilience and respond to eco-nomic fluctuations in differently. Some people arejust breaking $3000 a year and starting to contem-plate the purchase of their first basic luxuries: thebenchmark trinity of the refrigerator, television andmotorcycle. This group has grown fast in recent years.According to Roy Morgan research, the number ofhouseholds with all three key items went from 25%to 42% between 2006 and 2011. While this groupwill be an engine of growth because of its size, spend-ing power will fluctuate with general economic con-ditions and people will remain careful with money.

At the same time, a considerable portion of thepopulation will graduate into the globally recognisedmiddle-class bracket, where they will shop much likepeople anywhere else. These people are earning highwages, have bright prospects and are far more cush-ioned from economic shocks. Their spending willfluctuate, but is far less likely to disappear. Howev-er, they are also well educated and well read. Whilethey may be optimistic about their own futures, theyalso understand the dangers of the business cycle.A such, while they are more well off than those justentering the middle class, they too are quick to adjustspending during times of uncertainty. ROAD BUMPS: The year 2013 was one of volatilityand uncertainty for the Indonesian consumer, andthe myth of the monolithic middle class ended quick-ly. The rupiah fell some 21% in 2013, and the infla-tion rate rose, from about 5% to 8% during the course

204

SOU

RCE:

BI

Retail sales index growth (y-o-y), 2013-14 (%)

0

6

12

18

24

30

Jan-14DecNovOctSepAugJulJunMayAprMarFebJan-13

Retailers must contend with a rise in minimum wage

The minimum wage rose

44% in 2012 to $220 per

month, and increased again

to $244 per month in 2013.

While this growth is

helping to drive sales, it is

also hurting retailers’

bottom lines.


RETAIL OVERVIEW

of 2013 and into 2014. The economy also began tosputter mid-year. GDP growth slowed to 5.62% inthe third quarter of 2013, down from 6.17% a yearearlier. Retail sales numbers responded according-ly, and a clear rough patch in the middle of 2013 wasseen. Growth in retail sales slowed to 2% in Augustthat year, with the sale of food, beverages and tobac-co declining by 0.5%. Many consumers were livingon slim margins between having disposable incomeand not, and many others were aware that despitehigh salaries, circumstances can quickly change.THE SHOPS: Retailers are finding this a growing butchallenging market. They are facing not only risingwages, which may be improving sales somewhat andare also squeezing margins, but also increasing rentsas a result of both the mall construction moratori-um and the falling rupiah. The moratorium was firstintroduced in 2011 by Jakarta governor Fauzi Bowoand was extended in September 2013 by current gov-ernor Joko Widodo. Additionally, the status of theorder was raised from gubernatorial instruction togubernatorial decree. It is now closer to law than pol-icy. Retailers say that is making retail space morescarce and causing rents to increase. They add thatrents are generally denominated in dollars, mean-ing that the declining rupiah is proportionatelyincreasing their rent in local currency terms, andthat electricity prices are rising. Not all retailers seethis development as a complete obstacle. “The impact

of the proposed mall ban is yet to be fully determined.Theoretically it would not be a negative thing forretailers to acclimatise and learn how to use theirincumbent space which will likely improve futureproductivity,” Hitesh Bharwani, managing directorof Kanmo Retail, told OBG. Still, the increased costsare leaving the retailers in a bind. They can increaseprices and lose customers or keep their prices sta-ble and see their margins shrink.

“On the retail side, everyone is bleeding,” StifanusSulistyo, a research analyst at Bahana Securities,told OBG. “People’s incomes are increasing, but itdoesn’t translate to the bottom line. The top line isdoing okay, but they got hit on costs.”SENSE OF HOPE: However, the sector remains fair-ly optimistic. While the mall moratorium is certain-ly a challenge, new outlets are being built, and thegovernor has said that his office is fine if malls arebuilt in east Jakarta rather than in central or southJakarta, where mall concentration is high and traf-fic remains a problem. Recent financial statementssuggest that retailers were doing well in the secondhalf of 2013, with third-quarter results from eightcompanies showing revenue growth of between 9%and 27%, according to the January 2014 BI survey.Singapore-based Lippo Malls Indonesia Retail Trustsaid its gross revenues increased to $30m in thethird quarter of 2013, up 13.6% from the same peri-od in 2012, attributing the increase to “contributions

206

A recent moratorium on

the building of malls,

enacted in 2011, is making

retail space scarce and is

causing rents to rise.

However, there remains

ample opportunity to build

outside of central or south

Jakarta, where mall

concentration is high.

RETAIL OVERVIEW

from six new malls acquired in the fourth quarter of2012 and the positive rental reversions within theexisting malls”. The situation is also bright in termsof new activity and the entry of international brandnames. Indonesia has become somewhat of afavoured destination for global retailers. This hasincreased competition, and also helped to generategreater interest in shopping and style in general.

H&M, the Swedish clothing retailer, opened itsfirst store in Jakarta in 2013. The flagship outlet wasopened in Gandaria City, and the company plans toopen two more locations, one in Pondok Indah Malland the other in Grand Indonesia. However, most ofthe activity is from retailers from within the region.The Lotte Group opened a mall in South Jakarta in2013. The mall is the South Korean firm’s first inSouth-east Asia, and it has plans to build an outletin Bali as well. In 2013 Parkson, the Malaysian groupwith malls throughout the region, opened its first out-let in Jakarta at St Mortitz following its 2012 acqui-sition of Centro department store. Additionally, Thai-land’s Central Group is planning to open a store inJakarta in 2014, and Sinar Mas and Japan’s Aeonhave signed a deal to develop 20 malls in Indonesia.RESILIENT: To the same degree that Indonesian con-sumers can be quick to scale back and become tightwith spending, they also seem to be prone to do theopposite. When the economy turns for the better,they quickly switch back on and become active oncemore. In early 2014, following the uncertain monthsin the previous year, Indonesian consumers demon-strated their resilience. As the gloom dissipated inthe last quarter of 2013, the average Indonesianbecame optimistic again. In the Nielsen global sur-vey of consumer confidence, Indonesians scoredhighest in the fourth quarter of 2013, at 124 whilethe global average was 94. The mood seemed tohold into the following year. The BI January 2014consumer confidence index was 116.7, up from 116.5in December 2013. This is up from the trough of107.1 in September 2013, though down from the120.1 recorded in November 2012.

Despite uncertainties and higher prices, Indone-sians are heartened by the rise in wages and thatinflation seems to be slightly tamer than expected.They also seem to feel as though the 2014 electionswill be not be disruptive to the economy and incomes.Though income expectations are off recent highs in2013, price expectations are down as well. Middle-class dynamics are still in early stages, but when theeconomy has some positive momentum, the newconsumers will be quick to bounce back as well.REGIONALISATION: A major trend that has not goneunnoticed is the move of retail sales toward areasoutside Jakarta and its environs. The provinces havelong been an afterthought to the major retailers, whosaw them as interesting but not particularly com-pelling. However, consumers of these areas haveproven to be quite active and have become increas-ingly so in recent years. While the capital appearsto be caught in the doldrums, some secondary and

tertiary cities are booming. Faced with an uncertainoutlook in Jakarta, international and domestic retailfirms are turning to the relatively untapped marketof smaller cities and the capital's outskirts, accord-ing to Fernando Repi, spokesperson for departmentstore operator Matahari Putra Prima. “Modern retailis still lacking in second-tier cities when in fact, peo-ple there have experienced economic and, therefore,income upgrades,” he told the local media in Decem-ber 2013. In a December 2012 McKinsey Global Insti-tute report, the consultancy echoed the sentiment,concluding that, “Many other cities are growingmore rapidly, albeit from a lower base [than Jakar-ta...] These include Medan, Bandung and Surabayaas well as parts of Greater Jakarta.”ROLE REVERSAL: According to BI statistics, retailsales growth in Jakarta was down in the last quarterof 2013, and saw only 4% growth in January 2014.Retail sales in secondary cities, meanwhile, havebeen growing rapidly. In Bandung, sales were up40.6% in the first month of 2014, and during thatmonth they were up 20.5% in Surabaya, 24.7% in

207


SOU

RCE:

BI

*A

bove

100

is o

ptim

istic

Nationwide consumer confidence index, 2012-14*

0

28

56

84

112

140

Jan-14Oct-13Jul-13Apr-13Jan-13Oct-12Jul-12Apr-12Jan-12

Indonesia’s middle class is growing by 5m people every year

As the capital becomes

oversaturated with malls,

retail outlets are

increasingly finding

opportunities in secondary

and tertiary cities.

RETAIL OVERVIEW

Medan and 39.1% in Semarang. The trend appearsto be long term. Surabaya’s retail sales index stoodat 228 in January 2014, with the base having beenset at 100 in 2000. In Jakarta, the index was 90.7. Theprovinces were more optimistic as well. Surabaya’sconsumer confidence index stood at 137.1 in Janu-ary 2014 against Jakarta’s 104.8. BALANCING OUT: While the news has generallybeen good, concern is on the rise that consumptionneeds should be tempered in some ways. Given thecountry’s weakening balance of trade, imported lux-uries are a target of the policy makers. To reduce theinflow of high-end imported goods, the governmentwould like to increase the luxury tax on items likeclothes, handbags and cars. The luxury tax rangesfrom 10% to 75%, with most electronic goods at thelower end. The move is in line with the country’sgrowing interest in developing more coordinatedindustrial and trade policies in order to aid the econ-omy and help industry develop domestically. Whiledomestic demand is good for the country, excessiveimports are seen as a potential danger. Neverthe-less, some believe this is stifling growth:

“If luxury taxes were more relaxed, there would bea retail boom. The middle class continues to grow in

Indonesia and we have a very strong domestic mar-ket because Indonesians love to spend. Indonesiacould be a retail paradise if the right regulatorymeasures were put in place,” Irwan Danny Mussry,president and CEO of Time International, told OBG.

Industry analysts have indeed noticed a subtleshift in consumers’ tastes. While Indonesians aresometimes unaware of corporate origins of someproducts, they are increasingly becoming morenationalistic in their shopping habits, preferring tobuy local when possible. A survey by Kanter World-panel found that nine of the 10 most popular brandsin the country were domestic. Sedaap and Indomie,both instant noodles, were number one and two,respectively. Lifebuoy, a soap by Unilever, was num-ber nine (and the only foreign brand in the top 10).Coca-Cola was not in the top 50. As a result, localmanufacturers feel somewhat secure in this regard.“The 2015 ASEAN integration will not present animmediate challenge to the Indonesian food andbeverage market because initially, it will be hard forforeign companies to tailor their products to suit localtaste buds,” Warren Choo, director of ABC, told OBG. OUTLOOK: The outlook for retail in the mid to nearterm is clearly mixed. Waves of optimism will be bal-anced by periods in which economic reality holds backspending. The long-term trend, though, is positive.The economy will grow and more people will becomeactive consumers. In the meantime the retail sectoris going to have to work with what it has, cateringto the very wealthy high end and providing other lev-els of shopping for the new middle class. Higherwages will at the same time create new demand andplace pressures on the bottom line. Balancing thesetwo will be an exercise in human resources manage-ment and the improvement of efficiencies.

The rise in nationalist sentiment in the face ofeconomic difficulties could lead to more restrictionsin the sector. These could reduce consumption, leadto a fall in foreign direct investment and reduced com-petition and innovation. The country is also workingtoward a coordinated industrial policy, and if it con-tinues to pursue this sort of planning the retail sec-tor could find itself under scrutiny. There have beenseveral years of a relative free for all, with malls pop-ping up in many areas, as well as international brands.

208

Luxury taxes on goods range from 10% to 75%

Indonesian consumers have

shown a preference for

domestically produced

goods, with nine of the 10

most popular brands in the

country being

manufactured locally.

RETAIL ANALYSIS

Government Regulation No 82 sets obligations for e-commerce firms

E-commerce in Indonesia is booming, but it is notclear whether foreign investors can legally partici-pate in the expanding field. In 2013 the governmentannounced that online retailers would be treated likeall others: any company without a shop larger than2000 sq metres must be Indonesian-owned. By impli-cation, that would mean all internet retailers wouldhave to be locally controlled. The rule was written sobroadly that it seemed to include anyone conductingonline transactions of any kind in Indonesia.CONTINGENT: Much has since been clarified. Whilethe regulation was indeed issued by the Ministry ofTrade, it was never actually put into effect. That wouldhave required the agreement of other governmentbodies and implementation regulations, and none ofthese follow-up processes have occurred. E-com-merce had not in fact been restricted, but the ideawas being pursued. In late 2013, the Ministry of Tradesaid that it would be issuing new regulations regard-ing e-commerce, covering the regulation of bothproviders and products, consumer protection, and apossible tax, according to the ministry.

In the absence of more information, speculationcontinues as to how, when and even if the sector willbe regulated. Observers note that e-commerce fallsunder many ministries and departments, from trade,to information and communications technology tosmall and medium-sized enterprises, so the discus-sions will be complicated and will involve different par-ties with different interests. They add that given thehistory of regulation in Indonesia – especially the2009 Mining Law – regulations could be passed with-out fully accounting for unintended consequences. REGULATION 82: What is on the books already hasgenerated some concern. E-commerce is currentlygoverned by the Electronic Information and Transac-tions Act 2008 and supplemental regulations. Theprovisions relating to online trade are quite general.But Government Regulation No 82, the Implementa-tion of Electronic Transactions and Systems, was issued

in 2012 and broadly sets out the obligations of e-com-merce firms. The most worrying provision is the require-ment that all internet traders doing business in thecountry do so via a .id domain name. This was, in part,an attempt to curb internet fraud. If the governmenthad a registry of players in the sector, it would knowwho to go after should there be complaints.

But the provision was a problem for e-commercecompanies. Hosting within the country is not popu-lar with internet retailers due to concerns about thereliability of power and the susceptibility of Indone-sia to natural disasters. Observers said that the .idrequirement would inhibit development of the sec-tor, as registering a local name requires an incorpo-ration and a local address. More broadly, it woulddefeat one of the strengths of internet commerce –unfettered competition on the global playing field. GREAT POTENTIAL: Indonesia’s e-commerce sectoris seen as one of great opportunity. Because of thecountry’s population and the fact that transportationis difficult, e-commerce is set to explode as internetpenetration increases, which it is fast doing as the priceof smartphones drop, bandwidth increases and con-nectivity improves. The rise of payments systems is alsohelping. E-commerce has proved an attractive mar-ket for global companies. Rakuten, eBay and firmsfrom Germany and South Korea have recently set upin Indonesia. But whether they will be able to contin-ue operating in Indonesia is now open to question.

Observers say that even if e-commerce finds itselfunder the retail law, these firms may be able to oper-ate locally. However, even if they are able to exploitloopholes or set up workarounds to local ownershiprequirements, e-commerce could still be a challenge.The legal framework for online activities is sparse.Data protection and privacy laws, consumer protec-tion law and dispute resolution remain areas that areundeveloped or with only the most basic of statutesin place. Getting into the country might be one chal-lenge. Operating there could be another altogether.

An unclear regulation by

the Ministry of Trade puts

into question the future of

foreign e-commerce firms

in Indonesia. While no

binding statutes have been

passed, online companies

are paying attention.

209


A large population and

heavy traffic congestion

make the e-commerce

sector one that is attractive

and promising for online

companies. The challenge

will be in navigating

potential new regulations.

The e-commerce questionPaving the way for global firms to sell online

RETAIL INTERVIEW

VP Sharma, CEO, Mitra Adiperkasa

How will downward revisions of Indonesia’s GDP

impact retailers’ expansion plans going forward?

SHARMA: While it is true that this could affect theexpansion plans of some companies, for retailers oper-ating within the middle to upper income groups thereis great resilience. Demand in this area of the marketis therefore unlikely to be badly affected. Going forwardthough, such revisions affect overall market sentimentand with GDP growth forecasts being scaled down from6.8% to under 6% there is definitely a psychologicalimpact in terms of confidence. In the last couple of yearsthere has been vast growth within the retail sector, andit is likely there will be a period of consolidation overthe next 12 months. I would not say this is due to theelection but rather a combination of factors includingthe Jakarta Mall Moratorium, which will prompt amomentary and likely beneficial pause for retailers,which may allow them to consider their next move.

How do you foresee the incoming moratorium

impacting the retail sector’s growth, and how could

Jakarta benefit from such an action?

SHARMA: Rental rates are going up due a lack of newsupply, however, productivity cannot immediatelyincrease which puts pressure on the retailers in termsof their margins. There is certainly capacity for Jakartato have more malls relative to available land and percapita supply, however, the city’s infrastructure andrelated congestion problems must first be addressed.

The moratorium is very much the correct decisionfor the time being, as it will allow the city’s administra-tion to tackle existing infrastructural deficiencies. Indeed,Jakarta’s mass rapid transit and monorail projects arelong overdue and, once they are realised, I hope thatthey have a fantastic effect on the city’s retail prospects.

Regionally speaking, people need to be comfortablewith coming to Jakarta and travelling between ourexcellent shopping destinations; however, at present,this cannot be guaranteed. As a result we have beenlosing out to Singapore and Hong Kong, respectively.

What measures can be taken for Indonesia to com-

pete more effectively within the ASEAN region?

SHARMA: The significant reduction of the current taxon luxury goods is an important step. There are hun-dreds of outbound flights going to Singapore and HongKong where Indonesians travel to avoid domestic lux-ury taxes. Such measures must be abolished in orderto ensure that we keep our consumers in the country.

In Indonesia, the two biggest factors affecting theretail sector are rents and wages, and we are oftenparalysing ourselves in this sense. While rental is a morecomplicated issue, wage increases are having seriousaffects and any further significant increases will put aquestion mark over the sustainable operation of manygarment factories. While, on one hand, the wage increas-es will certainly benefit some workers, many otherswill likely be forced out of their jobs in light of result-ant factory closures. A balance must be found beforethe negatives outweigh the positives.

Another area where Indonesia can improve is in e-commerce. Retailers are investing in online infrastruc-ture and are starting to see encouraging results. WhileIndonesians still value face-to-face transactions at themall, there is a growing acceptance as to the benefitsof shopping online, which is being catalysed by greaterpenetration in the airline and hotel booking sectors.

Are current growth estimates realistic, and for how

long can the retail sector expand at this pace?

SHARMA: Indonesia is the fourth most populous coun-try in the world. In the next couple of years per capitaincome will likely cross the $5000 mark and there willundoubtedly be tremendous growth.

While some people overestimate the number of mid-dle class people in the country – for example referringto figures of between 40m and 80m people – a morerealistic number is around 40m-45m. There is still majorpotential in Indonesia and while it has perhaps beenoutshone by China and India in the past, looking aheadit is a country offering a bright future for retailers.

210

A bright futureOBG talks to VP Sharma, CEO, Mitra Adiperkasa


RETAIL ANALYSIS

Hypermarkets and supermarkets account for 20% of retail space

Indonesia has a fast developing retail sector, and all signspoint toward it evolving quickly from highly fragment-ed and basic in terms of quality, service and efficiencyto one similar to advanced ASEAN countries, with mod-ern trade outlets and large groups leading the way.Indonesian consumers are active and increasingly pros-perous. Firms are investing and quickly upgrading, andare under considerable pressure to improve given thefast rise in wages and the need to better manage theiroperations. The physical environment is also support-ing change: traffic and the lack of public transporta-tion encourages the establishment of well-placed andwell-run convenience stores. Indonesia is a country onthe cusp of a massive change in the retail sector. RESISTANCE: However, resistance to the larger trendsis considerable. While modern trade will grow, it will haveto evolve with an eye toward various interests. The gov-ernment has long been pushing back against overde-velopment – as evidenced by a 2011 decree for a mallmoratorium in Jakarta – and it is doing its best to sup-port and encourage small markets and mom-and-popshops. Consumers, however, are changing their buyinghabits by shopping at minimarkets instead of tradition-al stores, for example.

Meanwhile, the general economic background isthrowing greater development further into question.Indonesia is becoming more nationalistic and protec-tionist. Its new trade and industry laws empower thegovernment to protect the economy by setting up bar-riers and actively promoting sectors. In this environment,the retail sector might come under fire, as it has thepotential to increase the trade deficit with imports. Inan election year like 2014, modern trade could find themarket more challenging than expected. BIG MOVES: According to data from Euromonitor thatwas published by the US Department of Agriculture, themarket share of major modern retail chains has beengrowing steadily over the past decade. Traditional retailwas 74.2% of all retail in 2002. That was down to 55.8%by 2011. In that time, minimarts went from about 4.9%

to 22.4% of the total, while super markets and hyper-markets held steady at about 20%. Much of the gap hasbeen filled by the growth of convenience stores.

Perhaps the most significant development was thearrival of 7-Eleven in 2009. While Indonesia has had con-venience stores for more than two decades, the Japan-ese-owned chain lifted the standard and expandedquickly. Currently, the country has five dominant con-venience store players. They are 7-Eleven, Circle K, Law-son, Indomaret Point and Family Mart, which togethercontrol about 80% of the market, according to Indone-sian bank CIMB. The overall market, according to thebank, grew from 105 stores in 2008 to 415 by 2013.

Circle K – the first convenience chain in the country– is the largest, with 179 locations in 2012, accordingto CIMB. 7-Eleven was the second largest, with 129 out-lets in the first half 2013, followed by Indomaret Point,with 86 stores in the first half 2013. Lawson, the Japan-ese brand, had 84 points in 2012 after just two yearsof operation. A new entrant is Ministop, which openedtwo stores in Jakarta ins 2013. Two chains, Bright andampm, have been closing stores. Following the trendin other countries, the Japanese chains are fast expand-ing and quickly marginalising exiting players. PUSH BACK: In 2012 and 2013 new regulations wereissued that limited the growth of global chains to ensurethat locals are included in the expansion. These lawsrequired, among other things, that minimarts limit theiroutlets to 150, after which additional outlets have tobe 40% locally owned. Also, 80% of the raw materialsused in products sold and 80% of equipment in the storesmust be locally produced. The rules also apply to smallsupermarkets and department stores. Meanwhile, foodand beverage outlets are limited to 250 units, and firmswere given five years to comply.

The government has been in dispute with the Japan-ese chains, which has heated up considerably in 2013.Since at least 2012, the Ministry of Trade has chal-lenged 7-Eleven and Lawson licences. According to theauthorities, the outlets have restaurant permits from

While modern retailing is

on the rise in Indonesia, the

segment must contend

with certain challenges,

such as protectionism and

consumers’ loyalty to

traditional outlets.

211


New regulations limit the

number of outlets some

global chains can have in

Indonesia, with

requirements that any

stores above this threshold

have a minimum of local

ownership and locally

sourced products and

equipment.

Steady developmentNew outlets are transforming the retail make-up

RETAIL ANALYSIS

the Ministry of Culture and Tourism. However, becausethey sell consumer goods, they are retail outlets, whichshould be owned by Indonesians and be licensed bythe Ministry of Trade, the government contends.

In early 2014 public order officers gave notice to halfthe 7-Elevens in Jakarta that they did not have the rightpermits: 29 lacked operating permits and 31 lacked per-mits to sell food. Jakarta governor Joko Widodo weighedin in early January 2014 as one 7-Eleven outlet remainedopen despite a window sign saying that it had beenordered closed. Widodo said keeping the stores openchallenged the authority of the government, and thatif they continued to violate the order, the state may beforced to level the shops. Hours later, the outlets wereshut, but the firms insist they have the right permits.GROWING PROTECTIONISM: The current mood inIndonesia tends to be inward looking. The feeling in thecountry is that it has tried to open its markets, only tobe the subject of dumping from countries that havenot been nearly as open. Nationalism is on the rise

despite commitments Indonesia has made to both theWorld Trade Organisation and ASEAN. In the run up tothe July 2014 elections, politicians will be inclined tofavour policies that err on the side of protecting domes-tic businesses. Retail is particularly vulnerable, as inter-national brands and marketing attracts a good deal ofattention regardless of the value underlying business-es leaves in the country.

The small-scale retail sector also has a strong cul-tural connection for many Indonesians, especially thewarung, small family owned businesses. The govern-ment is always careful to support the small local shopowner because history has shown the political impor-tance of keeping these retailers on its side. In late 2013the Jakarta governor said that a tax to be levied againstfood stalls, as outlined in a 2011 bylaw passed by hispredecessor, will not be enforced. A restaurant with morethan Rp200m ($20,000) of sales was required to pay a10% income tax under the statute. The current gover-nor said that food stall owners and their relatively poorcustomers should not be made to bear the burden. FAVOURED: Momentum will help maintain the statusquo without government help. According to someresearch, the majority of transactions are conductedvia traditional channels, which will remain the case foryears. A 2013 report by global consultancy Bain & Com-pany puts the percentage of grocery transactions viatraditional channels at 85.2%. Of the rest, the majori-ty was delivered via minimarkets and conveniencestores. But modern trade channels are growing fast, thereport states. According to calculations, the hypermar-ket segment will grow 13% between 2007 and 2017,the supermarket segment 12% and convenience storesand minimarkets 23%. Traditional channels will grow 8%in that period. However, traditional retail will still makeup 82.3% of grocery sales by 2017, and modern tradewill not catch up until about 2030. “There is a place forthe traditional retailer. The space has stabilised,” Cather-ine Eddy, managing director at Nielsen Indonesia, toldOBG. “The wet markets have responded by upgrading.I cannot see the wet markets becoming irrelevant.”

212

The hypermarket segment is projected to grow 13% over 2007-17

In 2013 traditional

channels accounted for

85.2% of grocery

transactions, but this

avenue is expected to grow

only 8% between 2006 and

2017, slower than

hypermarkets and

convenience stores.

RETAIL ANALYSIS

Some observers argue that new policies will encourage smuggling

Alongside Indonesia’s emphasis on the importance ofeconomic development, the country is at the sametime working to protect itself from some of the unin-tended consequences of that development, especial-ly in the retail sector. The emerging middle class willcontinue to help drive the economy forward, but theretail sector that serves it has the potential to damagethe physical environment as it builds the infrastructureneeded to meet the demands of new consumers. Theconsumers themselves, meanwhile, can alter the coun-try's current account and trade balances as they buyan increasing number of products from overseas.MORATORIUM: The most visible effort to address thedownside of consumerism has been a moratorium onmalls in Jakarta, in place in one form or another for threeyears. The first mall moratorium was issued in late 2011by the then-Governor Fauzi Bowo and was set to expireat the end of 2012. Jakarta has experienced a boom inmall construction, leading to concerns that an increasein retail space was taxing the city's infrastructure andadversely affecting quality of life, for instance throughgreater traffic congestion. It was also widely believedthat malls were being built at the expense of parks andpublic space. According to press reports in 2011, only10% of the city was green space despite the 2000-10Spatial Bylaw calling for an increase to 13%.

However, the mall moratorium was quickly met withscepticism, especially in the press. The Jakarta Post

wondered at the outset whether it would be effectiveat all. While generally supportive, pointing to the city’sneed for more green space, the paper also claimedthat the moratorium would be unable to stop new con-struction, given that it was only set to last for a singleyear. Moreover, the paper noted that certain areas,such as Jl. Dr. Satrio, South Jakarta and East Jakarta,would even be exempt from the ban. The bottom line,the paper suggested, was that the moratorium wouldnot make a difference to the city’s overall quality of life.DISAGREEMENTS: In public comments, the IndonesiaRetailers Association said that the 2011 moratorium

had also been problematic for other reasons. For exam-ple, the regulations were not clear, making it difficultfor developers to plan accordingly. The association alsofound the entire concept of the moratorium at oddswith the goals of the administration to transform Jakar-ta into a centre for services. Others, however, haveexpressed support for the mall moratorium. Max Pohan,deputy of the Department of Regional Developmentand Local Autonomy of the National Development Plan-ning Board, has argued that malls lead to dangerousimbalances in the country, contributing to migrationinto cities from rural areas partly due to the promiseof employment offered by malls. Pohan said that newmall construction should be banned in Jakarta and thatit should be encouraged in areas outside the capitalcity. This would reduce internal migration, reduce con-gestion and result in development elsewhere. Even theindustry saw some good coming out of the moratori-um. In general, new malls in Indonesia receive a lot oftraffic, but that older malls are not as popular andbecause of that not well maintained.

The moratorium would encourage developers toinvest money in older establishments, according to Ste-fanus Ridwan, national chairman of the IndonesianShopping Center Association (APPBI). The battle againstmodern retail is part of a longer-term fight to save tra-ditional retail. In recent years, a raft of regulations havebeen issued in an attempt to protect wet markets andhawker stalls. For instance, Regional Regulation 2/2002says that modern retailers cannot be too close to tra-ditional retail outlets, while Presidential Regulation112/2007 requires modern retail outlets to be on mainroads. Moreover, Presidential Decree 111/2008 pro-hibits foreign investors from developing departmentstores smaller than 2000 sq metres.EXTENDING THE MORATORIUM: In 2013, Jakarta Gov-ernor Joko Widodo (known as Jokowi) said that the mallmoratorium would be extended. For the governor, thecity currently lacks the environmental capacity to sup-port new large retail outlets. He conceded, however,

Regional Regulation 2/2002

says that modern retailers

cannot be too close to

traditional retail outlets,

while Presidential

Regulation 112/2007

requires modern retail

outlets to be on main roads.

213


Tempering retailA moratorium on the construction of malls in Jakarta has split opinion

RETAIL ANALYSIS

that malls could continue to be built in areas that arenot yet well developed, such as East Jakarta.CONTROVERSY REMAINS: Some observers suggestthat better planning could allow for more retail spacewithout taxing infrastructure. They say that downtownJakarta is not yet overcrowded with skyscrapers and thatmore large buildings are possible if transportation isbetter organised. Industry representatives recommendthat rather than an outright ban, the government shouldinstitute more flexible policies adjusted to achieve anefficient and pleasant urban area.

The governor said that permits from the old admin-istration are valid but that new requests for permits willbe rejected if submitted. According to press reports,Jokowi's moratorium has been relatively effective andmall projects have been put on hold. The governor hasa long history of working to balance business concernswith the broader public interest. While he was mayorof Surakarta, he prevented the demolition of Fort Vas-tenburg by developers. The fort, which dates back tothe late 18th century, had been sold to the private sec-tor in the 1980s and, despite protests by architectsand historians, had been under threat of demolition foryears. Jokowi, while in favour of traditional retail, hasalways promoted a balance of interests. In Surakarta,

his support of street vendors was in part intended toallow for the transformation of areas that had beenoccupied by informal traders. He has gained a reputa-tion as a sound administrator, and so his moratoriumis likely to be more effective than those in the past.LUXURY TAX: In August 2013, a higher tax on import-ed luxury cars was included in the government's fiscalpackage to temper the fiscal boom, and later in the yearthe Ministry of Finance said that other items would alsobe subject to higher taxation, such as clothes, hand-bags and mobile phones. There was very widespreadconcern that higher imports were leading to tradeimbalances and balance of payments problems, caus-ing a fall in the value of the currency.

The import tax on mobile phones was raised from2.5% to 7.5% in March 2014. In the same month, Pres-ident Susilo Bambang Yudhoyono confirmed that theluxury tax on cars would be increased by 50% in April2014. At the time, the tax ranged from 10-75%, and itwas expected that the higher rate would go to 125%.The government also stated in April that all mobilephones would attract a higher tax, though earlier theMinistry of Trade said that only phones selling for morethan Rp5m ($500) would be hit with the 20% duty fromOctober 2014. The government estimates that $3bnworth of phones were imported in 2013 and that 15%of these were smartphones.INDUSTRIAL POLICY: The government believes thatthe higher taxes will not only reduce consumption butthat they will also encourage local production. Acrossthe board, it has been pursuing broad policies designedto help in the development of domestic industrial capac-ity. But critics wonder whether higher taxes will reduceimports or result in additional investment in domesticproduction. They say that the new policies will proba-bly encourage more smuggling, especially of mobilephones from Singapore and Malaysia, and could ulti-mately result in less local value added. It hopes to cutthe importation of the higher end phones by 50%.

As the situation currently stands, distributors aregetting a share of the business and are able to reinvestat a local level. However, in the event that they are dis-intermediated, all the value will go overseas and com-panies based within Indonesia will lose business. Interms of automobiles, the higher tax has been seenresulting in an increase in the number of used car sales.

214

Higher import taxes are designed to boost local production

The import tax on mobile

phones was raised from

2.5% to 7.5% in March 2014.

In the same month,

President Susilo Bambang

Yudhoyono confirmed that

the tax on luxury cars would

be increased by 50% as

of April 2014.

215

ConstructionMoving on with infrastructure development plansLocal producers expanding capacity for materialsRupiah depreciation one of the sector’s main challengesValue of the building equipment market is rising rapidly

CONSTRUCTION OVERVIEW

Sector growth is fuelled by the government’s $185bn MP3EI scheme

Increased government investment in infrastructure hashelped to unleash a boom in Indonesia’s constructionsector. With rapidly growing demand for residentialreal estate, office buildings, industrial estates and oth-er property across the archipelago, the constructionsector is tagging along for the ride.

The Indonesian Contractor’s Association (AKI) not-ed an increase in the construction and building mate-rials sector from $25bn to $40bn between 2011 and2013 as infrastructure development and propertyexpansion continues to bolster the country’s GDP. Thegovernment’s Master Plan for the Acceleration andExpansion of Indonesia’s Economic Development(MP3EI) is driving much of the sector’s growth, as$185bn has been allocated for infrastructure develop-ment. In 2013 the construction sector comprised 10.5%of Indonesia’s GDP, having risen nearly 3% since 2009.However, 2013 brought significant rupiah deprecia-tion, which, through increased building materials costsand subsequent project delays, was the year’s biggestchallenge for the sector. Still, growth persisted as newcontracts were signed and ground was broken for workacross the archipelago. With more projects on tap for2014, the sector’s contribution should increase further.FINANCE & DEVELOPMENT: State-owned firms havebeen reaping much of the benefits from infrastructureand tourism development since the governmentdeclared the sectors to be two of the six MP3EI corri-dors. By the end of the third quarter of 2013 Indone-sia’s top nine construction firms reached a combinedprofit of Rp849bn ($85m). The top earner was WijayaKarya, and Pembamgunan Perumahan recorded thesecond-highest profit, while Adhi Karya experienced thehighest growth from the previous year at 135%.

Kuala Namu International Airport in Medan and thenew Priok Port in Jakarta are two major recipients ofinvestment that has been allocated through MP3EI andthe state budget, and have contributed to significantyear-on-year growth for Indonesia’s top constructioncompanies. New hotel contracts, including those for a

new JW Marriot in West Jakarta, Uluwatu Hotel in Baliand Plaza Tunjungan V in Surabaya were the main con-tributions to Pembamgunan Perumahan’s profit. Thefirm’s success in early 2013 led it to set a goal for a27% increase from 2012 in new contracts for 2013.

Through the first semester of 2013, the top nineconglomerates contributed to 66.5% growth in theconstruction sector, with Pembangunan Perumahan,Nusa Raya Cipa, Nusa Konstruksi Enjiniring and AcsetIndonusa following Adhi Karya in the top five at 121.2%,120.1%, 106.9% and 98.4%, respectively.INVESTMENT: Foreign direct investment (FDI) in thesector has declined since 2012, when the total fell to$240m from $618.4m in 2010. Although there are plen-ty of investment opportunities, funding for a signifi-cant amount of infrastructure development has comesolely from domestic companies and the governmentbudget. As Jennifer Frederika Yapply, a constructionsector analyst at Bahana Securities, told OBG, “Privateinvestment is a challenge to recruit, because projectsare often being built in places that are under devel-oped. Therefore, they don’t offer much return.” Privatecompanies are also often left out of MP3EI projectinvolvement. Ronnie Tan, president director of AcsetIndonusa, told OBG, “Most large infrastructure and pub-lic sector construction projects are awarded to bigstate-owned enterprises, leaving private sector com-panies to compete outside of government tenders.”

The real estate sector offers more opportunity forprivate investment and ownership. Long-standing gov-ernment restrictions on foreign ownership have beenroadblocks for FDI (see Real Estate chapter), but recentlaws show hope for ease in the near future. In May2012 the government passed a new law that allows for-eign nationals to purchase condominiums, which arein high demand in Indonesia’s major cities, in a movethat could help drive up FDI for future construction proj-ects. The private sector is vital to fulfilling MP3EI plans,particularly in infrastructure. The increase in spendingon infrastructure projects drove up the construction

Foreign direct investment

(FDI) in the sector has

declined since 2012.

However, the government’s

new law that allows foreign

nationals to purchase

condominiums is likely to

help boost FDI for future

construction projects.

216

Still growingInfrastructure plans and demand for property drive the sector forward



sector’s overall GDP contribution to 10.5%, coming inbehind the trade and agriculture sectors at 13% and14%, respectively, but the Ministry of Public Workshopes that the construction sector will surpass thetwo within the next few years.PROJECT DELAYS: The most significant challenge tothe sector in 2013 was rupiah depreciation against theUS dollar, which drastically drove up the cost of build-ing materials. As the rupiah weakened, the prices forasphalt rose 21% and concrete 20%. While much ofIndonesia’s concrete is produced domestically, demandfor the material is so high that significant import isnecessary to fill supply gaps. Price hikes for asphalt andconcrete have thus caused major delays in plannedand active projects across the country, particularly tollroads, bridges and road repairs, with companies strug-gling to pay the hiked prices and contracts being rene-gotiated. By the fourth quarter of 2013, 60% of proj-ects requiring asphalt were halted and the constructionsector suffered a notable decrease in annual earnings.Many companies and contractors are waiting for thegovernment to intervene so that projects can be restart-ed. Meanwhile, banks have begun to slow grantingloans to construction companies, which could causethe sector to lose momentum. While the sector over-all was hot in the beginning of 2013, mid-year budgetcuts prompted a slowdown, which Bahana Securitiesanalysts anticipate will affect the sector through theshort to medium term, but does not imply a gloomy out-

look for the long term. Aditya Eka Prakasa, construc-tion research analyst at Bahana, told OBG, “After theelection, later in 2014, we should see momentum pickback up again.” While firms and contractors wait for relieffrom the government, the wait period may extend wellinto 2014 after the new administration is elected andgiven a chance to weigh in on sector regulations. IN & AROUND JAKARTA: While global sea levels arerising by an average of 1-2 mm per year, Jakarta has expe-rienced a drastic increase in land subsistence ratesover the past 40 years. The Jakarta Coast Defence Strat-egy (JCDS) predicts that by 2020 sea levels will rise by60 cm along the northern part of the capital. If it con-tinues at the current pace, 2050 would see Jakarta rest-ing 2.2 metres lower than where it was in 2008. Some40% of the capital is below sea level and another 10%could be added over the next one to two decades. Thisrapid increase in land subsidence can be attributed toa range of factors. In Jakarta construction works, as wellas groundwater extraction, are often cited as maincauses of land subsidence. Subsidence has causedsome dikes along the capital’s coast to no longer beable to hold back water, leading to an increased risk forflooding as the city continues to fall below sea level.Thus, there are plans to build a new embankment andimprove the city’s existing embankment.

However, according to Doddy Tjahjadi, managingdirector of Prada Tata International, “The main challengefor international and domestic developers looking to

217

One of the main challenges

for the sector in 2013 was

the rupiah’s depreciation

against the US dollar, which

significantly increased the

cost of building materials.

The prices for asphalt and

concrete, for instance, rose

21% and 20%, respectively.


Jakarta is finding available sites, where most land own-ers are not willing to sell.” A new land acquisition lawwas passed in 2011, which is expected to acceleratethe implementation of infrastructure projects.

While Jakarta remains a hub for housing, office, andretail and commercial development, the public and pri-vate sectors are looking to tap into potential outsidethe capital. Edwin W Ng, CEO of Maxxis Indonesia, toldOBG, “We are experiencing a shift in business oppor-tunities from Jakarta to the regions as the real estatesector in Indonesia’s secondary cities and outer regionsis rapidly expanding.” Bali is thriving with luxury real estatedemand, and Java has become an increasingly appeal-ing site for industrial property. “With over 140m peo-ple, Java is the manufacturing hub of Indonesia and con-tinues to attract increased FDI,” Wilson Effendy, directorof Bekasi Fajar Industrial Estate, told OBG.

Opportunity awaits beyond the capital, and whilestate-owned companies stand to benefit the most frominfrastructure projects, private investors– domestic

and foreign – are set to take advantage of the proper-ty development opportunities across the archipelago.BRIDGING THE GAPS: The construction sector isexpected to spend a total of $39bn throughout 2014,and much of this will go toward transport and infra-structure development. Since the government hasrecognised that there is not enough infrastructure inIndonesia to support economic development across thewhole country, it has boosted the number of projectsin the pipeline in accordance with MP3EI targets.

Dams, roads and bridges comprise the majority ofgovernment projects currently under construction orplanned for coming years. Toll roads and bridges willbe the first investment areas and the recipients of themajority of state investment, as the government looksto tackle connectivity issues. Road projects plannedfor 2014 currently total Rp33.7trn ($3.4bn), and mostare located in Java, Sumatra and Papua, according tothe Ministry of Public Works. These projects will be fol-lowed by new ports, dams and other secondary infra-structure projects. Water projects, including Titab in Bali,Pandan Duri in West Nusa Tenggara, Jatigede in WestJava, and Diponegoro in Central Java, are expected tototal Rp11.4trn ($1.1bn) in 2014. In the meantime,MP3EI plans require the involvement of the privatesector. Funding remains the main roadblock and manyprojects are facing delays due to inflation and insuffi-cient investment. Many government projects are backedby state-owned enterprises (SOEs), because it is moreattractive for bigger, private companies to invest inproperty and similar projects that offer more return.Furthermore, regulation can be a challenge to navigate,and potential investors often find there to be a lack ofconsistency in what the government allows.

SOEs will oversee airport and shipping port projects,which normally average three years to complete. Pri-vate companies are taking the lead in financing airportexpansion projects, except for in smaller cities wherethe projects are funded by local governments. Shippingports are also congested, causing vessels to rarely arriveon time. The government is planning to build a new port

218

Jakarta is boosting spending on sea defences and water management

Dams, roads and bridges

account for the majority of

government projects that

are currently under way or

planned to begin

construction in the next

few years. Toll roads and

bridges will be the first

investment areas as the

government seeks to

improve the nation’s

transport links.


system, which promises to afford logistics companiesbetter connectivity and reliability. In 2014 the nationranked 53rd on the World Bank’s Logistics and Perform-ance Index list, for which 160 countries were analysed.This was an improvement from 59 out of 155 coun-tries in the previous index in 2012.

While an improved infrastructure system would relieveIndonesia of many of its development roadblocks, Yap-ply suggested that road systems in places like Jakartawill have to get worse in order to get better. Whereasregional neighbours, such as Singapore and Malaysia,or developed economies such as the US or UK, havemore organised business districts and housing districts,Jakarta lacks a system of urban organisation that wouldkeep new projects from causing major interruptions totraffic flows. Jakarta is already notorious for its trafficjams, so building new roads or bridges without tidymapping is very challenging.

The government plans to move forward despite this,with new public transportation projects set to beginconstruction in 2014. Overall government spending oninfrastructure and commercial development is expect-ed to increase by 10% in 2014 to Rp407trn ($40.7bn),up from Rp369trn ($36.9bn) in 2013.AIR TRAFFIC: The fastest and most efficient way toimprove transport links between Indonesia’s 17,000islands is via air travel, which is becoming more afford-able for the rapidly expanding domestic consumer mar-ket. However, airports and airlines are struggling tokeep up with the boom. While Asia’s budget airlines aredriving growth in the overall sector, national carriers,such as Garuda, are expanding their fleets and open-ing new routes (see Tourism chapter).

Growth is overwhelming already congested airports,primarily Jakarta’s Soekarno-Hatta International Air-port, which serves 50m passengers a year, though itscapacity is 27m. The airport is the main entry point tothe archipelago, and it has only two runways, leavingthe airport capable of accommodating just 75 take-offsand landings per hour. Under the administration ofPresident Susilo Bambang Yudhoyono, a Rp7.6trn($760m) expansion project was kicked off in 2012 andis set for phase one completion in 2014. A secondphase of the expansion will finish in 2015, just in timefor the integration of the ASEAN Economic Communi-ty. Expansion projects have also started for the Bali andMedan airports, as both locations are trying to accom-modate the surge in travellers. The government has alsoannounced plans to build a second international air-port in Jakarta, which will help relieve the congestionat Soekarno-Hatta. Plans are under review and the gov-ernment intends to approach investors in 2014, withground-breaking to begin immediately thereafter.

While the aviation side is making progress, the gov-ernment’s focus is likely to shift to efforts to improvethe roads in and out of the airports. Traffic lanes arealready congested around the major airports and willworsen if additional roads are not built to accommo-date for the increase in arrivals and departures. WAGE WOES: While many projects have been delayedor halted due to the effects of rupiah depreciation,

companies are also factoring in increases in minimumwage while tightening their budgets. “Minimum wagehas increased 44% in Jakarta, and skilled constructionworkers’ wages have increased between 50% and 100%.Compounded by creeping inflation in commodity pricesand a fluctuating currency, end prices have gone up100% in 2013,” Harun Hajadi, managing director ofCiputra, said. The regional minimum wage was increasedby 44% in Jakarta and by a national average of 18.3%in 2013. Still, there is a demand for higher wages fromworkers, who are advocating to be compensated forhigher transportation costs due to fuel price increas-es. Many companies, especially small to medium-sizedfirms, are being forced to lay off employees or hire for-eign workers working for lower pay.

Meanwhile, more companies are reaching abroad tofill the sector with much-needed expertise. Due tocompetitive salaries and opportunities in the miningsector, some locations are experiencing a domesticbrain drain in the construction sector. Yapply told OBG,“Especially in Java, it is getting harder to recruit con-struction workers. Following the commodity boom that

219


SOU

RCE:

Min

istr

y of

Pub

lic W

orks

Construction sector GDP growth, 2007-12 (%)

0

2

4

6

8

10

201220112010200920082007

The island nation is boosting its air transport links and infrastructure

Total government spending

on infrastructure and

commercial development is

estimated to rise by 10% in

2014 to $40.7bn. An

improved infrastructure

system would help address

many of Indonesia’s

development roadblocks.


occurred seven years ago, people began moving toplaces outside of Java, because the pay became muchhigher. In Java, construction sector work is a low-incomejob, so professionals with more advanced training andskills are moving elsewhere.” Though construction work-ers are paid above minimum wage, many find benefitsin transitioning outside the sector to use their skills inanother field. Mining companies often pay higher thanconstruction firms because hazard premiums are added.That is attracting workers to the sector. However, whilesmaller companies are facing the bulk of the recruit-ment challenge, bigger firms claim that their workersare loyal and more often return for future projects.

Human capital development and a boost in industrystandards will be vital for the sector’s goal of increas-ing overall GDP contribution. Hediyanto W Husaini, con-struction division head from the Ministry of PublicWorks, told reporters in January 2014 that as of theend of 2013 there were 117,042 contractors and 4414consultants working in the construction industry, which

has a total of 6.6m workers. Around 159 engineershave ASEAN certification, and this number is very lowcompared to what Indonesia’s neighbours can offer.Doddy Tjahjadi, managing director of Prada Tata Inter-national, told OBG, “Architectural local expertise with-in the domestic architectural sector is stretched by thecurrent boom period. As a result, major architecturalcompanies like ourselves have to look abroad for sen-ior staff recruitment in order to service bigger andmore complex projects.” Around 60% of the populationis currently at a work-ready age, according to BahanaSecurities, and skills development in the trade will bevital to ensuring that safety and quality standards aremet. Considering that the industry is under high pres-sure to become more competitive in time for ASEANsingle market integration, developing Indonesia’s humancapital should be a key area of focus. OUTLOOK: Rupiah depreciation and the project delaysit is causing are the biggest challenges to the sector.However, as rapid urbanisation continues and the gov-ernment rolls out infrastructure development plansacross the country, the construction sector shouldremain resilient over the long term. Indonesia’s middleclass is expanding, driving up demand for housing asmore Indonesians look to purchase their first homes.Meanwhile, the country’s young population compris-es a sustainable labour source ready to carry out theplans if human capital development is prioritised.

These factors combined have led the government toforecast a 6-7% annual GDP growth through 2017.Spending across the sector is anticipated to reach$39bn in 2014, according to the Ministry of PublicWorks’ January 2014 estimates. Though the sector mayslow in the first part of the year, it is expected to gainmomentum once the new administration is electedand given time to establish new regulations. If it favoursinfrastructure development with similar fervour as thecurrent administration, the sector will continue to ben-efit from increased government spending. Further-more, it should make Indonesia a more competitiveeconomy as it enters the ASEAN single market in 2015.

220

In 2013 the construction sector accounted for 10.5% of GDP

Human capital

development and a boost

in industry standards are

key for the sector to

increase its overall GDP

contribution.

CONSTRUCTION ANALYSIS

Local producers are expanding capacity to meet demand for materials

As Indonesia’s real estate market has experiencedgrowth in recent decades, the demand for buildingmaterials has skyrocketed. The domestic market is thriv-ing, with Indonesia’s key players rapidly expanding pro-duction capacity of high-demand materials such asconcrete and metals. Inflation is high for importedbuilding materials and infrastructure challenges maketransporting materials logistically challenging.

However, as infrastructure is prioritised under the gov-ernment’s plans, companies should see relief fromlogistics challenges and opportunity for project involve-ment in the near future. Local producers have begunto expand capacity in order to meet high demand forbuilding materials amid a climate of rising import costs.HEAVY METAL: Indonesia is the fastest growing steelmarket in ASEAN, with this segment experiencing thefourth-fastest market growth rate in the world over thedecade to 2012, according to the OECD. Constructionhas also been the largest driver of this growth. Whilein the past, lower overall activity meant the domesticsteel sector was able to supply construction with themajority of its needs, in recent years there has been agrowing level of steel imports.

Metal building materials conglomerate, BlueScopeLysaght Indonesia, expects demand in the domestic mar-ket to continue annual growth too, as builders are usingless wood and more steel. The company provides met-al materials for walls, decks and roofing to developersas well as to major construction ventures, such as Jakar-ta’s Ciputra World. In 2012 metal building materialsused for roofing averaged a demand of 10,000 sqmetres per month. With around 10% of market share,BlueScope Lysaght will branch out further, having estab-lished two new factories in 2013, one in South Suma-tra and one in Riau, which will each have the capacityto produce 500 tonnes of roofing material every month.

Currently many companies are grappling with increas-es in imported steel prices, especially in the wake ofrupiah depreciation. Steel companies are also havingparticular trouble, because they are incurring their

costs in dollars, but are contracting in rupiah. SalmanFajari Alamsyah, research analyst at Bahana Securities,told OBG, “Steel products are sold in rupiah, which hassignificantly depreciated since the beginning of 2013.25-50% of the total supply is dollar-linked, so costshave gone up due to depreciation. Due to the spike incosts, companies are often forced to re-negotiate con-tracts.” Yet major investment from the private and pub-lic sector has allowed the metal, steel and iron sectorsto fund rapid domestic production expansion in recentyears. Indeed, overall, in the first half of 2013 the indus-try experienced 12.7% growth, as demand wasaddressed by boosts in production capacity.

Other challenges include a lack of a steel standard.“Developing and setting comprehensive national steelstandards continues to be the biggest challenge for thesteel industry. Well defined national standards drive con-sistency and allows fair competition domestically. Forexample, Singapore has no steel industry but still definesthe steel standard, by ensuring all steel imports meetthe required standards,” Cheong Ku Wei, president direc-tor of BlueScope Steel, told OBG.

While Krakatau Steel still wears the crown as Indone-sia’s top steel producer, capable of putting out 2.5mtonnes per annum, it has also been in the lead in boost-ing domestic expansion. In December 2013 the firmbegan operating a new blast furnace and plate mill inpartnership with POSCO from South Korea at Cilegon,West Java, while it also plans to open a hot strip mill in2014 and another blast furnace at the same locationin 2015. Indoferro also plans phase two of its blast fur-nace at Cilegon later in 2014. Other steel companiesexpanding over the next few years include JFE Steel Gal-vanizing at Bekasi in West Java, Gunung Raja Paksi alsoat Bekasi, Essar Indonesia and Gunawan Dianjaya Steel.This should boost domestic production, easing supplypressures and foreign currency risk.

Aluminium is also becoming increasingly popular asa construction material in Indonesia. New rules ban-ning the export of metal ores from Indonesia are also

221


With construction driving

wider economic expansion,

Indonesia is the

fastest-growing steel

market in ASEAN. The

sector recorded the world’s

fourth-fastest market

growth rate over the

decade to 2012, according

to the OECD.

In high demandBuilding materials are seeing investment and capacity expansion


aimed at supporting domestic production of this, witha new alumina refinery due to be completed in 2014. SET IN CONCRETE: As with steel, though cement is pro-duced domestically, annual output is not enough to meetIndonesia’s demand, leading the industry’s top playersto expand capacity. The Indonesia cement associationdocumented an increase in national cement sales from40.8m tonnes in 2010 to 48.8m tonnes in 2011 and55m tonnes in 2012. Into the third quarter of 201341.6m tonnes of cement was purchased from domes-tic suppliers, which are looking to expand productionacross the archipelago and the region. Semen Indone-sia, a government-owned cement manufacturer, andthe nation’s largest, sold 18.5m tonnes in the first ninemonths of 2013 and closed the year with 27.8m tonnessold. Semen Indonesia aims for an 8% increase in 2014and has budgeted Rp5trn ($429m) to invest in produc-tion expansion, which could boost its sales total to31.8m tonnes in 2014. If growth continues at the cur-rent rate, it could expand production capacity to 40mtonnes in 2017. The second-largest cement produceris Indocement, which is majority owned by Heidel-bergCement. The company is building a 4.4m-tonnes-a-year plant at Citeureup, while seeking licences for theconstruction of two more, 2.5m-tonne capacity plantat greenfield sites in Central Java. The third-largest isHolcim, which saw its capacity boosted in 2013 withits Tuban 1 plant coming on-stream, while Tuban 2 isscheduled to commence operations in 2015. Indeed,continued expansion in Indonesia’s cement industry maymake it more competitive in time for the ASEAN singlemarket implementation at the end of 2015. Overall, theindustry plans to allocate $6.7bn through 2017 in orderto expand cement production capacity, which will thenincrease from 60m tonnes to 90m tonnes.

Some 80% of domestic cement sales are by the bag,rather than in bulk, with the main driver of demand beingreal estate rather than large-scale infrastructure proj-ects. This could change though in the years ahead, asgovernment and public private partnership plans todevelop transportation infrastructure in particular forgeahead. Under the MP3EI, some $28.5bn of road proj-ects are planned, or Rp24trn ($2.4bn) per year through-out the plan period. In terms of aggregates, until recent-ly, Indonesia was not only a producer, but also anexporter. The 2014 ban on raw metal ore and mineral

exports halted this, leaving increased supply for domes-tic aggregate crushers and processors. As 2014 gotunder way, cement companies reported somewhatlower demand, partly due to poor weather, while alsodue to the general economic slowdown. Based oncement association data, the Jakarta Post reported inMarch 2014 that in 2013, domestic consumption hadrisen 5.5% to 58m tonnes. This was in comparison to14% growth in 2012. Continued pressure from exchangerates was also being experienced, as many of the sec-tor’s inputs, such as coal, are also dollar-linked. Elec-tricity costs – another major input – have also goneup. “The recent energy price hikes on large-scale indus-trial users are being felt in the concrete industry, espe-cially in factory-related operations. As a result, manycompanies are looking towards the feasibility of even-tually shifting to using alternative energy such as com-pressed natural gas,” Surakhman, president director ofAdhimix, told OBG. “As a result, many companies arelooking towards the feasibility of eventually shifting tousing compressed natural gas as an alternative.”OTHER MATERIALS: Production of ceramic floor, walland roof tiles is a major subsector in Indonesia, with2012 seeing the country rank sixth in the world in termsof total ceramics production. The country has largesupplies of the necessary raw materials, such as claysand silicas, with growing real estate construction themain driver of subsector growth. Heating, ventilationand air conditioning (HVAC) products are also seeinga rising demand overseas. “We are seeing increasingglobal demand for Indonesian ventilation and air con-ditioning products from countries near and far, includ-ing Nigeria, Panama and Vietnam,” Toto Djamaludin,president director of Air Tekindo Prima, told OBG. FURTHER DOMESTIC GROWTH: Despite major effortsto boost production capacity, Indonesia’s building mate-rials sector cannot meet the demand from domesticconstruction projects. The space could be filled by for-eign firms, but the government’s efforts to decreaseimports can be restrictive. Rupiah depreciation againstthe dollar has also raised the costs of many importedbuilding materials. Given that demand for materialswill only increase as infrastructure projects are imple-mented, investment in domestic expansion efforts willbe vital. Building material suppliers are thus set to ben-efit from continued investment and capacity growth.

222

There are plans to allocate

$6.7bn through 2017 to

expand cement production

from 60m tonnes to 90m

tonnes. This added capacity

is likely to make the

industry more competitive

by the time the ASEAN

single market is

implemented at the end of

2015.


Growth in leasing has led to increasing productivity in the sector

With a number of infrastructure projects being rolledout in the coming years, alongside overall real estateexpansion and economic growth, the constructionequipment sector has a vital role to play in Indonesia’sfuture development. Indeed, the value of the construc-tion equipment market doubled between 2008 and2013 – with Research and Markets analysts recentlypredicting a compound annual growth rate of 10% forthe 2013-18 period. The market is one in which for-eign firms, particularly those from Japan, have a majorpresence via local joint ventures and subsidiaries. Theseare benefitting from increased government investmentin transport and energy infrastructure in particular,coupled with rising demand for all kinds of real estate. MARKET STRUCTURE: While the supply of construc-tion equipment in Indonesia is concentrated in a hand-ful of globally linked suppliers, on the demand side, thecontractors’ market is a highly fragmented one. The mostrecently available figures, for 2011, show 182,200 con-tractors known to the National Construction ServicesDevelopment Board (NCSDB) – up from 112,000 in2008. These have been increasing in size, with the num-ber classified as ‘large’ rising from 695 to 1742 overthe same period. There are also an increasing numberof foreign contractors in the market, up from 79 to 130,according to the NCSDB figures. Four major contrac-tors are Adhi Karya (Persero), Wijaya Karya, Pemban-gunan Perumahan (PP) – all majority state-owned – andTotal Bangun Persada, a private outfit. The first two ofthese are the largest, with a roughly 7% share each. Allfour have operations across Indonesia, although mostconstruction activity focuses on Java. Four companiesaccount for 96% of production volume when it comesto the heavy equipment industry.

According to a 2014 report from the ConstructionIntelligence Centre (CIC), Komatsu Indonesia, a joint ven-ture between Japan’s Komatsu and United Tractors, isthe largest, with a 43% market share in 2012. Caterpil-lar Indonesia, a joint venture between Caterpillar ofthe US and Tiara Marga Trakindo, and Hitachi Construc-

tion Machinery Indonesia – a subsidiary of Japan’sHitachi – vie for second and third places. The formerhad a 19% market share in 2012, according to thereport; the latter, 21%. The fourth company is DayaKobelco Construction Machinery Indonesia, a subsidiaryof Japan’s Kobelco Construction Machinery, with 13%of the market in 2012. According to the CIC figures,the building construction equipment market was worthsome $142.61m in 2008, rising to $272.49m in 2013.The report predicted a value of $424.11m by 2017. Thelargest part of this has long been made up of crane andlifting equipment, with mobile cranes the most popu-lar variety, accounting for $185.14m of the 2013 total.

Earthmoving and tunnelling equipment, meanwhile,had a market value of $1.71bn in 2008, increasing to$2.55bn in 2013, with a predicted $3.71bn by 2017.Earthmoving equipment accounted for most of this, withexcavators at $848.51m in 2013, bulldozers at $625.6m.Road construction equipment added a further $159.8min 2013, mostly road and paving equipment, and build-ing material machinery $245.88m, with concrete andcement equipment the largest part of this. CHALLENGES: Bringing the supply and demand sidetogether, when it comes to the many smaller outfits,has long been a conundrum, given the high cost ofmachinery and the low financial capacity and tightmargins of many contractors. This has been increas-ingly resolved, however, via growth in leasing. This hasled in turn to rising efficiency and productivity in thesector, with vendors offering rentals on an increasing-ly wide range of equipment.

Costs, however, do remain an issue for many. Equip-ment prices are influenced by exchange rate risk too,given the number of imported parts and the costs ofother inputs, such as energy. These in turn get passedon to vendors and then to contractors in rentals, fur-ther squeezing tight margins in such a competitivebusiness. One expectation is that the sector could seesome consolidation, at the demand end, in the yearsahead, particularly if economic growth continues to slow.

223


According to the

Construction Intelligence

Centre, Indonesia’s building

construction equipment

market was worth

$272.49m in 2013,

compared with $142.61m

in 2008.

A vital roleThe equipment market is expanding along with the economy


The sector is looking to increase its competitiveness

With the implementation date of the ASEAN Econom-ic Community (AEC) set for December 31, 2015, Indone-sia’s construction sector must take the right steps toensure that it stays in the running.

The AEC aims to create a single market and produc-tion base with free movement of goods, services andskilled labour. Such a development will enable greateraccess for foreign competitors looking to enter theIndonesian market to satisfy rising demand for con-struction services and building materials. INCREASED SPENDING: Indonesia aims to be a top-10 global economy by 2025, but this ambition dependslargely on realisation of its infrastructure projects. Inline with this, a 10% rise in infrastructure and commer-cial development spending is planned for 2014 whichwill take the overall figure to Rp407trn ($41bn).

While such spending will inevitably boost the domes-tic construction sector, many argue that the govern-ment must provide greater support to companies byimproving access to finance and implementing more-favourable taxation conditions. ASEAN integration viathe AEC should boost foreign direct investment (FDI)in Indonesia, which has declined since 2012, but thedomestic construction sector must increase its com-petitiveness if it is to capitalise. Should it not, domes-tic companies will lose out to foreign competitors, ashas occurred in the past. Such a failure could alsodamage Indonesia’s FDI attractiveness as investorstarget countries that are more prepared.

The AEC is set to provide huge opportunities forconstruction companies all over the region, and Indone-sian contractors must go on the offensive to seekthese out. However, in an ASEAN marketplace with acombined GDP of over $2.1trn, higher domestic lend-ing costs and internal taxes could mean Indonesianfirms will struggle to be competitive.

The chairman of the Indonesian Contractors Asso-ciation, Sidarto, said recently that “Issues of interestrates and taxes could hamper local construction firmsin expanding their businesses to neighbouring coun-

tries.” Indonesian firms currently pay 13.5% interest,compared to competitors in Malaysia, Singapore andThailand, which only pay 3-4%. If the sector is to com-pete within the AEC, the government will likely beforced to reconsider these rates.DOMESTIC DRIVERS: As part of Indonesia’s commit-ment to the 2010 ASEAN Connectivity Master Plan,which will catalyse economic development beyondborders, large-scale infrastructure projects havebecome a strong driver of the domestic constructionsector. Many such projects are part of the Master Planfor the Acceleration and Expansion of Indonesia’s Eco-nomic Development (MP3EI), which aims to fostereconomic development through six economic corri-dors that were chosen because of their ability to giveIndonesia a competitive advantage.

One company to benefit was non-listed state con-struction firm Hutama Karya, which participated in theconstruction of Bali’s first toll road alongside anoth-er state-owned company, Adhi Karya. The 12.7-km roadconnected Nusa Dua and Ngurah Rai International Air-port via Benoa Bay, and was inaugurated by PresidentSusilo Bambang Yudhoyono in September 2013.INVESTMENT: In terms of securing infrastructureinvestment, the MP3EI envisaged that the private sec-tor should contribute 49% ($450bn), with 21% to becovered by public-private partnerships (PPPs). How-ever, the viability of the model is yet to be proven, asno PPP has ever reached financial completion in Indone-sia. At the start of 2014, Indonesia’s National Devel-opment Planning Board released a list of 27 projectsworth $47.3bn to be made available to investors, butmany are struggling to get off the ground. These fail-ures have had a knock-on effect as less opportunitieshave materialised for private construction players.

Of the large-scale infrastructure projects alreadyunder way, the majority are dominated by contractorsfrom Japan and China, which occupy over 60% of themarket. Indonesian companies have lost out due toeither a lack of expertise or technological capacity.

A 10% rise in infrastructure

and commercial

development spending will

boost the sector, but

improved access to finance

and more favourable

taxation conditions may

also be needed.

The MP3EI envisaged that

the private sector should

contribute 49% ($450bn)

of infrastructure

investment, with 21% to be

covered by public-private

partnerships.

224

Ready or notASEAN integration will challenge the domestic construction sector



While the government continues to work to improveregulatory certainty around Presidential RegulationNo. 67 of 2005, which established only a basic legalframework for PPPs, progress is slow. It is hoped thateventual improvements will act as a catalyst for PPPs,allowing private firms more opportunities to partici-pate. However, even then, their readiness to do soagainst tough foreign competition remains unclear.MATERIAL WORTH: In terms of providing materialsfor the projects that are boosting Indonesia’s region-al competitiveness, some domestic manufacturers areleading the charge. For example, Semen Indonesia,the country’s largest cement maker, aims to boost itsoutput to 31m tonnes in 2014, up from 27.9m in 2013.The firm is striving to compete with incoming opera-tors by establishing packing plants closer to construc-tion areas and improving logistics processes via its 11seaports. Semen Indonesia has also teamed up with astate-owned steel maker, Krakatau Steel, to produceslag powder for specialised cement products. NamedKrakatau Semen Indonesia, the joint venture is look-ing to invest Rp440bn ($44m) into building a blastfurnace that will turn slag into a cement ingredient.

Another domestic company looking to compete inthe ASEAN arena is Wijaya Karya (WIKA). However,having already become a subcontractor for infrastruc-ture in Africa, the Middle East and East Timor, WIKAhas raised concerns that domestic firms seeking to com-plete contracts abroad will have to pay tax in bothIndonesia and the contract country. According to theMinistry of Finance, Indonesia has signed bilateral taxagreements exempting Indonesian firms from payingadditional taxes outside Indonesia with most ASEANcountries, but this list excludes Cambodia, Laos andMyanmar. In addition to the risk of double taxation,domestic construction companies are also subject toa further fixed tax of 3% of the total project value.

Foreign construction firms are also looking toincrease their presence in Indonesia and ASEAN, Thai-land’s Siam Cement being one example. The industri-al conglomerate aims to boost cement production

across the region following infrastructure project delaysstemming from social unrest at home. Currently con-structing new cement factories in Indonesia, Cambo-dia and Myanmar, Siam aims to begin production at allfactories within two years, which will boost current over-all production of 24m tonnes per year by 20%. QUALIFICATIONS: Concerns over the sector’s abilityto compete in the AEC have centred on the availabil-ity of qualified human resources, with criticism levelledat the government for failing to provide assistance inthe form of adequate training. Data from the Ministryof Public Works indicated that only 10% of Indonesia’s6.34m construction workers were listed as “experts”,while 60% were listed as “unskilled labourers”.

Indonesia has only 159 engineers who are recog-nised by the ASEAN mutual recognition arrangementon engineering services. Furthermore, Bobby Umar, thechairman of the Indonesia Engineers Association, toldOBG, “The competencies we do have are mostly con-centrated in Java, and must be integrated into outly-ing regions.” Such shortages of qualified experts, andtheir uneven distribution, mean Indonesia is unable tooffer clients as many services as competitor countrieslike Singapore and Malaysia. According to Singapore’sBuilding and Authority (BCA), Singaporean companieshave provided construction services to more than 270projects around the world. Malaysian companies havealso had notable success through construction proj-ects in many countries, including Indonesia, Bosniaand Herzegovina, and South Africa.

Yet while Indonesia will have to work to hard to boostthe sector’s overall HR capacity, there will be an increas-ing number of regional opportunities for companies– made easier through cooperation with local part-ners, a tactic utilised extensively by Japanese firms. Thegovernment aims to boost the construction sector’scontribution, at 10.5% in 2013, to levels similar to trade(13%) and agriculture (14%) over the next few years,and it must realise that HR is a key component. As theAEC looms, it appears that there is room for improve-ment in all areas of Indonesia’s construction sector.

225

Concerns over the sector’s

ability to compete within

the ASEAN Economic

Community have centred

on the availability of

qualified human resources.

227

Real EstateAn expanding population boosts demand for housingNew loan-to-value rules introduced in autumn 2013Property laws remain a challenge for foreign investorsTake-up of REITs hampered by regulatory issuesNew investment driving demand for industrial landSecondary cities & tourist destinations fuelling growth

REAL ESTATE OVERVIEW

Some 42,000 new homes are set to come on-line in the next three years

Rising capital values, favourable interest rates andstrong demand have created a favourable environmentfor Indonesia’s real estate sector, which posted impres-sive expansion numbers in 2013. While the US andEU have struggled with the lingering effects of theglobal financial crisis, South-east Asia has poweredon, with Indonesia topping the list of the world’sfastest growing luxury real estate markets in terms ofprice. Though GDP growth fell slightly below 6% forthe first time in four years, it remains steady and mid-dle-class wealth is expanding rapidly. According toAnton Sitorus, the head of research for Jones LangLaSalle (JLL) in Indonesia, “Property investment con-tinues to increase at a high level and there is strongpurchasing capacity. We expect the sector to contin-ue to experience strong growth and it will start to accel-erate at full speed by 2015.”RULES & REGULATIONS: To address the potentialfor a property bubble, Indonesia’s central bank intro-duced a new loan-to-value (LTV) ratio in autumn 2013.While some developers and the Indonesian Real EstateAssociation (REI) fear that the new regulation will sti-fle demand in the sector, other experts suggest thatthis will allow the market to experience a much-need-ed cooling period. The new LTV ratio will require a first-time home buyer to make a 30% down payment at thetime of purchase, while those purchasing a secondhome will need to make a 40% down payment and athird 50%, reducing banks’ exposure (see analysis).

While sector experts expect the new LTV ratio tolower risk by limiting dependence on borrowed mon-ey, many are concerned about a second regulationintroduced in 2013 that will make it difficult for devel-opers to finance projects. “After issuing a regulationon LTV for a second and third house, the governmentalso issued a new law prohibiting banks from provid-ing loans for unfinished residential projects in aneffort to curb speculative buying. Now, bank loans canonly be disbursed once the house is completed. Thisis difficult for the market overall, because, until now,

developers had been able to sell residential projectsoff-plan and sales and purchase agreements wereusually done prior to the completion or through anindent procedure,” Sitorus told OBG. CHALLENGES: Since many buyers rely on bank loans,the new law makes it difficult for developers to sellunfinished projects. Thus, developers must have sig-nificant capital upfront, which is a challenge, partic-ularly for small to medium-sized developers. “This hasalso affected sales, which are likely to decline over-all, as we have seen in the past few quarters,” Sitorustold OBG. The Fitch Ratings’ 2014 outlook noted thatnew regulations could stifle the growth of mortgagesand property sales and purchases. This will likelyencourage developers to delay project launches untilthey can adjust to the new regulatory environmentand subsequent impact on the market. Projects andsales will likely gain momentum in late 2014 once thewait-and-see period around the new regulation andimpending national elections passes.RESIDENTIAL REAL ESTATE: Home prices in Indone-sia, particularly in Jakarta and Bali, continue to rise alongwith demand, though the central bank has madeefforts to cool the market. In the coming years, manyIndonesians will look to purchase their first homes,considering that more than half of the country’s250m-strong population is under the age of 30. Themiddle class is growing rapidly, meaning the numberof citizens able to buy homes is increasing as well.

With Jakarta seeing 1300 new motorcycles and 300new cars on its roads per day, little relief from trafficis in sight. The city’s only option is to build up, untilthe government can tackle the transport and infra-structure overhaul that the area desperately needs.In the meantime, a growing number of Jakarta’s work-ers will look to buy property in and around the citycentre in order to avoid the bumper-to-bumper com-mute. This is causing landlords to raise rents, as supply cannot keep up with demand and land valueshave risen to around $10,000 per sq metre in the area.

A new LTV ratio introduced

in 2013 aims to protect

against a property bubble

and requires first-time

home buyers to make a

down payment of 30% of

the purchase price, with

this rising to 40% and 50%,

respectively, for those

purchasing a second or

third home.

229


Rapid population

expansion, growth of the

middle class and increasing

road congestion in Jakarta

mean that demand for

properties in the city

centre is expected to

continue rising.

A favourable environmentStrong fundamentals are driving market expansion


GREAT GAINS: Jakarta and Bali, two of the world’smost expensive luxury real estate locations, came innumber one and number two, respectively, on theFrank Knight list of price growth at the close of 2012.Jakarta topped the list at 38% year-on-year (y-o-y)growth, while Bali came in neck-and-neck with Dubaiat 20% y-o-y growth. Indonesia, Taiwan, Brazil andTurkey were the top emerging markets to boost theglobal house price index of 2013, with Indonesia expe-riencing a 13.5% rise.

JLL noted that in the fourth quarter of 2013 stra-ta condominium sales totalled approximately 2250units, with only a slight decrease between the thirdand fourth quarters of the year. In 2013 sales reached13,260, a 4% increase overall from the previous year,and 10,800 new properties were launched by theclose of the year’s fourth quarter. JLL projects thatsome 42,000 additional residential units will enterthe market over the next three years. “It has been agreat year for the industry and prices are going up.The industry is actually growing so robustly that forthe first time construction workers are in such short

supply that projects are being delayed,” Harun Haja-di, managing director of Ciputra, told OBG.DOWNWARD PRESSURE: Looking at 2014, FitchRatings predicts that the government’s new mortgageregulations and higher average selling prices will causea decrease in the number of new projects, especial-ly in the luxury housing sector. New developments arelikely to be put on hold until after the 2014 elections.Although the previous two elections did not have amajor effect on the real estate market, with PresidentSusilo Bambang Yudhoyono reaching his two-termlimit, many sector players are expected to wait untilthe new administration’s regulatory plans are revealedbefore moving forward.NEW MEANS: Meanwhile, the Jakarta city adminis-tration has taken strides to address the lack of hous-ing for the area’s poorest residents. Governor Joko“Jokowi” Widodo announced a plan to build 38 newvertical apartment “villages” (kampung) in 2013, whichare owned through strata title and will include pub-lic and commercial space along with inexpensive flats.The villages will be funded by private investmentthrough corporate social responsibility programmes.While building new elevated villages, the Housing andAdministrative Buildings Agency also plans to over-see an effort to revitalise an average of 100 kam-pungs per annum, with Jokowi promising to see thecompletion of 360 by the time he leaves office.

Critics worry that the project’s aim of aiding impov-erished areas will be counteracted by the fact thatsome homeowners may rent out their properties toother tenants for a profit. Furthermore, the city willstill need to address the lack of employment oppor-tunities, which contributes to the state of poverty inthese communities. Overall, however, this is a step inthe right direction that should help to address the issueof housing for Jakarta’s poorest residents, who willgreatly benefit from an expanded public housingscheme, while also giving the congested capital anopportunity to reduce its urban sprawl.RETAIL: The retail sector experienced significantgrowth over 2013, due to high consumption and theincreased spending power of Indonesia’s middle class.David Cheadle, managing director of real estate firmCushman & Wakefield Indonesia, told OBG, “We con-tinue to see new international retailers coming intothe market; as well as ongoing expansion by existingoperators, so this sector clearly remains a focus forinternational businesses. There is a growing middleclass consumer market here and other locations inthe greater region, like India and China, are moreexpensive. In Asia, Indonesia remains an affordablemarket with a growing middle class consumer base.”

Although Jakarta gives the impression that it has asurplus of malls (it currently has just over 130), com-pared to other cities in the region, it actually has alow per capita ratio of mall space. The retail sectorsaw y-o-y growth of about 10% over 2012 and demandin the market is strong. However, due to a moratori-um on shopping malls construction in Jakarta, whichwas enacted in 2011, the only new projects that can

230

SOU

RCE:

Wor

ld B

ank

Bank lending rate, 1992-2012 (%)

0

7

14

21

28

35

20122010200820062004200220001998199619941992

Luxury property prices in Jakarta rose 38% y-o-y by year-end 2012

In 2012 the Indonesian

cities of Jakarta and Bali

were ranked first and

second, respectively, in

terms of luxury real estate

growth by price, according

to one global ranking.



about 80%,” Cheadle said. “That is the average. In real-ity though, many office occupiers are facing incrementsin excess of 100% over their previous contract rentalrate. This has been driven by the big surge in demandand limited new supply, with occupancy rates in mostbuildings at 95%, though many are running at 100%.Many companies are struggling to secure expansionspace. So the office market remains strong here.”

Only two major projects are expected to be com-pleted by 2016: International Finance Centre 2 andWisma Mulia 2. Office rental rates increased by 37.3%y-o-y by third-quarter 2013, according to JLL, as sup-ply of premium office space became more limited.

In the fourth quarter of 2013 net take-up fell to24,000 sq metres for central business district (CBD)office space and 22,500 sq metres for non-CBD space,bringing the 2013 total to 298,000 sq metres and150,000 sq metres, respectively. The occupancy ratewas 94% for CBD office space and 93% for non-CBDspace as of fourth-quarter 2013, driven by steadydemand. Gross rent came in at Rp262,450 ($26.25)per sq metre per month for CBD space and Rp157,000($15.70) for non-CBD space as of the same period.

The current supply of office rental space totalssome 4.7m sq metres in the CBD and 1.8m sq metresoutside of it, and future supply from projects to becompleted through 2017 will add a total of 2.3m sqmetres and 1.2m sq metres, respectively. HOTELS: The expansion of Indonesia’s middle class,the increase in foreign arrivals and the success of thelow-cost carrier industry have resulted in a rise intravel and demand for affordable accommodationthroughout the archipelago. Ciputra Group’s real estatedivision, Ciputra Property, aims to develop 20 budg-et hotels by the end of 2015. Each hotel is expectedto cost between Rp40bn ($4m) and Rp50bn ($5m),and construction on some has already commencedin West Java, Central Java and Banten, while the firmlooks to build in various other cities. Each propertywill have up to 140 rooms, costing between Rp300,000

233


SOURCE: Jones Lang Lasalle

Grade A Grade B Grade C

Occupancy 93.9% 94.5% 85.6%

Base effective rent 29 12 8 ($ per sq m/month)

Jakarta CBD office rentals, 4Q 2013

Gross rent was $26.25 per sq metre per month for office space in the CBD as of fourth-quarter 2013

While demand remains

strong, the supply of retail

space is increasing,

reaching 2.6m sq metres as

of the fourth quarter of

2013, and an additional

500,000 sq metres is

expected to become

available by 2016.

The occupancy rate was

94% for office space in the

central business district

and 93% for space outside

of it as of the fourth

quarter of 2013.

be completed are those that received approval beforethe ban was put in place and which can be opened inthe next two to three years. As such, competition forretail space is expected to intensify and rental rateswill increase in the coming years. Currently, however,rates remain stable at between Rp492,000 ($49.20)and Rp650,000 ($65) per sq metre per month.LAY OF THE LAND: According to JLL, as of the thirdquarter of 2013 Jakarta had a total of 2.4m sq metresof retail space and the retail vacancy rate reached 6.4%,thanks to expansion by international retailers. LotteDepartment Store, H&M and Uniqlo opened branch-es in Jakarta in 2013, a first for all three firms. LotteShopping Avenue and Pondok Indah Street Galleryopened their doors in the second quarter of 2013;combined, the two properties added 93,000 sq metresof retail space to the capital, bringing Jakarta’s totalprime retail space to 1.37m sq metres. In 2013 fash-ion and food and beverage remained the biggest driv-ers of demand, which was also supported by cinemas,supermarket chains, fitness clubs, department storesand other large-scale outlets.

Despite additions to Jakarta’s retail space in 2013,demand is still high and vacancy rates continue to fall.Some 75% of space in the Lotte Shopping Avenue andPondok Indah Street Gallery, along with the St MoritzMall, which opened in west Jakarta in 2013, was pre-rented, and rates will likely rise once the propertiesreach maximum occupancy. Rents in the retail sectorgrew 2.5% quarter-on-quarter (q-o-q) in the secondquarter of 2013 and remained stagnant through thefourth quarter of the year.

According to JLL, total net absorption in the shop-ping mall sector reached 179,000 sq metres in 2013and occupancy was 93% at the year’s end. Whiledemand remains strong, the supply of retail space isincreasing, reaching 2.6m sq metres as of the fourthquarter of 2013, and an additional 500,000 sq metresis expected to become available by 2016.OFFICE SEGMENT: Indonesia’s office market remainsconcentrated in Jakarta and Java. A third-quarter 2013report by JLL found that tenant demand, rental growthand investor interest are still on the rise in Jakarta’soffice segment. A major new project, DBS Tower atCiputra World Jakarta, opened in the second quarterof 2013, and, as tenants began to fill the office space,Jakarta’s vacancy rate increased slightly, to 4.7%. Theopening of DBS Tower brought an additional 1.3m sqmetres of grade-A space to the city’s office segment.

“If you had signed an office lease contract in Jakar-ta three years ago and were looking to renew it in 2013,operational costs, in percentage terms, will be increas-ing at the highest rate of anywhere in the world – by


($30) and Rp400,000 ($40) per night. The luxury hotelsector also continues to expand, with Hilton, Swiss-Belhotel and Best Western aiming to take advantageof Indonesia’s tourism market in Balikpapan, Tangerangand Jakarta. Hilton’s first Indonesia properties will beits five-star Waldorf Astoria, as well as its DoubleTreeand Hilton Garden Inn brands, which will primarilycater to business travellers in the capital.

Best Western is also looking to expand its localfootprint with an additional seven properties in Jakar-ta over the next few years, following the opening ofits property in Tangerang, West Java in the fourthquarter of 2013. Swiss-Belhotel’s newest property inBalikpapan will bring the number of the group’s hotelsin Indonesia to 34. Between 2014 and 2017 34 newhotels are slated to be built; 16 of these will have five-star ratings. With the election cycle in full swing, hotelscan look forward to a bumper year as journalists, can-didates, campaigners, non-governmental organisa-tions and foreign election observers drive up occu-pancy rates nationwide. FOREIGN OWNERSHIP: While foreigners can ownreal estate in Indonesia, property laws, which are influ-enced by colonial policy and traditional law, are achallenge to navigate. “Legal certainty and the regu-latory efficiency remain primary bottlenecks. Even if acompany takes all precautions and completes all duediligence, there is still significant risk of delay and evennon-completion,” Marcellus Chandra, the presidentdirector of Prioritas Land, told OBG.

The 1945 constitution, created during the post-colonial transition, said that land was owed entirelyby the state and was to be used solely by the peopleof Indonesia. While legal scholars interpret Article33/3 as a strict prohibition of foreign ownership,there are a number of ways for foreigners to pur-chase property legally. Building title rights, referredto as hak guna bangunan, can be obtained by corpo-rations, including foreign ones. The building title rightscan be owned for 30 years, with an option to extend

to an additional 20, and allow developers to buildproperty on land that is owned by someone else. It isalso possible for hak guna bangunan to be sold ortransferred to another holder. Hak pakai is a right toland use, granted for a 25-year period, and foreignnationals as well as foreign-owned firm are eligibleto receive it. The current laws are suitable for manu-facturers and other buyers, but not for those inter-ested in condominium ownership. A regulation waspassed in 1990 to allow foreign residents to purchaseapartments and offices, but only if the title is hakpakai. More often than not, these types of propertyare built using hak guna bangunan, because hak pakaiis often perceived as less valuable. New regulationshave been discussed, but the government has yet tomake new legislation. Reform would make it easier forforeigners to own property in Indonesia, and could alsogenerate further competition in the sector. “InMalaysia, a resident’s permit comes with a condo-minium purchase. In Indonesia, titles are leaseholdfor foreigners. To stimulate positive foreign investmentin real estate at the private individual buyer level, thegovernment should get to the point where it grantsownership title to foreigners for condominium pur-chase which is the same given to Indonesians, butunfortunately some foreign buyers have gone downthat route because of poor advice,” Cheadle said.OUTLOOK: While interest rates rose slightly in 2013,the benchmark currently rests at 7.5%. Keeping theloan rates below 10% has driven demand in the sec-tor, which would be badly affected if the benchmarkwere set higher. The US Federal Reserve’s tapering ofits quantitative easing programme could mean lessinvestment in emerging markets, but private invest-ment from local and foreign firms remains high.

Indonesia’s young population and growing con-sumer class will provide growing demand for proper-ty in the years ahead, and, as the country continuesto strengthen its appeal as a location for doing business, the real estate market should remain anappealing option for investors over the longer term.

234

In 2014-17 a total of 34 new hotels are set to be built, of which 16 will be five-star properties

Favourable rates have helped to drive demand for loans

While foreigners can own

real estate in Indonesia,

property laws are a

challenge to navigate.

Building title rights and

land use rights can both be

obtained by corporations,

including foreign ones.


REAL ESTATE ANALYSIS

In early 2014 there was only one REIT trading on the local bourse

Since real estate investment trusts (REITs) were giventhe legislative green light in 2007, Indonesia’s real estatemarket has boomed. With annual price increases thathave regularly been among the world’s highest, cou-pled with heightened investor interest and a trackrecord of strong economic growth, there has also beena widespread expectation that real estate could becomea major asset class on the local stock exchange. Yet whilethe Indonesian Stock Exchange (IDX) features manyproperty developers and construction firms in its mainboard’s property, real estate and building constructionindex, REITs are still under-represented. SLOW START: In 2011, several years after the law allow-ing REITs was passed, the first application to set oneup was received. The Kuala Lumpur-based Al AqarHealthcare REIT, a sharia-compliant trust that ownedtwo hospitals in Indonesia, became the first outfit tosubmit a proposal for such a trust. The decision to moveinto Indonesia was made because analysts and investorssaw the country as having major potential for REITs, withan untapped market ready for development. In addi-tion, a growing problem for the REITs in Kuala Lumpurand Singapore was the limited number of sizeableassets on offer there – a hitch that could be easilyovercome, it was felt, by the addition of the largeIndonesian market.

Indeed, a survey amongst Asia Pacific real estate pro-fessionals by the Trust Company and Baker & McKen-zie conducted in 2011 showed Indonesia leaping aheadof Malaysia, Philippines, Taiwan, South Korea and Thai-land as the market with the best prospects for realestate growth. In terms of potential opportunities forREITs, in 2011 the country also rose by more points inthe survey than any other market in Asia Pacific, exceptfor Malaysia. This confidence in the potential of theIndonesian real estate market had also been gather-ing steam thanks to the performance of two REITs thatheld major Indonesian property portfolios and owner-ship, yet which had chosen to list in Singapore – a mar-ket with a larger and more established board for REITs.

SCALING UP: Lippo Malls Indonesia Retail Trust (LMIRTrust, listed as SGX: D5IU) and First REIT (listed as SGX:AW9U) have both seen success in the Lion City. LMIRTrust was ranked amongst the largest REITs there in Jan-uary 2014, with a market capitalisation of $789.56m,and at 8.5% had the second-highest dividend yield afterSabana REIT, a Singapore-based, sharia-compliant trust.LMIR Trust has most of its property portfolio in Indone-sia, in the fast developing retail mall sector. Linked toIndonesia’s Lippo Group, a major conglomerate, via itssponsor, Lippo Karawaci, the REIT had eight malls andseven retail spaces within malls in its portfolio in Feb-ruary 2014. According to its year-end 2013 results,occupancy in the trust’s retail space was around 95%,with gross rental income up 16.5%, year-on-year. TheREIT’s retail locations are well chosen, in Jakarta andBandung on Java and Medan on Sumatra.

Yet the group did take a knock from the depreciat-ing rupiah in 2013, as it held debts in Singaporean dol-lars, which appreciated by 15.4% against the rupiah inthe fourth quarter of 2013. Nonetheless, the currentmoratorium on construction of shopping malls in Jakar-ta, which is likely to squeeze supply and limit competi-tion, along with underlying trends, such as the growthof the Indonesian middle class, per capita incomes andurbanisation, will likely see LMIR Trust continue to bea reliable pick in 2014 and beyond.

First REIT, meanwhile, is also sponsored by LippoKarawaci, but operates in the health care and hospital-ity sectors, with a portfolio of 14 properties, 10 ofwhich are in Indonesia. In March 2014 First REIT alsoannounced plans to purchase Purimas Elok Asri’s SiloamHospitals Purwakarta (SHPW), for $24.62m. This wouldboost the trust’s portfolio to 15 properties, with manyof its Indonesian assets already Siloam hospitals, locat-ed in places like Bali and Makassar, as well as on Java. EXPANDING: Purwakarta, a city in West Java, is a grow-ing regency capital. As Jakarta becomes overcrowded,secondary cities are becoming a greater draw for busi-nesses across the island, with demand for quality health

While REITs were approved

in 2007, it was not until

2011 that the first

application to set one up

was received. Given its size,

the Indonesian market is

thought to have

considerable potential for

REITs.

Despite currency

fluctuations and a

moratorium on building

new shopping malls in

Jakarta, the growth of per

capita incomes and the

middle class should help

to support the expansion

of REITs.

236

A new asset classUnderdeveloped so far, REITs have plenty of potential



care outside of the capital one side effect. At the sametime, the health sector is also benefitting from higherper capita incomes, economic and population growth,and urbanisation unconnected to Jakarta, with second-ary cities developing all over Indonesia. The acquisitionshould boost First REIT’s asset base to some $865.82m,from its current $834.05m. The company’s distributionyield in March 2014 was 7.03%.SMALL HOLD: Yet despite success across the water,back home REITs continue to be under-represented fora real estate market that has recently shown suchdynamism. In February 2014 only one REIT was record-ed as trading on the IDX, DIRE Ciptadana Properti RitelIndonesia. DIRE Ciptadana is also the first REIT to beoffered in the country and focuses on retail real estate.The question remains, why, to date, REITs have notsecured a stronger foothold in the Indonesian market.Part of the answer lies in the response to questions fromThe Jakarta Globe given by Al Aqar Healthcare REIT’sexecutive director, Yusaini Sidek, in May 2012. He report-edly said that his trust would consider opening inIndonesia provided there were clearer rules on foreignownership of land and tax incentives. LEGISLATION: Regulatory issues are thus key to unlock-ing the potential. The Trust Company and Baker &McKenzie report highlighted the same point, when itsrespondents ranked Indonesia last in Asia Pacific whenit came to assessing how supportive the regulator wasto new REITs. The law on foreign ownership of land and

real estate remains restrictive in comparison to otherregional peers (see overview). Title is often limited toleases granting the right to use, cultivate or build on aplot for a period of 20-25 years, or purchase can bemade via local proxies or by Indonesian registered com-panies. For many investors, this is not as satisfactoryas the clearer rights to title available elsewhere. Whenit comes to taxes, Singapore also operates a systemunder which taxes are only imposed on trust incomenot disbursed to unit holders. Additionally, as in Malaysia,no stamp duty charges are imposed on the transfer ofassets between approved trusts. Thus, while Indonesiapassed the necessary laws to establish REITs in 2007,some analysts feel that for such trusts to take off, sim-ilar tax and other incentive regimes also need to beapplied by Jakarta. Without these, REITs may prefer tocontinue listing in neighbouring countries.

The strength of the sharia-compliant markets – inMalaysia in particular, as well as Singapore – may alsodraw international REITs, given that sharia-complianttrusts and securities remain relatively undeveloped inIndonesia, while some of the world’s biggest REITs arefrom Islamic countries, such as Malaysia and the Gulf.

Asia Pacific has seen some spectacular growth inREITs over the last decade, becoming the world’s second largest market for REITs after North America.There is still much room for expansion, too, with Indone-sia likely to be one of the top picks for investors in theregion, once the regulatory issues have been ironed out.

237

Ambiguous regulations

that complicate foreign

land ownership, especially

compared to Indonesia’s

regional neighbours, need

to be addressed to boost

activity in the REIT market.


At present, there are 35 industrial parks totalling 18,000 ha in Jakarta

While Indonesia’s GDP continues its steady climb andthe middle class rapidly expands, many firms are look-ing at the country as a consumer market rather thanstrictly as an export hub. Domestic sales are rising,prompting suppliers to seek industrial land for expan-sion. Costs are increasing and capacity is maxing out,while food and beverage, building materials, chemi-cals, palm oil and metals producers are eager for moremanufacturing space. Colliers International reported a10.5% quarter-on-quarter rise in industrial land pricesin the first quarter of 2013, driven by high demand andlow supply. The automotive industry made up 73% ofsector activity, followed by food and beverages (7%),building materials (5%), chemicals (4%), steel (3%) andlogistics/warehousing (2%). While it has become moreexpensive to export, companies have more incentiveto produce for the domestic consumer market. Demandhas skyrocketed and private land supply cannot keepup, thus land values are expected to rise further.INDUSTRIAL PARKS: Since 2011 Japan has providedthe most investment in industrial real estate, as key play-ers like Suzuki and Toyota have expanded automotiveproduction. Wilson Effendy, the director of Bekasi FajarIndustrial Estate, told OBG, “Investment in Java has seenincreased appetite, especially in automotives, with multi-national manufacturers like Ford, GM and Mitsubishientering the fold. However, labour wages are rising andmanufacturers are setting up factories in cheaper partsof the island, like central and east Java, where the labouris up to almost 40% cheaper.”

Jakarta suburbs are also experiencing a transition;whereas industrial parks were once primarily based inthe regions, manufacturers are now looking into indus-trial real estate around the capital. Over the past 15years, manufacturers have moved into locations likeDepok, Bekasi and Bogor, increasing sector employ-ment by 159% in Jakarta. There are currently over 35industrial parks totalling 18,000 ha in the Jakarta region.DOMESTIC PROCESSING: In July 2013 the China-Indonesia economic and trade cooperation zone broke

ground on its first project, a nickel pig iron smelter inCentral Sulawesi. The new plant will have a capacity of300,000 tonnes per year and is to begin processing atthe end of 2014. Sulawesi Mining Investment is over-seeing construction of the plant, which is expected tobe the first of many across Indonesia since the govern-ment announced it will place a 20% export tax on rawore beginning in May 2014. Ibris Group of Singaporewill also invest $1.8bn in a new rotary kiln electric fur-nace smelter, also in Sulawesi. Though raw ore exportrestrictions have been criticised by the mining indus-try, the rush to build domestic smelting plants shoulddrive demand for industrial estate even further.

Palm oil processing firms are also expanding in Indone-sia and new plants should be fully operational by 2018,after palm oil firm TDM reaches its planting goals of40,000 ha. The company is constructing four new plantsin Nanga Pinoh, Kalimantan, which will have a process-ing capacity of 60 tonnes per hour. Currently in the plant-ing stage, the project will require around $312m infunding over the next four years. The company has hadsuccess in Indonesia in the past and will likely seekmore industrial land for high-demand palm oil produc-tion once these projects are completed.LOOKING AHEAD: While there are many opportuni-ties for expansion across the industrial real estate seg-ment, improving infrastructure, particularly roads andports, is the biggest concern for developers. Althoughindustrial estates can build and manage efficient inter-nal transport systems, the government must focus ontoll roads, bridges and shipping ports to relieve thelogistics headaches that often discourage rental andinvestment. Colliers International also noted that a lackof adequate land stock will pose a challenge to expan-sion goals in 2014, particularly for new tenants, as rent-ing priority is often granted to current tenants lookingto branch out. If interest rates remain stable and thedepreciating rupiah’s effect on building costs can bemitigated, the expansion of industrial land should con-tinue, supported by rising demand for production space.

Demand for industrial land

is being driven by a wide

range of projects, from

smelting and automotive

manufacturing to palm oil

processing. Ensuring an

adequate supply of land

will be a challenge, and

more will need to be done

to address existing

infrastructure issues.

238

Room to growDemand for industrial land looks set to continue expanding


REAL ESTATE INTERVIEW

Michael Widjaja, Group CEO, Sinar Mas Land

What do high growth rates in recent years, along

with the recent fluctuation of the rupiah, mean for

Indonesia’s real estate sector in 2014?

WIDJAJA: Domestic consumption has still not beengreatly affected and this is a positive sign for the sec-tor. Furthermore, new laws are being put in place thatslow down price increases in real estate in Indonesia,making real estate more affordable for all citizens. How-ever, the recent trend of depreciation the rupiah hasbeen on is something that does affect property devel-opers as our costs increase, especially those costs whichare incurred abroad. For some projects, quite a bit ofthe cost involved is pegged to the currency increase.However, as developers, we are committed to contin-uing to build large projects, and we simply have toabsorb these rising costs. So when a new project isundertaken we take all of these things, including cur-rency fluctuation, into consideration and implementbuffers. While I think there will certainly be challengesin 2014, preparations have already been made as every-one has been forecasting this to be a challenging year.

Would you characterise the rapid increase in Indone-

sian real estate values in 2012 and 2013 as a real

estate bubble, and what trends will we see in 2014?

WIDJAJA: I would call what happened in 2012 and 2013a phenomenon, and I think 2014 will mark a return tonormalisation for the real estate sector. If this trend ofrapid increase in real estate prices continued for anoth-er two or three years, then maybe the word bubble wouldapply. But I would hesitate to use this label because thegovernment took the necessary steps to help us avoidthis situation. Ever since a measure was introduced toregulate down payments by increasing the minimumdown payment to 30% of the value of a given house,we have seen business in the real estate sector stabiliserelative to the previous two years. This has eased prop-erty speculation and brought growth in the market toa normal rate. The rest of 2014 and beyond should seethis theme of normalisation in real estate continue.

How stressed is the domestic banking system when

it comes to financing these projects, and what role

will domestic capital markets play in 2014?

WIDJAJA: Our domestic market has been very strongin absorbing quality assets and it is not problematic toget the capital, but I think that domestic markets willnot be able to fill the gap entirely. I see this as a goodpoint for foreign investors to come in, as the rupiah isvery low at the moment. With the upcoming presiden-tial election and the nervousness that comes with itout of the way, I am sure our investment climate willexperience a boost. We are also seeing increasing inter-est from developers in South-east Asia in exploringgrowth in Indonesia, and this regional investment shouldcontinue to increase. In 2012 and 2013 we saw a lotof real foreign direct investment put into tangible assets,but these investments need time to be realised and thisrealisation will be achieved in the coming years.

How do you evaluate the dialogue between real

estate developers and government?

WIDJAJA: Dialogue with the government can often cre-ate positive results. For example, I think the moratori-um on building malls in central and south Jakarta is anecessary step. It is great for existing malls as it enhancesthe value of current properties by reducing competi-tion. In addition, it helps to regulate traffic in Jakarta,benefitting the city as a whole. Although as develop-ers we would like to develop more, this governmentmoratorium will really bring about some much need-ed control to the supply of retail space. However, thereis still room to develop better dialogue with the gov-ernment when it comes to areas like zoning. Oftentimes,when things like airport expansions are planned, thereis a high cost to land acquisition, as well as the priceassociated with relocation, leaving less money withwhich to actually build. I think in the coming years wewill see fresh ideas, and we are already seeing some ofthe results of new solutions when it comes to issueswith transportation and infrastructure being addressed.

240

Opening doorsOBG talks to Michael Widjaja, Group CEO, Sinar Mas Land



Local investors are active in land, hotel and resort development

One of the fastest growing real estate regions withinIndonesia in recent years has been east of Java – theresidential, resort and hotel market on the island of Bali.Today, however, there are signs of a push even furtherafield – to islands in the south- and north-eastern partsof the country that have previously been off the inter-national real estate radar. This expansion, driven bydemographic and economic factors, has great prom-ise, though it is also not without its risks, both in termsof overheating local economies and its potential envi-ronmental and social impact. HOLIDAY LAND: According to real estate consultan-cy Knight Frank, in 2013 prices grew 22% in the luxu-ry residential property market in Bali, the third-highestrate in the world after Jakarta and Auckland. The island’scapital, Denpasar, saw a 9.97% rise in residential pricesof all kinds in the first quarter of 2013, according toBank Indonesia figures. The areas of the island show-ing the highest growth have been those most popularwith tourists – Kuta, Legian, Seminyak and Oberoi – whilethe more historically neglected north coast, and theBukit Peninsula on the south side have also recentlyseen major developments. Most real estate investorinterest in the island has been in the development ofprivate villas, “condotels” (establishments that offerboth hotel and private condo units), hotels and resorts. LOCAL PRESENCE: Indonesian investors are quiteactive, particularly in land, hotel and resort develop-ment. Their presence is also strong given the ongoingdifficulties foreigners have with obtaining clean landtitles (see overview). The sector’s growth is not just beingdriven by foreign tourists either; Indonesians them-selves are represented heavily amongst luxury proper-ty purchasers, with Credit Suisse estimating that therewere 60,000 US-dollar millionaires in the country in2011. The current number is likely far higher, with a vil-la in Bali on many of the wealthy’s wish lists. At the sametime, in resorts, luxury villa complexes, high-end serv-iced apartments and condos in particular, brandingwith a global name is key to boosting yields, with Star-

wood’s W, Bvlgari, Banyan Tree and Alila some of themore recent arrivals. Upscale villas like these producehigh occupancy rates and high returns for investors,with purchase prices still lower than similar propertiesin Thailand or – in a sign of today’s higher aspirations– Hawaii. “Prices of high-end property have more thandoubled recently, inspiring investors to buy commer-cial, retail and residential property, thus creating aneven higher demand for supporting infrastructure, con-struction materials, equipment, including skilled humanresources such as engineers, architects and labour-ers,” Ronnie Tan, president director of Acset Indonusa,told OBG. This burst of development is not without itsconstraints, however. Infrastructure on the island, whilereceiving a boost ahead of the APEC conference in2013, has sometimes failed to keep pace with realestate, while popular tourist areas are experiencingsome congestion and a shortage of available land. Yetmore tourists keep coming, with Statistics Indonesia fig-ures for January 2014 showing arrivals at Ngurah RaiInternational Airport up 21.4% on January 2013 to278,685, making the airport Indonesia’s busiest. FURTHER AFIELD: The real estate boom has pusheddevelopments further out as well, with land prices upto $2000 per sq metre as far out from the main urbancentres as Canggu by March 2014. Land prices in areaslike Seminyak, meanwhile, tripled between 2011 and2013, with a March 2013 report from realtor EliteHavens suggesting a 100-sq-metre plot in the area wasworth around $275,000 at that time. Another recenttrend with land has been for owners to retain long-termcontrol by leasing rather than selling. This has not alwaysbeen welcomed by developers, who naturally prefer free-hold purchases. Nonetheless, with pressure on land sohigh, this remains very much a sellers’ market.

There are also concerns regarding the environmen-tal and social impact this development is having on theisland itself, as the very uniqueness of both representmajor draws for people to live on Bali, as well as to vis-it. There has been a surge in the expatriate population

241


The real estate boom on

Bali has resulted in higher

land prices and has pushed

development further out.

Most investor interest in

the island has been in the

development of private

villas, “condotels”, hotels

and resorts.

Go eastOpportunities are expanding on the island of Bali and beyond


too, with many native Balinese unable to afford the newproperty prices. In consequence, local authorities haveattempted to encourage development outside of themain areas, declaring periodic moratoriums on furtherbuilding in Denpasar and its environs. Not surprising-ly, however, these moves have further squeezed sup-ply, boosting prices.ALTERNATIVES: One answer to this growing pressureon Bali may be development taking place nearby. Theislands of Nusa Lembongan, Nusa Ceningan and NusaPenida all lie off the crowded shores of Denpasar, some12 km offshore and within reach via regular ferry serv-ice. These have seen development accelerate in recenttimes, particularly of high-end resorts and villa com-plexes. Further east, just across the Lombok Strait, liesLombok, for many years touted to prospective touristsas the “next Bali”. Off Lombok’s coast there are alsothe three Gili Islands, which have seen a surge in visi-tor numbers in recent years. They too are now seeingmore residential and resort real estate interest.

The opening of the new international airport hascertainly boosted tourism numbers to Lombok in gen-eral, with luxury investments made in the expectationof this now on stream. Indeed, figures from StatisticsIndonesia showed an astonishing 374% increase inarrival numbers at the airport in January 2014, year-on-year, albeit from a relatively low base: arrivals in Jan-uary 2013 totalled just 1077, rising to 5105 in January2014. Local press also reported resort-grade land priceson the main island of Lombok at around $150-250 persq metre in March 2014, considerably lower than onBali, with Senggigi and Tanjung two major centres forhigh-end developments.

It may be some time then before anywhere east ofBali reaches a comparative level of development interms of real estate. One reason for this is the qualityof infrastructure on such islands, with transport becom-ing less frequent and reliable once one crosses theWallace Line. Additionally, telecoms, electricity andwater supplies, the availability of skilled local labour and

a range of other capacity constraints begin to height-en in this area. Government efforts to improve all ofthese are under way, however, with the Master Plan forAcceleration and Expansion of Indonesia's EconomicDevelopment targeting infrastructure investment. HEAD NORTH: One place where the real estate mar-ket is already taking off is to the north-east of Bali, inSouth Sulawesi. The provincial capital, Makassar, sawthe highest annual increase in property prices in Indone-sia in the first quarter of 2013, according to BankIndonesia, at 15.6%. This had slowed by the last quar-ter but still remained at a strong 10.57%. The port city,home to 8% of Indonesia’s population, was historical-ly a major regional centre for trade and commerce, arole it later lost in Dutch colonial times. Today, the localshope that its strategic position will help restore the city’sformer glory, with several major national Indonesiandevelopers, like Lippo Group, Sinar Mas and Ciputra, andlocals such as Kalla Group and Asindoindah Griyatama,beginning major residential and retail investments sev-eral years ago. These have now reached completion,while new infrastructure projects, like roads and com-munications, have also helped drive growth.

Many high-end hotels have sprung up in the last fewyears, with Indonesians the main visitors and users ofnew meetings, incentives, conferences and exhibitionsspaces, like the Grand Clarion Hotel. Growth of Indone-sia’s middle class outside of Jakarta is often cited as themain driver, along with urbanisation and economicexpansion fuelled by Sulawesi’s commodities trade. LUXURY: The heightened acquisitiveness of this wealth-ier population is exemplified by Makassar’s TransStu-dio, the only luxury shopping mall and theme park ineastern Indonesia. The mall is an international draw aswell, attracting customers from as far away as PapuaNew Guinea in search of the closest Hugo Boss outlet.The boom shows no sign of abating in 2014. LippoKarawaci, the group’s property developer, reported toThe Jakarta Post in January 2014 that units in its Rp3.5trn($350m) Bloomington St Moritz development in Makas-sar, which includes a hotel, luxury mall, apartments, ahospital, school, entertainment area and private mem-bers’ club, were 75% sold before the project had beencompleted. The project is set to include the tallest tow-er block in eastern Indonesia. In North Sulawesi too, theprovincial capital, Manado, is also now seeing risingreal estate prices. According to Bank Indonesia, thefourth quarter of 2013 saw a quarter-on-quarter riseof just 0.48%, but on a year-on-year basis, the figurewas 23.23%, higher than that for Makassar. Manado’sgrowth is driven by similar factors as its southern neigh-bour, with economic expansion linked to commoditiesand commodity processing combining with populationgrowth from urbanisation. Indonesia’s real estate mar-ket today is becoming much more than just a Jakartaand Bali story. Secondary cities and new tourism des-tinations are rising stars, with the eastern part of thecountry offering major growth prospects. Coordinat-ing this with infrastructure development, while alsopreserving what makes such places attractive in the firstplace, will be key to taking expansion to the next stage.

242

Given the pace of development, concerns are being raised over its social and environmental impact

While areas to the east of

Bali are seeing increasing

real estate development,

infrastructure remains a

constraint. Government

efforts to address this are

under way, however.

The provincial capital of

South Sulawesi, Makassar,

saw the highest annual

increase in property prices

in Indonesia in the first

quarter of 2013, rising by

some 15.6%.



Santoso Gunara, President Director, Danayasa Arthatama

To what extent does the future growth of the real

estate sector depend on successful implementa-

tion of the 2011 Land Acquisition Law?

GUNARA: Land acquisition is the single most com-plicated aspect of property deals in Indonesia. Thereare a significant number of laws, many of which havebeen inherited from the past and have never beenmodified. Property developers have to go throughlegal procedures solely related to land ownership. Thegovernment can step in to address these issues. If not,the cost of investment in Indonesia increases and itbecomes difficult for any investor, particularly foreignones, to understand these laws. However, I am hope-ful of progress in this area. The major issue going for-ward will be the execution of the regulations and theside effects of that execution. Foreign investors wouldlike to have some certainty. Since the benefits of newproperty to both the city and the country are great,developers persevere through this lengthy acquisitionprocess. However, these burdens are unnecessarilyheavy and it is clear that land acquisition in Indone-sia needs to be reformed and streamlined.

Is Jakarta experiencing a real estate bubble, and

at what point will the current pace of rising prices

no longer be sustainable?

GUNARA: When you look at the price of propertiesin Jakarta, there are several variables to understand.Many people probably never look back at historicalprices or at regional comparisons, but this is neces-sary to understand the price increase of propertiesin Indonesia. Looking at property prices from the1990s until now, the rise in prices has not outpacedthat of our regional neighbours. For example, pricesare not rising higher than Malaysia or Singapore, asthese countries have experienced much higher pricelevels than we have in recent years. In Jakarta specif-ically, property prices have gone up very fast, butthere will be more of a price adjustment than a bub-ble. The term “bubble” would imply a sharp drop in

prices such that they become unsustainable, but I donot see this happening in Indonesia. When you lookat the growth of Jakarta’s population combined withthe limited supply of property, it becomes almostimpossible to consider this bubble-burst scenario.

How will the weakened rupiah influence proper-

ty developers and their activities in the country?

GUNARA: Indonesians, especially the older genera-tion, are not panicking, as we are used to currency fluc-tuations and have seen worse fluctuations in the past.On a global level, some countries actually purposelyweaken their currency. Here in Indonesia, there is asentiment that the rupiah must be strong all the time,but this is not necessarily true as currency exchangeis simply another financial instrument.

While most believe that a strong US dollar and aweak rupiah cannot benefit Indonesia, it actuallydepends on timing, what industry you are in and howyou control these instruments. That said, a weakenedrupiah has led to higher construction costs. Proper-ty developers will have to absorb some of the greaterconstruction costs by adjusting land value. However,the final selling price will remain about the same dueto the reactivity of land prices, which can absorbincreases in construction cost.

In what way will the Jakarta Monorail and Mass Rap-

id Transit system affect real estate prices?

GUNARA: Jakarta is similar to other sprawling citiesin that people do not want to drive across the city justto reach a particular destination. As such, developingreal estate near public transit hubs is lucrative and weare lucky that there will be major public transit hubslocated near SCBD. Foreign investors are looking atthis factor as well. Construction groups are eager todevelop buildings that provide useful accessibility tourban and national mass transportation, and there isa drive to develop areas that have strong linkages interms of property and mass transportation options.

243


Averting riskOBG talks to Santoso Gunara, President Director, Danayasa Arthatama


Eddy Sindoro, Chairman, Paramount Enterprise

What are the priorities for emerging townships and

where is government assistance needed?

SINDORO: Township developers have taken matters intotheir own hands with regard to the construction ofhard infrastructure, public facilities infrastructure andmanagement software infrastructure. However, formost, there is a primary focus on improving publictransport via the construction of mass rapid transit(MRT) and monorail systems, such as those which arefinally breaking ground in Jakarta.

This is going to become particularly relevant for newtownships that are being built from scratch where sucha transport system can be integrated into site designrather than becoming an afterthought as is currentlyhappening in the capital.

For instance, the city of Melbourne has incredibleinfrastructure, and so represents a model that Indone-sia ought to follow. However, in order to achieve this,we need the government to play a role in providing ade-quate infrastructure, not only for smallscale MRT sys-tems but also more generally. This will have a knock-oneffect in reducing the debilitating costs of logistics.Indeed, I would say that transport is in fact the mostimportant priority for the sector, and while it may belong overdue, it is not too late.

As prices in the real estate sector continue to rise

sharply what does this indicate? Is this increase

becoming unsustainable?

SINDORO: I am not overly concerned about priceincreases as the strong demand for property has a bal-ancing effect. Current prices in Jakarta are around one-tenth of the prices in Singapore and will continue torise in the coming years.

Jakarta’s GDP per capita is between $9000 and 12,000,but as low as $4000 in regional areas, whereas it is morethan $60,000 in Singapore. Therefore, our priority shouldbe about how quickly we are able to grow, having theright products at the appropriate time and ensuring thathomes are built to support greater social development.

How would you evaluate the foremost strengths and

weaknesses of the Indonesian economy?

SINDORO: An important factor to note about Indone-sia is that while there are prosperous cities like Jakar-ta and Surabaya, there are also far less affluent citiessuch as Kupang, the capital of East Nusa Tenggaraprovince, near East Timor. These cities are not only poorbut also lie in areas without natural resources. Kupangis a very interesting case in terms of identifying rapideconomic growth outside of major Indonesian cities,as consumer demand for high quality products andservices has seen a swift upward trend in recent years.Many other cities such as Samarinda, Banjarmasin,Manado and so many others are also seeing significanteconomic growth. Such strengths are also apparent inthe real estate sector where township developers areexperiencing strong demand for housing.

To what extent are opportunities for foreign enti-

ties shrinking with the growing number of well cap-

italised Indonesian developers?

SINDORO: While there are many well capitalised Indone-sian developers building quality structures, the pie isso big that there are still plenty of opportunities for for-eign entities. While domestic companies may have anadvantage in terms of acquiring clean land due to theirlocal expertise, foreign firms have maintained an edgein terms of funding and in utilising technology to cre-ate efficient structures. Indonesian companies haveplenty to learn from their foreign counterparts, partic-ularly when it comes to implementing green buildingpolicies. However, for such ambitious initiatives to besuccessful within the Indonesian market, they must beeconomically viable. Training and awareness-buildingprogrammes, in addition to government schemes, mustbe initiated properly, or progress will be slow. Suchmethods are particularly key when we are still far behindin terms of housing supply. Thus, we must make it aseasy as possible to adopt green policies, whilst at thesame time maintaining a suitable rate of construction.

244

Setting prioritiesOBG talks to Eddy Sindoro, Chairman, Paramount Enterprise


245

InfrastructureInfrastructure development crucial to economic growthEncouraging private sector involvement in utilitiesDemand for power increasing at around 9% per yearTarget set of 10m new water connections by 2015Vast potential for development of renewable energy

INFRASTRUCTURE OVERVIEW

Infrastructure investment as a share of GDP remains around 3%

A result of decades of underinvestment, creaky infra-structure has long been the Achilles’ heel of the Indone-sian economy. The archipelago has not been able tobuild the hard infrastructure essential for sustaininggrowth. The World Economic Forum’s “Global Compet-itiveness Report 2013-14” ranked Indonesia 61st outof 148 countries for the state of its infrastructure, andimprovements have not kept pace with the robust eco-nomic expansion that the country has witnessed sincerecovering from the Asian financial crisis of 1997-98.

Infrastructure investment as a share of GDP lingersat 3% – well below its pre-crisis level of around 7%. Itis now acting as a drag on its growth. According to Vander Schaar Investments, Indonesia could potentiallysee its GDP expand by 7-9% per annum if it could fix itsinfrastructure woes. Indonesia has fallen behind in partbecause the sources of financing for infrastructuredried up in the aftermath of the Asian financial crisis.Foreign investors shied away from large-scale projectsin an uncertain policy environment, and budget con-straints prompted the government to curtail publicfunding for new projects. Decentralisation of decision-making has also contributed to the slow development. COMING UP SHORT: “Indonesia’s lack of infrastruc-ture is the main thing preventing the economy fromreaching its full potential,” Scott Younger, director atNusantara Infrastructure, said. “The country is in needof a complete infrastructure overhaul in terms of focusand financing.” Lack of adequate infrastructure alsohurts Indonesia's competitiveness.

Over one-third (35%) of Indonesians lack access toreliable electricity, and even where the power grid doesextend, outages are frequent. Clean water and decentsanitation remain out of reach for around half of thepopulation. Access to safe drinking water ranged from87% of households in Java to 66% in Sumatra and around50% in Kalimantan in 2007. Overall, 73.43% of urbanhouseholds had access to improved sanitation in 2011,against 43.51% in rural areas, according to the WorldHealth Organisation. There is also a wide disparity when

it comes to electricity supply, ranging from a high of73% of households in some provinces to a low of 37%in others. This has had implications for investment pat-terns too. For example, in fourth-quarter 2013, Javareceived 66.23% of total foreign direct investment (FDI),while Kalimantan took in 10.21% and Sumatra 8.73%. MAKING PLANS: Regional disparity in infrastructurecan also limit Indonesia’s ability to benefit from impor-tant regional initiatives, such as the Indonesia-Malaysia-Thailand Growth Triangle – a potential market of morethan 70m consumers. Ramping up infrastructure spend-ing, the government is inviting the private sector to footpart of the bill. Under the Master Plan for the Acceler-ation and Expansion of Indonesia’s Economic Develop-ment (MP3EI), a total of Rp1786trn ($178.6bn) is expect-ed to be invested in infrastructure. Out of this, Rp68trn($6.8bn) will be spent on power and Rp291trn ($29.1bn)on water utilities and other services. The governmentwill finance 28% of the cost, while the rest will need tocome from the private sector (see analysis).

First presented in 2011, the MP3EI is a frameworkdocument that divides the country into six developmentcorridors and emphasises infrastructure projects asthe foundation for success in all other growth targetareas. However, there is still a need for legislation tobetter address the challenges involved in public-privatepartnership (PPP) projects.

The announcement in late 2013 by the IndonesianInvestment Coordinating Board (BKPM) that the for-eign equity portion in airports and ports would beraised to 100% was shortly followed by controversythat it contradicted the Civil Aviation Law No. 1/2009,which limits foreign ownership to 49%. Such uncertain-ty has affected the infrastructure segment in particu-lar. Some have emphasised that FDI in the sector is bynecessity a long-term investment, which is crucial toproviding for stable economic growth. In the case ofairports and ports, Raj Kannan, the managing directorof Tusk Advisory, said in January 2014 in Forbes Indone-

sia, “Most investors in ports and airports would want

Around $6.8bn will be spent

on power and some $29bn

on water utilities and other

services under the Master

Plan for the Acceleration

and Expansion of

Indonesia’s Economic

Development. The

government is expected to

fund 28% of the cost, with

the rest coming from the

private sector.

246

A change in focusPlans are under way to expand access to utilities, boost the powersupply and diversify the energy mix



to ensure the operations of these assets are efficientand profitable and thus prefer majority control. ... It’snot that I am saying that local investors don’t have thecapacity, I am simply arguing that we need more FDI inthe infrastructure in general and in the airports and sea-ports sectors more acutely.”INVESTMENT CLIMATE: The Asian financial crisis lefta legacy of suspicion between private investors and thegovernment. Many projects were cancelled and disputeswere settled by arbitration. Since then the governmenthas eased regulations to make the infrastructure sec-tor more investor friendly. This includes amending thelaw on PPPs and passing a land acquisition act. It hasalso put in place a legislative and institutional frame-work to accommodate private sector interests in theinfrastructure sector and addresses concerns regard-ing the apportioning of risk between the governmentand the investor. It has moved away from providingblanket guarantees to offering those that cover spe-cific projects. Infrastructure investment planning iscoordinated by the National Development PlanningAgency, which prepares the country’s five-year devel-opment plans. An inter-ministerial policy committeecontributes to the evaluation process for investmentneeds. It reports to the president and is responsible forpolicy coordination across ministries. The BKPM coor-dinates PPP projects and assists government agencieswith preparing bankable projects for private sector par-ticipation. It also publishes a PPP book that lists infra-structure projects on offer.

The Indonesia Infrastructure Financing Facility wasestablished in 2010 to act as a non-banking financialintermediary to mobilise capital for infrastructure andto help develop capacity in the financial sector tofinance PPP projects. The Indonesia Investment Guar-antee Fund, meanwhile, was created to improve thecreditworthiness of PPP projects by providing financialguarantees to investors in the event of a change ingovernment policies that would result in their cancel-lation. Established as a state-owned firm with its ownbudget, the fund allows the government to manage itsrisk by ring-fencing its obligations vis-à-vis guarantees.A risk management group within the Ministry of Financeevaluates projects prepared by the PPP unit and decideson the appropriate level of financial support.PPP LAW: In 2012 the government amended the lawon PPPs. It requires all PPP projects to be awardedthrough an open tender process after conducting fea-sibility studies and public consultation. The new law alsoempowered the federal government to provide directsupport for projects through funding and cover risksthat cannot be managed by private investors. Procure-ment processes have been simplified and a land fundnow makes it possible for the government to acquireland pre-tender, thereby removing a critical uncertain-ty that investors faced when bidding for projects.

It has sought ways to identify efficient mechanismsfor channelling subsidies, and the opaque practice of“hidden input subsidies” has been replaced by directcompensation to the infrastructure service provider(based on the difference between prevailing tariffs and

the cost of supply). Provision of public services, suchas water and electricity, is cautiously being advancedthrough competitive bidding, paving the way for grad-ual privatisation of infrastructure. Such measures result-ed in the successful tender for the Central Java powerplant in 2012. Seven consortia bid for the two 1000-MW coal-fired power plants. In 2013 Indonesia receivedover $1.46bn worth of FDI in power, gas and water sup-ply, data from the BKPM shows. POWER HUNGRY: Energy demand has outpaced sup-ply in recent years. Generation facilities are outdatedand insufficient, operating at an average capacity of66%. Homes across the country experience daily black-outs lasting up to four hours a day on average. Whilepower demand continues to grow at around 9% annu-ally, the electrification rate has fallen from 67% to 65%.The number of people without access to electricity hasincreased by over 2.5m per year since 2008, accord-ing to “The Indonesia Electricity System - An Overview”,a report published in 2012 by Differ Group. Indonesiais falling behind its goal of reaching 90% electrificationby 2020. According to Perusahaan Listrik Negara (PLN),

247


SOU

RCE:

Wor

ld B

ank

Electric power consumption, 2000-11 (KWh per capita)

0

160

320

480

640

800

201120102009200820072006200520042003200220012000

Demand for power continues to increase at around 9% annually

The government modified

the law on PPPs in 2012.

The law now requires all

PPP projects to be awarded

through an open tender

process after feasibility

studies and public

consultation have been

conducted.


the state-owned electricity monopoly, the countryneeds $9.75bn in investment to reach the target. RESOURCES: Indonesia does not lack energy resources.It is believed to hold 40% of the world’s total geother-mal resources and has 76 GW of hydropower poten-tial, but it has yet to exploit these. Instead, the bulk ofthe grid power is generated through oil. Indonesia alsohas a structural issue with its electricity supply. Thegovernment subsidises power through PLN, which pro-vides it at discounted rates. As a result, the powermonopoly remains cash-strapped and is unable to makesufficient investments in either expansion or mainte-nance. For 2014 alone, the budget for electricity sub-sidies set aside by the government was Rp81.7trn($8.2bn). The power grid consists of eight domesticinterconnected systems and 600 isolated ones, all oper-ated by PLN. A proposed grid linking Sumatra andMalaysia is expected in 2020 that would, for the firsttime, enable the two countries to trade electricity. NEW SOURCES: If power demand continues to growat the current pace of around 9% per annum, it will reach400 TW by 2019. The island nation has few options butto increase domestic capacity to handle this. Renew-able energy accounts for 10% of the total on-gridinstalled capacity. Some 5% of the total of 170 TW ofon-grid electricity in 2010 came from renewable ener-gy sources. On-grid renewable capacity consists main-ly of large-scale hydro and geothermal power plants,while off-grid generation capacity includes diesel gen-erator sets, small-scale hydro, biomass and solar pow-er generation, according to Differ Group. Hydropoweraccounts for 13% of distributed generation, whereasgeothermal made up less than 1%. Small-scalehydropower generation is gaining popularity and hasincreased by more than 700% since 2000.

Over the past seven years renewable energy gener-ation in Indonesia has increased by more than 5% annu-ally. More recently, private developers have also enteredthe market. So far, their focus has been on large-scaleprojects. The government has stated its intent to raise

the capacity of micro-hydropower plants to 2846 MWby 2025; of biomass to 180 MW by 2020; of wind pow-er to 0.97 GW by 2025; of solar to 0.87 GW by 2024;and of nuclear power to 4.2 GW by 2024. By 2025 thetotal investment required for the development of newand renewable energy is projected to be $13bn, as pera 2013 US government report on the power sector.

Power generation in Indonesia is projected to growat an average of 6.5% per annum from 2014 to 2022.The government’s plan includes constructing powerplants that would supply 20,000 MW of electricity inthe next 10 years, according to the International FinanceCorporation. In 2004 it announced a “crash” programmein which electricity generation capacity would be fast-tracked in two phases. The government is implement-ing the second phase of the programme, which seeksto create more than 10 GW of additional capacity by2014. Nearly half of the 70 projects will go to independ-ent power producers (IPPs). It has also raised the priceof electricity by 15% since the start of 2013. Despiteresistance, all four increments of 4.3% were implement-ed successfully in January, April, July and October 2013.In addition, the feed-in tariff for geothermal energy wasraised for a second time in June 2013, making the sec-tor more attractive to private investors. SHIFTING FOCUS: The government is shifting focusfrom expensive oil-fired power plants, which accountfor 27% of the total energy generation, to those fuelledby coal and gas. Coal is abundant and represents themost attractive quick fix for short-term capacity expan-sion. Over 70% of the 9900 MW of capacity developedby PLN under the first phase of the crash programmewas coal fired. Around half of the coal-fired capacity isoperational, and the remainder is expected to come on-line in 2014. In the next phase of the programme coalwill account for 3 GW of the total of 10 GW of powergeneration capacity. PLN will develop around 1.8 GW,while the rest is expected to come from private IPPs.The programme is set to run until 2016 and presentsan attractive opportunity for investors.

The government has budgeted $8bn for four nuclearplants with a total generation capacity of 6 GW, to beoperational by 2025. It aims to meet 2% of the coun-try’s power demand from nuclear energy by 2017. Butthe country sits on a tectonic plate and is vulnerableto earthquakes. The National Atomic Energy Agency waseyeing locations on Bangka Island to build two nuclearpower plants worth Rp54trn ($5.4bn) and expected tobecome operational in 2030. In February 2014 localmedia reported that a nuclear power plant with a capac-ity of 30 MW would be built in the western part of Java.

The most immediate opportunities for privateinvestors are in geothermal, biomass, hydro and solarpower. Geothermal sources have the potential to pro-vide 27,510 MW of power, the highest in the world,though not much more than 1000 MW has been devel-oped so far. Biomass resources have the potential toprovide 49,810 MW of power, but less than 1000 MWhas yet been utilised to date. Geothermal companiescurrently benefit from the 2003 law, which establishedlong-term licences for land use and a regulated price

248

The government has amended the law on public-private partnerships and passed a land acquisition act

Within renewables the

most immediate

opportunities for private

investors are in geothermal,

biomass, hydro and solar

power. Geothermal sources

could provide up to 27,510

MW and biomass as much

as 49,810 MW, but both

remain under-utilised so far.

The government aims to

meet 2% of the country’s

power demand from

nuclear energy by 2017. In

February 2014 it confirmed

plans to build a 30-MW

nuclear power plant in

western Java.



for geothermal energy, though PLN’s position as themain energy supplier complicates matters.

Private firms have tapped into fast-growing crops suchas cassava, jatropha and sweet sorghum for biofueldevelopment, and PLN in partnership with GeneralElectric will launch the country’s first biomass gasifi-cation project, which could produce more than 750 KW.The government has also announced a plan to conductauctions for solar and geothermal energy. In 2013 itlaunched a tender for 80 solar photovoltaic projectswith a combined capacity of 140 MW and worthRp2.8trn ($280m). Hydropower, particularly mini-hydropower, has potential as well, given Indonesia’sgeography. Large hydropower facilities are virtuallynon-existent and production hovers around 5000 MW.

The government is currently drafting a law on newand renewable energy that will offer new incentives toinvestors along with the tax breaks that have beenavailable since 2008. It expects at least 1000 MW ofnew power supply will come from IPPs. The Karamahydroelectric power plant in West Sulawesi is antici-pated to be put up for tender in 2014. The project, whichhas an estimated cost of $1.34bn, will provide 450 MWof electricity to the region, according to BKPM. WATER SUPPLY: The water supply sector suffers fromyears of underinvestment, partly as a result of the poorfinancial condition of the 400-odd regional water sup-ply enterprises. Lack of private investment is oftenattributed to low tariffs, an uncertain regulatory envi-ronment and the state’s less-than-favourable attitudetowards private sector involvement in what is consid-ered by many as a social good. According to the OECD,as of 2006 an estimated 8% of the water supply sys-tem in Indonesia was handled by PPPs.

Agriculture accounts for some 91% of the freshwa-ter consumption in Indonesia, followed by industry (8%)and then domestic use (3%). Just 9m Indonesians areconnected to water networks. The water supply net-work covers only 42% of urban areas and 11% of thecountryside. The main responsibility of providing waterrests with local governments, although the central gov-

ernment provides extensive financial and technicalsupport. The Ministry of Public Works aims to reach 62%coverage of piped water supply in urban areas (it is cur-rently around 50%) and 40% in rural areas by 2015. Anevaluation of the investment needs estimated that thiswill mean 10m new water connections. PRIVATE PARTICIPATION: The Water Supply Develop-ment Supporting Agency established in 2005 overseesthe water supply, acting as promoter and mediator inthe PPP process. The 2004 Water Resources Law allowsfor private sector participation through concessionsgranted by the local government.

The government has envisaged nearly 70% of waterinfrastructure investments between 2010 and 2014 tocome through PPPs, community participation and theprivate sector. However, private sector involvement inwater services is still limited. Some projects have nev-ertheless been arranged using the PPP scheme.

One project that is up for bid in 2014 is the $20mPondok Gede water supply project in Bekasi, West Javaaimed at supplying 300 litres of water per second fromthe West Tarum canal to households and industrialunits. Another one that will be put up for bidding in2014 is the southern Bali water supply project, whichwill provide 1000 litres per second of water and is esti-mated to cost some $218.84m.

Access to clean water is a challenge. The government’starget is to provide clean water to 68% of the popula-tion by 2015. According to a 2011 survey by the Min-istry of Public Works, only 44% of people have accessto clean water, and the scale of the problem will onlyincrease in size as the population grows. The Popula-tion Reference Bureau data shows that by 2050 Indone-sia is expected to have more than 310m inhabitants.OUTLOOK: Improving infrastructure will continue to bea priority. With Indonesia’s sovereign rating upgradedto investment grade and its economy growing at asteady pace. According to the government’s 2011 devel-opment plan, the private sector and state-owned enterprises will need to finance 70% of the infrastruc-ture investments through PPPs over the next 12 years.

249

Although to date the public

sector has been the

primary provider of water

services, the government

has envisaged that nearly

70% of water infrastructure

investments between 2010

and 2014 will come

through PPPs, community

participation and the

private sector.

INFRASTRUCTURE INTERVIEW

Djoko Kirmanto, Minister for Public Works

What can the government do to improve investor

appetite for public-private partnerships (PPPs)?

KIRMANTO: The government has established majorsupport facilities to bolster the realisation of PPPs,including the “One-Stop Service” and the Land Revolv-ing Fund. The latter features several dedicated infra-structure guarantee funds, underpinned by the Viabil-ity Gap Fund. Investment is a long-term, high-riskendeavour, so the government must meet investorshalfway by providing clearer regulation and a moresecure licensing procedure to improve legal certainty.

Crucially, this requires complete commitment fromcentral and regional levels of government, as both canact legally as contracting agencies for PPPs. Local gov-ernment also has the authority to manage water sup-ply and sanitation. However, as Indonesia’s experienceof such projects stretches back less than 10 years, theMinistry of Public Works has established the SupportAgency for the Development of Drinking Water Sup-ply Systems (BPPSPAM) to facilitate capacity buildingand information sharing, and achieve successful PPPs.

How does the ministry balance funding between

Java, where infrastructure bottlenecks are curtail-

ing growth, and outlying regions, which continue

to be affected by high poverty rates?

KIRMANTO: The government has increased its budg-et allocation for the Master Plan for the Accelerationand Expansion of Indonesian Economic Development(MP3EI) projects outside Java, particularly in FocusInvestment Areas such as commodity and mineral devel-opment. In the East Indonesia region, the governmenthas focused on accelerating construction of the threemain economic corridors: Sulawesi, Bali-Nusa Tenggaraand Papua-Maluku, to balance development across thecountry. To provide some perspective, in the Java Cor-ridor investment amounts to Rp116bn ($12m), or 21.2%of the annual total MP3EI budget of Rp546bn ($55m).At the same time, investment funding for Papua-MalukuIslands Economic Corridor is by far the highest for 2013

at Rp205bn ($21m) or 37.5% of the annual budget. Kali-mantan and Bali-Nusa Tenggara follow with Rp109bn($11m) and Rp43bn ($4m), respectively.

To what extent does Indonesia’s future economic

development depend on the successful enforce-

ment of the 2011 Land Acquisition Law?

KIRMANTO: According to the Islamic DevelopmentBank Survey in 2011, land acquisition is the primaryobstacle to infrastructure investment. In response, thegovernment issued several new regulations in 2012 tocatalyse land acquisition for the development of pub-lic projects. These provide specific time limits for landacquisition, categorising the three main phases of theprocess within an overall minimum of 319 days and amaximum of 583 days. These phases include planningand preparation (141-289 days), implementation (141-257 days) and result award (37 days).

How can the government fast-track the Mass Rap-

id Transit (MRT) project while also taking into

account the social impacts of land clearance?

KIRMANTO: Jakarta’s need for the MRT has never beengreater. Expected to serve 173,000 passengers per dayin its first year and decrease travel time by an averageof 28 minutes, the MRT will reduce CO2 emissions by30,000 tonnes by 2020 and create nearly 48,000 newjobs over a five-year construction period. Anticipatingconcerns over disruption caused by such a large proj-ect, Jakarta’s provincial government has initiated a dia-logue with residents affected by land acquisition.

The government will also establish a consignmentsystem for land acquisition, whereby individuals canappeal the amount of compensation offered to themby pursuing a just resolution in court. This arrange-ment was implemented during the construction of theEast Flood Canal. However, social impacts must be con-sidered alongside the first phase of development of theNorth-South Line, stretching from Lebak Bulus to Bundaran HI roundabout – a distance of some 15.7 km.

250

Going placesOBG talks to Djoko Kirmanto, Minister for Public Works


INFRASTRUCTURE ANALYSIS

Indonesia plans to invest over $390bn in infrastructure until 2025

Financing the infrastructure sector is a major chal-lenge for Indonesia. The government simply doesnot have the financial muscle to fund all of the nec-essary infrastructure projects on its own. Accordingto the Ministry of Public Works, Indonesia requires$192bn of infrastructure investment between 2010and 2014. The government and state-owned enter-prises can only provide around $56bn, so the privatesector will need to chip in as well.

Indonesia plans to invest more than $390bn ininfrastructure until 2025. Almost half of it will needto be financed by the private sector. According to MHatta Rajasa, the coordinating minister for the eco-nomic affairs, there remains a funding gap of 41%that needs to come from the private sector. Of theanticipated 25 priority projects set to begin by 2017,the government wants 16 to take the form of pub-lic-private partnerships (PPPs).

The National Development Planning Agency hasidentified 27 projects worth $47.3bn to be madeavailable to investors from 2014. This is a very ambi-tious target, and the country’s record so far hasbeen less than stellar. Most PPP projects in electri-fication and water supply are still in development.While some projects are yet to be released, othershave started and then stalled. No PPP project hasyet achieved financial closure. SOURCES OF FINANCE: A number of state-ownedentities have been created to assist with the financ-ing of public and PPP projects. Sarana Multi Infra-struktur and Indonesia Infrastructure Finance (IIF)were set up to provide alternative sources of fund-ing through debt and equity. The former is whollyowned by the Indonesian government, while the lat-ter is partly funded by the Asian Development Bank(ADB), the International Finance Corporation andtwo private financing institutions, Sumitomo MitsuiBank Corporation and German Investment and Devel-opment Corporation. The Indonesia InfrastructureGuarantee Fund (IIGF) and the IIF were established

by the government in 2009 to provide new meansof funding infrastructure projects in a move thatwas broadly welcomed by investors.

IIGF provides financial guarantees for specific proj-ects, while IIF was created to drum up local capitalfor infrastructure projects. Penjaminan InfrastrukturIndonesia is another government-owned entity thatoffers project guarantees to the private sector. Italso aims to improve the creditworthiness of publicsector partners, and thereby encouraging privatesector participation in projects. Sovereign wealthfund Pusat Investasi Pemerintah is financing landacquisition for PPPs. The Ministry of Finance hasalso established a Viability Gap Fund to ensure thereis additional capital available for projects.RAISING CAPITAL: The local financial ecosystem isstill in its infancy, and foreign fund managers are hes-itant about putting money into Indonesia’s infra-structure sector. That is because risk allocation inthe sector is still not favourable to investors. The IIGFguarantee, for instance, applies to only a handful ofprojects. It has yet to agree on the terms for its firstguarantee – for Central Java’s coal-fired power proj-ect (involving two 1000-MW plants). Investors believethe fund may not be sufficiently capitalised, andtherefore have concerns regarding its effectiveness. HIGH COST OF LOCAL BORROWING: The spreadbetween lending and deposit rates in Indonesia ishigh. According to data compiled by Bloomberg in2013, the average margin for the country’s leadingbanks is 7% higher than any of the other 20 largesteconomies in the world. This makes borrowing fromlocal banks expensive. The difficulty of raising localfinance has only been exacerbated by the centralbank’s decision to hike interbank lending rates by 25basis points to 7.5% in November 2013 in an attemptto manage the current account deficit, which as ofthe fourth quarter of 2013 stood at 3.3% of GDP.Although the high cost of local borrowing is less ofa constraint for foreign investors, it does put local

In Indonesia the spread

between lending and

deposit rates is high and

borrowing from local banks

is expensive. In 2013 the

central bank also increased

interbank lending rates.

251


Of the 25 priority

infrastructure projects

expected to begin by 2017,

the government wants 16

to take the form of

public-private partnerships.

Opportunities aboundEncouraging private sector investment in the sector


enterprises involved in the sector at a disadvantage.Indonesia ranked 86th out of a total of 189 coun-tries on ease of getting credit in the World Bank’s2014 “Doing Business” report. By comparison, itspeers in the region – Thailand (ranked 73rd) andMalaysia (ranked first) – did far better. RELYING ON INTERNATIONAL FINANCE: Thedomestic banking sector has limited experience ofproject risk calculation and this makes it difficult forthe government to raise local capital for long-terminfrastructure investments. Thus, although the costof accessing the international financial markets ishigh, Indonesia has had to rely on them.

Infrastructure projects have mostly been fundedby foreign banks and multilateral lending agencies,such as the World Bank or the ADB. However, thebiggest donor is the Japan International CooperationAgency (JICA), which is funding a total of 45 fast-track projects in and around the Jakarta metropoli-tan area. Its $13bn in funding will help cover almost30% of the project costs, while the rest will comefrom the Indonesian government and the privatesector. Projects include roads, rail, water and sani-tation, energy and ports.

With this kind of funding Asian firms often havean advantage over their Western competitors whenit comes to bidding for projects in Indonesia. Thesecompanies are often protected from risk by theirrespective governments and bring with them rela-tively inexpensive and easily obtainable export-cred-it financing. Japanese, Chinese and South Koreanfinancial institutions provide Indonesia with liberalfinancing at below-market rates. For example, The

Jakarta Globe reported in 2013 that the loan pro-vided to build the Indramayu coal-fired power proj-ect carried an annual interest rate of only 0.01%,with a 40-year repayment time frame and a graceperiod of 10 years thanks to the JICA.

While lending agencies are ready to assist, sincethe 1997-98 Asian financial crisis Indonesia has been

averse to taking on large-scale foreign debt. The useof offshore bonds for infrastructure financing hasthus grown substantially. It offers advantages. First,bonds can reduce the risk of speculative capital,which can bring infrastructure projects to a suddenhalt in the event of capital flight. Second, it minimis-es default risk for the investors.

The government’s target for bond issuance in first-quarter 2014 is Rp54trn ($5.4bn), and following aRp10trn ($1bn) sale in mid-March, it seemed to belargely on track to reach this. With the passing ofthe land acquisition act, there has been a surge ofoptimism among investors regarding land acquisi-tion for infrastructure projects. However, a decen-tralised political structure and challenges to the lawdo present some concerns. There has been some con-troversy due to previous legislation that restricts thegovernment’s authority to take over land, as well asuncertainty over legal ownership titles.BUDGETARY DISBURSEMENT: There are also sev-eral key bureaucratic and institutional roadblocksthat make obtaining adequate financing for infra-structure projects difficult. Ministries, for instance,have trouble disbursing their budgets. In 2013 theMinistry of Public Works announced plans to openbidding for 22,736 infrastructure contracts worthRp73.41trn ($7.3bn) in 2013, despite having onlydisbursed about 77% of its Rp75trn ($7.5bn) 2012budget as of early December 2012. The Ministry ofFinance insists on spending existing budgetary allot-ments first, and before accepting other sources offinance. According to the World Bank, developmentagencies have reported that some ministries haveturned down desired funding for fear of penalisa-tion by the Ministry of Finance for not spending thebudgets allotted to them in full. Some efforts havebeen made to address such issues. Spending ruleshave been revised to speed up disbursement. Accord-ing to Anny Ratnawati, the vice-finance minister,new rules allow ministries to hold tenders in Novem-ber for projects to be implemented in the followingyear, and provinces, regencies, and ministries mustprepare disbursement of their budgets every month.

Inherent in the PPP model is the expectation thatthe government would not need to provide the entireproject financing package, but investors will put upfinance only when they see adequate returns thatwill make up for the project costs and provide prof-it. Yet there remains a widespread view in the investorcommunity that most projects proposed under thePPP model in Indonesia lack the financial feasibilitythey seek. Although subsidies are being phased out,low tariffs in the power and water sector make itunattractive for investors to finance projects thatrequire a long time to break even. Until such issuescan be resolved, the government should be willingto put in more on its side to finance the projects.

Despite the challenges and risks, Indonesia’s infra-structure expansion over the next six years looksset to provide increasingly attractive opportunitiesfor international investors and financial institutions.

252

Government-owned entities provide project guarantees to the private sector

Infrastructure projects

have mainly been funded

by foreign banks and

multilateral lending

agencies, with the biggest

donor being the Japan

International Cooperation

Agency. The organisation is

funding 45 fast-track

projects in and around the

Jakarta metropolitan area.



Stuart Dean, CEO, General Electric ASEAN

What makes you confident in Indonesia’s poten-

tial and what medium-term challenges do you

expect to encounter?

DEAN: From a macro point of view, Indonesia isimportant. It has a balanced economy, big consumermarket and huge infrastructure needs. Indonesiatook longer to emerge from the Asian financial cri-sis and did not build infrastructure during that peri-od, therefore the country will be catching up byupgrading airports, railways, power generation andwater treatment over the next 10 to 20 years. Healthcare, particularly outside urban areas, requires hugeinvestment. Aviation is growing again, but, due to air-port capacity limitations, there is a restriction on avi-ation industry growth. Power demand is still huge,with more than 50 GW needed in the next five to 10years. If you read the long-term planning, you cansee that, without power, the growth of this countrywill not happen. Therefore we see the power sectoras the best place to invest. In all cases, Indonesia rep-resents somewhere between 30% and 50% of thetotal infrastructure market in ASEAN.

In terms of infrastructure development, besides

the provision of equipment, what else can be

done to improve the efficiency and investment

potential of these sectors?

DEAN: In most ASEAN countries you find infrastruc-ture that has been in place for more than 25 yearsand it has not always been adequately maintainedand updated. Firstly, there are great opportunitiesto improve the efficiency of the existing public andprivate infrastructure. If you go into factories thathave been operating for more than 10 years andthey were built when fuel prices were half of whatthey are today, they are not energy efficient. In thisarea there are many opportunities to boost energyefficiency. For infrastructure that will be newly built, I think the biggest change is the phenomenalimprovement in technologies that allow countries

to build much more efficient infrastructure. The maindriver there is $100-a-barrel oil. Using the exampleof an aircraft engine, half of the lifecycle cost of oper-ating an aircraft engine over its lifetime is made upof oil costs. When you discount that back to the cur-rent value of the dollar, the cost of oil is now greaterthan the cost of the engine in the first place. Assuch, investments in fuel-efficient aircraft engines,locomotives or power generation equipment areworthwhile. Oil prices do not look like they are goingto come down any time soon. Thus, I see two bigopportunities to improve efficiency.

In terms of individual sectors, Indonesia’s roads areclogged and trucks are responsible for much of thecrowding. So, if you can get the freight off of roadsand onto railways, it can relieve congestion. Rail-ways are more fuel efficient and, considering thatmany railways across ASEAN are outdated, they wouldprovide great opportunity for investment.

How do you see the ASEAN landscape changing

for investment once 2015 integration takes place,

and how will Indonesia be impacted?

DEAN: There has been huge progress in terms of inte-grating the economy over the last 20 years andessentially, from a manufacturing point of view, it isa free trade area. Notwithstanding this progress,there is plenty of room to continue improving serv-ices, capital markets and cross-border investment,among other areas. Indonesia, given its large domes-tic market, has a different balance, so trade is a lessimportant component of its overall economy.

I think the country needs to be more aggressivewith identifying what their industrial strategy is;some senior people are beginning to take note. Someof them think about it in terms of protecting the econ-omy as opposed to making Indonesia a force forexports in certain areas where they have competi-tive and comparative strengths. In my opinion thereneeds to be more awareness of the opportunities.

253


Long-term opportunitiesOBG talks to Stuart Dean, CEO, General Electric ASEAN


Bobby Umar, Chairman, Indonesian Engineers Association

When it comes to human capital, which engineer-

ing disciplines are most lacking in Indonesia?

UMAR: To provide a context, Indonesia has a popula-tion of 240m people but only 800,000 engineers –around one-third of the number that the country needs.Indonesia is lacking in engineering disciplines relatedto natural resource industries such as agriculture, ener-gy and mining – areas where we should be very strongby now. Those competencies that we do have are most-ly concentrated in Java and need to be more integrat-ed into outlying regions.

In answer to your question, we need all kinds of engi-neers – a new generation. The predominant obstacleis the low number of engineering students at schoolsand universities, largely due to the limited employmentopportunities associated with a period of “de-industri-alisation”. However, this period is coming to an end, withconsiderable growth in the construction and automo-tive sectors creating far more opportunities.

How fierce will competition for engineering jobs be

in light of the incoming 2015 ASEAN integration?

UMAR: We are above all concerned that the gap in thenumber of domestic engineers will be immediatelyfilled by foreign engineers. However, the Engineers Acthas been finalised and approved by legislators. This isa hugely significant development because all otherASEAN countries, apart from Indonesia, Laos and Myan-mar, have already installed such legislation. The act,something the Indonesia Engineers Association hasbeen working on for 25 years, will help prevent errors,better integrate technology and develop the compe-tency of Indonesian engineers to a standard equiva-lent with other countries.

How can foreign companies play a role in technol-

ogy and knowledge transfer?

UMAR: It is actually hugely important for Indonesia todevelop its own organic knowledge. With such exten-sive access to mineral resources, we must develop skills

accordingly rather than rely exclusively on foreign help.The government, which does not provide fundingaccrued from taxation such as that which is applied tocrude palm oil, must allocate state funds for researchand development (R&D). This is a positive process thathas been used in Malaysia for years, and while the gov-ernment has encouraged the private sector to investin R&D, it too must step up and provide support.

North West Jakarta is sinking four inches a year due

to depletion of underground water aquifers. What

can be done from an engineering point of view?

UMAR: This is a natural geological occurrence, but onewhich has been exacerbated by human development.The government of Jakarta must place greater empha-sis on pre-emptive city planning.

The depletion of aquifers is related to over-exploita-tion and to seawater destabilising the ground aroundthese rapidly depleting aquifers. The governor alreadyhas a plan to construct a sea wall to protect the city'snorth coast, with funding for the work to be providedby the World Bank. However, the rapid development ofthe Tanjung Priok Port and its surrounding apartmentbuildings is concerning to many.

How much of Indonesia’s successful infrastructur-

al development hinges on the successful imple-

mentation of the Land Acquisition Law?

UMAR: After the 2004 elections, the new cabinetannounced major plans for infrastructure develop-ment; however, after seven years, very little progresshas been made. This is largely because there was nocomprehensive implementation plan or supporting law.

The Land Acquisition Law arrived to combat someof the problems; however, supporting regulation stip-ulated that the law could only be used for new proj-ects. Therefore, all existing projects, which were riddledwith problems, would continue to use the existing law.The government appears to be afraid of executing the new law, which has now been pushed back to 2014.

254

Engineering successOBG talks to Bobby Umar, Chairman, Indonesian Engineers Association



Projects are often subject to long delays and implementation periods

In a series of bold steps to improve the infrastructuresector in the past few years, Indonesia has introducedregulatory reforms, expanded the space for privatesector participation, extended investment risk guar-antees, raised tariffs, passed the Land Acquisition Actand simplified registration processes. However, bureau-cratic red tape, lack of coordination between govern-ment agencies and weak institutional capacity in thecivil service remain the top challenges in the coun-try’s attempt to attract more private investment.

Capacity constraints within state institutions and alack of clarity as to who has the power to make deci-sions (and when) has contributed to significant delaysin project implementation. Efforts to prepare bank-able, market-ready public-private partnership (PPP)projects are often hamstrung by the lack of capacityat ministries to design such schemes. Land acquisi-tion delays have caused project suspension andinvestors have been put off by insufficient coordina-tion. So, while the infrastructure sector itself lookspromising, inconsistent policies and regulatory uncer-tainties make it a risky proposition for investors. BUREAUCRATIC RESTRAINTS: Governance short-comings in Indonesia are similar to those found in oth-er big emerging economies, such as India and Brazil.It is saddled with a large number of state-owned enti-ties entrusted with the task of planning, financing,coordinating and implementing infrastructure proj-ects. However, many of these bodies have overlap-ping authority and do not always coordinate theirstrategies and plans. For example, the responsibilityfor building and maintaining all national roads liesnot with the Ministry of Transportation, but the Min-istry of Public Works. The Ministry of Agriculture man-ages grain storage, but not irrigation facilities, whichcome under the purview of public works. Yet, whenit comes to industrial zones the responsibility for pro-viding power, transport, water and sewage falls underthe Ministry of Industry. While the Indonesia Invest-ment Coordinating Board is tasked with creating an

investor friendly climate, it does not exercise author-ity over any other ministries. Complicating matters fur-ther are other agencies calling shots in the sector.These include state logistics body BULOG and theMinistry of State-Owned Enterprises (MSOE).

While each ministry has its own responsibilities forplanning, policy and regulatory control, state-ownedenterprises (SOEs) hold the key to implementation andhave budgets of their own. SOEs fall under the MSOE’schain of command, but can also receive direction fromaffiliated sector-specific ministries and the Ministryof Finance. The relationship of SOEs to governmentministries can vary, as can the level of control theyhave over policy or project implementation. In theenergy sector, for example, state-owned electricity firmPerusahaan Listrik Negara (PLN) holds a de factomonopoly and is the exclusive provider of electricityfor consumers connected to the national grid. Localgrid power providers do exist, but they face pricingrestrictions set by PLN. This becomes a deterrent forthe development of any large-scale power projects.

Disagreements over policy are common and gov-ernment departments are known to guard what theysee as their turf. Ever since Indonesia decided to divestgreater revenue and administrative authority to theprovincial and sub-provincial level, inconsistencieshave emerged between policies and their implemen-tation. Following decentralisation, local governmentsnow have greater responsibility for realising projects,but these bodies often do not have the capacity toconduct feasibility studies, risk evaluations or pre-pare PPPs. All levels of government face capacity con-straints in planning, implementation, and operationand maintenance of infrastructure. CAPACITY CONSTRAINTS: Much of the bureaucrat-ic delay in spending existing budgets is due to theinability of government entities to identify and for-mulate new projects. There is a tendency for govern-ment priorities for high-cost infrastructure projectsto shift within a short period of time. The National

Governance shortcomings

in Indonesia are similar to

those in other emerging

economies and include

overlapping authority and a

lack of coordination among

different government

bodies.

255


State-owned enterprises

primarily fall under the

authority of the Ministry of

State-Owned Enterprises

but can still receive

direction from other

sector-specific ministries.

Filling the gapImproving institutional capacity and inter-ministry coordination


Development Planning Agency and the CoordinatingMinistry for Economic Affairs (CMEA) provide guid-ance to investors, but much of the power still lies inthe hands of SOEs, with direction from relevant min-istries often politically motivated.

While institutional inefficiencies and bureaucracyare often a source of delay, it is not always the rea-son for complete project suspension. The legal andregulatory environment in Indonesia can stall theimplementation of infrastructure plans as well. A primeexample can be found in regulations surrounding pri-vate sector involvement in the power sector. In 2002the government enacted the new Electricity Lawallowing the private sector to participate in electric-ity generation; the law also linked tariffs to the mar-ket. Two years later, in 2004, the Constitutional Courtruled the 2002 law to be unconstitutional, noting thatelectricity was a social necessity and that the right ofdelivery should sit with SOEs alone. This dealt a blowto the government’s attempt to open the sector upto private sector investments. MEETING NEEDS: The government has also limitedcapacity to procure consultants and tender servicesconsistent with donor agency guidelines and its ownnational laws. Project readiness and safeguards inparticular are often not advanced adequately to sup-port effective and timely implementation. Lack ofcoordination among ministries can lead to long delaysin obtaining forestry permits and environmental clear-ances. Even though the Land Acquisition Act has beenpassed by parliament, the actual process of land acqui-sition is still slow and continues to result in delays.Capacity constraints at the provincial level have hin-dered the use of budget allocations and project deliv-ery. These constraints become more apparent duringthe initial phase of project design and development.Lack of skills and the limited operational capabilitiesof local government departments have led to delaysin project implementation. Indonesia will need to workon improving its institutional capacity in order to meet

the needs of the private sector during the pre-con-struction stage, as well as resolve regulatory bottle-necks. Besides a lack of agency coordination, theseinclude: slow progress in determining spatial plan-ning; lack of institutional capacity to resolve contractdisputes; a lack of robust legal safeguards for investors;and overlapping central and regional regulations. GREATER RECOGNITION: But there is now recogni-tion, at least within the federal cabinet, that reformsmust be undertaken to speed up infrastructural devel-opment. In Jakarta there have been efforts to coor-dinate the work of various ministries.

The establishment of the CMEA was a significantstep forward. It is charged with coordinating variouseconomic and infrastructure efforts across severalministries. It was the lead body that assembled theMaster Plan for the Acceleration and Expansion ofIndonesia’s Economic Development for 2011-25. In hissecond term in office, President Susilo Bambang Yud-hoyono established the Presidential Work Unit onMonitoring and Controlling Development with themandate of removing investment obstacles caused byinefficiencies in the bureaucracy.

The government has also sought the help of for-eign governments and institutions. It is cooperatingon a technical assistance cluster (TAC) programme withthe Asian Development Bank to help meet its infra-structure objectives. Financed largely by the govern-ment of Australia, the $23m TAC programme will rununtil July 2017 and provide policy advise to the gov-ernment of Indonesia, prepare bankable infrastruc-ture projects and help to build capacity of relevantgovernment agencies to implement PPP projects.

In October 2013 leaders from the Asia-Pacific Eco-nomic Cooperation (APEC) met in Bali and announcedthe Multi-Year Plan on Infrastructure Developmentand Investment. The plan, which is set to run until 2016,is aimed at promoting a more business-friendly envi-ronment among member states in the infrastructuresector. As a first step the body has established a PPPCentre in Jakarta with the capability to assess infra-structure projects to receive private finance and guidethe successful execution of PPP projects. By offeringto host this centre, and with it an APEC PPP expertsadvisory panel, Indonesia has taken a bold step towardsbridging the capability gap that exists within its localinstitutions. The centre will connect them to otherregional networks, facilitating valuable exchange ofideas and best practices and fostering an investor-friendly attitude within the government.

Foreign assistance, however, can only go so far.There is much that Indonesia can do on its own toaddress this deficit. It needs to bring about a whole-sale shift in attitudes towards project managementand partnership with the private sector. However,this is unlikely to happen overnight and will requiresustained investment in training and skills develop-ment. Indonesia needs to raise the human resourcecapacity of its civil service, improve coordination andfurther remove obstacles in the way of faster proj-ect implementation to provide last-mile connectivity.

256

The government has partnered with international institutions to address existing gaps in capacity

The 2002 Electricity Law,

which allowed the private

sector to participate in

power-generation projects,

was ruled unconstitutional

in 2004 as electricity was

deemed to be a social

necessity and a right.

Despite recent legislation,

land acquisition can still be

a difficult process due to a

lack of coordination among

ministries and capacity

constraints at the

provincial level.


259

TransportNumber of vehicles on the road continues to riseHigh-speed rail between Jakarta and Bandung mootedPrivate sector involvement in ports increasingInfrastructure has suffered from underinvestment

TRANSPORT OVERVIEW

About 9.9m vehicles take to the roads of Jakarta daily

For an archipelago spread over 17,500 islands andspanning 5000 km from west to east, the need forIndonesia to have an efficient transport network thatseamlessly integrates sea, land and air transport sys-tems is manifestly evident. The transport sector is thebackbone of the economy, accounting for more than40% of overall infrastructure investment. Yet Indone-sia fares poorly when it comes to the quality of itstransport infrastructure. Failure to invest adequate-ly in ports, airports and roads has made logistics dif-ficult and raised the cost of doing business.

According to the World Bank the cost of logisticscan constitute up to 27% of GDP, compared to 19-22% in other Asian economies. If Indonesia is to shiftits economy from its dependence on extractive com-modities to value-added manufacturing it will needto deal with the problem of connectivity. Foreigninvestors can play a role in bridging the infrastruc-tural gap both as financiers and expert project con-tractors, but they will need a conducive business cli-mate, a level playing field, and concession guarantees. STATE DOMINATES: State-owned enterprises (SOEs)continue to dominate the transport sector in Indone-sia. The country’s airports are built, run and main-tained mostly by the state-owned Angkasa Pura; theseaports are the domain of Indonesia Port Corpora-tion (Pelindo, IPC); Kereta Api runs the national rail-way; and the national toll roads are operated by thestate-controlled Jasa Marga corporation. Since theend of the Suharto era there has been a tendencyamong civil servants to favour SOEs. This is partly dueto a backlash against cronyism. The public sectormanages 90% of the total transport infrastructure,while private sector involvement remains concen-trated on a few tolled highway projects and privaterail lines. Government officials see investors more asa “stop-gap” source of funding rather than as com-petitive service providers. Indonesia’s lack of institu-tional capacity and ambivalent attitude to the privatesector have hampered efforts to boost investment.

PLAYERS: The National Land Agency (Badan Per-tanahan Nasional, BPN), Ministry of Forestry, Min-istry of Public Works (MPW), Regional DevelopmentPlanning Agency (Badan Perencana PembangunanDaerah, BAPPEDA) and local governments are themost important stakeholders when it comes to theuse of land. The Ministry of Finance is the main fund-ing body for large transport infrastructure projectsand the Ministry of Transportation (MoT) under therespective directorate general holds overall regula-tory authority over the country’s major ports, rail-ways and airports. As for the national road network,responsibility for its building and maintenance restswith the MPW. The Toll Road Regulatory Agency(Badan Pengatur Jalan Tol, BPJT) is the regulator oftoll roads and it comes under the purview of theMPW. After the 2001 fiscal decentralisation, the roleof regional governments has become ever moreprominent in the provision of transport services.

Around 20% of the infrastructure investment usedto come from local governments but their contribu-tion has now jumped to 65%. The National Medium-Term Development Plan 2010-14 (Rencana Pemban-gunan Jangka Menengah Nasional, RPJMN) has putthe total infrastructure investment requirement atRp1923trn ($192.3bn). The government (includingSOEs) is only able to cover 65.26% of the cost. Theremaining Rp668.34trn ($66.83bn) is expected tocome from the private sector.

As the funding gap has become apparent, the gov-ernment has looked increasingly to public-privatepartnerships (PPPs) as an alternative source offinance. But local commercial banks have tradition-ally avoided financing infrastructure projects. To over-come this problem the government establishedSarana Multi Infrastruktur (SMI) with the explicitmandate to provide project financing and promotePPPs. Indonesia Infrastructure Finance (IIF), anotherfinancing firm, was established in August 2010 withcontributions from SMI, the Asian Development Bank

Around 20% of

infrastructure investment

used to come from local

governments, but their

contribution has jumped

to 65% since fiscal

decentralisation took

hold in 2001.

261


The public sector manages

90% of total transport

infrastructure, while

private sector involvement

is concentrated on a few

tolled highway projects

and private rail lines.

By land or by seaPrivate sector involvement could help integrate the transport network

TRANSPORT OVERVIEW

and the International Finance Corporation (IFC) as analternative source of long-term finance. Followingthe Asian economic crisis in 1997-98, Indonesia haddifficulty honouring its payments to investors. Manyinvestors dragged the government to internationalarbitration for breach of contracts. They won andIndonesia had to pay hundreds of millions of dollarsas compensation. The legal tussle raised the need fora mechanism that could manage risks. This led in2009 to the establishment of the Indonesia Infrastruc-ture Guarantee Fund (IIGF), which has a mandate toprovide investors financial guarantees, has its ownbudget and can therefore act as an independentguarantor of risk. Badan Koordinasi Penanaman Modal(BKPM) is the Investment Coordinating Board ofIndonesia, and is the primary interface between busi-ness and government, with a mandate to boost theamount of private investment in infrastructure. Theagency packages projects that are ready to be offeredto investors and helps facilitate their participation.In 2012, it helped BAPPENAS release a PPP guidebookshowcasing $41bn worth of transport projects avail-able or potentially available for investors to bid.ROADS: Roads carry 70% of freight and 82% of pas-sengers in Indonesia. The total length of the road net-

work was estimated to be 477,000 km in 2009 out ofwhich 258,744 km is paved. Of all the roads, 8.1% arenational, 11.5% are provincial, 80.7% are district roads,and only 0.2% are toll roads.

The first toll road in Indonesia was built in 1978,yet despite this early start the country has been slowto build expressways and additional toll roads. By2010, only 742 km of toll roads had become opera-tional. This is less than a third of the 2400 km ofroads the MPW had envisaged.

Although progress has been made, the implemen-tation of PPP road projects has continued to be con-strained by a complex land acquisition process, weakproject preparation and selection, and the absenceof an efficient viability gap funding mechanism. Some877 km of tolled expressways are planned for com-pletion by 2015, but the spending has been wellbelow the required average of Rp6.9trn ($690m) peryear. Land acquisition costs range from 10-30% of thetotal investment costs. Average urban constructioncosts, inclusive of land acquisition, are in the orderof Rp70bn-85bn ($7m-8.5m) per km, which can beas much as 10 times higher than the constructioncosts of a two-lane highway.

Meanwhile, the number of vehicles on the road con-tinues to grow at an average of 10-15% a year. As of2009 there were 70.7m registered motor vehicles onthe roads of Indonesia – two-thirds of which weremotorcycles. Poor public transport, easy credit anda massive fuel subsidy have all contributed to thegrowth of private vehicles.

The result of this is heavy congestion. In Jakarta traf-fic crawls at 8.3 km per hour. The Ministry of PublicWorks estimates that Indonesia needs around 1000km of expressways and 10,000 km of arterial roadsin the next five years. To meet that target, it will need$18bn. Bridging that financial gap without privateinvestments is going to be difficult. Roads attract40% of total infrastructure spending (Rp70trn, or$7bn, per year) and represent an asset value equiv-alent to more than 15% of GDP. RAILWAY: Indonesia still has a long way to go beforeit sees a revival of its railways. The total length of thecountry’s railway network is 8529 km, of which only565 km is electrified. In 2013, the national rail oper-ator, Kereta API, moved 203m passengers and 23m

262

In Jakarta, suburban rail services carry 550,000 passengers a day

Although progress has

been made in building toll

roads, the implementation

of PPP road projects has

continued to be

constrained by a complex

land acquisition process.

TRANSPORT OVERVIEW

tonnes of freight (about 55% of which was coal) onthree separate networks in north, west and southSumatra. In Jakarta, suburban rail services carry550,000 passengers a day, 60% of whom pay sub-sidised fares. The government reimburses only 30%of what Kereta API loses as a result. The burden onits $900m operations budget is made worse by hav-ing to pay for the maintenance of signalling equip-ment and upgrading of stations. EXPANDING NETWORK: This shortage of railroadsmeans that less than 3% of Indonesia’s coal (50% ofwhich is found in Kalimantan) can be extracted andexported. Indonesia is therefore pushing for the con-struction of the $2.1bn Puruk-Cahu-Bangkuang-LupakDalam railway line in Kalimantan under a PPP scheme,which it hopes will allow the movement of coal yearround. The government is also planning to develop10 more railway projects in Kalimantan by 2020. Theseprojects will form part of the Rp600trn ($60bn) Trans-Kalimantan Railway Master Plan that will cover 49important sections, out of which 20 have the poten-tial to be executed under the PPP model.

Others could be developed entirely by investors.One such railway connecting East and Central Kali-mantan is being developed by Russian Railways.Another project, the Muara Wahau-Lubuk TutungPort railway line in East Kalimantan, is being devel-oped by the UAE’s Middle East Coal Holdings.

Indonesia also has plans to develop a railway net-work in Sumatra. The MoT completed a new masterplan for the Trans-Sumatra rail project in July 2012,a $7bn, 2168-km railway line that will connect thesouthern Sumatran city of Bandar Lampung withBandar Aceh. Construction of the $1bn, 727-kmNorthern Coastal Highway (Pantura) rail line has accel-erated thanks to an additional injection of $150m.Some 17% of the project has been completed, withmost work taking place along the 62-km Cirebon-Brebes section of the Trans-Sumatra Railway. Thereare also plans to develop a 2000-km rail network inSulawesi. Another major railway project in Java is theretooling of the 780-km Jakarta-Surabaya line. The$1.1bn project is designed to support the develop-ment of the all-important North Java economic cor-ridor, one of six corridors prioritised for economicdevelopment. The railway line will connect all of themajor cities along the Northern Java coastline.COMMUTER RAIL: A key rail project is the commuterline between Soekarno-Hatta International Airport(SHIA) and the Manggarai district in South Jakarta.The airport train project was put on hold earlier afterthe central government decided to elevate sectionsof the railway in the central part of the city. The air-port commuter line will pass through Manggarai-Sudirman (Central Jakarta), Tanah Abang-Duri-Gro-gol (West Jakarta), Bojong Indah (West Jakarta),Kalideres (West Jakarta), Tanah Tinggi (Tangerang),Soekarno Hatta. Kereta Api hopes to get the projectup and running before the end of 2014. Once oper-ational it will cut the travel time between the inter-national airport and South Jakarta to 55 minutes.

Jakarta, whose greater metropolitan area has apopulation of 28m, remains one of the world’s fewlarge cities without a rapid transit system, despite plansfor one dating to the 1980s. The closest substitute,the TransJakarta Busway, can carry fewer than 400,000people a day, and even a dedicated bus lane does nothelp reduce travel times at peak times.

According to the Jakarta Transportation Agency,about 9.9m cars, motorcycles, trucks and other vehi-cles take daily to the capital’s streets, of which 2menter the city from neighbouring municipalities. Butnow, the central government, the Jakarta city admin-istration and a consortium of investors have cometogether to launch a series of rail projects that couldease the city’s traffic woes.

These include the first stage of the Mass RapidTransport (MRT) and above-ground rail system link-ing south and central Jakarta; two monorail projects;an express train to the airport from central Jakarta;and an elevated train circling the outskirts of centralJakarta that would connect to existing provincial com-muter rail lines west, south and east of the city.

Collectively these projects are expected to costabout $4bn. When complete the Jakarta MRT isexpected to carry some 173,000 passengers a day.The first phase of the MRT project will stretch 15.7km from Lebak Bulus to Bundaran HI roundabout.

263


Dwell time at ports fell from 8.7 to 7.7 days between June and July 2013

In 2012, the Ministry of

Transportation completed

a new plan for the

Trans-Sumatra railway

project, a $7bn, 2168-km

railway line that will

connect the Sumatran city

of Bandar Lampung with

Bandar Aceh.

SOURCE: BKPM BPJT: Indonesia Toll Road Authority; MoT: Ministry of Transportation

Project Agency Value ($ m)

Pandaan Malang toll road BPJT 418

Cisumdawu toll road BPJT 779

Manado-Bitung toll road BPJT 353

Pekanbaru-Kandis-Dumai toll road BPJT 1690

Maloy International Port MoT 287

Makassar New Port MoT 360

Cilamaya New Port MoT 3450

Soekarno-Hatta International Airport Rail MoT 2083

PPP projects, 2013-14

TRANSPORT OVERVIEW

MONORAIL: In June 2013, the Jakarta Monorail proj-ect, which had been stalled since 2008 due to finan-cial problems, was finally given the green light byGovernor Jokowi. The consortium, Jakarta Monorail(JM) which is led by Indonesia’s Ortus Holdings, con-firmed that it had the necessary funding to startwork on the Rp8.1trn ($810m) project.

It is proposing to build two lines: a green line, with16 stations, extending 14.27 km from Komdak (thecity police headquarters) to Satria Mandala Museum,both in South Jakarta; and a blue line stretching9.72km from Kampung Melayu in East Jakarta to Roxyin West Jakarta, with 11 stations. JM plans to oper-ate 10 trains comprising six cars each on the two linesby 2016, with each train capable of carrying 1220passengers. The monorail is expected to transport300,000-800,000 passengers per day.

Elsewhere, construction has also begun on a 30-km monorail system in Makassar, the capital of SouthSulawesi. The 300-passenger-capacity monorail willconnect Makassar International Airport and the citiesof Maros, Makassar and Gowa.

Some argue, however, that rail is not in a positionto replace road as the primary means of land trans-port. “While the incoming Trans-Java railroad will cer-

tainly compete with the road transport sector oncertain levels, we believe that using trucks will stillbe more cost-effective, and that many areas will stillnot be directly accessible by train,” Daniel Budi Seti-awan, the president director of Siba Surya, told OBG.AIRPORTS: Indonesia currently has more than 684operational airports. Of these, 233 are commercialairports, out of which 29 receive international flights.Angkasa Pura I operates 13 primary airports in east-ern Indonesia, while Angkasa Pura II manages 12 pri-mary airports in western Indonesia, includingSoekarno-Hatta International Airport. Combined, thetwo operators handle 90% of the total air traffic inIndonesia. The mining firm Freeport Indonesia alsooperates one primary airport in Papua. The remain-der of the financially unviable airports are operatedand managed by the MoT.

Since the aviation sector was liberalised in 2001the skies over Indonesia have become crowded withnew air carriers. According to Djoko Murjatmodjo,director of air transport in the ministry of transport,there are 19 airlines operating in the country, but atone point there were as many as 30. Stiff competi-tion has since resulted in a rapid growth of air trav-el within the country. Growing at an average of about10% per year, air passenger traffic growth in Indone-sia is already the third fastest in the world (exceed-ed only by China and India).

With the ASEAN Open Skies agreement cominginto play in 2015, this growth is expected to furtheraccelerate. In 2012, Indonesian airports handled atotal of 66m passengers (58.8m of which were domes-tic) and 970,000 tonnes of air cargo. Air freight vol-umes are forecast to expand at an average annualgrowth of 5.2% until 2017. Total volume had reached1.16m tonnes by the end of 2013.

Airlines are therefore gearing themselves up toget a piece of the action. Garuda Indonesia, forinstance, wants to make Kuala Namu International Air-port in North Sumatra and Sultan Hasannudin Air-port in South Sulawesi its new cargo hubs. It is prepar-ing to expand its cargo terminals at both airports andplans to launch a independent cargo division in 2014.Low-cost carrier Lion Air is also set to expand its car-go business, having set up a new cargo division calledLion Express. To meet the increasing demand in air

264

The two main ports cater to the container, dry and liquid bulk trade

Indonesia has more than

684 operational airports.

Of these, 233 are

commercial airports, out

of which 29 receive

international flights. Two

operators, Angkasa Pura I

and Angkasa Pura II,

handle 90% of total air

traffic.

TRANSPORT OVERVIEW

transport the Indonesian government has initiatedambitious development plans aimed at improvingthe air transport infrastructure. In 2012 it preparedthe National Airport Master Plan, which called for theconstruction of 14 new airports, and the renovationand expansion of 118 existing airports. The MoT isplanning to build 45 new airports by 2022, of which24 are expected by 2017.

Up to 25 commercial airports will also be expand-ed during this first phase. The $500m AdisutjiptoInternational Airport, in Yogyakarta Special Region(Central Java) is one of the biggest airport projectsto go on-stream in the first phase, while the $1.1bnKarawang International Airport in West Java will betaken up in the second phase. The construction ofeight airports is already on track.

According to the transportation minister E EMangindaan, nine new airports in eastern Indonesiaand three more in the west will start operations by2015. They will include the long-overdue Kuala NamuInternational Airport in North Sumatra and the Wai-sai Raja Ampat airport in Papua.

However, existing airports are facing over-capac-ity. Soekarno-Hatta International, for instance, wasdesigned for 22m people but currently handles morethan 51m passengers a year. Medan’s Polonia Airportis said to be running at six times its capacity. Ban-dung sees 1.3m passengers a year, well above itscapacity of 900,000. As growth in passenger num-bers outstrips the capacity of state-owned firms tobuild and expand airports, the private sector is beingactively courted to meet the rising demand.

At least four new airport facilities in Indonesia arebeing developed under the PPP model. These includethe $214m South Banten Airport, Pandeglang, Ban-ten; the $130m Kertajati International Airport, WestJava; the $500m Kulonprogo International Airport,Yogyakarta; and a $510m airport in the northerncoastal region of Buleleng, Bali.

In addition, the Indian conglomerate GVK receiveda contract in November 2012 to operate Bali’s Ngu-rah Rai International Airport as a joint venture part-ner with Angkasa Pura I. Almost 40% of all touristsvisiting Indonesia pass through this airport. Operat-ed by Angkasa Pura I, Selaparang Airport in Lombokhas been moved to Mataram and redesignated asLombok International Airport.

In addition to this, Surabaya’s Juanda Airport, alsooperated by Angkasa I, saw the completion of a newterminal in 2012, improving its capacity to handle pas-sengers by another 5m a year, while development

plans for Balikapapan’s Sepinggan International Air-port include a new terminal which will allow the air-port to handle 10m passengers annually. The maingateway, the Soekarno-Hatta International Airport,is also being expanded. In February 2013, a consor-tium that included Hyundai Engineering was award-ed a Rp4.7trn ($470m) contract to construct a newterminal, a train station, a parking area and severalroads. Once completed the expansion will be fol-lowed by the construction of a new cargo terminaland the integration of terminals 1 and 2.

Work on the $216m cargo terminal facility is sched-uled to start in 2014. By then Soekarno-Hatta isexpected to be able handle 64m passengers annu-ally. However, this will only be sufficient to meetdemand for the next decade as demand is expectedto soar to 87m by 2025. The government is there-fore exploring the possibility of building a new com-mercial airport 60 km from the capital. Estimated tocost Rp10trn ($1bn), the new airport will be built inKarawang, east of Jakarta, and will have an ultimatecapacity of 70m passengers. PORTS: Ports play a major role in the export of Indone-sia’s plentiful commodities, which include coal andoil. The country is also developing its role in the con-tainer shipping supply chain but is being held backby the generally poor condition of its infrastructure.Indonesia is served by over 700 ports but they havesuffered from perennial underinvestment.

Indonesia’s ports ranked 104th out of 144 coun-tries surveyed by the World Economic Forum in2012/13. The dire state of its ports explains why thecountry has so far failed to emerge as an export hub.Delays at the country’s ports and roads mean it costs$600 to ship a container from Padang to Jakarta butonly $185 from Jakarta to Singapore.

Meanwhile, ports are congested and the processof clearing goods takes too long. According to theWorld Bank, the average “dwell time” at Tanjung Priokhad gone up from 4.8 days in 2010 to 6.4 days in 2012.

265


Air passenger traffic is growing at an average of about 10% per year, the third fastest in the world

The MoT is planning to

build 45 new airports by

2022, 24 of which are

expected to be operational

by 2017. Up to 25

commercial airports will

also be expanded during

this first phase.

By 2014 Soekarno-Hatta

International Airport is

expected to be able

handle 64m passengers

annually. However,

demand is forecast to

reach 87m by 2025.SOURCE: WEF *out of 144 countries

Quality of Rank

Road 90

Rail 51

Port 104

Air 89

Overall 92

Transport infrastructure ranking, 2012/13*

TRANSPORT OVERVIEW

Waiting times at ports like Pontianak in west Borneocan be as long as 10 days. The country’s main portsare Tanjung Priok and Palembang, and cater to Indone-sia’s container, dry and liquid bulk trade. TanjungPriok, which handles 65% of the country’s cargo trade,has made some attempts to enhance its productivi-ty. Dwell time decreased from 8.7 to 7.7 days betweenJune and July 2013. However, the government’s goalfor reaching a dwell time of three days looks unlike-ly. Tanjung Priok can only process 170 containers aday. Many containers, particularly those destined foreastern Jakarta, have been directed to Marunda Logis-tics Park and the Cikarang dry port. CHALLENGES: Indeed, the main challenges comefrom the lack of capacity. Therefore, the opening ofKalibaru Port, or New Priok Port, being developed byPelindo II with an investment of $2.47bn is vital. Thefirst phase of the project will include three terminalswhich will have a total container handling capacityof 13m twenty-foot equivalent units (TEUs).

The project will cover an area of 400 ha and wouldalso eventually accommodate tank storage bulk trans-shipment and other port industries. The first contain-er terminal is due to be completed by 2014, while theremaining two container terminals and two fuel ter-minals are expected to be completed by 2016 and2017, respectively. The pressure on Tanjung Priok isalso forcing operators to increase capacity at otherports. Pelindo III has allocated Rp460bn ($46m) forthe expansion of berths and the addition of newcranes at Tanjung Perak Port in East Java and Banjar-masin Port in South Kalimantan.

Additional plans include increasing capacity at Tan-jung Sauh, a deepwater port in Batam, by 4m TEUs;undergoing berth space expansion at Tenau Port inKupang; and constructing a 500-metre wharf atSorong West Pacific port.

For a country so dependent on commoditiesexports, Indonesia has surprisingly few ports capa-ble of handling specialised products such as palm oil.

Belwan Port in North Sumatra is one such gateway,but it is working at overcapacity and ships often haveto wait for up to two weeks before loading. The Indonesian Vegetable Oil Refiners Association saysthat the country needs three more seaports equippedwith special terminals to boost palm oil exports. OUTLOOK: Despite the absence of a strong politicalpush to instil more competition in the transport sec-tor, there continue to be reasons for internationalinvestors to be optimistic about its future. The coun-try’s economy is growing and the global commoditymarket will continue to exert pressure for change.Increasing demand for Indonesian coal, for instance,is driving foreign investment in the transport sector– especially in the building of the freight rail network.The fundamental challenge for Indonesia now inadvancing its PPP agenda further is establishing andmaintaining investor confidence.

While convening investor summits is necessary topromote investments, focusing on strategic projectsand getting them implemented sends a more pow-erful signal to foreign investors. IFC participation ina 116-km build-own-operate-transfer toll road proj-ect on the north coast of West Java Province is there-fore, symbolically important.

The signing of the land acquisition bill by PresidentSusilo Bambang Yudhoyono in 2012 is an importantstep towards addressing a problem that has untilnow held back private sector participation in the sec-tor. The new law clarifies roles, imposes time limitson each phase of acquisition, and ensures safeguardsfor land-right holders. Land can now be acquiredwithin 260 days in cases where there is no disputeand 583 days if the takeover is challenged.

Most importantly, the law provides a clear mech-anism for enforcing the principle of eminent domain,or revocation of land rights that can prevent smallinterest groups from blocking projects. But the cru-cial power of revoking land rights still rests withprovincial governors and therefore their attitude willcontinue to bear on the pace of transport projects.

266

Several sections of a railway master plan have potential to be PPPs

Demand for Indonesian

coal is driving foreign

investment in the

transport sector, especially

in the building of the

freight rail network.


Indonesia has few ports capable of handling palm oil products

TRANSPORT INTERVIEW

Emirsyah Satar, CEO, Garuda Indonesia

What will the revision of Indonesia’s GDP figures for

2013 mean for the aviation sector in 2014?

SATAR: The country’s GDP output for 2013 may havebeen revised down farther than some expected, butgrowth prospects for aviation remain positive. While alower GDP will indeed correlate in some way, the mosturgent challenge for Indonesia’s aviation sector is infra-structure. Future growth in market size and demand isguaranteed. The challenges include hard and soft infra-structure, and the speed at which both must be devel-oped. Hard infrastructure such as airport terminals,runways and air traffic control systems, must be sup-ported by the requisite number of pilots, engineersand air traffic controllers. At current human resourceoutput, however, it will be very difficult for Indonesiato meet such demand for talent.

Assuming capacities similar to the US market, whichcarries about 100,000 passengers per aircraft per year,Indonesia will need over 350 more aircraft in the nextthree to five years. This means doubling current domes-tic capacity. These figures are adjusted to account forhigher incomes in the US; we’ve discounted the num-bers 20-30%. Regardless, this is the sort of growth tra-jectory the aviation sector will be facing, and we real-ly need to be ready for it. The government has alreadyinvested Rp2.8bn ($280,000) in several airports inIndonesia via its MP3EI plan. Though demand contin-ues to exceed supply, the developments at Bali, Lom-bok and Medan airports are concrete signs of progress.

How do you assess competition in the aviation sec-

tor, such as is catalysed by low-cost carriers (LCCs)?

How will this affect the sector’s development?

SATAR: Competition forces players to be more cre-ative, innovative and efficient. In Indonesia’s current mar-ket, I believe there is potential for all types of carriersto grow. However, LCCs and full-service carriers willbecome increasingly segmented. A number of full-serv-ice carriers have entered the LCC market simply becausethe pie is so big, but in the next couple of years play-

ers will consolidate. This will breed efficiency through-out the sector. Even so, at present there are still newopportunities in areas like turboprops, where domes-tic demand has not been met over the last few years.The Indonesian market continues to face new chal-lenges, but this can only help the evolution of compet-itive private players and of the market around them.

Will the ASEAN Open Skies initiative be ready for

implementation in 2015? How prepared are Indone-

sian carriers for the fresh competition it will bring?

SATAR: ASEAN Open Skies turns on two issues: full lib-eralisation and multilateral agreements within ASEAN.Thus far, it appears that multilateral agreements havewon out, though the roadmap aims toward unlimitedtraffic. The subject of cabotage – the rules dictatingwhether an airline registered in one country can fly with-in the borders of another – is still a sensitive one, andmust be discussed as openly as possible. Indonesian air-lines are prepared for Open Skies, but a level playingfield is still important. Whatever rights foreign airlinesare getting in Indonesia, Indonesian airlines should begetting in foreign markets.

Often, technical barriers are put up to obstruct theregional operation of airlines. At certain airports, forexample, scheduled slots are often artificially listed asfull even though an airline has the right to fly there.There is little recourse to negotiation. This means theairline may have to fly to a far-off secondary airport,which is unlikely to be commercially viable. To overcomesuch obstacles, Indonesian airlines must continue tobe as well-prepared and flexible as possible, and con-tinue providing efficient and quality services to passen-gers. This, in turn, will help market retention.

Indonesia is, after all, the biggest market in ASEAN,both in domestic traffic and to and from other ASEANcountries. Its aviation sector must take steps to ensurethat, when ASEAN Open Skies takes off in 2015, thereis a level playing field and proper transparency betweenregional authorities, for the future benefit of all involved.

267


Skies openOBG talks to Emirsyah Satar, CEO, Garuda Indonesia

TRANSPORT INTERVIEW

Sukmawati Syukur, President Director, Monorail

What has traditionally held back the development

of rail infrastructure in Indonesia?

SYUKUR: In the past, unnecessary bureaucracy hashindered the development of many rail projects. Theregional and central government need to better coor-dinate their goals and activities. The local govern-ments have limited resources and need to have theirplans subsidised while the central government has afull plate and therefore actions are sometimes slowto materialise. Both entities need to find a happymedium in dealing with one another. Having said that,relying solely on the government for help is hazardous.The private sector should be the driver of develop-ment. We want to show that the private sector iscapable of handling modern infrastructure challenges.

In light of this, Jakarta is now about 20 years behindthe regional curve in terms of its urban transporta-tion. Demand is high and supply is barely existent. InBandung, tourists come from all over the region,including Jakarta; however, travelling there is a night-mare. There is currently a direct flight there, so whycan we not travel by rail? Traffic is unpleasant, and itis hurting our economic development.

The government needs to deregulate the sector inorder to incentivise investors. We need to lay out thered carpet and be more inviting. In the end the peo-ple are the victims of bureaucracy and red tape.

In what ways does congestion affect the city’s

economy?

SYUKUR: In 2007, we calculated that congestion costsour green and blue line zones approximately $200m.If we were to extrapolate those figures forward to 2013,the costs are estimated to be closer to $1bn. Theamount of time that people spend commuting andaway from their work places is staggering.

We have an ambitious plan for the monorail sys-tem, which includes 30 stations to be connected tocommercial buildings throughout Jakarta. The chal-lenges to developing and implementing the monorail

will not be easy to overcome; however, the rewardsand benefits to the city will make the efforts worth-while. Our investors have fully supported us and havegiven us confidence moving forward

What will be the indirect or knock-on effects of

the monorail project for Jakarta?

SYUKUR: According to our property advisor, the landaround the monorail is set to triple in value upon proj-ect completion. Therefore, people with sufficientassets are starting to invest in nearby properties.

We are modelling our system on Thailand’s BTSGroup. The firm in Bangkok went public and was ableto raise $2bn. With that money they started to devel-op a new monorail line. Similar as well to Bangkok, weare considering a spin-off media business to capi-talise on the advertisements throughout the stations.

People will have easier access to the Jakarta CBDarea. Our green line means that people can travelhere from all parts of Jakarta. The monorail will pro-vide for clean, efficient and timely travel. Without themonorail, travel times become unreliable and unpre-dictable. Traffic sometimes means that people can trav-el up to two and a half hours.

How did you find a price point for tickets?

SYUKUR: We hired a Japanese consultancy, whichfound that ticket prices cannot exceed Rp10,000 ($1)in order to attract the desired 250,000 users per day.We project that total capacity will be around 600,000passengers per day, which we will predict will happenbetween 2020 and 2025. Once this occurs, we will haveto discuss the creation of additional routes.

Unfortunately our demand model didn’t considerthe introduction of the Low Cost Green Cars pro-gramme, which is set to flood the country with cheapcars. The policy is completely against our ethos of improving the environment. There are already1000 new cars and 5000 new motorbikes beingadded to the roads every day. This needs to be curtailed.

268

Rapid transitOBG talks to Sukmawati Syukur, President Director, Monorail


TRANSPORT ANALYSIS

Responsibility for land acquisition lies with the government

Investors will risk capital on long-term projects onlywhen they expect to capture adequate returns fromtheir investments. However, they will only do that ifthey can forecast, with some certainty, the lengthof time it will take to complete such projects. Since1993, the Indonesian government has promulgatedvarious regulations on land acquisition hoping thiswill encourage investors to make long-term com-mitments to infrastructural projects.CHALLENGES: The reluctance to fast-track landacquisition has caused lengthy project delays andcost overruns. The difficulty of acquiring land in areasonable period of time has tended to discourageinvestment in transport infrastructure such as roads,where land is a critical factor. Some of Indonesia’slaws are also not mutually supportive of one anoth-er. For example, the Land Expropriation Act No. 20of 1961 (issued under the Basic Agrarian Act 1960)and Forestry Law 41 of 1999 have objectives thatdo not support each other. These laws are not well-defined and have often ended up causing disputeswith the National Land Agency (Badan PertanahanNasional, BPN). A survey conducted by the IslamicDevelopment Bank in 2009 found that investors con-sidered the difficulty of acquiring land as the singlelargest constraint to infrastructure development inIndonesia. Other impediments included weak humanand institutional capacity, poor quality of gover-nance, and difficulties in finding adequate finance.

Given Indonesia’s pressing needs and its vast geo-graphical expanse, investors have often wonderedwhy the acquisition of land has been so difficult. Theanswer lies in a combination of factors, from thedesire of landowners to receive the highest price pos-sible for their property to corruption and an absenceof will on the part of the government to properlyenforce legislation. Landowners often inflate pricesof land needed for infrastructure projects. Forinstance, 65% of the land acquisition problems thathave occurred since 1970 were related to conflict

over compensation. Although Indonesia has legis-lation to address speculative activity, the law is notadequately enforced, and the government appearsto lack the will to do so. The Land Acquisition Act,which was passed by the parliament in 2011, wassupposed to make it easier for the government toacquire land for infrastructural projects. But in August2012, a presidential decree exempted all infrastruc-tural projects for which land was under negotiationsoutside the purview of the law until 2015, provok-ing much anxiety among investors. This effectivelydelayed the implementation of the law, and theentire episode brought to attention just how prob-lematic the issue of land acquisition is in Indonesia. EXPOSED TO RISK: The responsibility for acquiringland for any public infrastructure rests with the gov-ernment. For infrastructure projects undertaken aspublic-private partnerships (PPPs), regulationrequires that, before the tendering process, the gov-ernment will prepare, finance and execute the landacquisition plan. However, this has not yet been ful-ly implemented in practice due to limited governmentbudget allocations as well as the complexity of theacquisition process. Theoretically, a consensus isreached in advance about the schedule for landacquisition in the concession contract, with the gov-ernment responsible for acquiring the land, and theprivate sector responsible for financing the acqui-sition. The agreed land cost is to be paid by theinvestors after the land has been cleared for con-struction. This is supposed to give investors confi-dence of completing the project within a reasonabletime span. In reality, however, the government’sacquisition process takes much longer than antici-pated, resulting in cost overruns and delays in imple-mentation. The core issue is reaching agreement ona suitable price. The negotiations are conductedbetween the government and the landowners butoften turn out to be lengthy and frustrating, involv-ing diverse stakeholders, such as local government,

A survey conducted by the

Islamic Development Bank

in 2009 found that

investors considered the

difficulty of acquiring land

as the single largest

constraint on the

development of

infrastructure in Indonesia.

269


Landowners often inflate

the price of land needed

for infrastructure projects.

For instance, 65% of the

land acquisition problems

that have occurred since

1970 were related to

conflict over

compensation.

The promised landDifficulties around land acquisition remain a significant challenge

TRANSPORT ANALYSIS

landowners and non-governmental organisations.This exposes private investors to substantial risks dur-ing the project implementation stage.

Investors in toll road projects have been particu-larly vulnerable. As banks have been reluctant tolend money for land acquisition due to uncertain-ties surrounding the costs and acquisition period, tollroad developers rely on equity to finance land pur-chases. This arrangement is especially risky forinvestors in urban toll road projects, where the costof land can make up much as 50% of the total cost.Due to the slow land acquisition process, 20 of the24 toll road projects for which concessions agree-ments have been signed are stalled or experiencingsignificant delays, some dating as far back as 1996.

It is therefore unsurprising that investors havebeen reluctant to participate in bids. In 2007, forinstance, the Toll Road Regulatory Agency (BadanPengatur Jalan Tol, BPJT) invited tenders for 13 tollroad projects under its so-called “Batch II” package.However, it received just six bids. The tenders weresubsequently cancelled due to lack of interest, andthe agency had to consider restructuring the proj-ects. Discussions with investors revealed that lackof interest was because the rights of way for the landshad not been acquired for any of the 13 toll roadstendered, and the proposed concession agreementswere not seen as being bankable.

Even seasoned investors have been hurt by landacquisition problems. Citra Marga Nusaphala Persa-da (CMNP), Indonesia’s first private toll road opera-tor, had initially budgeted Rp700bn ($70m) for theDepok-Antasari toll road. But by 2012 the cost ofacquiring land rose to such an extent, reachingRp1.8trn ($180m), that the financial viability of theentire project came into question, forcing CMNP tore-negotiate the concession agreement with BPJT. MAKING IT EASIER: Presidential Regulation 65 of2006 has limited the legal options available to prop-erty owners to challenge government attempts to

acquire land for infrastructure projects. It also aimedat shortening the process and capping the cost ofland. However, the government has remained waryof acquiring land through legal proceedings, prefer-ring negotiations with landowners and establishinga revolving fund managed by the Ministry of PublicWorks and dedicated to acquiring land. In generalthis acquisition risk, which currently rests with theinvestor, should be addressed by the government pri-or to the investment decision, or be borne by thegovernment. That said, if the government is able tospeed up land acquisition it could boost the enthu-siasm of investors for the transport infrastructuresector, and so take Indonesia one step closer towardsrealising the goals of the Master Plan for the Accel-eration and Expansion of Economic Development,commonly known as MP3EI.

One key road project to benefit from speedy landacquisition would be the 653-km Trans-Java toll road.The project is part of the government’s plan to boostconnectivity between the eastern and western partsof Java – the longest part is the 116-km Cikampek-Palimanan section – but has seen several sectionsstalled due to problems with acquiring land. It hasaffected the financial position of the Bakrie Group,one of the companies working on the project, forc-ing it to halt construction. Another key road projectto benefit would be the 1000-km Trans-Sumatra tollroad which is scheduled for completion in 2015.

Railway infrastructure projects are also expectedto benefit significantly from swift land acquisition,due to their sizeable land requirements. Attractedby Indonesia’s plentiful coal reserves, the ongoingdevelopment of freight railways has successfullydrawn substantial investment. However, the govern-ment’s attempts to convert this interest into realisedinvestments suffered a setback in 2013 after India’sAdani Group pulled out of a $1.65bn railway projectwhich would have connected the Bukit Asam minein Tanjung Enim to the Sumatran port of Tanjung Api-api – a distance of some 250 km. The deal collapsedafter the Indian conglomerate balked at rising costs,mainly attributed to slow land acquisition and a min-isterial decree that gave control of the railway lineto the state-owned mining corporation Bukit Asam.Had it been completed, the railway would have beenable to transport 35m tonnes of coal each year.FORGING CONNECTIONS: Land acquisition couldassist plans to build a 144-km high-speed railwayline between Jakarta and Bandung. This is expect-ed to cost Rp56.1trn ($5.61bn) and is reportedlybeing developed through the framework of a PPP,based on the model of Japan’s Shinkansen. It will havesix stations, including one connecting to the plannedKarawang International Airport in Jakarta. Althoughthe effects of land acquisition are less likely to havean impact on the airport sector, it will still have amaterial impact on the project. This will be benefi-cial in attracting private investment as the govern-ment has shown itself to be willing to contract outairport operations and services to private companies.

270

Railway infrastructure projects are expected to benefit significantly from swifter land acquisition

The government has

remained wary of

acquiring land through

legal proceedings,

preferring negotiations

with landowners and

establishing a revolving

fund managed by the

Ministry of Public Works

and dedicated to acquiring

land.


TRANSPORT ANALYSIS

Major shipping lines have opened operations in Indonesia

Sea transport is vitally important to Indonesia. Thearchipelago nation’s maritime zone covers 7.9m sq km,almost four times its land area. While coastal ship-ping accounts for about 7% of total national freightand passenger movements, 90% of Indonesia’s exter-nal trade is conducted through seaports. Between2005 and 2010 container throughput increased by11%. Despite this double-digit growth, Indonesia’sports handle no more than 10m twenty-foot equiva-lent units (TEUs) of cargo annually – far below mostof its Asian peers. Indonesia’s geographical positionplaces it at the centre of some of the world’s majorshipping routes. Major shipping lines such as Maer-sk Line, CMA CGM, Hamburg Sud and Evergreen haveoperations in Indonesia. Given its geography, popu-lation, size and sheer dependence on waterbornetransport, the development of port infrastructureacquires critical importance for Indonesia. LAGGING BEHIND: Indonesia is served by over 700ports. Of these, 111 are commercial ports operatedby state-owned companies Pelindo I, II, III and IV, andonly 11 are container ports. The bulk of the contain-er traffic is processed through three main containerterminals: Tanjung Priok in Jakarta, Tanjung Emas inSemarang, and Tanjung Perak in Surabaya. TanjungPriok is the country’s largest international containerterminal and handles 65% of its entire cargo trade. Itis extremely congested and is working well beyond itspeak capacity. Tanjung Priok’s performance lags behindthat of most other major ports in South-east Asia.Measured by container volume handled, the portranked 24th in a list of 50 major ports in the 2005World Port Rankings (Containerisation International2008). Tanjung Priok also falls behind in Customsclearance, ship turn around time and port efficiency.The performance of smaller ports is little better. Car-go movement productivity at almost all Indonesianports is slow. The average turnaround time for shipsis anything between three and five days, with load-ing and unloading activity taking up to 35% of the time

at the port. Therefore, despite its many advantagesIndonesia has not yet emerged as a logistics hub. Thesingle most important factor inhibiting Indonesia’semergence as a major supply chain centre is the rel-atively dilapidated condition of its port infrastructure.According to the World Economic Forum’s “GlobalCompetitiveness Report 2013-14”, the country’s portsscored a 3.9 out of 7.0 and ranked 89th in a list of 148countries. They are not expanding or modernisingquickly enough to keep pace with the country’s macro-economic growth. Indonesia has few natural deepwa-ter harbours, and its river system is prone to serioussiltation, which restricts port depth.

Therefore, the country’s ports are only able toaccommodate ships that are carrying up to 4000 con-tainers. Although this is adequate for intra-Asian trade,it has made servicing markets further afield highlyuncompetitive. As a result, Indonesian ports havebeen left behind by neighbouring Asian rivals such asVietnam, which have become ports of call for directservices to the US and Europe owing to their abilityto handle larger vessels. Similarly, connections betweenports require further improvement.

“Intra-port connectivity in the form of road and railinfrastructure is absolutely vital and more taxationshould be placed upon road users so to reduce usageof these particular roads or at least improve theircurrent quality and durability,” Danang S Baskoro, pres-ident director of ASDP Ferry, told OBG.CONGESTION: Since the ASEAN-China Free TradeAgreement came into effect in January 2010, TanjungPriok, the country’s main trade gateway, has seenconstant congestion. Tanjung Priok was designed tohandle 5m TEUs, but it handled 5.6m TEUs in 2011and 6.2m TEUs in 2012. Container throughput at thefacility is projected to expand by 65.5% in the next fouryears to reach 10.3m TEUs in 2017. However, withoutsignificant investments in port capacity expansion aswell as an overhaul of its infrastructure, it is hard tosee how Tanjung Priok could manage such an increase.

While coastal shipping

accounts for about 7% of

total national freight and

passenger movements,

90% of Indonesia’s external

trade is conducted

through seaports.

273


Prioritising portsThe modernisation of ports is a prerequisite for economic expansion

TRANSPORT ANALYSIS

NEW DEVELOPMENTS: But the outlook is not allgloomy. Investments are being made in port develop-ment. The most exciting case is the development ofa new facility, 7 km along the coast from Tanjung Priok,known as the New Priok, or Kalibaru Port. It will cost$2.5bn and is expected to be completed by 2018.Pelindo II officially started construction in March 2013.The first phase of New Priok, a 1.5m-TEU-capacitycontainer terminal, is due to open in the second halfof 2014. With a 16-metre draught, the facility will beable to handle large ships with capacity of up to 8000TEUs. Plans are afoot for the port to ultimately accom-modate to very large container vessels with a capac-ity of 18,000 TEUs or more. The first two phases willcost up to $4bn. Medium-term developments at thenew port, which include plans to add two more con-tainer terminals with a total capacity of 3m TEUs bythe end of 2016, will ensure the facility remains aheadof demand and problems of congestion can be over-come. The New Priok port signals lucrative opportu-nities for the investors in Indonesia’s port infrastruc-ture sector. Once completed it will have a total capacityof 13m TEUs, making it by far the single largest portin Indonesia. However, the port is not the only one inthe pipeline. Indonesia also has plans to develop adiverse number of container ports.

Pelindo III is to build a new terminal at the Teluk Lam-ong Port in Surabaya, East Java that will begin oper-ations in 2014. The port will have a 600,000-TEUcapacity, with a 950-metre-long quay and maximumbasin depth of 14 metres. Pelindo IV will also start workon the Makassar New Port in 2014. It will have an annu-al cargo handling capacity of almost 300,000 TEUs inits first phase of development and will feature a draftof 14 metres and a dockyard of 320 metres. The newport is expected to be operational by the end of 2016.Two other container facilities – Kuala Tanjung Port andTanjung Sauh Port – will add a further 1m TEUs and4m TEUs, respectively, to Indonesia’s container port’scapacity. Kuala Tanjung Port will be able to handle the

new class of mega vessels with a draught of 17m. Atotal of eight port projects worth $15.8bn were envi-sioned in 2012. This includes construction work of$4.14bn at the Cilamaya Port in Karawang, West Java(scheduled to begin in 2017) and $3.2bn for theBitung International Port in North Sulawesi. PRIVATE SECTOR PARTICIPATION: Investors havemostly shied away from port infrastructure due to thelack of a clear regulatory framework, few bankable proj-ects and low returns on investment. PPPs started in1995 with a concession to Hutchison Whampoa torehabilitate and operate Koja Container Terminal for20 years. Desperate to raise capital during the Asianfinancial crisis, the government carried out a partialprivatisation of the Jakarta International ContainerTerminal, selling a 52% stake to Hutchison Whampoa.It also sold 49% of Tanjung Perak Container Terminalto P&O (DP World). Subsequent efforts to offer Bojone-gara Port in West Java and Lamong Bay Port in EastJava to private investors have not been successful.

Before the new maritime law (Law 17 of 2008)came into force, Pelindos acted both as landlords andan operator under PPP contracts. This has deterredprivate investment. There are simply too few PPP proj-ects to go around. Then there is the question of tar-iffs. Investors expect port tariffs to be determinedthrough a competitive bidding process, but tariffs, inaccordance with law, are set by the port authority afterconsultation with the Ministry of Transportation andare often too low to generate interest from investors.BIG PLAYERS SHOW INTEREST: Indonesia’s mostpressing challenge will be to improve the efficiencyof its ports. In 2014 the country’s four major port oper-ators – Pelindo I, II, III and IV – will come together toform a new container terminal company, PetikemasIndonesia. The new company will operate terminalsat Belawan (North Sumatra), Batu Ampar (Batam),Tanjung Priok, Tanjung Perak (Surabaya), Makassar(South Sulawesi) and Sorong (Papua). It is hoped thatby pooling resources and sharing expertise the oper-ator will cut down on the cost of logistics and inte-grate terminal operations across the island.

International terminal operators are slowly expand-ing their footprints and getting more involved in run-ning facilities and developing ports in Indonesia. Thedevelopment and operation of the first New Priokcontainer terminal was awarded to Japan’s Mitsui &Co in February 2013. This Japanese investment is setto attract the Japanese shipping lines Mitsui OSK andNYK to the terminal as well as Evergreen, Hanjin Ship-ping and APL. Singapore-based international portsoperator PSA International is reportedly keen to par-ticipate in a bidding process for the main contract todevelop the New Priok Container Terminal. A total of18 international firms including Hutchison Port Hold-ings (HPH), DP World and APM Terminals have shownan interest in operating the other two terminals at thenew facility. Meanwhile, CMA CGM is set to take partin developing the planned port of Tanjung Sauh. Devel-opments such as these should go a long way in improving investor confidence in the transport sector.

274

Port tariffs are often considered to be too low to generate interest from potential investors

Investors have mostly shied

away from port

infrastructure due to the

lack of a clear and

predictable regulatory

framework, a shortage of

bankable projects and low

returns on investment.

The New Priok port signals

lucrative opportunities for

investors in infrastructure.

Once completed, New Priok

will have a total capacity of

13m TEUs, making it the

single largest port in

Indonesia.


TRANSPORT ANALYSIS

The cost of logistics is equal to about 24-27% of GDP

The government is addressing challenges relating to alack of high-quality infrastructure by encouraging pub-lic-private partnerships (PPPs). Infrastructure investmenthas lagged in recent years, averaging 3-4% of GDP since2000, well down on the 7% or more from before theAsian financial crisis in the late 1990s. While recent yearshave seen some spikes, notably in 2009 and 2010,when infrastructure investment averaged close to 6%of GDP, spending has again fallen back to 4%. The costto the economy is likely significant. Insufficient infra-structure places burdens on existing businesses, whichmust deal with transport and logistics systems that arenot equipped to handle current volumes, and commu-nication networks that are outdated. The IndonesianLogistics Association has said the cost of logistics isequivalent to 24-27% of GDP, compared to 19-22% inother Asian countries. Inadequate infrastructure alsodiscourages global businesses from setting up shop inIndonesia, as foreign investors seek out more favourableenvironments. According to a recent report by theQatar-based QNB Group, ageing infrastructure in Indone-sia is holding back GDP growth by 3-4% each year. Thebank has estimated that the economy will grow at 5%per year in the 2015-18 period, below trend, due to thepoor state of infrastructure.PLANS TO ACCELERATE INVESTMENT: The govern-ment is well aware of the challenges that it faces andhas proposed several plans to address infrastructuralshortcomings. The National Medium-Term Develop-ment Plan 2010-14 states that infrastructure invest-ment will be focused on meeting basic needs as wellas on improving the competitiveness of Indonesianproducts. The central government estimated that thenecessary investment over the 2010-14 period amount-ed to Rp1923trn ($192.3bn), with some 70% of this tocome from the private sector, PPPs, local governmentsand state-owned enterprises (SOEs).

However, the most significant driver behind infrastruc-ture development will be the Master Plan for the Accel-eration and Expansion of Indonesian Economic Growth

2011-25, or MP3EI, issued in 2011. This augments ratherthan replaces existing government initiatives, such asthe National Medium-Term Development Plan. It is amore focused document, and one that places partic-ular importance on infrastructure.

The government has estimated that a total Rp4012trn($340.12bn) will be spent on MP3EI, with Rp1786trn($178.6bn) allocated to infrastructure. The central gov-ernment is expected to account for about 10% of fund-ing, with 18% to come from SOEs, 51% from privateenterprise and 21% from PPPs. Of the 79 MP3EI proj-ects, 32 are set to be PPPs. According to Wishnu Ward-hana, chair of APEC Business Advisory Council 2013 andgroup CEO of Indika Energy, the biggest obstacles arelegal and regulatory, as well as coordination amonginstitutions and the central and local governments.“We have been discussing PPP for a long time, yetprogress has been limited. The public sector needs toaddress the regulatory environment. Infrastructure isa long-term investment, and businesses want to ensurethat they will earn adequate return, and for that rea-son, issues such as legal certainty, risk environmentand overall investment climate matter,” Wardhana toldOBG. He added that many projects have been delayed,which has undermined overall confidence in the gov-ernment and added to investor costs.NEW MOMENTUM: The government hopes to give theMP3EI added momentum, with the Ministry of Nation-al Development Planning and the Ministry of Economyhaving identified 27 priority projects intended to launchin 2014. These projects, with a combined price tag of$47.5bn and encompassing the transport, utilities andcommunications sectors, are set to be carried out asPPPs. This is a positive development, suggesting thatthe government is committed to speeding up the pro-vision of essential infrastructure. Having said that, theroll-out of these projects is likely to be a lengthy process,and while there are significant opportunities forinvestors and contractors, downside factors will haveto be weighed carefully during the negotiation stages.

The Ministry of National

Development Planning and

the Ministry of Economy

have together identified 27

priority projects that are

intended to launch in 2014.

277


According to a recent

report, ageing

infrastructure in Indonesia

is holding back GDP growth

by 3-4% each year. Forecast

growth of 5% per year over

the 2015-18 period is below

trend, due to the poor state

of infrastructure.

Seizing momentumShortcomings in infrastructure supply are gradually being addressed

TRANSPORT INTERVIEW

Djarwo Surjanto, President Director, Pelindo III

How will the creation of the Teluk Lamong termi-

nal and the Java Integrated Industrial and Port Estate

(JIIPE) affect the economy of East Java?

SURJANTO: The development of the Teluk Lamong ter-minal will go a long way toward improving Surabaya’soverall port capacity. Other than the boost in capaci-ty, Teluk Lamong represents the future standard for thenation’s ports due to the fact that it is an entirely greenterminal. We agreed with Organda, the national landtransportation association, that Teluk Lamong will beserviced only by trucks running on natural gas ratherthan gasoline. We must initially accommodate trucksusing other fuel types, but we are hoping that withinsix months all of our customers and partners will accli-matise to this new standard. Furthermore, by askingtruckers to use gas, we are to some extent indirectlyhelping the government to decrease the gasoline sub-sidy, if only by a small amount at first. We are planningon launching this green terminal concept with TelukLamong, then moving towards the conversion of oth-er existing conventional terminals. This way, within fiveyears, we hope that all operations in the Tanjung Per-ak port in Surabaya will be gas-based.

The JIIPE, which we are developing in partnershipwith AKR Corporindo, will serve a significant role in thefuture growth of Surabaya. An industrial park of thisscale will have a number of immediate economicimpacts. In addition to the job creation that will occuras firms establish operations in Surabaya, JIIPE is alsoexpected to stimulate additional exports from East Javaand facilitate greater logistical efficiencies, by minimis-ing the distance from the industrial park to the port.

How are port operators preparing for the increase

in activity brought on by the growth of the econo-

my and improvements in regional integration?

SURJANTO: Port operators are rapidly scaling up devel-opment activity in anticipation for this increase in activ-ity. Although Teluk Lamong is not yet finished, we arealready beginning development on other integrated

terminals. When the ASEAN Economic Communitybecomes a reality, we have to be at least as efficient,and to offer the same level of services, as our neigh-bours including Malaysia, Thailand and the Philippines.We are therefore pursuing many concurrent projectssuch as the development of Teluk Lamong and the JavaIntegrated Industrial and Port Estate; the constructionof further ports in Central Java; and the creation ofnew projects that will help to prevent flooding at ports.

Investments are also taking place in order to enhanceservice quality. We can work in conjunction with ourASEAN neighbours and with nations around the worldto facilitate these improvements. In areas like the devel-opment of our human capital, for example, we send per-sonnel overseas to attain the highest levels of trainingand to use that experience to ensure the sustaineddevelopment of local ports at global standards.

What role can partnerships with foreign firms play

in the continued development of Surabaya’s ports?

SURJANTO: In terms of terminal operations, it is cru-cial for us to partner with foreign companies to enhancethe quality of our services. In areas like dredging, theexperts are all from the Netherlands, and we work inconjunction with them to develop these processes inIndonesia. The key thing when it comes to foreign part-ners is the development of long-standing partnerships.We fully understand that the government has a limit-ed budget with various priorities, and therefore the eco-nomic players themselves must take an active role inproviding the demand for this level of growth.

Through our partnerships with companies like VanOord, with whom we are working on deepening andwidening access channels, we are providing an exam-ple to the community that this is the way forward forour continued growth. The industrial park will providea basis for more companies to come to Surabaya thathave the capacity to form these kinds of partnerships.With this in place, I am confident that East Java can con-tinue to attain high levels of growth in the years to come.

278

Sustained developmentOBG talks to Djarwo Surjanto, President Director, Pelindo III (PERSERO)


279

Telecoms & ITTelecoms market poised for much-needed consolidationLong-running decline in ARPU set to be haltedFostering a stronger data culture one of the tasks aheadAddressing the last-mile challenges facing broadbandImproved international connectivity a high priority

TELECOMS OVERVIEW

The country currently has some 36m smartphone subscribers

In some ways, little has changed in Indonesian tele-coms over the past year. The country still has eightoperators and average revenue per user (ARPU) isstill among the lowest in the world because the mar-ket is so crowded. In other ways, everything haschanged. Mergers are in the works and the marketis poised for consolidation. Once the number ofproviders is reduced to seven, it is expected thatpricing will stabilise, investment will rise and quali-ty will improve, resulting in more usage and bettermargins. “This is the most bullish period in 10 years,”said Riaz Hyder, a research analyst at MacquarieSecurities. “We are seeing evidence of consolidation.”KEY DEAL: The XL Axiata and Axis Telekom Indone-sia merger was made official in 2014. The former is66.5% owned by Malaysia’s Axiata Group and underthe agreement the firm bought a 95% stake in Axis,which was owned by the Saudi Telecom Company.The deal received bureaucratic support, as the gov-ernment wanted to reduce the number of players inthe market. In July 2013 the Ministry of Communi-cations and Information Technology (MoCI) gaveconditional approval, requiring that the new entityrelinquished a number of blocks of mobile frequen-cy spectrum. Satisfied that the conditions would bemet, the MoCI gave the deal the go ahead in late2013. After pricing and specifics regarding integra-tion were worked out, the merger was completed inearly April 2014. The combined entity is now thesecond-largest player in Indonesia. XL Axiata has49m subscribers, while Axis has an estimated 17m.Together, the two will probably have more thanIndosat’s 59m subscribers. “Competition will likelyease due to the Axis deal,” said Leonardo HenryGavaza, a research analyst at Bahana Securities.

Now that the deal is concluded momentum shouldbuild, with further transactions helping to bringprices into alignment. Hutchison 3 Indonesia is oneof the most aggressive on data pricing, despite itsrelatively low market share, which was estimated at

7% in early 2013. It keeps the top three from con-trolling more than 70% of the market, and its priceskeep the competitors off balance. There has beenspeculation over a possible Hutchison 3 acquisitionof Indosat, which could give the latter the financialand technological strength needed to compete withTelekomunikasi Selular (Telkomsel), although therewas no news on this at time of press.

The market is looking to end a free-for-all that hasresulted in low ARPU and underinvestment in criti-cal network infrastructure. It is generally believed thatthe ideal size of a telecoms market is two or threemajor operators. “Hutch has been the most aggres-sive on data pricing,” said Hyder. “Only when it exitswill we move to a more stable oligopolistic structure.Until then pricing will not move up.”BREAKING AWAY: Along with talk of a turnaroundcomes an increasing sense that the market is evolv-ing and becoming more segmented, with increaseddifferentiation among players. This is also helping theindustry to move beyond the commodity stage, ascustomers begin to pick and choose and are nolonger seeing all carriers as being the same.

Most importantly, Telkomsel – a unit of TelkomIndonesia that is 35% owned by Singapore Telecom-munications – is breaking away from the pack. Whileit has always been well ahead of the crowd, given itsstrong shareholding and financial position, and supe-rior network, its leadership is now recognised, asmuch of the rest of the sector struggles under debtor operating losses. The primacy of Telkomsel couldhelp stabilise the market. With a stable market leader,other companies could fall into line and take pric-ing and services cues from the top company.LONG TIME COMING: The light at the end of the tun-nel has been a long time coming. Since XL initiateda price war in 2007, when it broke the Rp1/minutebarrier, the market has struggled to regain its foot-ing. Telkomsel almost doubled its subscriber num-bers over four years – from 65m in 2008 to 125m

There is a growing sense

that the market is evolving,

with increased

differentiation among

players as customers begin

to pick and choose.

The merger between XL

Axiata and Axis Telekom

Indonesia received

approval from the MoCI in

December 2013, and the

deal was completed in

2014. The combined entity

is set to become the

second-largest player in

Indonesia.

280

Consolidate to accumulateA reduction in the number of players could help shore up ARPU


TELECOMS OVERVIEW

in 2012 – but ARPU has dropped by more than a third,from Rp59,000 ($5.90) to Rp39,000 ($3.90). AtIndosat, ARPU fell from Rp38,639 ($3.90) to Rp27,400($2.70) over the same period, as subscriber numbersrose from 37m to 59m. The penetration rate haspassed 100%, standing at 117% in early 2013. Evenby 2011 there was a feeling that the market was sat-urated, with little growth possible by adding newcall and text subscribers. With price wars the ruleand ARPU low, service suffered, with reports ofdropped or missed calls and poor signal quality.

The number of telecoms companies has remainedhigh, despite heavy losses for some. Bakrie Telecomis a good example. In 2012 the company lost Rp3.1trn($310m) on declining revenues. While it recoveredsomewhat in 2013, it continued losing money:Rp293bn ($29.3m) in the first half of 2013. Axisreported a net loss of Rp5.5trn ($550m) in 2012.

Mobile phone businesses bring prestige to theirowners, which may be a contributory factor in somebeing retained despite losses. Yet there are alsopractical considerations at work. Merging is not assimple as it may seem, with integration proving tobe a problem. The merger of Smart Telecom andMobile 8, for example, was complicated and costly.According to ZTE, which assisted with the integra-tion, the two companies were working off two verydifferent platforms that offered different features.The challenge was to combine the systems seamless-ly into one without loss of functionality, and do sowithout existing vendor support, as past vendorsgenerally refuse to help once they know that theyare being replaced. Mergers between carriers maybring as many expenses as benefits, with the poten-tial for service interruption. “Network integrationcan be a headache,” said Chandra Pasaribu, head ofequity research at Danareksa Sekuritas.SPECTRUM: The business of a smaller carrier maynot be worth much given the trouble involved incombining entities. It may be more expensive to con-sume the assets than they are worth. Still, mergerswill take place, if not for the networks, customerbases and technology then for the spectrum. Indone-sia has a shortage of spectrum and mergers are thebest way for a company to increase its service.

Hutchison 3 and Axis are particularly attractive inthis respect. In a March 2013 report, CIMB said thetwo companies had the lowest number of SIM cardsper unit of bandwidth, with the former at 1.05m SIMcards per MHz and the latter at 680,000 SIMs perMHz. That compares with 2.68m SIMs per MHz atTelkomsel. While additional spectrum has been auc-tioned since the report and refarming could boostcapacity, spectrum remains at a premium and will beneeded for firms seeking to offer stable data prod-ucts in the future. It is also important because itreduces the number of base transceiver stations(BTS) needed, reducing capital costs. The physicalassets may not be of interest to buyers, but the spec-trum is. This has resulted in deadlock, whereby sell-ers believe their business is worth more than what

is offered, while buyers are only willing to pay for thespectrum. “Why is consolidation not happening?They want spectrum and nothing else,” said Pasaribu.“With more spectrum you do not need more BTS.”AUCTION: New spectrum has been added, but slow-ly and in a way that leaves the market in need of reor-ganisation. In late 2012, after four postponements,the MoCI auctioned two blocks in the 2100 MHzfrequency, bringing the total at that frequency to 12blocks. Telkomsel and XL Axiata were announced asthe winning bidders in March 2013. While this willhelp, it does not solve the long-term spectrum prob-lems. The 2100 MHz frequency, for example, is messydespite being relatively new. Five operators havespectrum there, but their channels tend to be sep-arated. For example, Hutch 3’s two channels are splitby Telkomsel and Axis channels. Concerns have alsobeen raised about interference from Smart Tele-com’s CDMA frequency. It is hoped that spectrumwill be rearranged so that all operators at 2100 MHzhave contiguous channels. The worry is that rearranging channels will be costly and disruptive.

281


Integration when attempting mergers has proved problematic

Spectrum is at a premium

and will be needed by firms

seeking to offer stable data

products. It also reduces

the number of base

transceiver stations that

are required, thereby

lowering capital costs.

0

20

40

60

80

100

120

Users (m)

2017*2016*2015*2014*2013201220110

9

18

27

36

45

54

% of total

Smartphone users, 2011-17

SOU

RCE:

eM

arke

ter

*F

orec

ast

TELECOMS OVERVIEW

Between 478 MHz and 806 MHz is used for ana-logue television, and a dividend of 112 MHz is expect-ed when digital TV arrives in 2015 in the large citiesand nationwide in 2018. At 2600 MHz, the spectrumis used by satellite TV and broadband wireless. At1800 MHz, operators have non-contiguous blocks– Telkomsel has three blocks and Indosat two – andit is not known whether refarming could be done tosupport newer technologies. At 850 MHz, four oper-ators are providing CDMA services, each with only5 MHz, too narrow for newer technologies. Theresources exist, but they are not properly arranged.

However, changes are afoot. In August 2012Indosat received permission to use the 900 MHz fre-quency on a technology-neutral basis. The compa-ny had been providing 2G services at 900 MHz, whereit has 10 MHz of bandwidth. By October 2013 it wastesting 3G services at that frequency in Bukittinggi,West Sumatra, and planning to roll out the servicein Jakarta, Depok, Tangerang, Bekasi, West Java andBali, according to Indonesia Finance Today. Mean-while, Telkomsel has asked that its 22.5 MHz of band-width at 1800 MHz be made technology neutral.The plan is to go straight from 2G to 4G service atthat frequency. XL also has bandwidth at 900 MHz.The Axis-XL Axiata merger should change the land-scape. The former has bandwidth at 2100 MHz and1800 MHz and the latter at 2100, 1800 and 900. Butthe MoCI has said that spectrum is the government’sproperty and that decisions on usage are for the gov-ernment to make, not companies. DATA: Development of data will take time and involvebreaking key thresholds. The quality of data is cur-rently low and the experience for smartphone usersis inconsistent at best, with slow download speeds,low capacity in congested areas and spotty cover-age outside city centres. Operators want to get dataservices to more people, so their fees are low for therelevant services. In Indonesia, a megabyte of mobilebroadband costs about 8 cents. In Singapore it isabout 15 cents and in Malaysia about 30 cents. Theresult is a vicious circle. As customers have a less-than-optimal experience, they tend not to use dataservices much. This makes it more difficult for oper-ators to justify investment in their data networks,which contributes to weak service.

However, analysts say the data market is startingto achieve the critical mass needed to justify signif-icant investment. Venture capital firm Kleiner PerkinsCaufield & Byers reports that Indonesia has 36msmartphone subscribers, and that the total numberof users is estimated to have grown by 34% over2012. It is predicted that the tipping point will comewhen the price of a smartphone drops to $50 ahandset. It is now at around $70. “Pricing is quite low,and service is poor. Once the service is good, peo-ple will use it more,” Stifanus Sulistyo, a researchanalyst at Bahana Securities, told OBG.

Consumer behaviour partly explains the lack ofdemand for fast networks. As the existing connec-tions are limited in terms of bandwidth, users have

become accustomed to using applications and serv-ices that do not require high data transfer volumes.The market has evolved around the offerings. Pro-viding more bandwidth may not result in much take-up at this point, as it would require people to dumpapplications they like and learn new ones. “That iswhy providers are taking it slowly. People are onlyusing it for chatting and surfing. If we rush into 4G,it will only be used for streaming and social media,”said Aditya Eka Prakasa, a research analyst at Bahana.BUREAUCRACY VS. TECHNOLOGY: The lack of thedevelopment in 4G services is partly a result ofbureaucratic indecision. The government has beenslow to publish specifications. In 2012 the MoCI saidit would take at least two years to get everything set-tled and standards published. This would leave thecountry as one of the few in the region without 4G.

The government backed WiMAX in 2011, bettingon a system that has been overtaken globally byLong-Term Evolution (LTE). It is now treading care-fully while trying to rearrange the spectrum for LTE.The government would like to go with the 700 MHZfrequency for LTE, as it is far more efficient than 2300MHz (which was reserved in 2010 for 4G), but as 700MHz is currently used for television, it could be a num-ber of years before bandwidth is available.

That said, momentum is building. In early 2013,Indosat held LTE trials in Bandung and Surabaya, andXL Axiata and Telkomsel offered LTE services on BaliIsland during the APEC summit in October 2013.Telkomsel also said that it would be conducting LTEtrials in Medan and Manado at the end of 2013.

At the same time, the market seems to be matur-ing, and it may no longer make sense to hold backon faster services requiring large investments. Thereare signs that a turnaround in pricing is on the hori-zon due to data demand, and the commercial caseis now quite strong. According to analysis by Aus-tralian digital media consultancy Venture Consult-ing, voice ARPU will continue dropping over the nextfive years, as will SMS ARPU, but the company seesdata ARPU firming in 2014 and rising after 2015.

The sense is that the market is transforming fromone that is purely about the sale of minutes into onethat is more about providing a valuable service.“What we see now is innovation, not just pricing,”said Norico Gaman, head of research, BNI Securities.OUTLOOK: The prospects for the sector are the bestin years. Mergers, additional spectrum and new tech-nologies are helping to stop the decline in ARPUthat defined the market for so long. The vicious cir-cle is now giving way to a virtuous circle, with demandencouraging investment, which should furtherincrease demand. Much remains to be done. Thegovernment needs to sort out the issue of spec-trum, chart a course for 4G and give the marketdirection. The operators have to allow mergers to goahead. Larger companies need to offer a fair priceto reduce the number of players and the smallerfirms need to sell. Nonetheless, once a few transac-tions take place, conditions should greatly improve.

282

The quality of data is low

and the experience for

smartphone users

inconsistent at best, with

slow download speeds, low

capacity in congested areas

and spotty coverage

outside city centres.


It may no longer make

sense to hold back on

faster services requiring

large investments. There

are signs that a turnaround

in pricing is on the horizon

due to data demand, and

the commercial case is now

quite strong.

TELECOMS INTERVIEW

Arief Yahya, President Director, Telekomunikasi Indonesia

What progress has been made on the national

broadband network and how are you overcoming

the challenges of connecting the archipelago?

YAHYA: Good progress has been made, despite theinevitable challenges of connecting a nation made upof thousands of islands. To build the infrastructure forthe national broadband network, we have launchedthe Indonesia Digital Networks 2015 initiative.

So far, true broadband has reached 8.6m home pass.We are building a digital ring spanning more than 75,000km to serve as the network’s backbone, connecting allof the main islands. Most of this ring, about 68,000 km,has been completed and the Sulawesi-Maluku-Papuabranch is expected to finish by 2015. At that point, thering will reach about 85% of the population. Providingaccess for people in remote areas, however, remainsone of the biggest challenges. Satellite will be neededto connect the rest of the archipelago, in the areas fur-ther away from the main islands.

We are also looking to build more than 100,000 sqmetres of data centres. This will support informationand communications technology (ICT) in the countryand facilitate innovation in both vertical and horizon-tal markets. A project of this magnitude has not yet beenattempted, and since deploying new technology requiresnew skills and accurate planning, there are of coursemany challenges. One is ensuring that partners under-stand the new technology and are ready to set up therequired components: previously market forces servedas an effective driver, but to carry out a project of thisscale we are now having to lead and facilitate this readi-ness. Another is site acquisition. In every deploymentone has to secure the site and deal with licensing issues.To this end, we are partnering with various infrastruc-ture owners across the nation to pool resources.

How much is the growth of data services in Indone-

sia driving revenue in the sector?

YAHYA: The greatest area of growth in the sector iscurrently in mobile data. While most revenue still comes

from legacy services such as voice and SMS, these arein relative decline. In mobile, SMS is still growing atabout 8% and voice is still seeing small growth as well.The price of these services, however, is decreasing, sowe need to look elsewhere for revenue in the comingyears. In Indonesia as in all countries, voice services forfixed lines are in decline as well. We expect data serv-ices, which are reaching about 27% growth, to com-pensate for decline in these older services.

This is why we are deploying broadband so aggres-sively. It will serve as a base from which innovation cangrow. Broader penetration will have a big effect onIndonesia’s economy as a whole: a projected 10% growthin penetration could add 1.4% to the economy. Note,too, that much of the growth in mobile subscribersand data is outside of Jakarta – in Java, Sumatra, Bali,Sulawesi, and some of the larger cities in Kalimantan.This expansion of mobile data, such an important trend,is going on all around the country.

How competitive is the quality of Indonesia’s human

capital in the ICT sector, especially with ASEAN inte-

gration around the corner?

YAHYA: To be truly competitive in the region, Indone-sia must hurry to prepare a ready workforce in ICT. Theopportunity is ripe: the nation has a fast-growing youngpopulation eager to contribute to the sector’s future.There needs to be an increased focus on education –especially secondary education – that will train thenation’s young and create a talent pool at internation-al standards. Local companies are increasingly partner-ing with leading multinationals to develop the nation’smobile and cloud services. Such partnerships are cru-cial to raising Indonesia’s ICT standards to a global lev-el. Local firms also need to reach across borders toattract human capital from the region’s more advancedand saturated ICT markets such as Singapore and HongKong. I am optimistic that if these advances in educa-tion and global reach can be achieved, Indonesia could become one of the region’s leading players in ICT.

283


Broader bandOBG talks to Arief Yahya, President Director, Telekomunikasi Indonesia(Telkom)

TELECOMS INTERVIEW

Hasnul Suhaimi, President Director & CEO, XL Axiata

What is your outlook for new mobile subscribers

growth over the next 18 months, and how are oper-

ators competing for this new market?

SUHAIMI: There are between 280m and 290m activeSIM cards in Indonesia for a population of 250m, so pen-etration is nearly at 120%. Taking these statistics intoconsideration, we cannot expect significant growthunder the present market’s conditions, at least whenit comes to voice and SMS. In the past we got used todouble-digit growth, but in 2014 it will be much morecontained. Our subscriber base, for instance, grew by10%, but it did not really affect our revenue and prof-itability as prices continue to be low and the marketdoes not respond well to increases, even modest ones.

Given the increasingly high level of penetration,

which mobile business segments offer the great-

est potential for future growth?

SUHAIMI: Data transmission represents the future, butit is increasingly difficult to introduce new products inthe domestic market as margins for derivatives are toolow – 25% as opposed to 40% in the voice segment.Low revenue represents a challenge for operators andkeeps the market stagnant.

Prices will need to be revised to create a healthierenvironment for investments. Beyond data, other seg-ments such as mobile commerce, mobile money, mobileadvertising and mobile finance are growing, althoughthey are still in an early stage.

About 1% of total domestic trading is done throughe-commerce, a figure that is below the regional aver-age of 3-4% or even 10% in exceptional cases like SouthKorea. However, considering the size of the domesticmarket, it is an encouraging start. People are just begin-ning to realise the potential of e-commerce, so we aremonitoring this segment closely and forecast that it willbe taking off within three to five years. We also fore-see consolidation happening soon as seven out of 10operators compete in data transmission. A number ofmergers and acquisitions will be inevitable in the future.

How well is investment in telecoms infrastructure

keeping up with demand, and what sort of progress

has been made in terms of infrastructure sharing?

SUHAIMI: Sharing existing infrastructure will be essen-tial to streamlining the sector and increasing efficien-cy. On our side we have already cemented stronger tieswith Indosat, especially when it comes to sharing trans-mission through towers, and I must say the agreementhas proved to be successful. Moving forward, it will becrucial to also share the radio access network, some-thing that has proven to be difficult as we need addi-tional frequency to push forward the agreement. Eachoperator should receive a similar bandwidth, which isnot always the case at the moment.

How are operators balancing capital expenditures

between improving coverage and quality?

SUHAIMI: Considering Indonesia’s geography and phys-ical characteristics, as well as the need to ensure agood experience for a growing customer base, IT invest-ments in the past concentrated on coverage expansion.Currently though, the priority should be redirectedtoward creating a better balance between coverage andcapacity, which is still inadequate especially for datatransmission. I believe the sector as a whole is awareof the structural problem and soon we will be able tosplit investments equally between expanding coverageand improving the quality of the existing network.

What are the challenges facing the introduction of

long-term evolution (LTE) networks in Indonesia?

SUHAIMI: The LTE network was designed to increasethe capacity and speed of wireless data networks, andthe greatest challenge that we will face is the availabil-ity of frequencies in the domestic market. The LTE stan-dard covers a range of many different bands, each ofwhich is designated by a frequency that varies fromregion to region. Ideally, we would want the 800 MHz,1800 MHz or 2300 MHz available in Indonesia, as these are used in North America, Europe and Australia.

284

Pushing forwardOBG talks to Hasnul Suhaimi, President Director & CEO, XL Axiata


TELECOMS ANALYSIS

New mobile hardware has been flooding into the country

The mobile market in Indonesia is largely depend-ent on increased use of the right kind of handsets.Operators may be able to supply the bandwidth, butif users do not have devices to take advantage of itthe demand will not be there. The country also needsto nurture a stronger data culture if growth is to beachieved. For the operators, without the phones itdoes not make sense to invest in base transceiverstations. Yet without the capacity, customers havebeen limited to talking and texting.

However, the dilemma seems to be solving itself.In 2013 the phones started to get ahead of band-width as a result of two different trends. Low-endclones from China flooded in and acceptance ofthem increased, while perhaps more importantlySamsung made a big push in Indonesia that changedthe landscape of the market and resulted in massuse of what had previously been a luxury item. Theoperators and the regulators are now playing catchup, working to meet the bandwidth demands of thesmartphones and their users. THE SAMSUNG STORY: Samsung has been activein Indonesia for years in a wide range of product lines.It began operating in the country in 1991, makingIndonesia its second export target in the region afterThailand. It set up its first factory in the country in1992 and then another in 1993.

Samsung started selling mobile phones in Indone-sia in 1999, and reached the number two positionfor mobile sales within four years. Its operations inthe country quickly moved from export-oriented todomestic demand-oriented. In 2004, local sales forthe company were almost half of all sales for Sam-sung Indonesia, and the company decided to startincreasing its local advertising spend.

As other companies, such as Sony, were loweringtheir profile and commitment to Indonesia becauseof the slow recovery in the economy, Samsung wasdigging in. By 2011 Samsung Indonesia contributed0.5% of the group’s total global revenue. The follow-

ing year, the company set a sales goal of $1.5bn and1% of global revenues. Mobile products are expect-ed to provide most of that growth; Samsung also sellsair conditioners, cameras, microwaves, air purifiersand a range of other products in the country. PROMOTION: A key component of Samsung’s glob-al mobile phone strategy is heavy promotion, andIndonesia is no exception. The company has beenaggressively pushing its new products with adver-tising and generous campaigns. In Indonesia, mobilephone models are launched simultaneously in majorcities – the Samsung Galaxy Pocket, for example, waspremiered at 28 locations in Indonesia in May 2012– and debuted with limited-time discount offers.

The tone of the advertisements is also significant.When the company entered the market the messagewas one of luxury. Its products were expensive(around $500) and were sold as status items. Thecampaigns of the past few years have been decid-edly mass market: the theme now is that anyonecan afford a smartphone. Samsung, both in Indone-sia and globally, has ensured that even its cheapestofferings are feature-rich, although compromisesare made in terms of lower specs on some of thefeatures. The shift has been as important to the mar-ket as it has been to Samsung. The average personno longer views a smartphone as unobtainable, butas something that they should and can have. NEW OFFERINGS: One of Samsung’s recent offer-ings demonstrates its strategy at work. In Decem-ber 2013 the company introduced the SamsungGalaxy Core Advance smartphone, with the newmodel replacing the Galaxy Core, which came out justa few months earlier. Samsung is peppering the con-sumer with release after release, keeping interest highand creating a wide range of options. At present, thecompany offers approximately 40 models in Indone-sia, ranging in price from Rp1.2m ($120) to Rp9m($900). While this is a global strategy, and most ofthe models offered are international, this approach

For operators, before the

arrival of smartphones it

did not make sense to

invest in base transceiver

stations. However, without

the capacity, customers

had been limited to talk

and text.

285


Horse before the cartThe arrival of modern handsets is paving the way for data

TELECOMS ANALYSIS

is particularly effective in a country which has sucha large range of incomes among its people. MARKET SHARE: The numbers appear to indicatesuccess. Samsung’s mobile market share went from2% in 2010 to more than 50% in 2013, and accord-ing to government statistics the company imported$1.2bn of the $4.5bn of mobile phones brought intothe country in 2012. In the Android smartphone cat-egory, Samsung claimed an 80% market share in ear-ly 2013, and four of the five top-selling handsets inIndonesia are from Samsung. In 2013, the companyindicated that it may increase its commitment bybuilding a mobile phone factory in the country.

Samsung has been helped by global trends thathave had a local impact. The rise of Android as anoperating system and the fall of BlackBerry meantSamsung was well placed to capture market share.In 2012 Android took the top spot for operating sys-tems for smartphones with a 56% market share, upfrom 36% in 2011, according to International DataCorporation and Bloomberg. BlackBerry stood at 37%,down from 43% a year earlier. In that time, Symbiancollapsed, from 19% of the market to 2%.

In an instant, Indonesia embraced open systemsand dumped the operating systems that had previ-ously dominated. Samsung is hedging its bets byoffering phones on a number of platforms, includ-ing Windows 8. Some of the non-Android operatingsystems are clawing back share.

Windows, while still under-represented, is gaininginterest following Nokia’s deal with Microsoft, goingfrom 0% in 2011 to 2% in 2012, while iOS has tickedup from 1.2% of the market to 2.5%. Yet the Androidphenomenon has played into the Samsung strategyof offering powerful phones at low prices.A ROSE BY ANY OTHER NAME: A parallel develop-ment that is also having an impact is the growingacceptance of no-name or lesser-name handsets. Fora time, the market was sceptical about anything out-side Samsung-Nokia-Apple, and people were willing

to overpay for mobile devices that carried the rightbrand. Now Indonesian consumers seem to bebecoming more price sensitive. For example, theiPhone 5c, Apple’s new low-end model, is expectedto face a lukewarm response as it will cost over $500,more than five times the cheapest models. Mean-while, the lower-end makers are putting up a fight.Chinese manufacturer ZTE is pushing for marketshare, and was targeting 200,000 units in 2013.CONSUMERS: Fuelling this trend is the willingnessof operators and retailers to offer own-brand phones,putting their names on handsets. Some of the prod-ucts have capabilities at or near the major brands.Smartfren, for example, started offering two phonesin 2013 with quad-core processors. Local brands,such as Nexian, Blueberry, HT Mobile and Tiphone,are also putting out products that give users whatthey want at a discount to international brands.

Indeed, the market is becoming quite sophisticat-ed and increasingly more interested in performanceand reliability than brand. When the Samsung CoreAdvance came out, consumers immediately startedto pick apart its features and performance, com-menting on the low pixel density of the screen, onthe design and on the many variations of the samephone with very little difference between them.

As of early 2014, it seemed Samsung fatigue hadset in and the brand image had begun to weaken.The company was smart to be in the market at boththe high and low ends, but the strategy may back-fire as consumers become more educated. The riskis that the smartphone becomes commoditised andthat brand no longer matters. Samsung may havenoticed what is happening. While it remains com-mitted to selling mobile phones in the market, it qui-etly dropped its plan to manufacture there. Yet theincreased competition is good news in a way. Mainbrands dumping their phones to meet the challengefrom imported clones is likely to help the marketexpand. The challenge is for operators to catch upand offer the necessary bandwidth for these devices.

286

Indonesian consumers seem to be becoming more price sensitive

Operators and retailers are increasingly offering own-brand phones

Acceptance of no-name or

lesser-name handsets is

growing. The market is

becoming quite

sophisticated and

increasingly more

interested in performance

and reliability than brand.


TELECOMS ANALYSIS

Operators hope to oversee a transition from voice and SMS to data

Businesses supporting and on the periphery ofIndonesia’s telecoms market have been active overthe past year as the sector evolved and grew. Firmsselling mobile phones or owning and operating basetransceiver station (BTS) towers have taken on part-ners, made significant investments and formed newventures. These businesses are now in a perfect posi-tion to capture growth in telecoms services.GROWTH: According to consultancy Frost & Sulli-van (F&S), towers is a good business to be in inIndonesia. While BTSs are capital intensive, and thusunattractive to some operators, they do not requireas much investment in new technologies.

Operators have an expensive period ahead as theyhave to transition their users from voice and SMS todata. That will take a considerable amount of mon-ey, and the capital expenditure will be a drag ongrowth. F&S forecasts that 45% of cellphone userswill have 3G devices by 2015, compared with the cur-rent 23%. While F&S anticipates growth rates of 15%in the tower business, it is looking for revenue growthof 7.6% in 2015 for the operators’ main businesses.

The big deals of previous years – Indosat, for exam-ple, sold 2500 towers to Tower Bersama in 2012 –were in short supply in 2013, but some are in theworks. Indosat has said it will divest itself of the 5%stake in Bersama it gained in 2012, and still has7500 towers it could sell if it needed to raise funds.

Telekomunikasi Indonesia (Telkom) said in Novem-ber 2013 that it was considering listing its Telkom-sel subsidiary via an initial public offering or a reversetakeover, and that it was also contemplating the saleof its tower subsidiary, Dayamitra Telekomunikasi(Mitratel). It was looking for an arrangement withan existing tower operator, with a swap with Profe-sional Telekomunikasi Indonesia (Protelindo) or Tow-er Bersama among the options. The fundraisingefforts would be undertaken to allow Telkom to focuson its main business. Telkom agrees with F&S’s assess-ment that the market has reached saturation point

and growth will begin to stagnate in 2014, with anexpansion rate of 6-7% expected. However, ratherthan stay in the faster-growing tower business, it seesthis as a time when it should be investing in its corebusiness to maintain growth there. BUYING IN: Other companies are choosing to getinvolved or become more involved in the business.In December 2013 Nusantara Infrastructure bought39.55% of Tara Cell Intrabuana for Rp598bn ($60m).Telecoms infrastructure firm Solusi Tunas Pratamatargeted 1000 new towers in 2013 – most of themin Jakarta – raising its total to 3500. It has budget-ed $150m for the expansion. The company said itwas considering the acquisition of existing towersfrom other companies, but that supply was limited,meaning it would have to build new towers. From Jan-uary to March 2013, the company bought 493 BTStowers and built 200. Despite the fact that the cap-ital was crowded with cell towers, demand existsbecause of the rise of smartphones. Analysts saidthat the major operators often preferred to rentfrom companies such as Solusi Tunas Pratama.

Other investments are being made for develop-ment-related and broad economic reasons. In August2013 the World Bank’s International Finance Cor-poration (IFC) announced an investment of $50m intoProtelindo, the country’s largest independent tow-er operator. According to the IFC, towers are vitalinfrastructure for the country, and Protelindo, with9000, is a key player in the sector.HANDSETS: The mobile retail sector has also beenbusy. In March 2013 Trikomsel – the country’s largestmobile retailer – formed a joint venture with USwireless distributor Brightstar. The deal is expectedto help Tricomsel, which trades under the name OkeShop, improve distribution and develop buy-backand trade-in solutions. Brightstar will control 51%of the venture. The move highlighted the increasingsophistication of the distribution sector and suggestsconsolidation, led by advanced players, is inevitable.

Companies selling mobile

phones or owning base

transceiver station towers

have taken on partners,

made major investments

and formed new ventures,

and these businesses are

now in a strong position to

capture growth in telecoms

services.

289


Towers of strengthCapital-intensive segment could be set to pay off in the coming years

IT OVERVIEW

The retail side of the sector is continuing to expand

While much IT-related activity in Indonesia is very basic,it is on a large scale and is growing rapidly. A densityof use is being attained that is driving profitableadvances. Significant development is also being seenat the business and enterprise level, suggesting thattechnology is starting to take root in the economy.Questions remain about infrastructure, inclusivenessand local development, but a foundation has been putin place on which a thriving sector can be built.

The retail side of IT has long been strong and is get-ting stronger. As of May 2013, Indonesia had the world’sfastest-growing rate of Twitter use (up 44% since thesecond quarter of 2012), and it is number four for Face-book use after the US, India and Brazil. As of 2012, 88%of internet users were active in social networking. Intotal, the country has more than 72m internet users.STRONG BASE: A Time Mobility Poll, conducted in2012 with Qualcomm, demonstrates a very activeonline culture and supports the thesis that wherethere is internet in Indonesia, it is used at least as muchas in other countries. Of the Indonesians surveyed, 83%browsed the internet at least a few times a week, com-pared with an average of 66% among the surveyedcountries (the US, Brazil, China, India, Indonesia, SouthKorea, South Africa and the UK). In the US the figurewas 46%, and in the UK it was 47%. Only China was high-er than Indonesia, with 86%. The poll also indicates avery engaged market: 74% of Indonesians said they con-ducted business regularly using their wireless mobiledevices, the highest ratio (the average figure was 47%).Only 2% said they could go a week without their hand-held device. Indonesians were performing 12 websearches with their devices a day, the second-highestin the survey. Indonesian Internet Service ProvidersAssociation (APJII) data also indicates that users areengaged with the internet: according to a 2012 APJIIsurvey conducted in 42 cities, 68% of smartphoneusers were accessing the internet from their devices.

The APJII forecasts that the number of internet usersin the country will grow to 139m by 2015. Smartphone

use grew by over 100% in 2011 and 2012, and by 58%in 2013. While growth will slow in the coming years,it is expected that the number of smartphone userswill double by 2016, and that almost half of all mobileusers will have smartphones by 2017, according todata from eMarketer.com. The 2013 smartphone-own-ing population was 36m, the ninth-largest in the world,according to Kleiner Perkins Caufield & Byers. Indone-sia already has more smartphone users than France,Germany, Russia and Mexico. Internet commerce isalso growing rapidly, doubling between 2012 and 2013,and it is expected to more than double again by 2015. BIG PICTURE: The broader picture is even more impres-sive and demonstrates that the activity of consumers,much of which is sourced and hosted abroad, is begin-ning to generate substantial business activity on theground. According to International Data Corporation(IDC), overall IT spending is set to rise to $16.4bn in2014, up 12.5% from 2013 despite the weakeningrupiah. The cloud, meanwhile, grew by 43% in 2012.

The growth in broadband take-up and quality hasbeen impressive. According to Akamai, the broadbandadoption rate was up 292% between the second quar-ter of 2012 and the second quarter of 2013, while thecountry’s average peak connection speed rose 35% inthat time to 11.5 Mbps, ahead of India and just behindChina. In the World Economic Forum’s E-NetworkedReadiness Index 2013, the country went from 80th to76th, ahead of the Philippines and Vietnam, and justtwo points behind Thailand. The Economic Forum notesthat the country did particularly well in two respects.In affordability it is 39th, ahead of Vietnam, Thailand,the Philippines and Malaysia. In business usage it is 40th,ahead of all three developing economies in the region.

Mobile broadband penetration is high, at 31.9 per100 inhabitants, and ranked 54th in the world in a Sep-tember 2013 International Telecommunication Unionreport. That compares very favourably with the rest ofthe world and the region. The global average is 22.1.Thailand comes in at 0.1 per 100, Malaysia at 13.5, Viet-

A recent poll demonstrates

a very active online culture:

of the Indonesians

surveyed, 83% browsed the

internet at least a few

times a week, compared to

an average of 66% among

surveyed countries.

290

All down the lineAn internet-literate populace provides solid foundations for IT growth


IT OVERVIEW

nam at 19.0 and China at 17.2. Growth appears strong:in early 2013 IDC forecast that the overall broadbandmarket in Indonesia, including both fixed and mobile,would double in 2013, from $650m to $1.16bn.

IDC noted some trends that suggest a healthy sec-tor. It said that the growth did not come so much fromthe increase in subscriber numbers but from higherusage, an indication that demand was increasing forthose people who were connected. IDC said that itexpects the broadband market to continue growingat a 55% annual rate through 2016. A number of fac-tors are driving growth, including improved coverageby the operators and lower costs for users. LAST MILE: The country has made broadband a pri-ority, despite the geographical challenges and lowaverage incomes in some areas. The National Broad-band Plan has some bold targets. By 2018 fixed broad-band coverage should be 40-70% of the population at2 Mbps, and 50-80% of buildings should be connect-ed at 1 Gbps. It also calls for 75% of Indonesians tohave mobile broadband at 1 Mbps and envisions 100%of the country covered by the internet backbone.

Much has already been accomplished. The PalapaRing, which was 80% complete by the end of 2013, willconnect the entire archipelago by high-speed fibre opticcable. The project was started in 2001 and will total28,704 km when completed (with more than 35,000km of undersea cable and almost 22,000 km of inlandcable). In May 2013 a groundbreaking ceremony washeld for the final leg of the project, running 5300 kmfrom Sulawesi to Papua. The project in its entirety isscheduled to be finished by 2015.

Indonesia is intently focused on the last mile. To anextent, it is a digital divide issue. Those on low incomesare unable to afford the technology, and both the gov-ernment and the private sector are working to bridgethat gap. Telkom Indonesia in cooperation with Intelhas established mobile Broadband Learning Centres,minibuses which take high-speed internet and othertechnology resources to remote areas. Telkom alsosponsored the Ministry of Education’s SabakMoE pro-gramme, which aims to get tablet computers into theclassroom. A major element of the Masterplan forAcceleration and Expansion of Indonesia’s EconomicDevelopment is improvement of connectivity through-out the archipelago, and while that includes trans-port, it also has a major communications component.

The issues are also technical. The last mile for fixedbroadband often involves digging up roads and wiringbuildings. Fortunately, technology has overtaken theproblem and allowed connectivity to be achieved whenit is too difficult to cable. The growth of wireless inter-net has acted as a workaround and enabled people toconnect before trench digging is finished. The combi-nation in the end might be the ideal mix, with the longdistances being covered by installed optic fibre andthe rest through high-speed wireless. SMARTPHONES: The trend toward high-speed wire-less broadband started years ago. By 2008, just a yearafter introduction of wireless broadband technology,HSPA connections (at 315,000) outnumbered fixed-

line connections (300,000). Since then, the markethas grown rapidly as new technologies have beenintroduced and as consumers have become moreadept at utilising them. Informa put 3G subscriptionsin June 2013 at 45.5m, or 18.4% of the population.

Yet the real impetus behind the growth has been arise in smartphone ownership. According to Roy Mor-gan Research, ownership doubled from 12% in March2012 to 24% in March 2013, with overall mobile own-ership up by 10% to 84% of the population. Accordingto eMarketer, total smartphone ownership was 16.6%in 2013, up from 10.6% in 2012. Nielsen puts smart-phone penetration at 23%, with Indonesia ahead of bothIndia (18%) and the Philippines (15%). In 2011 only 4.8%of the population owned a smartphone.

A report by Canalys in January 2013 anticipated 52%smartphone growth in 2013, and a study by Yahoo! andMindshare sees ownership rising by some 151% toover 100m by 2017. The figures suggest that the mar-ket is undergoing a major transition. While consumershad previously been satisfied with voice, text and basicmessaging, they are starting to adopt data services.

291


Mobile ownership was up 10% year-on-year in March 2013

The National Broadband

Plan has some bold targets.

By 2018 fixed broadband

coverage should be 40-70%

of the population at 2

Mbps, and 50-80% of

buildings should be

connected at 1 Gbps.

International internet bandwidth, 2007-2017 (m)

SOU

RCE:

UN

ESC

AP

*Fo

reca

st

0

0.4

0.8

1.2

1.6

2.0

Bandwidth (Mbps)

2017*2016*2015*2014*2013201220112010200920082007

IT OVERVIEW

HANDSETS: The handset market is also developingquickly, driving broadband use. While the market isdominated by Samsung, with 80% of the Android smart-phone share in early 2013, competition is fierce. Androidovertook BlackBerry as the preferred smartphoneoperating system in 2012, with BlackBerry’s sharefalling from 39% in the second quarter of 2012 to 21%a year later. But in the Android space, competition isbreaking out that has boosted the overall market.

Chinese manufacturer Oppo has taken aim at Indone-sia. It opened in the country in early 2013 and by Octo-ber it had 1000 employees, 18 branches in Jakarta andwas selling 16,000 phones a month. The company saidthat if it hit 50,000 a month, it would start to manu-facture locally. Ninetology, a Malaysian smartphonefirm formed in 2012 and claiming a 12% market sharein Malaysia in 2013, is also targeting Indonesia. Mon-ica Agnes, a local star and its largest shareholder, isthe face of the company, which is expected to help sales.

Smartfren is producing its own brand of smart-phones in cooperation with Chinese manufacturers,and they are selling for under $200. In the third quar-ter of 2013 its Andromax model was the second-bestseller after Samsung, according to IDC. Consideredthe largest local maker, Evercross was also in the top10 with its mass market phones. Mito, another localbrand in the top 10, also operates at the low end.PRICES: The competition has had an effect on prices.At the end of 2013, a dual core Andromax phone wasretailing for Rp950,000 ($95). Ninetology is in the mar-ket with a Rp1m model ($100). As is the case global-ly, the flood of cheaper models has had an impact onthe brand names, which are bringing out their own low-end models to compete. In Indonesia, for example, aSamsung Galaxy Star Pro – an Android phone with dualSIM cards, WiFi, GPRS and EDGE – retails for $130.

The tablet business is also booming. According toNielsen, tablet penetration hit 5% in 2013, up from 1%in 2012. According to market research firm GfK, tabletsales in Indonesia totalled 1.3m units between June

2012 and May 2013, up 141% year-on-year (y-o-y). A2013 Mindshare/Yahoo! study saw the number oftablets owners hitting 16.2m in four years. Researchalso suggests that an increasing number of peoplehave multiple terminals, resulting in consistent usagethroughout the day. PC sales were also up, rising 17%y-o-y. IDC says that the PC remains strong outside ofurban and relatively wealthy areas. In the first quarterof 2013, sales of PCs in Jakarta and Bali were down6.2% y-o-y; everywhere else, sales were up 8.4% y-o-y.

Another driver of growth is increased competitionfrom internet companies, with the Chinese particular-ly active in this space. China’s Tencent, the firm behindthe QQ messenger, formed a joint venture with Indone-sia’s MNC. The latter has been working to create asearch engine to challenge the dominance of Yahoo!and Google. Another Chinese firm, Baidu, initiated anaggressive expansion plan in 2012, introducing anIndonesian version of its hao123.com website, a por-tal. In 2013 the company launched 10 products in thecountry, five for mobile devices and five for PCs. E-COMMERCE: Helping to drive development of theinternet, or in part driven by the internet’s develop-ment, is e-commerce. TokoBagus, the biggest site, had1bn page views in July 2013, four times what it wasgetting in April 2013. Kaskus, a relatively new competi-tor, was reporting 600m pages view a month. Tokope-dia is reporting a 10-20% rise in shipments. Some bigplayers have become involved. A new e-commercecompany – Lamido – was formed by Germany’s Rock-et Internet in late 2013, and also in 2013 eBay enteredthe market in cooperation with Telkom Indonesia witha venture called Blanja.com. In November 2013, XLjoined up with Korea’s SK Planet to form e-commercemarketplace and escrow payments system Elevenia.

Estimates suggest Indonesia’s e-commerce marketis growing rapidly. Vela Asia research put the segment’svalue at $900m in 2011, $4bn in 2012 and $8bn in 2013.It forecasts the market hitting $12bn in 2014 and$18bn in 2015. A South-east Asia eCommerce Readi-ness Index, developed by Vela Asia, ranked Indonesiatop in the region, though the score was skewed by mar-ket size. Singapore was number two, and Malaysia waslast. Payment and escrow systems have been impor-tant. Indonesia has a range of services that can act asintermediaries in a transaction. Doku has been aroundsince 2007, Ipay88 since 2006. IpayMu, Veritrans and Inapay also provide escrow or payment services.

292

Increased competition has had a considerable impact on prices

Research put the value of

Indonesian e-commerce at

$900m in 2011, $4bn in

2012 and $8bn in 2013.

The market is expected to

hit $12bn in 2014 and

$18bn in 2015.


SOURCE: UN ESCAP

Cambodia 0.8

Indonesia 1.0

Laos 0.4

Malaysia 15.6

Myanmar 0.3

Philippines 5.5

Singapore 258.3

Thailand 6.6

Vietnam 5.2

Regional bandwith per capita, 2013 (Kbps)

IT OVERVIEW

THE CLOUD: The development of the cloud market isan indicator of the increasing commitment to IT. In aFrost & Sullivan (F&S) survey published in September2013, 45% of the respondents (IT decision makers atIndonesian corporations) said that the cloud was theirtop priority in 2013, and 40% said that they were fac-ing pressure from their management to implementcloud solutions. The larger players are actively devel-oping the market. Telkom Indonesia has offered its E-Office solution for a number of years, while Indosatstarted offering its X-Cloud at the end of 2012.

F&S noted that the Indosat programme is innova-tive, as it involved cooperation between a telecoms firmand IT companies. In this case, Indosat partnered withHuawei, IBM, Fujitsu, Microsoft, Intratec and Man-dawani. While local players are behind the interna-tional trend in terms of offering and service, brandrecognition is high, which is helping keep the interna-tional giants from taking too much market share.Google has been able to develop a following in theIndonesian cloud due to its high profile globally, butAmazon has not as it is not well known in Indonesia.CONCERNS: While technology is rapidly advancing inIndonesia, problems remain. In e-commerce businessis not always smooth. In September 2013 Japan’sRakuten broke from MNC, its local partner, and madeits Indonesian e-commerce operations a wholly ownedsubsidiary, and in May 2013 e-commerce store Multi-ply shut its doors. Operators have been caught flat-

footed by demand, with rapid adoption of smartphonesand tablets outstripping network capacity.

Indonesia for the most part either taps overseasservices or clones products. IT is dominated by foreignplayers, even if local firms front the technology. Thegovernment is becoming increasingly protectionist tohelp remedy this imbalance, and companies are start-ing to see the benefits of hosting and developingdomestically. “In the past Indonesia has relied on for-eign firms for advanced technological products, butnow it is making a push to grow this industry locally,”Abraham Mose, the president director of government-owned technology and electronics firm Len, told OBG.Indonesians need to start creating their own technol-ogy and services, otherwise the gains will flow over-seas in the form of profits and royalties. “There are 200-300 IT firms in Indonesia, but the majority are involvedin services such as system integration,” Indra Sosrod-jojo, director at Andal Software, told OBG.OUTLOOK: Indonesia’s technology market is on itsway up. Twitter and Facebook are still important, butincreasingly the cloud, e-commerce and wireless broad-band lead. It seems that Indonesia has hit the take-offperiod, catching many by surprise in doing so. The nextfew years should bring rapid growth and intense com-petition. Companies from all over the world will bebattling for market share, which should help keepprices down. Last mile and digital divide issues remain,but as they are solved the market will expand further.

293

Indonesian IT is foreign

dominated, even if local

firms front the technology.

The government is

becoming increasingly

protectionist to help

remedy the imbalance, and

firms are starting to see

the benefits of hosting and

developing domestically.

IT ANALYSIS

Wireless broadband has helped expand high-speed internet access

As Indonesia develops connectivity domestically, ithas to begin thinking about international links. Theemphasis to date has been on unifying the nationvia the internet, and considerable progress has beenmade. The building of the internet backbone hasbeen important in getting more of the remote cor-ners of the archipelago online, while wireless broad-band has helped expand high-speed access.

Yet domestic connections are of limited value. Ifthe country is to have a robust technology sector,its internet will need to be better integrated with theglobal network. Otherwise it will be hard for Indone-sia to extract full value from its network. Its systemwill be relatively closed and less useful than oneseamlessly connected to the rest of the internet.INTERNATIONAL CONNECTIONS: The country iscurrently linked to only one intercontinental cable– the South-East Asia-Middle East-Western Europe3. This optical fibre submarine cable runs 39,000 kmfrom Europe, through the Middle East, across toSouth-east Asia and Korea via China and Japan. It landsat Medan and Jakarta. Indonesia has no direct con-nection to the Asia-America Gateway, a 20,000-kmcable running from the US West Coast across thePacific Ocean to South-east Asia, despite the fact thatTelkom is an investor in the cable. The country linksinto that line indirectly, via the 73-km Batam-Singa-pore cable, which has six pairs of fibre, though fourpairs have intentionally been left dark.

Indonesia does have good regional connections.Between 2003 and 2010, 10 cables were installedbetween the country and South-east Asia. But itlacks direct connectivity to the global network. Thisis worrying as, according to Terebit Consulting, mosttraffic is bound for the US and Europe; even muchof the intra-ASEAN traffic is only making a hop towarda destination outside the region. CHOKE POINT: A 2013 report by the UN Economicand Social Commission for Asia and the Pacific(UNESCAP) highlighted the concern that most of

Indonesia’s international internet capacity runsthrough Singapore, and this choke point invites less-than-competitive pricing. The numbers indicate thatIndonesia is faring poorly in the wholesale markets.By the end of 2012 volume purchases of bandwidthby Indonesia were estimated at over $60 per Mbpsper month. In Malaysia, it was around $25 per month.

Indonesia is also suffering from a shortage ofinternational connectivity. According to the UNESCAPstudy, the country had 362,000 Mbps of interna-tional bandwidth in 2013. Capacity is up, and set togrow further – it has increased 340 fold in a decade,and is expected to double by 2015 and again by2017. However, on a per capita basis, Indonesia stillranks low, with very little international bandwidth perperson. UNESCAP estimates that there is 1 Kbps ofbandwidth for each Indonesian. That compares poor-ly with regional competitors. Thailand is at 6.6 Kbps;Vietnam, 5.1; and the Philippines, 5.4. Singapore has258 Kbps of international bandwidth per person. NEW LINES: Efforts are being made to improve con-nectivity. In 2012 Telkom made a bid for Pacnet,which was formed from the 2008 merger of PacificInternet and Asia Netcom, and is region’s largestowner of undersea cable, with 46,000 km worth.The deal was cancelled soon after, however.

Two additional cables are in the works, but theydo not seem to promise a solution to the capacitybottleneck. The Brunei Darussalam-Indonesia-Malaysia-Philippines East ASEAN Growth Area hasbeen discussing a $150m cable to link the memberstates. The project was talked up a few years ago,but has received very little attention since then. Itwould also appear to not offer much in the way ofinternational bandwidth to Indonesia.

A Singapore, Indonesia and Australia cable hasbeen on the drawing board for a number of years;indeed, two groups have been competing to installthe line. The projects are very compelling, as theywould help lower Australia’s internet costs and

The country is currently

linked to only one

intercontinental cable –

the South-East Asia-Middle

East-Western Europe 3,

which runs for 39,000 km.

UNESCAP estimates that

there is 1 Kbps of

bandwidth for each

Indonesian, which

compares poorly with

regional competitors.

Thailand is at 6.6 Kbps;

Vietnam, 5.1; and the

Philippines, 5.4. Singapore

has 258 Kbps of

international bandwidth

per person.

294

Network newsImproving international connectivity is among the items on the agenda


IT ANALYSIS

improve Indonesia’s connectivity. However, the proj-ects are stalled and it appears that little progress willbe made in the short term. Discussions about cablesare about more than just Indonesia’s needs. Thecountry’s technological fate is part of larger discus-sions in the international bandwidth community.

An intercontinental cable brings participation froma diverse range of parties. In the Pacific market,entrenched interests have the financial might andexpertise but are best served by limiting capacity,whereas entrepreneurs see unmet demand and anopportunity to serve markets and circumvent exist-ing bottlenecks. So while the demand for new capac-ity exists in both Indonesia and Australia, the rightset of stakeholders could not agree on the project.DOMESTIC HOSTING: Larger and more recent issuesalso have the potential to affect the future of a sub-marine cable business, according to Sunil Tagare,developer of the 28,000-km Fibre optic Link Aroundthe Globe (FLAG) project. He said that the trendtoward in-country hosting requirements – in whichGoogle, for example, would be required to have itsservers for Indonesian customers located in Indone-sia – threatens the sector. He writes that this trendis so significant that it could lower demand for capac-ity and bring the cable industry to a standstill.

The push goes back a number of years. Some rel-evant regulations were drafted in Indonesia in 2009,and heated up in 2011 when requiring BlackBerryto host in-country was discussed. The issue is nowback, with a bill under consideration that wouldrequire all data centre companies to keep their dataand recovery facilities onshore. The mood in thedeveloping world is to force major internet compa-nies to host domestically, as evidenced by Brazil’spush to have Google do just that. The countries aredriven by security and commercial issues. Politiciansin developing countries argue that keeping datawithin their borders would limit the exposure oftheir citizens to hacking. While experts say that thelocation of servers makes little difference, as theinternet is interconnected and one part of it can bereached from any other, many electorates feel thathaving data at home would help protect information.

The other motivation is commercial. Countriessuch as Indonesia are concerned that most techno-

logical developments are currently taking placeabroad, and that the resulting products are being soldwithin their borders via the internet. The idea is thatby forcing firms to open operations domestically,more value will remain onshore. The push for in-country hosting is related to other semi-protection-ist measures, such as those involving downstreamprocessing of raw materials. SERVERS: Just as the push for smelters has receivedinternational criticism, so has the push for domes-tic servers. The key to the cloud is critical mass. Bybuilding very large and efficient server farms in thebest locations, the cost of data storage and pro-cessing can be cut dramatically. The networkingeffect can also be enhanced because of the lowlatency within the cloud. By forcing servers onshore,Indonesia would miss out on many of the cloud’sadvantages. It would not get the same economiesof scale, and would put its corporations and entre-preneurs further from resources they need. Hostingwould also be taking place in a less-than-ideal loca-tion – a country which suffers frequent power out-ages and has high logistical costs. Indeed, forcinghosting onshore could actually slow technologicaldevelopment in Indonesia, rather than enhance it.

295

The push for in-country hosting goes back a number of years

The key to the cloud is

critical mass. By building

very large and efficient

server farms in the best

locations, the cost of data

storage and processing can

be cut dramatically.

IT ANALYSIS

Customers are looking to do more with their handsets

The rise of the smartphone has dealt a blow to thefortunes of BlackBerry globally, and it has been hitespecially hard in Indonesia. The country was tradition-ally one of the best markets for the company. Black-Berry’s market share in the country went from less than10% to almost half the market in two years to 2011. Ithas now dropped down to about 20%, and is still falling.

While the collapse was sudden, it was a long timein the making. The Indonesian tech market has becomefar more competitive, consumers are more technolog-ically oriented and prices have dropped. BlackBerrydeclined as the market advanced; the product held onprimarily because the BlackBerry Messenger (BBM) wasused by many people, and a BlackBerry device was fora time the only way to be connected to that group.COMMUNICATIONS TO COMPUTING: What is hap-pening is not just a company being caught out by achange in the market. For years, Indonesia’s commu-nications market has been dominated by text and chat.Now, customers want to do more with their terminals:they want the internet and apps, and they want to cus-tomise. Handsets now have to be computers, which iswhy Android-based devices have done so well.

In October 2013 the company released BBM forAndroid, allowing people who liked BBM but wantedthe extras of a smartphone to have both. The strate-gy seemed to be successful, at least in terms of main-taining their customer base. It appears that mostIndonesian users would at least download the newBBM application. In a Games in Asia poll, 87% of thoseasked said they would try the BlackBerry Android prod-uct. The makers also seem to be buying into the strat-egy. Cyrus, an Indonesian maker of phones, tabletsand pads, is selling a phone with BBM preinstalled,and with some of the popular BlackBerry features suchas the QWERTY keyboard, for Rp1.5m ($150).

The company has been especially focused on retain-ing the loyalty of Indonesians. In late 2012 BlackBer-ry – then known as Research In Motion – opened aninnovation centre in Bandung with Bandung Institute

of Technology, with BlackBerry offering 30 studentsone-year scholarships in mobile computing. The priceof BlackBerry products has also been dropping. Whilethe newer models remain expensive – the Z30, intro-duced in October 2013, came out at Rp8m ($800) –lesser models are cheaper. The BlackBerry Curve 9320was recently quoted at Rp1.95m ($195).COMMITMENT: BlackBerry is also reaffirming its com-mitment to the country. It has promised to keep all itsemployees in Indonesia even as it sheds workers else-where. In addition, in December 2013 the companyannounced a five-year deal with Foxconn to manufac-ture devices in Indonesia and Mexico. The first prod-uct offered by the new partnership – a 3G phonebased on the BlackBerry 10 – will be out in 2014.

However, it is as yet unclear whether BlackBerry cansucceed; smartphones offer everything available ona BlackBerry, while messaging has become a robustand highly competitive subsector of tech. BBM is verypopular, but it has serious challengers. Line, Viber,WeChat and KakaoTalk are all making efforts to buildpopularity and take market share. In October 2013Viber introduced a local language version of its prod-uct, and KakaoTalk is on an advertising blitz. OTHER FACTORS: BlackBerry has faced other issuesin Indonesia. The product’s performance has beenwanting and its reputation has been damaged. In thefirst half of 2013 customers suffered at least three serv-ice outages, and regulators considered a Rp1000($0.10) per customer fine on the company. Observerssaid the regulator’s response was related to the coun-try’s ongoing dispute with BlackBerry over local host-ing of data. In 2011 the government said Research InMotion would have to set up a data centre in Indone-sia so that customer information would be held onshore.The company also had a dispute with the regulatorsover the establishment of service centres. However,despite its declining market share, the company still has a sizeable base in the country – approximate-ly 15m users, or 18% of the product’s global market.

Indonesia’s tech market has

become far more

competitive in recent years,

consumers are more

technologically oriented

and prices have dropped.

BlackBerry is reaffirming its

commitment to the

country, and has promised

to keep all its employees in

Indonesia even as it sheds

workers elsewhere.

296

Thorny issueThe rise of smartphones has left one major player seeking to adapt


299

TourismExpansion efforts will boost airport arrival capacityBroadening the offering with support for key nichesPromotional events abroad improve prospectsUnlocking the potential of Komodo National Park

TOURISM OVERVIEW

Natural attractions have been drawing more visitors in recent years

Boasting some of the world’s greatest biodiversityand dynamic landscapes, Indonesia has long been apopular destination amongst tourists. The appeallies in experiencing life on one of the country’s17,000 islands, sampling the famous South-eastAsian gastronomy, or seeing the orangutan andKomodo dragon in their natural habitats.

After oil and natural gas, palm oil, coal and rub-ber, tourism is the sixth-largest contributor to Indone-sia’s national economy, and received a 27% increaseto $6.7bn in foreign direct investment in the first quar-ter of 2013. With the implementation of the Mas-ter Plan for the Acceleration and Expansion ofIndonesia’s Economic Development (MP3EI), theadministration of President Susilo Bambang Yud-hoyono has prioritised the tourism sector, one of thesix corridors in focus under the plan. FOREIGN ARRIVALS: In 2013 the ASEAN region asa whole saw a 12% increase in tourist arrivals since2012, having received 90.2m visitors. June 2013 sawa record for the number of foreign tourist arrivalsin Indonesia that month. With a 13.52% growth, for-eign arrivals hit 789,594, breaking the December2012 record of 766,966 by a large margin.

According to the Jakarta Tourism Board, Malaysia,China, Japan, Singapore and South Korea providedthe most visitors to the capital in 2013; as of August2013 foreign visitors from those markets arriving viaSoekarno Hatta Airport topped off at 298,255,294,674, 197,590, 387,889 and 123,543, respective-ly. Beyond Asia, Indonesia also saw an increase in for-eign arrivals in the past two years. Expansions amongMiddle Eastern carriers, international promotionactivities, and the draw of Muslim tourists to theworld’s most populated Islamic nation resulted inarrivals from the UAE and Saudi Arabia increasing122.4% and 34.2%, respectively.

European tourist numbers also rose, a positivesign amid the economic crisis, with arrivals fromRussia up 25%, and visitors from the Netherlands and

Germany up 15% in June 2013. In order to accom-modate the increase of tourism traffic, the govern-ment has said it will tap into its $43bn infrastruc-ture budget to build 19 new airports and 10 newcruise ship ports by the end of 2015.

E-commerce brought in $1bn to the travel indus-try in 2011 and the integrated tourism companyPanorama Group predicts that it will account for20% of total revenue by 2017, as internet usageincreases across Indonesia, and firms are able toreach more customers through social media adver-tising. With 60m Indonesian internet users spend-ing at least three hours per day online, Panoramaexpects e-commerce growth in the domestic mar-ket to become apparent by 2016.DOMESTIC CONSUMPTION: Having the fourth-largest population in the world and a growing mid-dle class, Indonesia possesses a domestic marketthat is already a major source of revenue, and isforecasted to grow. The government, as well as theprivate sector, is eager to further tap into the domes-tic market, as outbound tourism is projected to havea 9% increase between 2013 and 2017.

The middle class comprises approximately one-third of the population and is the major source fordomestic and outbound tourism. Middle-class spend-ing priorities have shifted, notes Panorama Group;the number-one goal for most consumers is savingmoney and number two is travel. With low-cost car-riers and the increased availability and accessibilityof online business, Indonesians are travelling more.

For Indonesians, peak travel times are June and July,and during Muslim holidays like Ramadan, whichchanges each year according to the lunar calendar.Local tourism companies are making efforts to boosttourism in the off-season by offering discountedpackages and all-inclusive holidays.

While the leisure tourism market is reaping the ben-efits of the growing domestic middle class, businesstourism has slowed. Donni Mahendro, traveller and

The development of an

Islamic heritage tourism

niche has seen an increase

in arrivals from Gulf

countries. Arrivals from the

UAE and Saudi Arabia

increased 122.4% and

34.2%, respectively, in

2013.

301


A day in the sunChanges to the tourism offering could see big gains in the medium term

TOURISM OVERVIEW

transaction services manager at Carlson WagonlitTravel, told OBG that, “Business travel today is slight-ly down. We hope that 2014 will be better, but thesituation will likely continue through the short term.Business travel throughout the Asia Pacific regionhas experienced an approximately 10% decrease,and business travel to Europe and the US hasdecreased by approximately 20-30%. This is mostlydue to the economic crises in Europe and the US,and to rising fuel prices.” These factors may beencouraging domestic business executives to con-duct meetings via telephone or internet, rather thantravelling while expenses are high.RUNWAYS & SKIES: The year 2013 was a success-ful one for low-cost carriers, which were creditedfor boosting Indonesia’s domestic market growth inrecent years. Despite Batavia ceasing to operate, topremaining low-cost carriers (LCCs), including Tig-erair Mandala and Garuda affiliate Citilink, kept upthe pace of growth, which reached 20% in 2012, upfrom 16% in 2011, 18% in 2010 and 17% in 2009.The number of air travellers in Indonesia continues

to rise annually; 2012 showed a 15% climb with72.6m passengers and 83.4m were projected for2013. While LCCs are driving domestic market growth,Indonesian national airline Garuda, as well as a num-ber of foreign carriers, are seeing the benefits of theexpanding market internationally. Garuda Indonesiaannounced in November that, by 2025, it will add250 new planes to its fleet. For short-haul routes,the airline will seek single-aisle planes, like the Boe-ing 737 Max and the Airbus A320 Neo, but will requirelarger vessels, such as the Boeing 787 and 777 orthe Airbus A350, for its long-haul flights.

Garuda spread its wings further in 2013 by open-ing a new daily route between Jakarta and TanjungPinang, the capital of Indonesia’s Riau Islands. Man-dala, a private LCC, also opened a new internation-al route, this time between Surabaya’s Juanda Inter-national Airport and Bangkok’s SuvarnabhumiAirport. Indeed, during the first quarter of 2013, for-eign arrivals to Juanda increased by 15.73% and theEast Java Branch of the Central Statistics Agency(BPS) found Thais to be the top group of visitors. Byopening this route, Mandala is poised to gain fromthe steady increase that brought 70,374 foreignarrivals to Juanda during the first quarter of 2013.

International carriers are also looking to takeadvantage of increased air traffic in Indonesia. BritishAirways, Air Niugini (Papua New Guinea), as well asMiddle Eastern carriers Egypt Air, Jordan Aviationand Oman Air have begun non-stop flights to Jakar-ta’s Soekarno Hatta airport.HIGHLIGHTING NEEDS: The rapid industry growthindicates promising opportunity for airlines, but theyalso face the challenge of meeting the demand forqualified crews. On April 13, 2013 Indonesian LCCLionAir experienced a blow to its safety reputationwhen one of its planes crashed into the ocean afterattempting to land on a Bali runway. All passengersand crew survived, but the incident raised awarenessto the concern that the quickly expanding airlinesof the region are struggling to meet their humanresources demands. As air travel is projected to con-tinue its steady increase in Indonesia, the shortageof skilled aviation professionals must be addressedin order to insure that the sector expands safely.

Infrastructure is the second challenge to the indus-try, and is regarded as the most formidable. As moreroutes open and passenger numbers climb, airportsare struggling to accommodate. One project underway to address this issue is the $7.8trn expansion ofJakarta’s Soekarno-Hatta. Due to finish in the fourthquarter of of 2014, the expansion will bring airportcapacity to 66m passengers annually. With the imple-mentation of the ASEAN single market in 2015, moreinfrastructure development will be vital if Indonesiais to keep up with the increased air traffic and logis-tical demands on the region’s horizon.BUSINESS OFFERING: The meetings, incentives,conferences and exhibitions (MICE) segment is aconsistently successful one for Indonesian tourism.In 2013 Bali hosted a number of globally publicised

302

Travel & tourism spending by type, 2007-14 ($ bn)

SOU

RCE:

WTT

C

0

10

20

30

40

50

Business spendLeisure spendDomestic spend

2014F2013201220112010200920082007

Jakarta’s airport is being expanded to handle 66m passengers per year

The number of air travellers

in Indonesia rose 15% in

2012, reaching 72.6m.

Projections for 2013 were

high, with as many as

83.4m travellers forecast to

fly that year.


TOURISM OVERVIEW

conferences and events, including the Asia-PacificEconomic Cooperation (APEC) summit, Miss World,and a World Trade Organisation Ministerial Confer-ence. With an APEC guest list that included Xi Jin-ping, President of China, Shinzo Abe, Japanese PrimeMinister, Russian President Vladimir Putin, and PrimeMinister Tony Abbott of Australia, the event placedIndonesia more prominently on the world’s stage,serving as a successful international tourism promo-tion activity. MICE tourists are estimated to spendtriple the $1333 per trip that leisure spent in 2012.

According to Mahendro at Carlson Wagonlit, Baliis the top destination for business travel in Indone-sia. Jakarta, which lacks the leisure tourism draw thatBali, Lombok and similar resort-style locations haveto offer, is more popular with MICE. However, infra-structure headaches and cheaper prices elsewherein the ASEAN region often drive business tourists tochoose other locations. Mahendro noted that “infra-structure development is the most important task

in boosting the sector. Connectivity issues are lead-ing business tourists to fly elsewhere in Asia andavoid Indonesia. A five-star hotel in Thailand is almostthe same price as a four-star in Bali and this makesBangkok a more popular host for business events.”Though MICE is a breadwinner for the tourism indus-try and had a successful 2013, the sector could growmore if Indonesia receives much-needed infrastruc-ture development and if accommodation pricesbecome competitive among ASEAN destinations.HOTELS: Indonesia’s hotel industry has long been asuccessful one, as the steady stream of visitors drawnto the country’s diverse cultures, nature and land-scapes has kept demand high and rising. The expand-ing middle class is also travelling more, and, with theupcoming transition to the ASEAN single market,hotel expansion across the region has become atheme for local players. For example, in 2013, San-tika Indonesia Hotels and Resorts opened a branchin Singapore, making it the group’s first foreign estab-lishment. Santika looks to expand further before2015, when the ASEAN single market of 600m peo-ple is set to open. Tauzia Hotel Management, a four-star hotel brand based in Jakarta is also setting itseyes on the wider ASEAN market, with plans toexpand first in Malaysia, the Philippines and Vietnam.

On the domestic front, top foreign players, includ-ing Swiss-Belhotel, Best Western and Hilton havemade steps to tap into the expanding market bykicking off projects in Balikpapan, Tangerang andJakarta, respectively. Swiss-Belhotel will target thebusiness traveller market after having opened its34th Indonesian property near the Sepinggan Inter-national Airport in December. In Tangerang, West Java,Best Western also looks to reap benefits from theincrease in business travel, with the opening of itslatest seven-story contemporary hotel in the fourthquarter of 2013. Beyond Java, the Best Westerngroup plans to open a minimum of seven propertiesin Jakarta within the next few years, part of an effortto quickly multiply its group of leisure and business

304

Leisure tourists spent an estimated $1333 per trip during 2012

The ASEAN single market is

set to be introduced at the

end of 2015, generating a

host of new opportunities

for the sector. With this in

mind, local hotel companies

are now expanding, both

domestically and across

the region.

TOURISM OVERVIEW

hotels around the country while demand is high.Hilton, which previously did not have a significantfoothold in Indonesia, will build its five-star WaldorfAstoria along with its DoubleTree and Hilton GardenInn brands across the capital, expanding beyond Bali.

In Jakarta alone, according to Poul Bitsch, the gen-eral manager of Hotel Borobudur and chairman ofthe Jakarta Hotels Association, 34 hotels are to bebuilt between 2014 and 2017, 16 of which are five-star hotels. By October 2013 occupancy rate in thecity had risen to 69% and average room rates hadincreased by 15%, as opposed to Bali, where, despitethe increased number of visitors, hotel oversupplycaused a decrease in occupancy rate. HUMAN RESOURCES: While this implies a promis-ing opportunity for Jakarta tourism, it also presentsa major challenge: establishments will face a short-age of qualified workers.

Bitsch told OBG that “one of the biggest chal-lenges of the hospitality industry is maintaining stan-dards of well-educated people” and the ability toretain qualified workers. Many hotels are alreadyexperiencing high employee turnover due to thefact that highly trained workers are often beingoffered higher salaries and new opportunities byrival hotel companies. Furthermore, a lack of suffi-cient training programmes make it a challenge to hirelocally and many establishments are recruiting for-eign workers to fill the roles that require significanttraining and experience.

To mitigate this challenge, Bitsch told OBG that thefocus needs to be at the vocational level in localeducational institutions, which can produce youngprofessionals qualified for the middle managementlevel. From there, hotels could further develop theirskills during on-the-job training. Indeed, hotels keepgrowing and if there is no balance with humanresources, then operators will face a big problem withproviding quality and maintaining high standards. Inorder for the surging hotel industry to be able to sus-tain its success in the future, “we have to put in alot of effort and invest a lot of resources to addressthis major problem,” Bitsch said.OVERCOMING PAST CHALLENGES: A range ofwatershed events, including threats of disease andepisodes of violence, have had pronounced effectson the industry in recent decades. Following theSARS scare in the early 2000s, average occupancyfell from 70% to 17%. A recent series of severe vol-canic eruptions also shut down tourism in the pop-ular destinations of Java and Sumatra, after many liveswere lost, hundreds of thousands were displacedand a massive amount of property was damaged. In2003 the JW Marriott Jakarta was bombed, and a sec-ond bombing attack in 2009 targeted both the Marriott and the Jakarta Ritz Carlton. Bali also suf-fered a similar tragedy, when hundreds were killedand hundreds more were injured during a 2002attack on the tourist district. These events resultedin a temporary but serious decline in tourism activ-ity, and also hurt investor and builder confidence.

To mitigate threats of violence and other safetyand security risks, hotels and venues have mademajor security boosts in the wake of bombings. It isnow common for all cars to be briefly inspected byestablishment security before nearing the building,and every visitor must pass through metal detectorsbefore entering hotels, shopping malls and otherpublic venues. Meanwhile, travellers are realisingthat prospects of violence are not specific to Indone-sia, and have regained more confidence in the abil-ity to safely travel throughout the country. PROMOTION: After setting a goal to reach 9m for-eign tourists in 2013, the Indonesian Tourism Boardopened branches in Sidney, Beijing, Taipei, Taiwan andAmsterdam in order to market Indonesia more direct-ly to foreign communities. The government allocat-ed a budget of around $1.53m for marketing effortsabroad in 2013, which also included promotionalevents in China, India, and Turkey.

The Ministry of Tourism and Creative Economy(MTCE), while promoting MICE and leisure tourism,is overseeing efforts to boost music, architecture,

305


As new hotels come on-line, pressure is building to find employees

The government allocated

approximately $1.53m for

international marketing

efforts in 2013, focusing on

events in new markets such

as China, India and Turkey.

SOU

RCE:

Sta

tistic

s In

done

sia

*Unt

il Se

pt.

Foreign visitors, 2003-13 (m)

0

2

4

6

8

10

2013 *2012201120102009200820072006200520042003

TOURISM OVERVIEW

gastronomy and other creative industries so thatthe tourism sector can benefit from a more vibrantarts culture. The government has also noted theimpact that Thai and Malaysian restaurants aroundthe world have had as a tourism recruitment tool,and have identified 30 national dishes that can beused to promote Indonesian gastronomy. No plansare in place as to whether the government will fundrestaurants abroad or develop domestic programmes,but research is currently under way to examine howIndonesian cuisine can best be used to draw visitorsto the diverse culinary regions of the archipelago.

In early 2014 Indonesia was ranked number fouron a list of top halal-friendly tourist destinations, fol-lowing Malaysia, the UAE and Turkey, according to asurvey by Crescentrating, a travel rating servicefocused on the halal-friendly segment. Praised forits plethora of halal restaurants and the availabilityof prayer rooms in public spaces, the country ispoised to benefit from its halal-certified label, giv-en that the Muslim travel sector is projected to gross$200bn by 2020. While serving Muslim visitors toIndonesia, the expansion of Middle Eastern airlines,namely Qatar Airways, Kuwait Airways, Egypt Air andJordan Aviation into Jakarta is also set to serve the

Indonesian population making the hajj and umrahpilgrimages, as well as other religiously themed trips.

As Panorama Group CEO Budi Tirtawisata told OBG,“People will always come to Indonesia, because wehave a rich cultural heritage and natural resources.However, the country’s full potential has not yetbeen tapped. Thailand is a benchmark for success,especially in the context of medical tourism. If Indone-sia wants to catch up to the success rates seen inThailand, Singapore and Malaysia, the regional lead-ers, more must be done to ensure that the country’sfull potential is reached.” The government is increas-ingly aware of this and is prioritising accordingly.NEW NICHES: As the tourism industry had beenunder-utilised, the government is starting to turn tonew niches to increase foreign tourist arrivals. Some8m foreign tourists arrived in Indonesia in 2013,compared to about 19m in Thailand and 24m inMalaysia. Singapore also had more, with 14m arrivals.The government has set a goal to attract targeting25m foreign tourists by 2025. To do this, the MTCEhas identified nine locations with potential as sharia-friendly destinations: West Sumatra, Riau, Lampung,Banten, Jakarta, West Java, East Java, Makassar andLombok. Another campaign involves becoming acentre for marathon running in South-east Asia.Hotel occupancy rates reached 80-90% for the Jakar-ta Marathon in October 2013, according to the Jakar-

ta Post. “We plan to make the Jakarta Marathon anannual event, and we expect it can be one of theworld’s major marathon events in the next five years,”Rizki Handayani, the special interest tourism direc-tor at the MTCE, told the Jakarta Post.OUTLOOK: Infrastructure hurdles and humanresource recruitment remain the top challenges, butthe government’s prioritisation of tourism as one ofthe six MP3EI corridors is a good sign. As the nation’s$43bn infrastructure investment budget continuesto support projects, tourism is set to benefit fromthe improved connectivity. With the Indonesian mid-dle class continuing to grow, the domestic marketwill remain a top source for revenue. And as inter-est in visiting Indonesia grows around the world,tourism industry can count on the steady increaseof foreign arrivals to continue, as long as safetyissues and human resource shortages are addressed.

306

Undeveloped areas are set to benefit from government investment

Some 8m foreign tourists

came to Indonesia in 2013,

compared to 19m visitors

to Thailand and 24m to

Malaysia. To boost visitor

numbers, under-utilised

niches are getting

increasing attention.

TOURISM ANALYSIS

Tourism villages will each receive investment of $75,000-100,000

Throughout 2014, the Ministry of Tourism and CreativeEconomy will begin establishing 561 tourism villagesin 19 regions across the archipelago, and aim to expandto 1400 in the coming years. An effort to engage thepublic more directly with tourism, localise sector earn-ings and maximise authenticity of the tourist’s experi-ence, the ministry will invest RP75m-100m ($75,000-100,000) in each of the designated villages, which arebeing scouted. The ministry plans to conduct skillsdevelopment at each site, focusing on visual culture,gastronomy, foreign language learning and tourismmanagement, once the villages are selected. TRAINING DAY: The newly established People Empow-erment Independent National programme will overseethe training programmes, part of a larger effort to maketourism in Indonesia more sustainable, environmental-ly friendly and community-based. Village residents willlearn preservation techniques that will be applicableto their specific environments, and develop ways to max-imise tourism potential in their communities. Meanwhile,tourists will be given a more hands-on experience whenthey visit the villages, engaging in craft-making, learn-ing farming techniques and enjoying cuisine unique tothe regional culture. Budi Tirtawisata, CEO of integrat-ed tourism company Panorama Group, told OBG, “Com-munity-based tourism is popular, because locals arepart of the experience, rather than an object to a trav-eller.” The Ministry of Tourism and Creative Economywill select villages based on their potential to partici-pate in sustainable community-based tourism. The gov-ernment is promoting the offering in Singapore,Malaysia, Australia, China and Japan, key markets for vil-lage tourism and ecotourism, according to a 2013 study.ECO-OPTIONS: Along with the village tourism market,the Indonesian government is beginning to activelypromote ecotourism in an effort to sustain the very bio-diversity and dynamic landscapes that draw tourists toIndonesia in the first place. Ecotourism, which is prac-ticed with minimal environmental impact, has the poten-tial to benefit from a recent declaration to protect a

majestic member of the country’s marine life. In Feb-ruary 2014, Indonesia became the world’s largest sanc-tuary for manta rays after the government declared thecreatures off-limits to fishing and export. At home inthe 5.8m sq km of ocean surrounding Indonesia, man-ta rays could contribute millions to the ecotourismindustry, as they attract divers and adventure tourists.

As the low-cost carrier industry has expanded rap-idly in South-east Asia and driven growth in Indone-sia’s domestic market, the increased availability ofaffordable flights is allowing more tourists to travel ona budget and still experience the attractive features ofIndonesia’s diverse regions. For example, KomodoNational Park has now become more accessible sincethe September 2013 completion of Labuan Bajo Air-port’s new 2150-metre runway, allowing it to receiveBoeing 737s and other large aircraft, whereas it waspreviously restricted to accommodating propeller planesand small jets. Komodo is an attractive destination forecotourists, as East Nusa Tenggara province is the onlynatural habitat of the Komodo dragon. KEY CHALLENGES: Infrastructure issues once againpose a challenge to the industry in this context, asmany enticing locales across the archipelago are inac-cessible, require rugged overland travel or necessitatemultiple legs in one journey. However, many top desti-nations for those interested in exploring Indonesia’stropical forests or observing native species, such asorangutans, tigers, rhinoceroses and elephants, arebecoming more reachable since the administration ofSusilo Bambang Yudhoyono prioritised infrastructuredevelopment with its $43bn budget allocation.

While regions with potential for ecotourism are poisedfor more business, some destinations face recoveryefforts before moving forward. Java and Sumatra, twoimportant tourism regions, suffered setbacks when achain of volcanic eruptions halted tourism. In Sumatraalone 25,000 people were displaced. The governmentmust ensure safety and sustainability as it moves for-ward with its plans to develop community-based tourism.

307


Indonesia is shifting focus

to ecotourism and

community-centred

offerings, and is examining

19 possible regions to

begin rolling out training

programmes.

Getting their hands dirtyTourism villages and ecotourism expansion

TOURISM INTERVIEW

Anthony Akili, President & CEO, Smailing Tours

What outbound tourism trends are you noticing

with the rise of Indonesia’s middle class, and how

can tour operators accommodate this?

AKILI: Indonesians are becoming increasingly edu-cated as the middle-income class continues toexpand, and indeed those who used to be in themiddle-income bracket have now risen to a higherincome level. With higher incomes come differentspending and travelling habits.

Typically over the last 10 years, when Indonesianswould go on holidays they requested the cheapestlarge group packages, or would visit countries orcities in the shortest time possible. In the past wewitnessed a lot of 12-day trips to Europe, where agroup of families would visit five to seven countriesduring their stay. Every day they would pass througha new country, but we have seen this habit startingto change. These more affluent people are now trav-elling outside of the traditional large group packagesand tend to be on their own or with their own fam-ily in small groups. Tourism companies used to focusprimarily on the destination and the best tourismattractions in that location.

Now tourism companies need to specifically tai-lor packages to each customer’s individual tastesand make sure something is included for everyonein the family. Furthermore, we’re seeing some of thehighest numbers of outbound tourists going toEurope, which has been a popular destination forIndonesians. Of course, they also travel in high num-bers to Asia, Australia and the US.

How much does the lack of connectivity contin-

ue to limit Indonesia’s product offering?

AKILI: It really is a huge impact. If we want to increasetourism penetration in Indonesia and expand ourproduct offering, the country’s transport infrastruc-ture needs to be improved, particularly to far-flungregions. We should ask ourselves whether we real-ly want to go on holiday and travel three or four days

on the road, on the bus or waiting for a boat. Nobodyis interested in doing that. However, that is how longit sometimes takes to get to the other side of thecountry where there are still beautiful, untouchedtourist destinations that can offer some very attrac-tive ecotourism and adventure tourism experiences.Greater access to these destinations can give Indone-sia’s tourism industry a competitive edge againstneighbouring countries, such as Singapore, whichdoes not have these offerings.

Garuda Airlines is making important progress nowby creating airport hubs. By not only focusing onJakarta and Surabaya and including more of thecountry’s secondary cities, it will create a new kindof tourism. In the past, all the flights had to go backto Jakarta or Surabaya, but now they can travel with-in their own region. I think this will create a newmodel for domestic tourism.

How does Indonesia’s meetings, incentives, con-

ferences and exhibitions (MICE) offering com-

pare to other countries in the region?

AKILI: Indonesia is still ranked rather low in theregion for MICE tourism, but despite that we do havehigh volumes of business travellers. Indeed, the vol-ume is growing tremendously every year, but theway we execute our MICE offering just is not up tostandard yet. The international standard of MICE isvery different to what Indonesia’s tourism sectorcan currently accommodate. When people want tohold an event or an exhibition there are issues oth-er than finding hotels and conference halls. Forinstance, if you have an art exhibition, it is current-ly difficult for the international participants to bringtheir own art. They need to put the pieces throughCustoms, which involves a long process and caninclude many bureaucratic delays, which can dis-rupt the flow of business. Once these challengescan be overcome, however, Indonesia will then haveall the ingredients to be a global MICE destination.

308

Changing tastesOBG talks to Anthony Akili, President and CEO, Smailing Tours


TOURISM ANALYSIS

Major events have attracted international figures to the country

After hosting a number of international events, follow-ing the launch of a new national strategy to developbusiness tourism, Indonesia is becoming a choice des-tination for the meetings, incentives, conferences, andexhibitions (MICE) segment. Jakarta, Bali and emerg-ing regional centres have expanded facilities to meetdemand, with the Ministry of Tourism and CreativeEconomy (MTCE) designating 2013 the year of MICEtourism. As business tourism revenues rise, 2014 willsee Indonesia bolster its MICE offerings on the back ofcontinuing promotional campaigns, a new landmarkconvention centre, and high-end hotel builds.IDENTIFYING MICE: MICE tourism was identified asan important segment of overall tourism activities in2004, when President Susilo Bambang Yudhoyonoinstructed the MTCE to increase MICE activities nation-wide. Since then, the country has hosted major events,including the inaugural UN Framework Convention onClimate Change, held in Bali in 2007; the 2009 WorldOcean Conference, hosted in Manado; and the 2011ASEAN Summit, hosted jointly in Jakarta and Bali.

Indonesia’s MICE segment showed tremendousgrowth between 2005 and 2010, according to theMTCE’s 2012 report, “Indonesia MICE Promotion.” Theministry reported that MICE tourists comprised just67,147 out of 5m total tourist arrivals in 2005; by 2010this number had grown by 251% to reach 236,082 outof 7m total arrivals. Nonetheless, the MICE tourists stillcomprised just 3.37% of total arrivals in 2010.

MICE promotion is an important facet of Indonesia’sMaster Plan for the Acceleration and Expansion ofIndonesia’s Economic Development 2011-25 (MP3EI).In an effort to bolster MICE activities, the MTCE offerssupport for MICE events, including bidding assistance,support for media campaigns, help desks at interna-tional events, pre- and post-event tours and activities,and coordination with relevant government institu-tions. To qualify for these benefits, an event must havea minimum of 500 international participants from 10countries, include a three-night stay in Indonesia, and

receive broad media coverage. The ministry also part-nered with Bank Danamon American Express and RajaM-ICE.com in 2008 to launch the annual Indonesia Cor-porate Meetings & Incentive Travel Mart (ICMITM),which promotes MICE events. However, with the MTCEmarketing budget shrinking as it rolls out multiple pro-motional campaigns, the ministry announced in May2013 it plans to re-evaluate its role in ICMITM, follow-ing the loss of former sponsor RajaMICE.com in 2012.PROMOTIONAL EVENTS: MICE promotion remainsstrong in Indonesia. In July 2013 MTCE minister MariElka Pangestu announced that 2013 was the year ofMICE tourism in Indonesia, with a number of high-pro-file MICE events planned for the country, including theWorld Trade Organisation (WTO) Conference, the Asia-Pacific Economic Cooperation 2013 summit, the ForbesCEO Summit, and Miss World 2013. Promotional activ-ities in 2013 included a tourism trade mission to India,while Japan’s National Tourism Organisation later openedits 14th overseas office in Jakarta in 2013, hosting aMICE seminar in Jakarta in June, which was attendedby Japanese suppliers and convention bureaus.

“The MICE segment in Indonesia will grow rapidlyover the next 10-15 years as there is a strong appetitefor doing business here. However, until now most ofthe exhibitions have taken place in neighbouring coun-tries,” Andy Wismarsyah, president director of DyandraPromosindo, a local exhibition organiser, told OBG.

The World Travel and Tourism Council reports thatbusiness tourism spending comprised 20.8% of over-all tourism revenues in 2013, reaching $8.92bn, andanticipates business travel revenues will grow by 9.9%in 2014 to reach $9.8bn in 2014. According to theMTCE, average tourist spending in Indonesia hit $1333per person in 2012, but Pangetsu has said MICE touristsspend three or four times more than other segments,preferring high-end dining, accommodation and trans-port during business trips. Indonesia is also an emerg-ing golf destination, with 114 golf courses offeringattractive recreational opportunities to MICE tourists.

MICE tourist numbers grew

by 251% between 2005

and 2010, from 67,147 to

236,082. This segment

spends three to four times

more than conventional

tourists and has become

the focus of new

development.

309


Business tourism spending

comprised approximately

20.8% of global tourism

revenues in 2013, reaching

$8.92bn. The segment is

expected to top $9.8bn in

2014.

The main eventsBuilding on strengths in a key high-value niche

TOURISM ANALYSIS

JAKARTA: Capital city Jakarta remains a dominant forcein the MICE segment, with MICE activities largely divid-ed between Jakarta and Bali. The city has experiencedsteady growth in visitor arrivals in recent years; accord-ing to the Jakarta City Government Tourism and Cul-ture Office, Jakarta welcomed a total of 28.8m air arrivalsin 2012, with real estate consultancy Cushman & Wake-field reporting in its “Hotel Views Asia Pacific 2014”report that the government’s MICE promotions havebolstered Jakarta’s growing demand for new hotelrooms. According to the report, Jakarta’s total roominventory stood at 26,113 in 2012, with demand expect-ed to grow on the back of new infrastructure, includ-ing airport upgrades, which will increase the country’sattractiveness to MICE organisers. Cushman & Wake-field expects an additional 5900 rooms will be addedto the existing room inventory before 2016. Indeed, theMICE consumer preference for high-end hotels andrestaurants has contributed to a surge in luxury hotelbuilds in recent years; for example, the Accor groupannounced plans to increase its Indonesian portfolioto 100 hotels by 2015, opening 18 in 2013. A week afterannouncing plans for its first Waldorf Astoria Hotel inBali, Hilton Worldwide unveiled plans to build the Wal-dorf Astoria Jakarta, featuring several MICE facilities: abusiness centre, meeting room and ballroom.

Jakarta is already home to a handful of MICE facili-ties, most notable of which is the Jakarta ConventionCentre (JCC), which was built in 1992 to host the 10thNon-Aligned Summit. The JCC is Indonesia’s largest con-vention venue, offering a plenary hall with a 5000-per-son capacity, 11,000 sq metres of exhibition halls, andassembly halls capable of hosting 3500 guests. Jakar-ta’s offerings are poised to expand, with the construc-tion of the Jakarta International Exhibition and CongressCentre, a 60,000-sq-metre exhibition space that willinclude an arena, outdoor meeting space, 45 meetingrooms, and a plenary hall with capacity for 18,000 peo-ple. The centre is due to open in March 2015 and willbe 30% larger than any existing Indonesian facility.BALI: Meanwhile, Bali has shown impressive growth inMICE activities in recent years. The MTCE has identi-fied the Bali-Nusa Tenggara Corridor as one of six eco-nomic corridors in the country that will receive specialtourism development focus, placing emphasis on Bali-Nusa Tenggara’s MICE segment, which could include

cruise ship and yacht-based business events. Hoteldevelopment has also taken off in Bali, with BadanPusat Statistik Indonesia reporting Bali held 24,215hotel rooms at the end of 2012, with the classifiedsegment increasing by 6% over 2011. Cushman & Wake-field estimates an additional 6600 rooms entered theBalinese market in 2013: 11% in the upscale segment,31% in the upper upscale segment, and 11% in the lux-ury segment, with an additional 4600 rooms to becomeavailable in Bali before 2018. Brands including Ritz-Carl-ton, Ramada, Best Western, Sofitel, Shangri-La, Regent,Mövenpick, Renaissance and Jumeirah currently haveprojects in the pipeline. The surge in Bali’s hotel roomscan be partly attributed to the growth of the MICEmarket; Bali co-hosted the 2011 ASEAN Summit andrecently hosted the APEC and WTO summits, as well asthe Miss World Contest, in 2013. Bali has two high-capacity convention centres catering to MICE activities,including the Bali International Convention Centre,which has 13,827 sq metres of meeting space, includ-ing two ballrooms, one auditorium and up to 25 meet-ing rooms, and which also hosted the 2007 World Cli-mate Change summit. The Bali Nusa Dua Conventioncentre (BNDCC) was opened in September 2011, withits first phase completed in just seven months, provid-ing 19 meeting rooms, a 4400-sq-metre convention hallwith capacity for 5000 people. In preparation for theAPEC 2013 Summit, the BNDCC’s expansion opened inAugust 2013, covering a 2.4-ha site, which includes3974 sq metres of additional meeting space, a plena-ry space with capacity for 2000 people, a 1000-sq-metre lobby, and 100 five-star hotel rooms.REGIONAL GROWTH: MICE events have spread intoregional cities and are set to continue growing. Emerg-ing MICE destinations include Medan in northern Suma-tra and Batam. Lombok is another strong contenderfor future MICE development, hosting its first interna-tional MICE fair in 2010. Bill Barnett, founder and man-aging director of C9 Hotelworks, told delegates at the2013 Indonesia Real Estate Conference that Lombokis a prime future hospitality investment destination,with land costing as little as $50-100 per sq metre.“There’s a finite amount of land in south Bali, so peo-ple who want to make rational investments will go fur-ther. We see companies like Media Nusantara Citra[buying] land in Lombok,” he told attending delegates.

310

Jakarta and Bali are

considered “established”

MICE destinations, but they

will soon have to compete

with up-and-coming

Medan, Batam and Lombok.

TOURISM ANALYSIS

East Nusa Tenggara is characterised by a diverse landscape

After welcoming 8.8m visitors in 2013, Indonesia’stourism industry is set for further expansion in 2014,bolstered by growing foreign investment in hotel con-struction. While Bali and Jakarta typically receive mostinternational visitors, the pristine and unique provinceof East Nusa Tenggara (ENT) is also slated to see its vis-itor arrivals and regional infrastructure grow, bolsteredby the increasing global popularity of its diverse attrac-tions, including the world-famous Komodo Island. Thegovernment has ramped up efforts to promote theprovince in recent years, with opportunities for hotelinvestment underpinned by planned airport upgrades,while new flight services should enhance accessibility.OVERVIEW: Located in the eastern region of the Less-er Sunda Islands, ENT, known within Indonesia as NusaTenggara Timur (NTT) is a geographically and cultural-ly diverse province. Predominantly Catholic and heav-ily influenced by Portuguese colonists, the area is knownfor its European heritage and unique natural beauty.NTT is made up of 566 islands, with Flores, Sumba andWest Timor (part of Timor island) home to the largesturban centres. Others include Adonara, Alor, Komodo,Lembata, Menipo, Raijua, Rincah, Rote, Savu, Semau andSolor. West Timor is the principal landmass in terms ofpopulation and home to the regional capital, Kupang.

NTT’s islands are formed by protruding peaks of amountain chain spanning from northern Sumatra andacross Java to the east. The rare ecosystem offers a hostof natural wonders, which are expected to boost futuretourism development, including Komodo Island, withits population of Komodo dragons, Kelimutu volcanoon Flores, Mount Mutis to the east of Kupang, NihiwatuBeach on Sumba Island, and Nemberala Beach on Rote.

Outside of tourism, NTT’s economic activities arelargely constrained to agriculture, fisheries and min-ing, with the tourism, fishery and animal husbandrysectors contributing 56% to regional GDP, according toAbraham Klakik, head of the provincial tourism agencyfor the Ministry of Tourism and Creative Economy(MTCE). In a 2012 interview with Antara News, Klakik

reported that these sectors increased their contribu-tion to regional GDP by 11% annually between 2009and 2012, with tourism expected to become the mainlong-term growth driver in the province.NATIONAL STRATEGY: Tourism promotion and eco-nomic development of the historically poorer easternregions of Indonesia have been highlighted under thegovernment’s Master Plan for the Acceleration andExpansion of Indonesia’s Economic Development2011-25 (MP3EI), with the Bali-Nusa Tenggara corridorreceiving special focus on tourism development.

In late 2012, President Susilo Bambang Yudhoyonovisited NTT in an effort to highlight the need for invest-ment in that part of the country, announcing that 48%of the government’s 2012 infrastructure budget ofRp194trn ($19.4bn) would go to projects in easternIndonesia. Meanwhile, NTT’s provincial government isworking to expand the tourism industry to become aneconomic pillar for the province’s 4.6m inhabitants.

Tourism inflows to NTT have increased tremendous-ly in recent years, rising from 148,763 visitors in 2010,to 412,072 in 2011. According to Klakik, the provincehoped to attract 1m tourist arrivals in 2013, up from750,000 visitors in 2012. KOMODO NATIONAL PARK: Located between theislands of Sumbawa and Flores, Komodo National Park(KNP) is spread over three main islands, Rinca, Komo-do and Padar, and numerous smaller ones. Covering anarea of 219,322 ha, the park is home to a diverse ecosys-tem, which includes open grass-woodland savannah,tropical deciduous forest and quasi-cloud forests. KNPwas initially established to conserve the population ofKomodo dragons, which are estimated at 5700, withnative colonies on each of Komodo, Gila Motang, Rin-ca and Flores. In 1977, the park was declared a bios-phere reserve by the UN Educational, Scientific andCultural Organisation, with Komodo Island designateda World Heritage Site in 1991. The government hasramped up efforts to promote the island internation-ally in recent years, hoping to bolster visitor numbers

Komodo National Park, an

area of 219,322 ha, covers

three main islands – Rinca,

Komdo and Padar – as well

as several smaller ones. The

park is home to a unique

ecosystem, including open

grass-woodland savannah,

tropical deciduous forest

and quasi-cloud forests.

311


The 566 islands that

comprise Nusa Tengarra

Timur are formed by an

extensive mountain chain

that runs from northern

Sumatra to Java.

Natural wondersKomodo National Park set to drive tourism growth in the region

TOURISM ANALYSIS

and enhance local economic development throughentrance fees charged at the park. In 2011 the MTCEbegan a six-month festival on Flores, gateway to Komo-do Island, after the park was announced as a finalist tobecome one of the New7Wonders of Nature. TheNew7Wonders Foundation announced that the island’sbid was successful in May 2012, with KNP officiallyinaugurated in September 2013. Since then, there hasbeen a steady rise in the number of foreign tourists. InDecember 2013, Sustyo Iriyono, a KNP spokesperson,announced that more than 60,000 tourists from 104countries visited the park in 2013, a jump of 10,000visitors, or 20% growth, over 2012. Tourists from theUS, Russia, Germany, Italy and South Korea comprisedmost arrivals, with Iriyono reporting that the park couldbecome a profitable venture generating substantialtourism revenues, if entry ticket prices were raised fromcurrent levels of Rp2000 ($0.20) for domestic touristsand Rp20,000 ($2) for foreign visitors.

Sailing also represents a future source for increasedrevenue and visitor numbers. NTT is already servicedby vessels travelling from Jakarta, Surabaya, Denpasar,Makassar and Biak. An annual touring sailing event,created under the Sail Indonesia umbrella, was held inNTT for the first time in 2013, and could set the stagefor sailing to expand its contribution to tourism rev-enues. Yudhoyono attended the opening ceremoniesof Sail Komodo 2013, titling it “The golden bridge towardEast Nusa Tengarra”, in September 2013.INFRASTRUCTURE UPGRADES: In April 2014, MariElka Pangestu, Indonesia’s minister of tourism and cre-ative economy, announced that tourism investmentsreached $602.6m in 2013, of which $462.5m camefrom foreign investments, driven by new hotel con-struction and expansion of existing international chains.

The fishing settlement of Labuan Bajo on Flores, theentry point to Komodo Island, has seen a steady influxof domestic and foreign tourists following theNew7Wonders announcement. However, provincialofficials reported in 2012 that tourists had been forcedto postpone visits to the town during peak season, asexisting facilities consistently stood at 100% occupan-cy. As such, opportunities for future hotel investmentin NTT are plentiful. According to Statistics Indonesia,the province offered just 18 classified hotels, with a totalof 1458 beds as of 2013. Some 34,836 guests stayed

in the province’s non-classified hotels and 57,300 in clas-sified hotels in 2011.

Aviation upgrades will also help to meet new tourismdemand, with handling capacity increased in 2012 andseveral new projects set to commence in 2014. NTT cur-rently has 14 airports, although most can only accom-modate small airplanes such as MA-60s, Fokker 50s andATR 72s. Flight services are relatively limited; Kupangserves Darwin in Australia twice a week, while regularshuttle flights from Bali, Makassar and Surabaya pro-vide additional connections. In the run-up to Sail Komo-do 2013, NTT moved forward on three new runwayextension projects at Komodo Airport in Labuan Bajo,Frans Seda, also on Flores, and Umbu Mehang Kundaon Sumba. The airports previously offered 1.85-km longrunways capable of accommodating Boeing 737-300aircraft, with Komodo and Frans Seda later extendingtheir runways by 200 metres, while Umbu Mehang Kun-da extended its runway by 600 metres, respectively.

Future expansion of Komodo Airport could dramat-ically improve visitor arrivals. The Ministry of Trans-portation’s (MoT) air transportation directorate gen-eral allocated Rp5.6trn ($560m) in 2014 to build andmaintain 178 non-commercial airports under its man-agement, while Bambang Tjahyono, airports directorat the MoT, has announced the ministry is preparingdocuments to tender management of three non-com-mercial airports, including Komodo, in the first quarterof 2014. The ministry plans to tender 10 additional air-ports after the first three tenders, selecting high-poten-tial facilities witnessing arrivals of more than 500,000passengers annually, as well as double-digit growth.

Komodo Airport, with an estimated 800,000 annualpassengers, represents one of the best opportunitiesfor near-term investment. In April 2014, Indonesianflagship carrier Garuda announced it would be the firstcompany to submit a proposal to take over manage-ment of the airport. Tjahyono told the Jakarta Post thatGaruda had submitted a written statement to expressits interest due to Komodo’s potential. Garuda hadalready begun offering direct flights to Komodo in late2013, with early successes leading to the April propos-al. Given that Indonesia’s visitor arrivals exceeded 8.8min 2013, and are set to reach 10m in 2014, new arrivals,coupled with a growing interest in visiting less-fre-quented sites, should continue to drive NTT’s growth.

312

Indonesia has set a target

of attracting 10m tourists

in 2014, with several

infrastructure projects in

Nusa Tengarra Timur

expected to contribute to

this by increasing hotel bed

capacity and boosting

aviation links.

TOURISM ANALYSIS

The government is looking to diversify tourism across the country

Although tourist numbers have steadily increased inrecent years, Indonesia has some way to go to reachits potential as a major global destination. Accordingto the World Travel and Tourism Council (WTTC), tourismearnings comprised 9.5% of global GDP in 2013, totallingapproximately $7trn. These numbers are expected torise further in 2014, but have the potential to be sub-stantially higher if various constraints are addressed,particularly by way of relaxing visa policies, developingtourism infrastructure and increasing the number ofsector jobs. Indonesian tourism, though already a suc-cessful industry, would benefit from implementing thesechanges, especially considering that South-east Asiais currently the world’s top travel and tourism location.

Throughout 2014, the Ministry of Tourism and Cre-ative Economy (MTCE) will put the majority of its atten-tion on 16 regions in order to diversify popular tourismdestinations around the archipelago. Lombok, Bromo-Tengger-Semeru National Park, Flores-Komodo (seeanalysis), Lake Toba and Borobudur Temple are includ-ed in the list, which will be extended to 88 destinationsby 2025. January 2014 saw a 22.5% increase in foreigntourist arrivals over the same month in 2013, showingearly promise for the sector’s performance in 2014.

While infrastructure remains the focus of develop-ment, and creative industries receive greater investment,the tourism sector will continue to increase its contri-bution to Indonesia’s overall GDP. Further, if key con-straints are remedied, Indonesia will be poised to takeadvantage of the uptick in global tourism numbers andassume a stronger position in its attractiveness as aninternational destination.EASING VISA RESTRAINTS: A tourist visa currentlycosts $25 and is obtainable on arrival in Indonesia’s des-ignated ports of entry. The visa lasts for 30 days and,if a tourist wants to extend his or her stay, another feeis required. If the government allowed for a 90-day visaon arrival, it could encourage extended stays and allowtravellers to visit more destinations throughout thearchipelago during a single visit. While this option is

not yet on the table, an upcoming shift in visa require-ments is set to aid freer flow of tourism within theASEAN region. The integration of the ASEAN Econom-ic Community (AEC) will occur alongside the openingof a common AEC visa on December 31, 2015. This willallow citizens of the ASEAN bloc access to Indonesiawithout the need for a visa on arrival. Tourism withinASEAN is projected to provide $480bn in profits in thenext 10 years, provided it continues at its current paceof growth, which reached 12% in 2013, up from an8.3% average between 2005 and 2012.

Once the AEC common visa is implemented, upgrad-ed and expanded, infrastructure will be vital to thecountry’s ability to accommodate increased air andland traffic generated by tourists. Considering that cur-rent traffic and connectivity problems often deter vis-itors, it will also ensure that transit runs smoother andcongestion is relieved. This would make travelling to andwithin Indonesia more attractive for citizens of the sin-gle economic community, which can help the tourismsector realise its potential in the coming years.

According to Mari Elka Pangestu, the minister oftourism and creative economy, the tourism sector com-prised 3.8% of Indonesia’s GDP in 2013, which reached$900bn. With more investment in transport and infra-structure development, as well as the creative indus-tries that draw tourists, national GDP could see greatercontribution from the tourism sector. TAPPING INTO THE CHINESE MARKET: As the Indone-sian government pushes forward with internationalpromotion efforts, it has put more focus on China,which leads the world in terms of tourists and travelspending. Bali is already a top destination for Chinesetourists, but the MTCE sees room for further growthbeyond the island, to the country as a whole. The gov-ernment has opened a new website for tourism pro-motion in Mandarin in an effort to boost tourist arrivalsto 1m by year-end 2014. Bali alone received some52,060 Chinese visitors in January 2014, which was an80.5% increase year-on-year. After Australians, Chinese

Tourism within the ASEAN

bloc is expected to garner

$480bn in profit over the

next decade. Citizens of

the ASEAN Economic

Community will be able to

enter Indonesia visa-free as

of December 31, 2015.

313


Moving up the ranksTaking steps to cash in on rising international tourist numbers

TOURISM ANALYSIS

visitors are the second-largest tourist group to Bali, and387,533 visited the island in 2013.

Indeed, the Chinese consumer market is rapidlyexpanding, and a growing number of middle class aretravelling annually. In 2013, some 73m Chinese touristsvisited overseas, with this figure set to jump to 100min 2014. If the current growth rate continues, more than200m Chinese tourists will travel internationally by2020, according to the investment group CLSA.

Tourism receipts in Indonesia reached $10.05bn in2013. With the sector already a major contributor tothe economy, Chinese tourists are set to boost the sec-tor further, owing to new promotion techniques andairline expansion to new routes between the two coun-tries. Direct flights from China to Bali have contributedto ease of travel in the past, and even more passen-gers are likely to take advantage of new flight options,once Drangonair (a branch of Cathay Pacific) opens itsroute from Hong Kong to Bali in mid-2014, which willbe the carrier’s first location in the archipelago.

Currently, Tigerair Mandala, Hong Kong Airlines andGaruda fly direct to Indonesia from China, and wererecently joined by Jetstar Airways and Hainan Airlines,respectively, which commenced routes at the begin-ning of 2014. According to Pangestu, increasing thenumbers of foreign arrivals per annum has driven upthe amount of foreign exchange in the tourism sectorat a rate that is higher than GDP growth.PROMOTING JAKARTA: In an effort to transform Jakar-ta into more than just a transit hub, the Indonesiangovernment will also focus on developing the capital’stourism potential in 2014. The city is often avoided dueto notorious traffic conditions, but upcoming transportdevelopment projects have the potential to relieveJakarta of its congestion woes and, in the process, con-vince more travellers to visit and explore.

The Jakarta Tourism and Culture Office (JTCO) is aim-ing for a 20% boost in the city’s tourism earnings in 2014,having recorded around $258m in 2013. The capital isset to benefit from increased investment in the creativeindustries segment, further developing its potential as

a destination for tourists to experience festivals, musicand the arts. The city is now home to double-deckercity tour buses, which began service in February 2014,and will help draw tourists to explore greater Jakarta.The capital has consistently been a location for meet-ings, incentives, conferences and exhibitions. Arie Bud-himan, head of JTCO, expects to see 2013’s momentumcontinue, when Jakarta held 246 events, up from 147in 2012. Overall, some 35m domestic visitors and 2.25mforeign visitors are expected to travel to the city in2014, according to Budhiman. GOING FORWARD: The WTTC reported in March 2014that global travel and tourism is projected to createapproximately 6.5m new jobs in 2014. It will also bringa 5.6% increase in investment and a 4.8% rise in visitorexports. As the Indonesian consumer market contin-ues to expand, domestic and outbound travel shouldincrease along with foreign visitor numbers.

In order to ensure that the industry reaps the ben-efits of growth in global tourism, the government willneed to prioritise investment and promotion, as it hasbegun to do since naming tourism as one of the cor-ridors in the Master Plan for the Acceleration andExpansion of Indonesia’s Economic Development.The creative industries segment will need to be devel-oped and strengthened simultaneously with the tourismsector, so that the two can mutually benefit.

According to Budi Tirtawisata, CEO of PanoramaGroup, a leading integrated tourism company, “The gov-ernment is aware of the necessity of proper engage-ment in tourism and creative industries. There are 14sectors, such as music and architecture, that are themain creative industry focus points being developed inan effort to boost tourism.”

Much needs to be done for Indonesia to catch upwith neighbouring Thailand, Malaysia and Singapore,which, by numbers, are regional leaders of tourism. Ifthe MTCE reaches its goal of 9.2m foreign arrivals and255m domestic tourists by 2014, Indonesia will be onits way toward realising its potential, and the sector will prove its significance as a major contributor to GDP.

314

China accounts for a

growing number of visitors

to the archipelago, with

tourism likely to capitalise

further as new airline

routes between the two

countries come on-line.

TOURISM ANALYSIS

The country hosted two international fashion events during 2013

As concerns grow that an over-reliance on resource-related exports could see Indonesia repeat the boom-bust cycle of its past, the country is being encouragedto accelerate moves to diversify its economy away fromcommodities and towards areas such as the creativeindustries. Two major fashion events, Jakarta FashionWeek and Indonesia Fashion Week, are helping show-case Indonesia’s creative capacity, although critics saythe government is not doing enough to help the cap-ital or the country as a whole fulfil its potential as acentre for creativity. Effective government support isall the more important now, at a time when globaldemand for natural resources is dipping and as neigh-bouring rivals are ramping up their creative sectors.SIGNIFICANT CONTRIBUTOR: Indonesia’s consumerand natural resources boom faltered this year, withGDP expanding at an annualised rate of 5.8% in the sec-ond quarter, the first time since 2010 that this figurehas fallen below 6%. Meanwhile, the growth potentialof Indonesia’s creative industries – including music,film, fashion, architecture and interactive gaming – issurging. The sector’s contribution to GDP in 2012 stoodat RP524trn ($46.7bn), according to data from the Min-istry of Tourism and Creative Economy (MTCE).

A report on enhancing the competitiveness of Indone-sia’s creative industries by three researchers based atthe Bandung Institute of Technology, published in 2012,emphasised the broader benefits of the sector on theeconomy. "Creative industries have a significant eco-nomic contribution to the [Indonesian] economybecause they can create a positive business climate,strengthen the image and identity of the country, sup-port the utilisation of renewable resources and have apositive social impact," the report said.

As part of government efforts to boost the sector,the MTCE has applied for four cities, Bandung, Peka-longan, Surakarta and Yogyakarta, to be included in theUNESCO "Creative Cities" initiative, which aims to boostthe fashion, arts, film, music and architecture industries.“We expect that the designation will help the cities to

boost their creative industries, which in turn contributesto our creative economy. This kind of economy createsmultiple added-values compared to any other econo-my,” the minister of tourism and creative economy, MariElka Pangestu, told the Jakarta Post. However, somecritics have questioned the MTCE’s decision to omitJakarta from the application. “Why are there not moreinitiatives and government-backed programmes to pro-mote and highlight the vast palate of creativity thatresults from the roughly 10m residents of the capitalcity?" asked the Jakarta Post in an op-ed piece.BARRIERS TO GROWTH: Critics say that humanresources and entrepreneurs’ access to capital andmarkets must be improved. One possible way of meet-ing the industry’s financing needs would be throughthe introduction of so-called crowd-funding arrange-ments, similar to those organised through well-knownUS website Kickstarter.com. In 2012, two indigenouscrowd-sourcing websites were launched, Patungan.comand Wujudkan.com. So far both websites have fundeda number of successful projects, including book pub-lications and the creation of a handicrafts productionworkshop. In addition to financing constraints, themusic and fashion industry also faces issues over intel-lectual property rights, with the Indonesian RecordIndustry Association estimating in April that recordcompanies experience potential losses of RP16bn($1.4m) a day due to illegal downloads.

At the Popcorn Asia 2013 international pop culturefestival, held at the Jakarta Convention Centre in July,artists and observers said they are not getting the sup-port they need from the state, adding that Japan, SouthKorea, Thailand and Malaysia have government fundsand programmes that specifically support the creativeindustry. Last year, Malaysia’s government launched anRM200m ($62.7m) fund for the creative industry, withofficials saying it had "exciting growth potential". Thisprogress in Malaysia highlights the lack of support bythe Indonesian government. "[Indonesia has] missedout on the industrial age, with much of our natural

315


The increased focus on

creative industries,

particularly popular

culture, has resulted in an

uptick of crowd-sourcing

activity, with both national

and international

crowd-sourcing websites

featuring Indonesian

content.

In need of a boostSupporting creative industries to improve sector growth

TOURISM ANALYSIS

resources and industry being controlled by foreigninvestments. And yet as the resources that run theindustrial age are depleted, industrial states such as theUS, Japan and Korea are maintaining their global pow-er by developing their creative economies. Those coun-tries see Indonesia as a potential market,” Ivan Chen,chairman of the Indonesian Creative Copyright Asso-ciation, an organisation that pushes for intellectualproperty rights, told the Jakarta Globe.

Despite the difficulties faced by the sector, foreigninvestors are taking notice of Indonesia’s potential. InSeptember, Malaysia’s External Trade Development Cor-poration led a delegation of 28 Malaysian creative con-tent and multimedia companies to Jakarta, with aspokesman stating that the city was "an attractive mar-ket destination [for the creative industries], being thecentre for Indonesia’s entertainment and content indus-try". Such developments underscore the fact that,unless the government introduces incentives and sup-port for the creative industries, foreign investors couldcome to dominate the creative sector’s momentum, asthey have done with the natural resources sector.INVIGORATING INDUSTRY: If growth barriers are over-come and creative industries receive the boost theyneed, the tourism sector will be more capable of reach-ing its potential. The Minister of Tourism and CreativeEconomy announced in mid-March 2014 that they willaim to attract 9.3 to 9.5m tourists to Indonesia thisyear, which would account for a 6-8% increase from

2013. Furthermore, it hopes to see 255m tourists trav-el domestically before the year’s end. Developing cre-ative economies will be a vital step toward ensuring thesegoals are met this year and set higher in the near future.

In 2011 the government began taking steps to boostIndonesian food exposure abroad, designating culinaryarts as one of the country’s fourteen tourism industrysubsectors. Taking the lead from countries like Thailand,an incentives programme was designed to encouragebusinesses to set up restaurants with neighbouringcountries and beyond, as a new venture in culturalexchange and creative economy promotion. Serving asculinary ambassadors, restaurant businesses abroadoffer a way to boost Indonesia’s reputation as a foodtourism destination. Investment in this venture canhelp Indonesia garner a foothold similar to that whichthe Thai, Chinese, Japanese and Vietnamese food indus-tries have achieved for their respective tourism sec-tors. The government is examining Indonesian restau-rants established abroad to determine best practicesfor future businesses. The challenge is choosing fromIndonesia’s wide range of traditional meals.

In 2011, CNN gave promotion to Indonesian culinaryarts by naming one of its signature dishes, rending,number eleven on its list of the “World’s Most DeliciousFoods.” Considering that exploring new cuisines is a highmotivator for many foreign travellers, the government’sefforts to make Indonesian food more popular abroadshould help boost arrival numbers in coming years.

316

In an effort to capitalise on

the attraction of creative

industries, Indonesia is

working to boost visitor

numbers by 6-8% in 2014

with new offerings in this

segment.

317

AgricultureGrowing population ensures that demand remains highDiversifying production to include small and large farmsEnsuring sustainability a major goal for the industryGovernment focusing on maintaining reliable supplies

AGRICULTURE OVERVIEW

The sector is one of the major sources of employment in the country

Tasked with providing sustenance for the country’snearly 250m citizens while contributing a steady streamof export revenue, the Indonesian agriculture sectorremains an indispensable industry with an influence thatextends across a broad spectrum of the social, econom-ic and political landscape. The country’s vast territorycombined with favourable soil and climactic conditionshave given rise to a host of homegrown agro-industri-al giants, as well as drawing the attention of some ofthe world’s largest international outfits.

As a whole the agriculture sector made up 14.4% ofIndonesia’s total GDP in 2013 as measured in currentprices, similar to 14.5% the previous year, according todata from Statistics Indonesia (BPS). Food crops remainby far the largest contributor to the sector, account-ing for more than half of the industry’s value, thoughas the world’s top producer of palm oil, commodityexports to ports across the globe also provide a reli-able inflow of foreign currency.

Other cash-generating segments include rubber,cocoa, coffee, tea, cinchona, sugarcane, tobacco andthe fisheries subsector. Efforts to modernise produc-tion have a part to play. “The fragility of the tobaccocrop can be mitigated through the installation of irri-gation systems, and this will likely require significantinvestment from the private sector,” Ronald Walla, thepresident director of tobacco firm Wismilak, told OBG. BOOK VALUE: As a whole, the Indonesian agriculturesector contributed Rp1.31qrn ($131.1bn) at currentprices to the country’s GDP in 2013, up 9.8% fromRp1.19qrn ($119.3bn) in 2012, according to BPS data.The accelerated growth was led by expansion in thefood crops subsector driven in large part by rising riceproduction, which increased by 2.62% in 2013 aftergrowing by 5% the previous year. Food crops contin-ued to contribute the lion’s share of value in 2013,accounting for 47.4% (Rp621.8trn, $62.18bn) of agri-cultural production, followed by the fisheries subsec-tor with 22.2% (Rp291.8trn, $29.18bn), estate crops with13.3% (Rp175.25trn, $17.5bn), livestock with 12.5%

(Rp165.16trn, $16.5bn) and forestry with the remain-ing 4.3% (Rp56.9trn, $5.7bn). The sector is also thelargest employer in the country, accounting for 34.36%(38.07m workers) of Indonesian workers over the ageof 15 as of August 2013, according to data from BPS.

In spite of falling vegetable oil commodity prices, theplantation subsector was also able to record gains onthe strength of continued expansion in the palm oil seg-ment. Agriculture exports for 2012 increased 8.5% to$5.58bn compared to the previous year, accountingfor 3% of all exports on the year, according to prelim-inary data from Bank ICB Bumiputera. Export values wereaided in the first quarter of 2012 by an increase inglobal staple food prices due to supply disruptions inNorth and Latin America as a result of drought condi-tions, as well as poor wheat harvests in the Black Searegion and China due to weather conditions.

However, prices softened in the second quarter andstabilised in the second half of the year, with demandfor food remaining steady in spite of a sluggish globaleconomy. Exports for the first half of 2013 continueda positive growth trend, increasing by 2.41% to $2.53bncompared to the same time period in 2012 STAPLES: Consistent with the average Indonesian’sbasic diet, rice, maize and soybeans are among themost widely grown crops in the country and are culti-vated primarily for domestic consumption. Whiledemand and climactic conditions have fostered a con-tinuous expansion of rice production to keep pace withpopulation growth, development of alternatives suchas maize and soybeans has stagnated over the past fiveyears in spite of concerted diversification efforts.

In 2013 Indonesian paddies yielded 70.9m tonnes ofrice, up from the 69.1m tonnes produced the previousyear and in keeping with the larger trend, which hasseen consistent growth going back to the 51.9m tonnesrecorded in 2000, according to BPS data. Over the sameperiod, the production of soybeans – which are the pri-mary ingredient in widely consumed traditional Indone-sian dishes – has tailed off from 1.02m tonnes in 2000

In 2013 the sector

accounted for 14.4% of

total GDP. Food crops

represent the largest

segment with more than

half of the industry’s value.

Rice, maize and soybean

are among the most widely

grown crops and are

cultivated primarily for

domestic consumption.

With a total output of

70.86 tonnes in 2013, rice

is the dominant staple food.

318

Keeping the ball rollingEfforts to boost efficiency and sustainability are under way



to 807,568 tonnes in 2013, despite an increase in farm-ing efficiency that saw soy yields improve from 12.34tonnes per ha to 14.57 tonnes per ha over the sametime period. This is due in part to a substantial curtail-ing of soybean acreage, which was been reduced byroughly one-third from 824,484 ha in 2000 to 554,132ha in 2013, as well as new import and tariff policies.

Finally, efforts to diversify the local diet by increas-ing the production of maize (for which Indonesia’s cli-mate is less favourable compared to rice and soy crops)have led to a rise in production from 9.68m tonnes in2000 to 18.5m tonnes in 2013, though growth hasslowed considerably since 2009. Over this period, maizeyields have increased dramatically from 27.65 tonnesper ha to 47.99 tonnes per ha, while cultivated acreagerose from around 3.5m ha in 2000 to 3.86m ha in 2013.

Despite the gains made in past years to boost thecountry’s food output, Indonesia’s expanding popula-tion and the changing appetites of its growing middleclass will require continued expansion of the food cropsector to keep pace. Consumption of hulled rice (con-verted from non-hulled product with a 63% yield and16.4% shrinkage rate) is expected to rise from 36.5mtonnes in 2012 to 39.5m tonnes by 2020, along withcorresponding increases in corn from 20.36m tonnesto 22.07m tonnes and soybean from 2.71m tonnes to3.06m tonnes, according to the Indonesian Chamberof Commerce and Industry’s food development pro-gramme, Vision 2030. To meet and even exceed thisincreased demand for basic food crops (soy bean andwhite sugar excepted), the roadmap calls for a widerange of measures to boost productivity and output,including expanding food production areas, limitingthe conversion of existing cropland for other purpos-es and increasing yields in these areas. While the coun-try has in the past ventured into hybrid stains of cropssuch as rice and corn to boost output, further work willbe needed in terms of improved irrigation, training offarmers, logistics and storage practices, and otherissues across the value chain in order to maximise yields. POLICY: In addition to the long-term strategic aims offood self-sufficiency and increasing cash crop exports,the government is taking measures by which it hopesto achieve the twin goals of reducing domestic foodprice volatility and boosting demand for locally grownproducts. A key piece of legislation enacted to this endis the Food Law of 2012, which updated previous leg-islation concerning food security, domestic agricultureand trade restrictions, among other things. Includedin the Food Law is the bolstering of the State LogisticsAgency (Bulog) to expand its role as well as increaseits authority to carry out its mission of stabilising keydomestic food prices through the practice of buyingand selling staples locally at set rates and regulatingthe import and export of products. While rice is by farthe most important crop under Bulog’s authority, addi-tional commodities such as beef, corn, sugar and soy-beans are now subject to similar regulations that couldlead to a wider dispersion of distortions in the market.

While the 2012 Food Law and Bulog’s role within thisframework have been effective in achieving targets for

the sector so far, there are concerns that the methodsemployed may not be the best solution in the longterm. Detractors, including the OECD and the Ameri-can Chamber of Commerce, have voiced concerns thatmarket distortions caused by these policies will harmthe sector over time by encouraging inefficiencies,while pushing up consumer prices in the short termand discouraging investment over the long term.

Although it is too early to determine the wider rang-ing implications of these protectionist strategies, ear-ly data indicates a rise in both wholesale and consumerfoodstuff prices since the changes were made in August2012. The composite consumer price index of 66 citiescompiled by the BPS shows an average monthly rise infoodstuff prices of 0.57 points from August 2011 toJuly 2012, half of the 1.18 average increase exhibitedin the 12 months after implementation. Core food infla-tion as measured by the Bank Indonesia (BI), the cen-tral bank, also outpaced non-food commodities in thefourth quarter of 2012 by 5.5% to 3.6%. By contrast,international commodity prices for basic foodstuffsrice, wheat, corn and soybean all declined or remainedstatic after August 2012 through the end of that year.

319


Sustained demand should keep profits high for large plantations

The government is focusing

on both reducing food

price volatility and

increasing the contribution

of domestic production to

consumption in the

country.

SOURCE: BPS * Preliminary figures

Rubber Oil palm Cocoa Coffee Tea

2001 506.6 3152.4 158.6 62.5 83.3

2002 492.9 3258.6 145.8 58.2 84.4

2003 517.6 3429.2 145.7 57.4 83.3

2004 514.4 3496.7 87.7 52.6 83.3

2005 512.4 3593.4 85.9 52.9 81.7

2006 513.2 3748.5 101.2 53.6 78.4

2007 514.0 4101.7 106.5 52.5 77.6

2008 515.8 4451.8 98.4 58.3 78.9

2009 482.7 4888.0 95.3 48.7 66.9

2010 496.7 5161.6 92.2 47.6 66.3

2011* 524.3 5306.1 92.1 47.8 66.2

2012* 524.6 5406.9 92.1 47.9 64.5

Estate area by crop, 2001-12 (000 ha)


Other measures included in the Food Law are incen-tives structures designed to promote domestic pro-duction, including a higher government purchasingprice (which was increased by 25% in February 2012)paid by Bulog to purchase its reserve stocks, improveddomestic trade system for agricultural goods and theimplementation of an import ban on processed foods,which resulted in a 32.6% decrease in imports and acorresponding increase in domestically producedprocessed food products of 12.8%. Apart from the FoodLaw, other temporary measures were also taken in2012 to ensure a continuous supply of staples, such asa reduction in tariffs on soybean imports starting in thethird quarter of 2012 to counter a temporary globalsupply shortage and ensuing price hike. PALM OIL: One of two countries along with Malaysiathat dominate the global production, processing andexport of palm oil, Indonesia has capitalised on grow-ing demand for the versatile commodity, which hasmade palm oil the largest revenue generator within thesector in spite of the recent drop in demand and glob-al commodity prices for the product. While demand forpalm oil expected to continue its upward trajectory, pro-duction and cultivated acreage growth in Indonesia, aswell as Malaysia, should be substantially slower thanthe rapid double-digit increases that characterised thepast decade of expansion for the industry. This is dueto both the gap between supply and demand closingin as a result of rapid expansion in capacity over thepast decade and greater efforts by both the govern-ment and industry players to implement more environ-mentally sustainable cultivation practices.

Production continued to increase in 2012, reachinga total of 26.5m tonnes on the year, up from the 23.5mtonnes recorded in 2011 and the 21.8m tonnes in 2010,according to data from the Indonesian Palm Oil Asso-ciation (GAPKI). The majority of this was exported, with18.22m tonnes shipped in 2012. Exports consisted of16.77m tonnes of palm oil (9.46m tonnes processed,7.31m tonnes crude) and 1.46m tonnes of palm ker-nel oil (673,490 tonnes of processed, 783,930 tonnesof crude). The largest recipient of Indonesia’s palm oilexports was India, which purchased a total of 5.85mtonnes, followed by the EU with 4.17m tonnes and Chi-na with 2.96m tonnes.

Through the first seven months of 2013 exportswere on pace to outperform 2012 with a total of 12.21mtonnes shipped, and the US Department of Agricultureprojected total 2013 production of around 31m tonnes

(28m tonnes by GAPKI) – well above rival Malaysia’s esti-mated output of 19m tonnes.

Over the past 15 years, the palm oil industry hasbeen one of Indonesia’s success stories, as its rapidlyexpanding palm plantations became an increasinglyimportant foreign exchange earner and employer. Asof 2013 there were roughly 9m ha of palm plantationsin the country located primarily in Sumatra and to alesser extent in Kalimantan, up more than four-foldfrom the approximately 2m ha present in 2000, accord-ing to the Ministry of Agriculture. Of these, some 3.6mha are operated by smallholders – 1.6m under thenucleus/plasma system producing up to 5-6 tonnes perha and 2m ha of individual smallholders producing 1.8-2.1 tonnes per ha – and the remaining 5.4m ha workedby large estate plantations yielding up to 8 tonnes perha. The large, export-oriented palm oil firms operatingin Indonesia have grown into international agribusi-ness powerhouses in their own right and include thelikes of Astra Agro Lestari, Indofood Sukses Makmur,Sinar Mas, BW Plantation, Bakrie Sumatera Plantations,Wilmar Group, Sampoerna Agro, Musim Mas, Raja Garu-da Mas and PP London Sumatra Indonesia.

Driven primarily by population growth and rising percapita incomes in developing counties, production ofoilseeds and the by-products of protein meals and veg-etable oils is projected to grow by 26% by 2022 withpalm oil share increasing to 34% of all vegetable oils(and around two-thirds of exports), according to theOECD and UN Food and Agricultural Organisation’s“Agricultural Outlook 2013-2022”. This would placeIndonesia as the world’s single-largest exporter of veg-etable oils in 2022 with a 34% market share, followedby Malaysia with 30%, with no other single countrymaintaining more than a 10% share.

Similar to its rival Malaysia, the government is mak-ing concerted efforts to add more value to the indus-try by encouraging domestic refinery. As a result, theexport tax on refined palm oil products has been reducedfrom 25% to 10% in 2012, while the export tax on crudepalm oil has declined from around 15% in mid-2012 to7.5% by January 2013 due to the implementation of asliding tax scale linked to the international palm oilprice ranging from 7.5% to 22.5%.RUBBER: The rubber sector has had a tough go ofthings over the past few years as plummeting demandsent commodity prices into a tailspin, which has led toa decline in both exports and value for the world’s sec-ond-largest exporter of natural rubber. Production

320

Palm oil production

increased from 23.5m

tonnes in 2011 to 26.5m in

2012, the majority of which

(18.22m tonnes) was

exported.


SOURCE: BPS *at 2000 constant market prices

2006 2007 2008 2009 2010 2011 2012

Agriculture, livestock, forestry & fishery 262.40 271.51 284.62 295.88 304.78 315.04 327.55

Food crops 129.55 133.89 142.00 149.06 151.50 154.15 158.69

Estate crops 41.32 43.20 44.78 45.56 47.15 49.26 51.76

Livestock & products 33.43 34.22 35.43 36.65 38.21 40.04 41.97

Forestry 16.69 16.55 16.54 16.84 17.25 17.40 17.42

Fishery 41.42 43.65 45.87 47.78 50.66 54.19 57.70

GDP 1847.13 1964.33 2082.46 2178.85 2314.46 2464.68 2618.14

GDP by agricultural segment, 2006-12* (Rp trn)


improved slightly to 3.18m tonnes in 2013, up from3.04m tonnes in 2012 but down from 3.99m tonnes in2011, according to statistics from the Indonesian Rub-ber Association (GAPKINDO). Smallholders are the dom-inant producers within the sector, accounting for atotal of around 2.5m tonnes of output as compared to340,000 tonnes from government estates and some370,000 tonnes from private estates.

In spite of stable production figures, export valuesfell off from $11.76bn in 2011 to $7.86bn in 2012 fol-lowing a dip in commodity prices that has continuedthrough the first half of 2013, according to GAPKIN-DO. The price of benchmark export-grade ribbed smokedsheet (RSS) type 3 fell to $2.75 per kg in mid-2012, farbelow a record high of $6.40 per kg in February 2012.

In terms of volume, the country shipped a total of2.44m tonnes in 2012 compared to 2.56m tonnes theprevious year. The US was the top destination for exports,taking in 572,278 tonnes, followed by China with437,750 tonnes and Japan with 389,234 tonnes. Themajority of exports are shipped in the form of standardIndonesian rubber, which accounts for around 97% ofexports, with RSS making up 2.7% and 0.3% in the formof latex concentrate.

With the vast majority of smallholders feeling thepinch of lower rubber prices in Indonesia, along withtop producers Malaysia and Thailand, there is a real threatthat farmers may choose more lucrative crops as theystruggle to maintain profits. In order to combat this,the three countries, which are responsible for around70% of global rubber output, agreed to cut down rub-ber trees and trim exports by 300,000 tonnes betweenOctober 2012 and March 2013, although the strategyproved largely unsuccessful as larger global econom-ic factors continued to depress commodity prices. OTHER CROPS: In addition to food crops, palm oil andrubber, Indonesia also produces substantial quantitiesof other crops, including coffee, sugar, tobacco, tea,cocoa, fruits and vegetables, and seafood. Coffeeremains the leading non-manufactured cash crop forexports, with the country shipping $1.24bn worth ofbeans in 2012, up from exports of $1.03bn in 2011,according to BOI figures.

This growth trend will likely come to an end in 2013,however, due to a combination of aging trees, ineffi-cient cultivation and harvesting practices, and a par-ticularly wet harvest season that has damaged cropsas the majority of farmers are still reliant on sunlightto dry and cure beans prior to shipping. Production isprojected by the Association of Indonesian CoffeeExporters and Industries to taper off at 728,000 tonnesin 2013, down from the 748,109 tonnes the previousyear, but still significantly higher than the 633,991tonnes cultivated in 2011.

The fisheries subsector also plays a substantial rolein agriculture exports with $1.11bn in shrimp ship-ments in 2012, along with an equal amount of exportsof fish and related products. Other major cash cropsinclude spices with $631.80m in exports, cocoa beansworth $388.33m, fruits with $181.32m, vegetableswith $134.13m and tea with exports worth $126.75m.

OUTLOOK: Favourable weather conditions, as well asmoderate increases in cultivated acreage and yield in2012 have given Indonesia a significant boost in its pushfor food self-sufficiency so far. Maintaining this momen-tum is the next challenge for the sector and the nextfew years will provide an insight into how the govern-ment’s increased regulatory presence in the form ofBulog will affect further investment in the industry, aswell as the effectiveness of other programmes to boostefficiency and sustainability.

Although the days of double-digit expansions forplantation crop acreage are now in all likelihood a thingof the past, continued demand should be enough tosustain profits for large agro-industrial exporters, if notat the margins they once were. In terms of the sector’soverall composition, food crops will likely remain thedominant segment for the foreseeable future. Howev-er other subsectors should continue to take on a grow-ing role as they have in the past few years when theaverage annual growth from 2002 to 2011 of the fish-eries (6.5%), plantation (5.1%) and livestock (4.8%) seg-ments continued to outpace that of food crops (2.9%).

321


The country’s cash crops also include fruits and vegetables

The fisheries segment is a

significant contributor to

exports, with $11.1bn in

shrimp shipments in 2012,

as well as an equal amount

of fish and related

products.

SOU

RCE:

BPS

Rice production, 2003-13

0

16

32

48

64

80Total tonnes (m)Tonne/ha

2013P2012201120102009200820072006200520042003

AGRICULTURE ANALYSIS

Much of the country’s demand is met by domestic production

As the primary food staple for the vast majority ofIndonesians, maintaining a reliable supply of rice remainsa social and economic priority for the government asa growing domestic population continues to drivedemand. In spite of being one of the world’s leadingrice producers, the country has been forced to rely onimports to make up the shortfall from domestic pro-duction. In 2011 and 2012 the country imported 2.75mtonnes and 1.38m tonnes, respectively, in order to sta-bilise reserves, according to data from the StatisticsIndonesia (Badan Pusat Statistik, BPS). Currently importsrepresent a fraction of domestic output levels, whichsurged to 70.87m tonnes in 2013, up 2.6% from 69.06mtonnes the previous year on the strength of a bumpercrop aided by favourable weather conditions and rel-atively mild pests and plant diseases, according to BPS.HOMEGROWN: Java remains the centre of paddy pro-duction, accounting for 48.6% of all rice output in 2013,while maintaining higher yields of about 58 tonnes perha on average compared to an average of 45.8 tonnesper ha for the rest of the country. Although some ofthis expansion can be attributed to a correspondingincrease in paddy acreage, which has spread from11.79m ha in 2000 to 13.77m ha in 2013, intensifica-tion efforts within the sector have also substantiallyboosted productivity across the board. After yieldingan average of 44.01 tonnes per ha in 2000, productiv-ity has improved consistently over the years to a highof 51.16 tonnes per ha in 2013. Annual output is pro-jected to nudge up slightly to 70.87m tonnes in 2013,according to BPS projections.

The government has set about enhancing domesticfood security through various new regulations in recentyears. The most notable of these is the passage of the2012 Food Law targeting food security and importrestrictions among other items. The key provision ofthe law involves reinvigorating the State LogisticsAgency (Bulog) in August 2012, which is responsiblefor procuring, storing and distributing strategic com-modities, such as rice, to stabilise the supply of staples

and insulate them from external price shocks. Theorganisation was previously successful in meeting self-sufficiency targets in the mid-1980s and again in 2008-09. Bulog holds a monopoly on imports, exports anddistribution of commodities under its authority andhas generally maintained rice stocks in the range of1.5m-2m tonnes at any given time through domesticpurchases and, if need be, imports, although this fig-ure is expected to increase to 4m tonnes in 2014. MOVING FORWARD: While the rice yields of the pastfew years represent an incremental improvement overthe past decade in terms of both yield and production,overall output remains well short of long-term goalslaid out by the Indonesian Chamber of Commerce andIndustry’s food development programme, Vision 2030.Under this plan, rice production is targeted to increasefrom the 66.5m tonnes produced in 2010 to 81m tonnesby 2020 and 90.1m tonnes by 2025.

According to the roadmap, the country is planningto boost cultivated paddy acreage while simultaneous-ly increasing efficiency through a variety of measuresthat include greater fertiliser utilisation, farmer edu-cation and training programmes, expansion of paddyareas and the number of harvests per year, and the useof high-quality seeds. In addition to these initiatives,the government is working to refurbish and expand itsirrigation infrastructure. Udhoro Kasih Anggoro, thedirector-general of staple foods at the Ministry of Agri-culture, said in August 2013 that the government hadallocated Rp6trn ($600m) to rehabilitate the irrigationsystem in 2013 with the goal of repairing all damagewithin four years, which could boost production by 7m-9m tonnes per year. Smallholders are also being aidedby a number of educational programmes, public-pri-vate partnerships to provide farmers access to mod-ern farming methods and technologies, and subsidisedfinancing programmes. Complementing efforts to boostproductivity, the roadmap also calls for a reduction indemand from Indonesians by promoting the consump-tion of alternative staple crops and minimising waste.

Java is the centre of rice

production, accounting for

48.6% of the total in 2013

and maintaining higher

than average yields of

around 58 tonnes per ha.

Efforts to boost paddy

acreage and productivity

include greater use of

fertiliser and high-quality

seeds, education and

training programmes for

farmers, and expansion of

cultivated areas.

322

A full plateThe government is working to maintain reliable supplies of rice


AGRICULTURE INTERVIEW

Franky Widjaja, Pres. Commissioner, Sinar Mas Agribusiness & Food

How can balance be maintained between agricul-

tural productivity and sustainable farming?

WIDJAJA: Sustainability isn’t just about caring for theland; it is also about conducting business without com-promising the future generation’s ability to meet itsown needs. It is, therefore, a balancing act between theneeds of the environment, the economy and the peo-ple. While palm oil failed to achieve a place on APEC’slist of environmentally friendly goods, it remains animportant product for many countries, with the indus-try directly employing some 4.5m people in Indonesia.

Regarding sustainability, palm oil producers mustensure that no development occurs on high carbonstock forests, high conservation value areas and peatlands. In addition, free, prior and informed consent fromindigenous and local communities must be received andproducers must comply with all relevant laws and inter-nationally accepted certification criteria.

The Partnership for Indonesia Sustainable Agricul-ture (PISAgro) initiative was launched at the Asian WorldEconomic Forum in June 2011. This initiative beganwith 14 global and local companies, working with theIndonesian Ministry of Agriculture and Ministry of Trade,to improve sustainable production of key commoditiesfor the enhancement of food security and the liveli-hoods of smallholders. After one year from the estab-lishment of PISAgro, activities are under way in eightstrategic agriculture commodities including cocoa, cof-fee, corn, dairy, palm oil, potatoes, rice and soybean.

How can the environmental impact of agriculture

be reduced without stifling sector growth?

WIDJAJA: A multi-stakeholder engagement process isundoubtedly the strongest platform from which to findsuch solutions. In terms of minimising post-harvest andvalue-chain waste, the following policies can be imple-mented with considerable effect: zero waste strategy,soil fertility management and integrated pest manage-ment. The zero waste strategy is to reuse, recover andrecycle so that production waste can be used as organ-

ic fertilisers and as a source of energy. Alongside this,regular control of soil fertility must be implemented inorder to ensure that nutrient management practicesmaintain or improve soil fertility. Integrated pest man-agement is a way to minimise the use of pesticides andmitigate the possible impact of pest control on theenvironment by deploying biological and natural con-trols wherever possible.

Finally, water management must also be utilised tominimise any risk of water pollution, either surface orground. It is vital that the government actively helpsmall and medium-sized businesses implement theabove strategies through training and developmentschemes if it is serious about improving Indonesia’syields across all agricultural enterprises in a way whichdoes not further burden the natural environment.

What are the most effective tools to boost yields

in key staples such as rice?

WIDJAJA: Research and development is an area whereIndonesia must seek to be on the cutting edge by con-ducting joint research programmes with reputableresearch institutions. There must be a drive from all par-ties, particularly the government and large companies,to improve best practices across the sector, from palmoil breeding to increasing yields of staples, such as rice.Indonesia is the world’s largest rice consumer, so boost-ing production should be a priority.

However, it is important to remember that we arealso importing between 60% and 70% of all food, andthis is simply not sustainable. Increasing productivitywill enable producers to output more from less land,reducing the environmental impact of the agricultur-al industry. Higher yields will also help improve the liveli-hoods of smallholders and reduce the pressure for newland to be opened. Furthermore, logistics costs mustbe mitigated through the construction of key transportinfrastructure. It is still cheaper to buy oranges grownin China than those from Kalimantan due to the extor-tionate transport costs. We must seek to change this.

323


Sustainable growthOBG talks to Franky Oesman Widjaja, President Commissioner, SinarMas Agribusiness and Food

AGRICULTURE INTERVIEW

Franciscus Welirang, Director, Indofood

How can Indonesia make further progress in

meeting its food security goals?

WELIRANG: Indonesia’s ultimate ambition is tobecome the breadbasket of Asia. However, it hasunfortunately not made sufficient progress in theshort term in meeting its own national food securi-ty targets. Put simply, the basic system is not thereyet as outlined in the government’s Master Plan forthe Acceleration and Expansion of Indonesian Eco-nomic Development. To successfully jumpstart thesector, Indonesia must focus on overhauling its infra-structure and implementing policies on food secu-rity in line with investors’ expectations. It is vital tofind the appropriate balance between the interestsof investors, farmers and smallholders.

Most of Indonesia’s farmers live in Java, which alsocontains 60% of the country’s population. There-fore, it is particularly important for the island toimprove its handling of post-harvesting and storage,and to concentrate on higher value-added products.At the same time, there needs to be an expansioninto other regions such as Sulawesi, which is moresuited to the mass production of rice and poultry.

What kind of contribution can the private sec-

tor make towards Indonesia’s food security goals?

WELIRANG: In today’s world it is no longer feasibleto rely on the government or smallholders alone toboost food security. As a result, increased participa-tion by private actors in the agricultural sector isabsolutely vital. Indonesia must work to facilitateand incentivise private equity investment by creat-ing a more congenial legislative framework.

For example, a major challenge currently faced byprivate investors is the lack of clarity regardinglandownership. Due to the Indonesian government’spolicy of decentralising its authority to regional andlocal tiers, around 650 mayors now exert direct influ-ence over land procurement and development acrossthe country. Therefore, negotiations must take place

between all concerned parties before these newinvestments can go ahead smoothly.

What are the aims of the Partnership for Indone-

sia’s Sustainable Agriculture (PISAgro) with regard

to the operations of small farmers?

WELIRANG: The PISAgro initiative works with exist-ing small farms to bring them up to the highest qual-ity standards. Its main priorities are to encouragefarmers to increase their productivity and improvethe overall quality of their production. Currently, upto 40% of palm plantations in Indonesia are in thehands of smallholders, but their output is only one-third of what large corporations are able to produce.

Indonesia’s priority must be to increase the pro-ductivity of small farmers. For this reason, empha-sis should be placed on the education and trainingof small farmers, especially when it comes to inno-vative and sustainable farming methods. This issuehas been overlooked for too long in Indonesia andrequires urgent attention from all stakeholders.

To what extent has the lucrative palm oil busi-

ness crowded out investment in more staple

foods that are integral to food security?

WELIRANG: Edible oils are considered a vital com-ponent of our effort to achieve food security. More-over, Indonesia has the right environment in whichto grow these crops. While it is of course true thatIndonesia makes a sizeable contribution to globalfood security through the palm oil business, it is alsoactive in producing other crops, namely rice andcorn. Therefore, the government needs to come upwith the right financial scheme, incentivising farm-ers to function as private entrepreneurs and financeseasonal crops. Having said that, the internationalcommunity has accepted that food security mustbe available to all. This is not an issue that can beconfined to any single country or region alone, but must be dealt with by humankind as a whole.

324

Hungry for progressOBG talks to Franciscus Welirang, Director, Indofood


325

Education & HealthLocal governments required to spend 20% on educationNew curriculum to be rolled out nationwide by 2015Private providers building up capacity and expertiseOvercoming the hurdles to provision of universal careShortage of medical professionals a stumbling block

EDUCATION OVERVIEW

Indonesia has 50m students, the fourth-largest number in the world

The Indonesian educational system is large, well fund-ed, fast growing and quickly improving. Despite somedifficult years as a result of the 1997-98 Asian finan-cial crisis and some ineffective policies instituted in itsaftermath, the government has made a significantcommitment to the sector. Both the central and localauthorities are required to spend at least 20% of theirbudgets on education. This benchmark, now enshrinedin the fourth amendment to the constitution, is a lev-el of spending achieved by few nations and promisesto make Indonesia a country of great opportunity forboth students and educators alike.

Yet there is a wide gap between the country’s edu-cational goals and the reality on the ground. Becauseof lingering structural issues and persistent constraintson capacity, money is not getting to the students or tothe schools, and outcomes are far from where theyshould be. The 20% figure, for example, has in most yearsbeen impossible to achieve. The funds have either notbeen fully distributed or not properly used.

Another potential issue is the introduction of a newcurriculum, which began in 2013. While proponents saythat it will help produce better, more capable students– and better citizens – critics quoted in the local presssaid that it shifts the balance of course work away fromthe practical and more toward subjects that will do lit-tle to prepare students for a modern, services-orient-ed, high-tech economy. As a result, they say, Indonesiacould potentially suffer a shortage of qualified talent. SIZE & SPENDING: Indonesia has 50m students, 2.6mteachers and 250,000 schools, according to the WorldBank. For size, its educational system is number threein the region and number four in the world: only India,China and the US have larger ones. It is also well fund-ed, making it an exception in the developing world. In2012, the government set the budget for education at$35bn. Education spending doubled in real termsbetween 2000 and 2006, according to the World Bank,and almost tripled between 2001 and 2011, reaching3% of GDP (about the same level as Singapore) from

less than 1% two decades ago. Education has becomebetter in other ways. A 2005 teachers law changed thecriteria for certification in a bid to improve teacherquality, and the World Bank says that educational gov-ernance improved between 2009 and 2012, notingbetter transparency and educational management.A BRIEF HISTORY: Formal education in Indonesia wasfirst introduced in 1906, when the country set up a sys-tem of village schools. Earlier but less systematic effortswere made by colonial governments and religious insti-tutions, according to Mission Schools in Batakland

(Indonesia): 1861-1940, by Jan S Aritonang. Still, by1946 only 6% of the population was literate, accord-ing to the paper “Decentralising Education in Indone-sia”, by Stein Kristiansen and Pratikno.

In 1945, however, a constitutional amendmentdeclared the right of all Indonesians to an education.After that, national education became a priority. Oil rev-enues from 1973 on helped boost education, and thenumber of schools and students doubled by 1984. Alsoin that year, the goal of universal primary education wasreached. Education spending as a portion of the cen-tral budget hit a high of 17-18% during that decade.

After the 1997-98 Asian financial crisis, educationsuffered. Spending decreased and enrolment dropped.As of 2001, on the advice of international donors, thegovernment launched a decentralisation programmewhereby accountability, responsibility and control ofmuch of the business of government were devolved tothe local level. The idea behind dispersing power wasto prevent a repeat of past errors. Since then, by somemeasures education has done well. The 20% spendingmandate became part of the constitution in 2002. Ateacher law was passed in 2005. By 2009, spending final-ly reached the 20% level required, and enrolment fig-ures rose. According to the World Bank, secondaryschool enrolment, as a percentage of gross enrolment,jumped from 18% in 2000 to 81% in 2011.PERFORMANCE: On balance, though, decentralisationhas been more problematic than helpful. It was

In 2002, a new amendment

to the constitution

required that central and

local authorities spend at

least 20% of their budgets

on education, a level

achieved in only one year,

2009.

Government spending on

education doubled

between 2000 and 2006

and almost tripled between

2001 and 2011, reaching

3% of GDP from less than

1% two decades ago.

326

Subjects of changeThe government’s top-down initiatives are proving a challenge


EDUCATION OVERVIEW

approached in a “big bang” style, whereby power wasdevolved immediately to the local levels. Administra-tions at this level were unprepared to handle the newresponsibilities suddenly foisted upon them.

Most measures of education in Indonesia confirm this.According to the World Bank, the sector suffers fromproblems with governance, accountability, transparen-cy and efficiency. According to research by Kemitraan,a community group, none of the country’s provinceshave been able to spend the required 20% on educa-tion, although spending is higher among cities andregencies and many have exceeded the 20% target.Leakage of funds has been reported by the SupremeAuditing Board, and as a result parents are often requiredto pay for education that should be free.

Such weaknesses show in educational outcomes.According to 2012 rankings by the Programme forInternational Student Assessment and published bythe OECD, Indonesia came in second to last among thecountries covered. In the Pearson index of cognitive skillsand educational attainment, Indonesia came last outof 40. According to press reports, less than a third ofstudents finish their schooling, less than half of teach-ers possess proper qualifications (one study says therate is as low as 37% for elementary school teachers)and the distribution of resources is inefficient. Absen-teeism is high among students and teachers alike: about15% of teachers miss school on an average day. Toblame for low teacher quality are oversupply, low salariesand a weak recruitment system, according to “Assess-ment of Policies to Improve Teacher Quality and ReduceTeacher Absenteeism”, a paper by Asep Suryahadi andPrio Sambodho of the SMERU Research Institute inJakarta. The style of teaching – stressing rote memori-sation and discipline, discouraging creative thinking –has also been criticised. BROADLEAF TOWERS: While the higher educationsystem certainly has strengths and some substantialimprovements have been made, it too faces challenges.The number of university and college graduates, forexample, doubled between 2005 and 2012, accordingto the British Council. Enrolment rates, however, are low– in the neighbourhood of 20-25% – and questionsabout quality persist. In the U21 Ranking of NationalHigher Education Systems, conducted in 2013 by theUniversity of Melbourne, Indonesia came in last out of50 countries. In the QS World University Rankings 2013,only one local university, the University of Indonesia,was included in the top 400, ranking 309th. As a result,the country is lacking in skilled workers to staff com-panies. Reports indicate that 25% of new hires have tobe retrained. According to the OECD, many graduateslack needed skills as they enter the workforce. HOPE OF CHANGE: Various educational reforms haverecently been initiated. In 2013, the number of yearsof compulsory education was increased from nine to12 (the former had been required since 1994). Reformsin higher education have also been enacted. In 2012,the country passed the Higher Education Act, whichsignificantly altered the landscape for tertiary educa-tion. It increased the autonomy of universities and gave

institutions more control over their managements andbudgets. The hope was that this restructuring wouldincrease accountability, improve performance andenable them to raise funds outside of traditional statechannels. The act also called on all municipalities anddistricts to establish community colleges and, above all,urged educational bodies to become more interna-tional. Relationships with foreign universities, seen asa threat to national security, were long restricted in thecountry. Under the new law, foreign institutions areencouraged to set up in Indonesia, though to do so theyare required to collaborate with local institutions. NEW CURRICULUM: The new curriculum was pub-lished in late 2012 and introduced on a limited basis in2013. It was a matter of great debate as it was beingdeveloped and remains a much discussed subject.According to a July 2013 article in The Jakarta Globe,the new curriculum “slashes” the number of subjectstaught in a day and drops “dedicated classes [in] sci-ence, English-language and social studies courses infavour of classes on Bahasa Indonesia, nationalism andreligious studies”. The Jakarta Globe article said the

327


SOU

RCE:

Wor

ld B

ank

Primary school enrollment, 1998-2011 (% gross)

0

28

56

84

112

140Percent

20112010200920082007200620052004200320022001200019991998

Books for the country’s new curriculum will be distributed for free

In 2013, the government

increased the number of

years of compulsory

education from nine to 12,

the former having been the

requirement since 1994.

EDUCATION OVERVIEW

Indonesia’s leaders say it is a good programme.According to comments by the deputy minister of edu-cation, Musliar Kasim, the curriculum will improve stu-dents’ character and make them more tolerant andempathetic. The education and culture minister, Moham-mad Nuh, has defended the overhaul. He assured thelocal press that more religious education would notinspire extremism but rather reduce its likelihood, aschildren would receive better instruction in the sub-ject. In late 2013, Jakarta Governor Joko Widodo saidthat he supported the changes. “I agree that the Indone-sian language should be prioritised. English should beoffered when [students enter] junior high school,” hewas quoted by The Jakarta Globe as saying. “But I thinkthat for elementary school, it’s better [to offer] Indone-sian language and local educational content.”

The ministry claims one other practical benefit. Text-books for the new curriculum were written and pub-lished by the government, and will be distributed freeof charge. Students previously were required to buy theirown books. The curriculum is to be rolled out in phas-es. During its initial introduction in July 2013, it was madeavailable to just 6000 schools and only to students inthe first, fourth, seventh and 10th grades. The goal isto implement the curriculum nationwide by 2015.

Parents, educators and foreign investors are con-cerned. They fear that the reformed curriculum mayproduce less qualified graduates and reduce the num-ber of skilled workers at the very time Indonesia is seek-ing to advance economic development and expertisein manufacturing and services. Other concerns arerelated to the logistics of the undertaking. Teachers wereprovided 52 hours of training on the new curriculum,which some educators say is not enough. PURPOSE OF MONEY: Indonesia has committed greatsums of money to improving education, but observerswonder if it is being used efficiently. They argue thatthe country needs to focus on being more effective ifit is to improve educational outcomes and train studentsfor the challenges ahead. They say the country shouldfocus less on gross numbers and instead on howresources are used. Funding is not the issue; rather,implementation must be improved. “I think what’s mostimportant is not so much the amount, but how the mon-ey is being spent,” said Pedro Cerdan-Infantes, an edu-cation economist at the World Bank’s Jakarta office.OUTLOOK: Optimists say the next few years could bethe best half-decade for Indonesian education. Thecountry has worked its way through past difficulties andbegun to build a system that could greatly improve per-formance and outcomes. Observers are particularlyhopeful that reforms at the tertiary level will cause uni-versities to become more productive, competitive andfinancially sound. But concerns remain. The chief wor-ries are that resources will not be used well and thatthe emphasis on character and national interests willobstruct better reforms. If Indonesia can carry out itsprogrammes effectively, the improvements will bereflected both in test scores and in international rank-ings. Foreign universities would then be keener to formpartnerships that further raise its global standing.

328

The number of university and college graduates doubled over 2005-12

A recent overhaul of the

primary and secondary

school curricula is being

slowly introduced across

the country. The goal is full

implementation by 2015.


SOU

RCE:

Wor

ld B

ank

Public spending on education, 2001-11 (% of govt expenditure)

0

5

10

15

20

25

2011201020092008200720052004200320022001

main concern was about the shift toward softer sub-jects at the expense of “English, computers and science.”

Critics believe the programme has the potential toweaken the educational system. A January 2013 Jakar-

ta Post article, which quoted teachers’ union officials,said that the Ministry of Education and Culture was try-ing to combine science with civics and religion, whileYohanes Surya, a physicist who helped write the cur-riculum but believes it ultimately went too far, said inan article in The Jakarta Globe that science needs tobe taught as a dedicated subject from grade four ratherthan mixed with other subjects through grade six.

The programme is being defended by the Ministryof Education and Culture, which argues that many ofthe criticisms of the new curriculum are simply inac-curate. It insists that there has been no change in theamount of English being taught, and while headlinehours in science are down in elementary school, sci-ence remains very much a part of all coursework. Theministry adds that information technology will be usedthroughout the school day, so a separate informationand communications technology course is unnecessary.

EDUCATION ANALYSIS

There are 92 public universities and around 3000 colleges

Indonesia has a sizeable higher education system,encompassing some 92 public universities and 3000colleges. The country has tried a number of differentstructures in an attempt to make these institutionsboth financially strong and effective in educating peo-ple regardless of economic background. So far, at least,it has not found the right mix of public control and pri-vate participation.

Measured by head count, the country’s tertiary edu-cation is hitting a clear growth patch. Aided by its demo-graphics and rapid economic expansion, Indonesia isexpected to have one of the largest university popula-tions in the world by 2035. The chief issue, though, isfunding. Most of the great sums the country is com-mitting to education will be spent on primary and sec-ondary schooling. The World Bank estimated in 2010that spending on higher education was just above 1%of GDP, which is low by international standards. Publicexpenditure on universities was about 0.3%. TELLING FIGURES: One fear is that, unless local uni-versities are improved, the country’s brain drain will beexacerbated. At present more than 36,000 Indonesianstudents study overseas, mostly in Malaysia, Singaporeand Australia. The lack of qualified graduates, mean-while, is leading to a severe labour shortage that threat-ens the country’s prospects. In May 2013, a report bythe Boston Consulting Group said that Indonesia wasfacing a talent gap: half of all jobs, it said, will soon bemanagerial or administrative, up from 38% today.

Research and development (R&D) is another con-cern. The country’s institutions tend focus only on theircore mandates, and subsist on fees and governmentfunds. As a result, they are little able to invest in long-term projects and programmes. On the whole, the coun-try spends very little on R&D – 0.08% of GDP in 2009,compared with 1% in Malaysia and 2% in Singapore. TO & FRO: The road to change has been a winding one.In 1999, Government Regulation 61 transformed sev-en universities from public entities to independent legalones: the University of Indonesia, Bandung Institute of

Technology, Bogor Agricultural University, Gadjah MadaUniversity, Indonesia University of Education, Universi-ty of North Sumatra and Airlangga University. The ideawas to improve their operations and finances. As inde-pendent bodies unencumbered by obligations to thebureaucracy, which was seen as inefficient and obstruc-tive, they would be free run their own accounts, raisetheir own funds and build their own endowments. Thiswould in turn allow them to pursue research apace. Thistreatment was extended to all universities in 2008, viathe Law on Educational Legal Entity.

Both laws generated a great deal of concern. Edu-cators and students fretted that universities wouldeventually be privatised. Corporate interests, ran theargument, would take over and run them with too muchemphasis on profit. That would lead to tuition hikes, put-ting education out of reach to the poor.

So, in 2010, the Constitutional Court annulled the law,on the grounds that educational legal entities wouldnot best serve the interests of all levels of society. Uni-versities were once more placed under the direct admin-istration of the Ministry of Education and Culture.

A fresh attempt came in August 2012, when a newlaw gave universities fiscal autonomy again, this timewith conditions. The ministry is to evaluate whether eachinstitution is managing its finances properly, and inter-vene if it finds commercial considerations to be inter-fering with a university’s primary mandate. In early2013, the government also reverted the seven publicuniversities back to being state-owned. GOING INTERNATIONAL: The state has taken two oth-er steps toward reform. First, it is giving universities morefreedom to internationalise. Foreign institutions arenow allowed to set up branches in the country, anddomestic ones are encouraged to hire more foreign lec-turers. Second, the government said it plans to build500 community colleges in five years. This, it says, willbetter balance the supply of graduates to fit the econ-omy’s needs. Such reforms are not so much about edu-cating new leaders as helping train a future workforce.

Spending on higher

education in Indonesia was

just above 1% of GDP in

2010 – low by international

standards. Public

expenditure on universities

was about 0.3%.

329


More than 36,000

Indonesian students study

overseas, mostly in

Malaysia, Singapore and

Australia. Meanwhile, at

home, half of all jobs are

soon to be managerial or

administrative, up from

38% today.

Hairpin turnsThe road to educational reform has been winding

HEALTH OVERVIEW

By 2019 all Indonesians will receive medical care free of charge

While Indonesia has traditionally had limitedresources to commit to health, it has provided adecent basic service to its citizens. According to theWorld Health Organisation (WHO), the country hasan adequate level of primary care, delivered throughboth health centres and sub-centres.

Indonesia has faced significant setbacks in thepast, but it has made real progress in health care pro-vision, and the system is about to dramaticallyimprove. The country is currently implementing auniversal health care plan and, if all goes accordingto schedule, by 2019 everyone in the country –including those who were too well off to be consid-ered for the Jamkesmas system for the poor andnear-poor – will receive medically necessary serv-ices free of charge. It is a time of great opportunityfor the sector, as well as great and potentially pos-itive changes for the people of Indonesia. HISTORY: In 1950 the country had only 1200 doc-tors for 72m people. Some improvements were madethat decade, but investment was limited due to theweak economy and lack of funds.

Health care improved greatly under the Suhartoadministration, and outcomes and indicators suggestthat real achievements were made, according to thepaper “Surviving Decentralisation – Impact of Region-al Autonomy on Health Service Provision in Indone-sia”. Community health centres (puskesmas) wereestablished starting in 1968, a year after the begin-ning of Suharto’s rule. The goal was to have onehealth centre per 30,000 people, and by the late1980s that was achieved. Smaller sub-centres werealso established in villages. The centres focused onpreventive and basic medicine, such as immunisa-tions, pre- and post-natal care, dentistry and nutri-tion. They were well staffed by nurses, midwives anddoctors, who were required to do mandatory gov-ernment service after graduation.

The system was in many respects a great success.It was highly centralised and tightly managed, and

fees were set low, so treatment was within the reachof the average Indonesian. While the local centresmainly focused on the most simple goals, such assanitation, the results were good. For many yearsIndonesia was seen as a country that was able toeffectively improve the health of its people. In 1968,for example, average life expectancy at birth was 51years. It is now 70. Infant mortality fell from 120 per1000 life births to under 30.INSURANCE: In 1968 the government began pro-viding health insurance to civil servants in a pro-gramme managed by Indonesia Health Insurance(Asuransi Kesehatan Indonesia). It currently coversover 4m workers and 11m of their family members.A programme for formal sector workers was addedin 1993, managed by Workforce and Social Insurance(Jaminan Sosial dan Tenaga Kerja, Jamsostek). How-ever, this coverage was not widely utilised and mem-bership was low for many years; the InternationalLabour Organisation put the total at 10m in 2011.While the country has a number of different pro-grammes to provide health coverage, much of thecost is still paid by the people seeking treatment. Cur-rently, around two-thirds of all relevant costs arecovered by the individual out of pocket.AFTER THE CRISIS: The Asian financial crisis of1997-98 greatly weakened the country’s ability todeliver quality health services. Incomes declined andgovernment finances weakened, resulting in an esti-mated 25% drop in health spending per person.

According to the WHO, decentralisation, whichbegan in 2001 at the suggestion of internationaldonors, has had a significant impact on health caredelivery. While decentralisation did not dismantle thenational health programmes, it did lead to a weak-ening of relevant institutions and create difficultiesin managing the system. The WHO notes a breakdownin information reporting, which has made distribu-tion of funds, and investment and training, difficult.This has led to a lower quality of work, inefficiency

Community health centres

were established starting in

1968. The goal was to have

one centre per 30,000

people, and by the late

1980s that was achieved.

While decentralisation,

which began in 2001, did

not dismantle the national

health programmes, it

weakened institutions and

created difficulties in

managing the system.

330

All changePlan to provide universal care has opened up a host of opportunities


HEALTH OVERVIEW

and less-than-ideal use of available resources. Oth-ers argue that decentralisation led to inconsistentexpenditure, as finance was largely left to the local-ities and some areas are much poorer than others.

Some indicators do suggest that the health of theaverage Indonesian has been worsening in recentyears. This was not only the result of the 1997-98crisis and decentralisation, but also general trendsin terms of increased stress and worsening diets.

Diabetes affected an estimated 2.1% of the pop-ulation in 2013, up from 1.1% in 2007. Hypertensionaffected 31.7% of the population, up from 25.8% in2007, according to the Ministry of Health’s “BasicHealth Survey”. Mortality from non-communicablediseases rose from 41.7% in 1995 to 59.5% in 2007.UNIVERSAL HEALTH CARE: The country has beenworking for more than a decade to implement uni-versal health care. In 2004 Law No. 40 was passed,declaring that universal health care would be pro-vided. However, it took years for the programme tobe initiated, due in part to logistical difficulties, costsand resistance from employers, who will have to con-tribute toward coverage.

It took the intervention of the judiciary to pushthe programme forward. In 2010 the Social Securi-ty Action Committee (KAJS) sued the governmentbecause it had failed to implement the 2004 law. TheKAJS won the action, and the central Jakarta courtordered that the coverage begin.

The programme started on January 1, 2014, withtesting having taken place in three pilot areas –Aceh, Gorontalo and West Java – from July 2013. Atotal of 1700 hospitals are included in the pro-gramme, as well as 9000 community clinics.

According to the World Bank, the programme willcost between $13bn and $16bn per year once it isrolled out nationally in 2019. Funding will come fromthe budget and premiums paid. Formal workers willcontribute 5% of their salary, with 1% coming fromthe worker directly and 4% coming from the employ-er. Workers in the informal sector will pay premiumsof between Rp25,500 ($2.55) and Rp59,500 ($5.95)per month, with the higher rates gaining the personcovered a higher standard of hospital room.ATTRACTING CRITICISM: The system has many crit-ics. According to The Jakarta Post, the roll-out hasnot been smooth. Hospitals are still demanding pay-ments from patients, because they are concernedthat the government will be late in reimbursing them.In the past, the government has taken up to a yearin some cases to transfer funds to hospitals for treat-ment given under official programmes, and hospi-tals are seeking to protect themselves.

The introduction of free health care has beencharacterised by confusion. Patients do not seem tounderstand the system. To get treatment at special-ist hospitals, they are supposed to get a referral first.This is done to limit overcrowding and prevent peo-ple from using hospitals for primary care.

However, when free health insurance for the poorbecame available in Jakarta in 2012, people flood-

ed the hospitals, bypassing the proper procedure.As a result, service quality declined, according toreports in the local press. The budget for the edu-cation of both people and providers on how theproject works and what it provides has been low –an estimated Rp20bn ($2m), versus the Rp1trn($100m) that is needed, according to HasbullahThabrany of the University of Indonesia.COSTS: Service providers and administrators arealso having difficulty understanding the programme.The payment system has been changed, which iscausing confusion at all points in the process, fromthe Social Security Management Agency to the gov-ernment and hospitals. Charges were previouslymade on a fee-for-service basis. Now they are madeon a fee-for-diagnosis basis, resulting in administra-tive bottlenecks throughout the system.

In its initial stages, the programme does not actu-ally do much that was not already done. It simply cob-bles together a number of different schemes whichalready cover about the same number of people.Jamkesmas, originally called Askeskin, was formed to

331


SOU

RCE:

Wor

ld B

ank

*per

100

0 liv

e bi

rths

Under-5 mortality rate, 2000-12*

0

12

24

36

48

60

2012201120102009200820072006200520042003200220012000

Bottlenecks are resulting from the current fee-for-diagnosis system

Diabetes affected 2.1% of

the population in 2013, up

from 1.1% in 2007, and

mortality from

non-communicable

diseases rose from 42% in

1995 to 60% in 2007.

HEALTH OVERVIEW

insure the poor. Some districts also created theirown organisations, called Jamkesda, to provide healthcare for the near-poor. According to the US Agencyfor International Development, all the programmesput together, including the system for military per-sonnel and voluntary health insurance, covered halfof the country by 2008. By 2013 the number ofinsured was an estimated 65% (Jamkesmas had 86.4mmembers, up from 76.4m just a year earlier).

Most of all, critics of the system say that pay-ments, when they are made, are too low to covertreatment. The government pays Rp19,225 ($1.92)per month per eligible low-income individual to cov-er hospitalisation. However, this level was set in2004, and costs have greatly increased since.

According to Hasbullah, the minimum paymentshould be Rp54,000 ($5.40) per covered person permonth. He said that if the amount is not increasedpeople could lose faith in the system, and that thehigher payments could encourage greater privateparticipation in the sector.

Hasbullah also believes that the programme shouldnot be totally free for the end users, as this encour-ages overuse, and does not incentivise people toconsider whether they really need medical attention.However, the price should be low enough that itdoes not prevent people from seeing doctors – andperhaps waived altogether for the poor.DOCTOR SHORTAGE: Structural issues remain thatcannot be solved overnight and may become morepressing as the number of patients increases.

For example, Indonesia is currently facing a severeshortage of medical professionals. It has been esti-mated that in the next decade, the country will need10,000 more physicians, largely because of the intro-duction of universal health care.

At present, the country has only 0.3 physicians per1000 people, compared with 1.2 per 1000 in Malaysiaand 1.9 per 1000 in Singapore. Ali Ghufron Mukti,Indonesia’s deputy minister of health, said in 2013that the ideal ratio in the country is 1 for every 2500people, or 0.4 per 1000. That would mean increas-ing the number of doctors from 88,309 to 101,040.

Medical professionals are unevenly distributedthroughout the country, which serves to exacerbatethe shortage. According to the Indonesian DoctorsAssociation, 60% of the country’s doctors are in Java.The main problems, according to the association,are the lack of proper medical facilities in remoteareas and the low wages paid outside of urban cen-tres. Its research indicates that doctors in ruralIndonesia receive just above the nation’s minimumwage, so qualified professionals, particularly spe-cialists, are not interested in working in these places.

In some ways, though, the country is a model ofefficiency in terms of utilisation of its medical work-force. While it has a low number of physicians, thestructure of the system helps leverage skills and takecare of people, even as the numbers rise due to theintroduction of universal care and earlier schemes.Expectant mothers, for example, have received freecare related to pregnancy since 2011 under the Jam-persal programme. And while demand has risen, thesystem has been able to handle the uptick in usage. MIDWIVES: The country utilises an integrated mod-el for care. Midwives, who used to handle only deliv-ery, now provide a wide range of services. They offerpre-natal care, blood work and ultrasounds, and canindependently handle low-risk pregnancies.

The midwives act as the service gatekeepers. Theyreceive a bundled payment from the government perpatient to provide a full range of services and onlyrefer to the physician, under which they are regis-tered, in the case of complications or high-risk deliv-eries. The programme appeared to have improvedboth services and outcomes in its first two years.Attended deliveries in the country rose from 73% to83%, while deliveries in health facilities jumped from46% to 63%. In that two-year period, infant mortal-ity dropped from 34 per 1000 to 21.

As of 2012 the country had 93,889 midwives,according to UN Population Fund figures. It has a fullsystem in place for the licensing of midwives and theaccreditation of midwifery institutions, of whichthere are 436 in the country. When all health careprofessionals are taken into account, including doc-tors, nurses and midwives, the rate of coverage ismuch better that the oft-quoted headline physicianrate: 2.3 per 1000. The UN also notes that 93% ofnew mothers receive at least one antenatal check-up and 82% receive four antenatal check-ups. NURSES: The situation with nursing is more compli-cated. While some hospitals report a shortage, thecountry has unemployed nurses and is an exporterof these professionals. Historically, it has had one ofthe highest ratios of medical support staff to doc-tors. According to a 2011 article in The Lancet, theratio of nurses and midwives to doctors was 6.8, byfar the highest in the region. The global average is2.1. In Malaysia, the number is 2.5. In Thailand, it is4.6, in Myanmar 2.8. The ASEAN average is 4.7. PRIVATE PARTICIPATION: Indonesia is increasing-ly seen as a country of opportunity for care providers.Increased investment – the government will build 150

332

Midwives receive a bundled

payment from the

government per patient to

provide a full range of

services, and only refer to a

physician in the case of

complications or high-risk

deliveries.


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HEALTH OVERVIEW

hospitals in 2014 – rising incomes, a large and youngpopulation, and growing problems with lifestyle-related diseases mean the makers and sellers ofmedical equipment and technology are viewingIndonesia as a good place for business development,according to Frost & Sullivan (F&S). In particular, theconsultancy says the country is now of great inter-est for companies dealing in medical imaging, med-ical devices, health care information technology,pharmaceuticals and biotechnology. F&S predictsthat Indonesia’s medical sector will double in size to$61bn by 2018. The pharmaceuticals segment, in par-ticular, could be set for changes in the years ahead.“As wages rise, automation will take a larger role inpharmaceuticals manufacturing,” Elfiano Rizaldi,president director of Indofarma, told OBG.STEMMING THE FLOW: The government is partic-ularly motivated as it sees medical tourists leaving– to places like Singapore, Malaysia, Thailand and thePhilippines – as a drain on the country’s balance ofpayments. According to estimates by EdelmanIndonesia, Indonesia may have lost $1bn in outflowsto Malaysia alone in 2013, and maybe another $500melsewhere. More than half of all medical tourists toMalaysia were from Indonesia, and the total num-ber of people leaving the country for medical treat-ment is estimated to be over 1.5m per year.

By improving its domestic health care infrastruc-ture, the country will be able to keep more of its peo-ple and their money at home. Also, given the costbase and the right investment, Indonesia may itselfbe able to attract some medical tourists.

Private participation is important. By the end of2013, the indications were that most services for uni-versal care would be handled by public hospitals. Theprivate sector is waiting to see how much actuallygets paid for services by the government, and howit gets paid, before committing to accepting patientsunder the programme. Yet if the country is to buildthe necessary infrastructure it will need funds fromthe private sector. Reimbursement rates need to beset at a level that the government can afford, butalso one that attracts the full participation of thefor-profit medical groups. The development of pri-vate health insurance may also help, as it would cre-ate an incentive to build more specialist hospitals.

OUTLOOK: Indonesia is undertaking a major trans-formation of one of the largest health care systemsin the world. It will not be easy, especially in termsof funding and logistics. Yet it is important that theprogramme be implemented to improve the coun-try’s health metrics, and ensure that its young andgrowing population is productive. Indonesia is invest-ing not only in health but also in its economic future.For that reason, it has a good chance of succeed-ing. The country will likely become more efficient andeffective in deploying its health care resources.

For international medical groups, the country willbecome a major target for business and investment.It needs equipment, technology and capital to buildthe sector. If the government allows for enoughinternational participation on good terms, it will bea profitable and growing market for them.

Observers note, however, that the country has asmall window of opportunity. It has the wherewith-al and the political will to implement a programmethat could take Indonesia on a path toward betteroverall health and productivity. However, if it fails tomake the right investments or allow the right levelof international participation, it may be hard to findthe support to rebuild the system next time around.

333

More than 1.5m people per year leave the country for medical care

Reimbursement rates need

to be set at a level that the

government can afford, but

also one that attracts the

full participation of

for-profit medical groups.

HEALTH ANALYSIS

Several of the country’s hospitals operate at international standards

While the Indonesian government works to build auniversal health care system for its citizens, the pri-vate sector is active too. It is sitting on the sidelineswaiting to see if the government programme makessense from a business point of view, but it is still active-ly building up its capacity and expertise.

Private health provision in Indonesia is quickly evolv-ing and could become internationally competitive ina short period, providing quality care and opportuni-ties for international investors and suppliers. OPPORTUNITIES: The sector hopes to attract someof the 1.5m Indonesians going overseas for medicalcare each year. It would also like to begin servingupwardly mobile Indonesians, those who are not at thelevel of income that would allow them to go overseasfor treatment, but are increasingly able to afford bet-ter quality in-country care, or are taking out privateinsurance that can support such treatment. The emerg-ing middle class wants good health care as much as itwants consumer items. Ultimately, the sector wouldlike to attract inward medical tourism dollars, andbegin competing with the likes of Thailand, the Philip-pines and Malaysia. With its lower cost base, it has apotential competitive advantage.

Health care professionals also say that the govern-ment’s programme for universal care will eventuallybe of interest to the private sector. The reimbursementrates are very low and there is concern that paymentsmight be delayed. Yet it is very possible that the hos-pital groups will find a way to make it work for them,especially in rural areas or in services that can be pro-vided in bulk to many people. The fact is, the govern-ment is spending billions on health care, and the cashflow alone is very attractive to large hospitals.UP TO STANDARD: Some of the country’s hospitalsalready operate at international standards. For exam-ple, a number of them have been approved by JointCommission International (JCI), which is affiliated withthe Joint Commission, a US-based non-profit whichaccredits hospitals. The JCI-approved institutions in

Indonesia are two Eka hospitals, Fatmawati General Hos-pital, three RS Premier hospitals, RSUP hospitals, RumahSakit Pondok Indah, Santosa Hospital Bandung Cen-tral and Siloam Hospitals Lippo Village. EXPANSION: The major medical groups in Indonesiaare expanding. Siloam International Hospitals, thecountry’s largest private health care group, is perhapsthe most active. In September 2013 it began tradingon the Indonesian Stock Exchange, after an initial pub-lic offering raised $122m. The company plans to build20 hospitals by 2015, and 40 by 2018. Also in 2013Siloam Hospitals acquired 80% of BIMC, which has twofacilities on Bali. In March 2014 the parent company,Lippo Karawaci, sold $75m worth of shares in the firm,reducing its stake from 86% to 78.9%, and said it wouldinvest the proceeds in hospitals and infrastructure.

Kalbe Farma, the country’s largest listed drugs com-pany, is investing Rp20bn ($2m) to build 20-25 clinicsper year in the Jakarta area. In 2013 Ramsey Health-care formed a joint venture that would combine its threehospitals in Indonesia with Sime Darby’s health careassets in Malaysia. IHH, the region’s largest hospitalgroup, is considering investing in Indonesia, and GE saysthat it is considering investing in rural care in the coun-try. Foreign investment is allowed into hospitals up toa limit of 67% of equity, though non-Indonesians canwholly own specialist clinics. Pharmaceuticals compa-nies can be 75% foreign-owned.

The majority of medical equipment is imported, andthe government has made it easier for foreign firmswishing to bring products into Indonesia. The e-RegalkesMedical Device Registration and Household HealthSupplies platform was introduced in 2012. The onlineservice allows importers and manufacturers to regis-ter equipment without going to the Ministry of Health.Documents can be uploaded via the website. Whilemore doctors are needed and the Ministry of Healthhas said it would like more doctors from overseas, theregistration process is not easy, and the public and the sector both oppose importation of medical talent.

Ultimately, the sector

would like to attract inward

medical tourism dollars and

begin competing with the

likes of Thailand, the

Philippines and Malaysia.

Most medical equipment is

imported, and the

government has made it

easier for foreign

companies wishing to bring

products into Indonesia.

334

Growing interestThe private sector is set to become more involved in the industry


HEALTH INTERVIEW

Nafsiah Mboi, Minister of Health

Is health tourism a threat to local service providers?

MBOI: While I know this issue has many people con-cerned, my priority is to ensure the quality of the healthcare services we have in Indonesia. These will cater tothe majority, for whom health tourism is not an option.The chief focus is on addressing quality concerns acrossprimary and secondary care and on ensuring sufficientstaffing and medication. In theory, if we improve domes-tic care, people will remain in Indonesia to receive treat-ment. We are therefore urging hospitals to obtainnational accreditation. At present 50-60% of hospitalsare accredited, and we are proud to have 11 interna-tionally accredited hospitals (nine private, two public),with the number increasing every year.

Indonesia’s universal health system will present an

unprecedented challenge for the government in

terms of quality and capacity. How can this be met?

MBOI: The system is now nearly 10 years in the mak-ing. Over the last five, we have focused on ensuring pri-mary care by preparing manpower and equipment, andsecuring access to water, electricity and internet. Asfor doctor numbers, we are nearing the World HealthOrganisation (WHO) standard of 40 per 100,000 peo-ple: we currently have 38 and, with 7000 doctors grad-uating every year from our medical schools, will achievethat standard by the end of 2014.

My main concern, however, is not numbers but qual-ity and distribution. At some medical schools, disappoint-ingly, only 10% of students graduate as doctors. We havetherefore developed a new law that sets standards formedical education and caps faculty intake to ensurethat students get better attention. As for distribution,we are using affirmative action to provide doctors toisolated areas – a system being extended to nursesand dentists. We publicly list hospitals and clinics withshortages, and have received good responses fromyoung medical professionals willing to serve in remoteareas. Even so, there is a shortage of specialists, andour plan must focus on supplying district hospitals first.

In which areas could the domestic sector benefit

most from foreign investment and knowledge?

MBOI: My immediate answer is research for the devel-opment of our medicinal and pharmaceutical indus-tries. Indonesia has incredible biodiversity, yet we importmost of the raw materials the sector uses. We shouldseek help from foreign experts who can help us use ourplants and resources effectively for the medicines weneed. Using biodiversity to serve our people is a duty.Technical assistance and targeted investments inresearch and development can help us do so. We needcountries with highly developed medical technology tohelp us develop our own. We also have the potentialto increase health exports, having achieved expertisein producing medical vaccines over the last decade. Bycollaborating with other countries, this capacity couldbe significantly strengthened.

What steps is the ministry taking to address the

prevalence of smoking in Indonesia?

MBOI: Fortunately, we are not alone here: many civilsociety organisations are already active in this area. Wealso now have Regulation 109 of 2012, which is help-ing us tackle the problem more practically. Some arguethat tobacco growers will suffer, and some companiesare already importing tobacco from Brazil as it is morecost effective. What I suggest is, first, that we imposehigh taxes on these imports, and second, that we workto improve our own tobacco production. Finally, wemust open a dialogue with tobacco farmers to makethem aware of other beneficial ways to use their land.

We recently did a review of the diseases that are cost-ing the government the most money. The results werecancer, stroke, renal failure and high blood pressure –all closely related to smoking. The suffering caused bysuch diseases affects not only the infirm person butalso their family. We are seeing increases in the levelsof these non-communicable diseases, and are there-fore making extensive efforts to raise awareness not only about smoking but also about healthy living.

335


A healthy mediumOBG talks to Nafsiah Mboi, Minister of Health

HEALTH INTERVIEW

Hasbullah Thabrany, President, SEAPHEIN

What are your priorities for the National Social Secu-

rity System, and how do you see its implementation

alongside the Social Security Organising Body (BJPS)?

THABRANY: We decided to utilise public financing toensure that those most in need would receive healthcare for free, while still securing operational efficien-cy by using competition by market players. The system’ssuccess is based upon public refinancing, whereby thepopulation shares the burden of health care provision.As such, the biggest hurdle is the government’s pricesetting for the BJPS, which is being negotiated amongthe government, employers and labour unions. How-ever, one danger is that unions will petition for the low-est contribution without considering the benefits ofsuch a system for their workers in the long run. If thereis not enough money contributed, then the quality willbe poor. While the concept is that everyone will even-tually contribute, the population living below the pover-ty line cannot be expected to. If we look at the $2 perday World Bank poverty standard, we still have about45% of 110m people living below such a level. We arethus working with the Ministry of Finance and the Min-istry of Health to ensure that health quality goals canbe achieved at a low cost. The government’s contribu-tion is still to be decided, but the private sector will offera minimum of 5% of the worker’s salary. The maximumlevel of tax in Indonesia is 35%, with overall collectionlow, so we cannot rely too heavily on the government.

How can the varying fees charged by clinics and hos-

pitals of different calibres be harmonised?

THABRANY: It is difficult to identify those serviceswhich can be accurately benchmarked. A complex pro-cedure like brain or cardiac surgery, for example, cancost three times more than at a private hospital inMalaysia because there is no regulation on price here.The Malaysian government regulates private sectorpricing to keep it competitive, while also providing stim-ulus for production of good quality products by limit-ing import tax on medical equipment and drugs. In

contrast, our government still taxes drugs for cancer,which may cost $20,000 and are therefore consideredluxury goods. Unfortunately, Indonesian doctors arealso often able to charge whatever they want, even inpublic hospitals because they allocate people into dif-ferent classes. Although the government has in thepast required public hospitals in Jakarta to allocate atleast 70% of beds to low-income patients, they actu-ally provide something like 20%, in favour of accom-modating affluent patients who will pay more.

Are there going to be enough doctors, nurses and

care staff to support these new hospitals?

THABRANY: While we have enough general practi-tioners, they are unevenly distributed. We mainly lackspecialists, though the surplus in the Philippines andVietnam can help with this shortage. The difficulty liesin changing mindsets in Indonesia, in particular amongmedical doctor associations and the government, whoare afraid of outside competition. The key is to opentheir mind to maximising the quality of our health care,which means bringing in foreign doctors.

How will the relationship between the two social

insurance bodies be managed?

THABRANY: There are two social insurance agencies,Askes and Jamsostek. Askes is managing insurance forcivil servants and public employees, while Jamsostek ismanaging social insurance for private employees. How-ever, our previous social insurance law contained an“opt out” option, meaning that private sector employ-ers who could afford private health insurance were notmandated to join Jamsostek. As such, only 5% of employ-ees in the private sector are currently enrolled in thescheme. We thought that those employers were insur-ing their employees via the private sector, however, thenumbers do not add up. In fact, there are only about7m people (including family members) enrolled, whichis just 5% of the total. We have thus moved to reformthe system to ensure that there is no more opt out.

336

Harmonising the systemOBG talks to Hasbullah Thabrany, President, South-east Asian PublicHealth Education Institutions Network


337

TaxMost foreign firms set up as limited liability companiesIncome tax is collected through a withholding systemDouble tax treaties typically reduce interest ratesBonded zone status expected to be applied to more firms

TAX OVERVIEW

Foreign investors mainly set up as limited liability companies

The Indonesian tax system continues to evolve but forseveral years has been mainly based on three primarytax laws: the General Tax Provisions and Procedures Law,the Income Tax Law, and the Value-Added Tax (VAT) andLuxury Sales Tax (LST) Law. These tax laws are routine-ly amended to accommodate the country’s rapidlychanging business environment and support the gov-ernment objectives of improving the investment climatewhile increasing tax revenues.

In an effort to reshape and improve Indonesia’s taxenvironment, tax officers are receiving more and bet-ter training, not only in local laws but also in the rulesand practices of other jurisdictions. Tax concessions arebeing offered to taxpayers in particular sectors and/orparticular regions, with additional benefits such as taxholidays offered for those in specific pioneer industries.

Indonesia is largely a self-assessment tax environment,and enforcement remains a priority of the tax author-ities. The director-general of tax (DGT) is focusing effortsto combat abuse by targeting tax audits on certainindustries, professionals and high-net-worth individu-als, as well as taxpayers who meet other specified cri-teria. Transfer pricing audits are on the rise and are aprimary area of concern for multinationals.

The key attributes of the Indonesian tax system andmain areas of tax developments are summarised below. CORPORATE TAXATION: Indonesian companies aretax residents by virtue of having their incorporation orplace of management in Indonesia. The primary typeof company foreign investors use is an Indonesian lim-ited liability company, referred to as a PT company. Onlysome categories of foreign businesses such as bank-ing and public works can establish an Indonesian branchoperation (a permanent establishment, PE).

The general corporate income tax rate is 25%. Thistax applies to net taxable profits, which are determinedby taking the accounting profits (in line with Indone-sian accounting standards, which largely reflect inter-national accounting standards) and making fiscal adjust-ments where different treatments apply for tax and

accounting. For instance, certain provisions and ben-efits in kind should be accounted for as expenses foraccounting purposes but generally are not deductibleexpenses for tax. Capital assets can also be depreciat-ed differently for tax and accounting purposes. Somecategories of companies, such as certain labour-inten-sive industries, depending on their legal status or typeof business, may be subject to different corporate taxrates, reliefs and/or assessment mechanisms.

If a company suffers a loss in a particular year, thetax losses may generally be offset against profits forthe next five years, though there are some cases wherethis can be extended. Carrying back tax losses is notallowed and tax consolidation or group relief amongentities is not available. Tax resident firms are taxed ontheir worldwide income under a self-assessment sys-tem. Foreign firms creating a taxable PE in Indonesiaare taxed in a similar manner but only on the incomeattributable to the PE. A PE is also subject to branchprofits tax of 20%, which is calculated on the net fig-ure after income tax. The branch profits tax may bereduced under an applicable double-tax treaty.

Specific tax rates, generally referred to as final incometax, apply to certain types of income. Land and build-ing rentals, for instance, are subject to 10% tax on grossrental amounts. Final income tax also applies to con-struction service fees at 2-6%. Transfers of land and build-ing rights have a final tax at 5% of the gross proceeds.WITHHOLDING TAX (WHT): A large proportion ofincome tax is collected through a WHT system, whichapplies to both resident taxpayers and non-resident tax-payers. For resident taxpayers, WHT mainly applies topayments or accruals for services rendered.

The general WHT rate of 2% applies to fees for manysuch services, and the tax represents a pre-paymentagainst the service provider’s annual income tax liabil-ity. The WHT rate for interest and royalty income receivedby a domestic taxpayer from an Indonesian firm is 15%.

In principle, dividend income received by a residenttaxpayer from a PT company is taxable as ordinary

339


Evolving environmentChanges to the tax system and regulations for potential investors

TAX OVERVIEW

income for the taxpayer receiving the dividend. How-ever, if the dividend recipient is a PT company with aminimum shareholding of 25% in the firm paying thedividend and the dividend is paid out of profits, theincome is tax-exempt. Dividends received by individ-ual resident taxpayers are final-taxed at 10%.

The importation of goods into Indonesia is also sub-ject to WHT at 2.5% (if an import licence is held) or inother cases 7.5%. This WHT also represents a pre-pay-ment of the taxpayer’s annual income tax. Dividends,interest, royalties and fees payable to non-residents with-out treaty relief are generally subject to 20% final WHT. DOUBLE TAX TREATIES: For payments to non-resi-dents, a WHT exemption or a WHT rate reduction maybe available under an applicable tax treaty. Treatiestypically reduce rates on interest, dividends and royal-ties to 10% or 15%, although some select treaties havemore favourable rates. Indonesia has entered into 65tax treaties (with only two effective in 2014). To enjoythe benefits, the income recipient must provide a cer-tificate of domicile (CoD) by filling out the form pre-scribed by the DGT (i.e., a Form DGT-1 or DGT-2, as thecase may be), which must be certified by the tax author-ity of the recipient’s home country. Appropriately cer-tified CoDs in a non-prescribed format are acceptedonly under specific circumstances. THE ISSUE OF BENEFICIAL OWNERSHIP: In the caseof dividends, interest and royalties, the recipient mustbe the beneficial owner of that income. This means thatthe entity receiving the income and benefitting froma tax treaty cannot be a pass-through entity. To sup-port the beneficial ownership position, the CoD formrequires a number of declarations to be made by therecipient that the use of the treaty jurisdiction has notbeen done merely to obtain the benefit of the treatyand to prove “substance”. In most situations, benefi-cial ownership is determined under a series of tests out-lined in the form, all of which must be met. In broadterms, these tests require the recipient entity to be, insubstance, the economic owner of the income and nota pass-through entity. Where a treaty does not have abeneficial ownership requirement, the relevant testrequires that the recipient entity was not establishedand the transactions were not undertaken primarily totake advantage of the tax treaty.WHT ON SALE OF SHARES: The sale of shares in a non-listed Indonesian company by a non-resident is subjectto a final 5% WHT based on the transaction value (orif higher, market value for a related party transaction).Where the seller and buyer are non-residents, the WHTmust be accounted for by the Indonesian companywhose shares are being sold. This tax may be exempt-ed under most of Indonesia’s tax treaties with a fewnotable exceptions. If the buyer is Indonesian, then thebuyer is responsible for the payment of the tax. Gainson the sale of non-listed shares sold by an Indonesiancompany are taxed under normal principles.

The 5% WHT also applies to the sale of shares in aconduit company domiciled in a tax haven country andused to escape Indonesian tax. In this respect, the saleof shares in the conduit company interposed between

the actual shareholder and the Indonesian PT compa-ny (or foreign company with an Indonesian PE) is treat-ed as a direct sale of the PT company shares (or theIndonesian PE). Sales of shares in an Indonesian listedcompany are subject to a 0.1% final tax based on saleproceeds (see further comment below).PAYROLL TAX & PERSONAL INCOME TAX: Individualtax residents are liable for tax on their global income.An individual is regarded as an Indonesian tax residentif he/she stays in Indonesia for more than 183 days inany 12-month period or intends to stay permanentlyin Indonesia. Individual tax rates are progressive. Thehighest marginal tax rate is 30% and applies to incomeover Rp500m ($50,000) per year. Employment incomeis taxed through a monthly withholding system.VAT & LST: VAT is due on all transactions involvingtransfers of taxable goods or the provision of taxableservices in Indonesia. Most goods- and business-relat-ed services are categorised as taxable goods or serv-ices. Those categorised as non-taxable includeunprocessed mining or drilling products, natural gas,certain books, gold bars, securities, banking, insuranceand finance leasing services. The standard VAT rate is10% and is calculated by applying the rate to a relevanttax base. In most cases, the tax base is the transactionvalue agreed between the parties concerned.

The rate applicable to exported goods is 0%. Certainexported services, such as toll manufacturing, repairand maintenance, and construction services are alsosubject to 0% VAT. The VAT must be collected at thetime of delivery when risk and ownership of goodshave been transferred or when income from a servicedelivery can be reliably estimated or measured.

The VAT system operates on an input-output mod-el. In most cases the supplier of goods or services isresponsible for collecting VAT from the buyer. The taxcollected constitutes output VAT for the vendor andinput VAT for the buyer. Firms liable for VAT are requiredto account for VAT on a monthly basis.

The minister of finance recently introduced an elec-tronic VAT (e-FP) invoice system to make it easier forVAT-able taxpayers to collect VAT. An e-FP will be manda-tory for certain VAT-able taxpayers that fulfil the stip-ulated criteria. Non-compliance will result in the affect-ed taxpayers being deemed not to have issued a VATinvoice and an administrative sanction of 2% from theVAT imposition base will be imposed on the taxpayer.A paper-based VAT invoice is still applicable for all oth-er taxpayers and on export-oriented transactions.

A payment must be made to the extent that outputtax exceeds input tax, and the taxpayer is entitled to arefund of the excess where the input tax exceeds out-put tax. Refund applications can be made at the endof a book year. It can take up to 12 months or more forcompanies to receive VAT refunds, after going througha VAT audit. However, taxpayers meeting certain com-pliance criteria may obtain pre-audit refunds. Month-ly refunds are possible for certain taxpayers, e.g.exporters of goods or services, suppliers to VAT collec-tors, companies in pre-production stage and suppliersof goods or services for which VAT is not collected.

340


TAX OVERVIEW

In addition to VAT, deliveries or imports of goodscategorised as luxuries are also subject to LST. Thesegoods include certain alcoholic beverages, householdappliances and sporting equipment. After the govern-ment recently revisited the LST rules in 2013, LST nolonger applies to many products. Where applicable,LST is due either upon import or upon delivery by themanufacturer to another party, and the rates current-ly range from 10% to 75%.OTHER TAXES: Stamp duty is nominal. The amount isgenerally Rp6000 ($0.60) for each document stamped.Land and property tax is due every year. The effectiveproperty tax is either 0.1% or 0.2% of the official valueof the land and buildings (a predetermined proportionof a deemed sales value determined by the government).The value is updated every one to three years by thegovernment in light of market values. The transfer ofland and building rights is subject to a 5% duty basedon the official value or the transaction value, whichev-er is higher. The duty is payable by the purchaser.TAX PAYMENT & REPORTING: Corporate income taxreturns must be submitted to the DGT on an annual basis.Monthly instalments of corporate income tax must bemade based on the firm’s prior year tax liability. Any taxpayable after taking into account the monthly instal-ments and tax withheld by third parties must be set-tled before filing the annual corporate income taxreturn. The annual filing must occur within four monthsof the book year-end. The time may be extended up totwo months by notifying the DGT in writing togetherwith a provisional tax calculation. Final settlement ofthe tax payable must be made before the end of thefourth month. For extension requests, the tax payableper the provisional calculation must be settled beforesubmission of the extension notification. Payments oftax beyond the deadline will trigger an interest penal-ty of 2% per month with a maximum of 48%.

VAT, LST and WHT must be accounted for on a month-ly basis. A VAT return for a particular month must befiled by the end of the following month, whereas aWHT return for a particular month must be filed by the20th of the following month. VAT and LST paymentdeadlines are before the reporting date, but WHT tax-es must be settled by the 10th of the following month. ACCOUNTING FOR TAX: PT companies generally mustmaintain their books in rupiah and in Indonesian. Therecords must be kept in Indonesia. The tax year mustcoincide with the book year, which may be the calen-dar year or any 12-month period ending on a specifieddate, but consistency must be maintained.

Based on specific DGT approval, foreign-ownedIndonesian companies, PEs and taxpayers presentingtheir financial statements in their functional currencyof US dollars in accordance with the financial account-ing standards applicable in Indonesia, can maintaintheir books in US dollars and in English. An approvalapplication must be filed with the DGT no less than threemonths before the commencement of the US dollaraccounting year. The DGT must issue a decision on theapplication within a month. If no decision is made with-in a month, the application is considered approved.

TAX AUDIT SELECTION DEVELOPS: Indonesia contin-ues to focus efforts on promoting foreign investment,capital accumulation, and the export of goods otherthan oil and gas, in an effort to expedite economicdevelopment and to become internationally compet-itive. As a result, a broad range of deregulatory meas-ures has been implemented and additional changes canbe expected to further enhance the investment climate.

For one of these measures, the DGT has developeda benchmarking methodology for reviewing taxpayer-s’ compliance, the benchmark behavioural model (BBM).Previously, the DGT used the total benchmarking ratio(TBR) as its benchmarking methodology. Most of thefinancial ratios used in the TBR are also adopted in theBBM (e.g., gross profit margin and corporate tax toturnover ratio). The BBM is intended to be used onlyas a supporting tool in assessing the tax compliancelevel of a taxpayer, and a discrepancy in respect to anyparticular ratio does not in itself prove non-compli-ance by a taxpayer. The discrepancy may prompt a fol-low up from the account representative for furtherexplanation. If the review of the discrepancy reveals non-compliance with the tax law, the account representa-tive may request an amendment of the tax return orrecommend that the taxpayer be subject to a tax audit.

This change in tax audit methodology is evidence ofthe government’s continued commitment to tax admin-istration reform, which aims to increase reliance ontaxpayer compliance and to improve good governancein tax administration by strengthening transparencyand accountability mechanisms. TAX AUDITS & TAX ASSESSMENTS: The DGT mayperform a tax audit on a particular taxpayer for vari-ous reasons. A request for a tax refund will trigger atax audit. The below factors may also trigger a tax audit: • Declaring continual tax losses in the tax returns;• Failure to file a return after a DGT reminder; • Change in fiscal year; • Change in book-keeping method; • Performed fixed-asset revaluation; and

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PT companies must keep their books in rupiah and in Indonesian

TAX OVERVIEW

• Business restructuring, including acquisitions, merg-ers and liquidations.

The DGT may also select a taxpayer to be audited basedon risk-based selection criteria.

Effective February 2013, tax audit timelines are nowsplit into the examination and discussion phase. Fieldaudits should be done within six-eight months andoffice audits within four-six months. The subsequentdiscussion phase should be done within two months.Further extensions are only allowed in limited circum-stances. Based on tax audit (or a similar tax verifica-tion process) findings, the DGT will issue a tax assess-ment letter. Under the General Tax Provisions andProcedures Law, a tax assessment letter for a particu-lar period or year may only be issued within five yearsof the end of the tax period or year in question (reducedfrom 10 years previously). Under the transitional pro-visions, any assessment letters for fiscal years 2003 to2008 must be issued no later than 2013. In view of theseprovisions, the tax audit focus in 2013-14 will includetaxpayers showing a tax loss position and/or filing VATreturns with overpayment compensations.

Tax audits in Indonesia can prove to be a difficult andprotracted process. As such, all taxpayers are advisedto be prepared in advance. This includes making surethat relevant documentation is ready for delivery to thetax auditors within a month of request. Under the one-month rule, any documents delivered beyond a monthfrom the request date can be ignored by the DGT.

In addition, a new tax “e-Audit” technique was intro-duced by the DGT in May 2013. To be conducted byspecially assigned and trained e-auditors, the processis designed to understand a taxpayer’s organisation,business process, electronic systems as well as data col-lection and conversion process to support the tax auditprocess. As one of the e-Audit processes involve allow-ing the DGT limited access to taxpayer’s IT systems toread and download data, taxpayers with extensive ITsystems should be ready in the event of an e-Audit.

A coordinated approach may also be taken for con-current tax audits of group companies. Group tax auditprocedures were issued in 2013 to set out the proce-dures, document templates and coordinating protocolsfor use between the relevant regional tax offices andtax service offices prior to the formal audit findings.TAX DISPUTE RESOLUTION: A taxpayer who does notagree with a tax assessment letter can file an objec-tion with the DGT within three months of the issue ofthe assessment letter. The DGT has to issue an objec-tion decision within 12 months of the objection beingfiled. If no decision is issued within this time frame, theobjection is deemed to be accepted.

Under the General Tax Provisions and ProceduresLaw, taxpayers can elect to pay the amount of tax theyconsider due and contest the balance in the objection.However, if the objection decision is unsuccessful, a 50%penalty applies on the unpaid tax. This amount increas-es to 100% if the objection decision is appealed in theTax Court and the court’s decision is unfavourable.

A taxpayer who does not accept an objection deci-sion can file an appeal with the Tax Court within three

months of the receipt of the objection decision. To theextent that the objection decision calls for a paymentof tax due, according to the Tax Court Law, at least 50%of the tax due must be settled before filing the appeal.As set out in the General Tax Provisions and ProceduresLaw, the taxpayer is only required to pay an amountagreed in the tax audit closing conference. This cre-ates a mismatch and taxpayers are generally advisedto pay the 50% amount to ensure the Tax Court acceptsthe case. However, recently the Tax Courts have inter-preted that the tax due refers to the amount agreedby the taxpayer as stated in the objection or appeal,which was already paid in full, and hence no addition-al tax in dispute needs to be paid. The Tax Court shoulddecide on an appeal within 12 months. In certain cir-cumstances its decisions can be submitted for a judi-cial review to the Supreme Court. Supreme Court deci-sions are closed hearings with no representations madeapart from the submission of a written review request.

Previously, there was only one Tax Court in Jakarta tohear cases from taxpayers across Indonesia. Howeverfrom 2013, taxpayers with their tax identities’ registeredin Surabaya, Medan or Yogyakarta should have their cas-es heard at the Tax Courts in the respective major cities.TRANSFER PRICING: By law, transactions betweenrelated parties must be conducted at arm’s length; oth-erwise the DGT has the right to re-determine the trans-actions accordingly. Under the General Tax Provisionsand Procedures Law, the government requires taxpay-ers to maintain specific transfer pricing documenta-tion to prove adherence to the arm’s length principle.

The number of tax audits with transfer pricing as thekey focus area has significantly increased following theissue of regulations related to transfer pricing in recentyears. The DGT has issued detailed guidelines which,broadly stated, typically follow OECD principles. Trans-actions under particularly close scrutiny include pay-ments of royalties and technical or management serv-ices fees, intercompany services, financing transactionsand exports to related parties. New transfer pricingaudit regulations and technical guidelines have also beenissued to provide greater certainty to taxpayers on theapproach, basis and nature of documents to be adopt-ed by the DGT during the audit process.

Where a taxpayer has no documentation availableto substantiate these transactions, there is a high riskthat deductions for the payments will be denied in full.In this regard, the one-month-rule time limit withinwhich a taxpayer must produce any documentationrequested by the DGT during an audit is being enforced.Transfer pricing disputes may be resolved through thedomestic objection and appeal process, or, where thedispute involves a transaction with a related party in acountry that is one of Indonesia’s tax treaty partners,the parties may request double tax relief under theMutual Agreement Procedures (MAP) article of the rel-evant tax treaty. The domestic dispute resolutionincludes applying for a tax objection, appealing to theTax Court, and requesting a reduction or cancellationof administrative sanctions. There is a restriction thata MAP application shall be discontinued if an appeal

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TAX OVERVIEW

decision is declared by the Tax Court prior to the final-isation of the MAP. However if a MAP agreement isreached prior to the finalisation of the tax objectionprocess, the MAP result will be taken into considera-tion. If a party is not satisfied with the Tax Court deci-sion, a judicial review by the Supreme Court is allowed.

The tax law authorises the DGT to enter into advancepricing agreements (APAs) with taxpayers and/or anoth-er country’s tax authority on the future application ofthe arm’s length principle to transactions betweenrelated parties. The process may or may not involve coop-eration with foreign tax authorities. Once agreed, anAPA will typically be valid for a maximum of three taxyears after the tax year in which the APA is agreed. TheAPA can also be applied to tax years before it wasagreed if certain conditions are met, such as the taxyear has not been audited and there is no indicationof tax crime. However, the rollback of an APA to prioryears is not automatic and will be subject to agreementbetween the taxpayer and the DGT.BONDED ZONES: Bonded zone status can be grantedby the minister of finance to qualifying companies thatare export-oriented, upon their making a specificrequest. Import duty and VAT concessions are provid-ed to companies with bonded zone status. This entailsthat no VAT or import duty is payable provided theunderlying goods are exported (prior to August 26,2013). It is worth noting that effective August 26, 2013,the facilities restriction in bonded zones for domesticproducts has been relaxed. Moving forward, more eco-nomic areas are expected to be designated bondedzones. More than 2000 companies enjoy this facility. CAPITAL MARKET-RELATED INCENTIVES: A gain fromthe sale of shares traded on the Indonesian StockExchange is not taxable in the normal fashion, nor isany loss claimable as a deduction.

The sale of listed shares is subject to final WHT of0.1%, which is based on the transaction value. Found-ing shareholders are required to pay 0.5% tax at the timeof listing based on the listing price. If this tax is not paid,those shareholders are taxed on any subsequent gainsbased on normal principles. Interest income on Indone-sian bonds is subject to final WHT of 15%. A 5% corpo-rate tax cut is granted to public companies that satis-fy three conditions: a minimum public listing of 40%; aminimum number of 300 public shareholders, eachholding no more than 5% of the company’s shares; andthe maintenance of the first two conditions for at least183 days in the relevant year.TAX-FREE MERGER & ACQUISITION: The transfer ofassets in a business merger, consolidation or expan-sion must be accounted for at market value. However,the transfer of assets at book value may be allowed forcertain qualifying mergers, consolidations or expansions.Certain criteria such as the business purpose test mustbe met and specific approval must be obtained fromthe DGT. If the merging companies are VAT entrepre-neurs (i.e. taxpayers subject to VAT), the transfer ofVAT-able goods between the merging firms is VAT-exempt. Merging companies can apply for a 50% reduc-tion of duty on the acquisition of land/building rights.

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Tax holidays are available for firms in certain pioneer industries

INCENTIVES FOR PES: Facilities for foreign companiesoperating through their branches in Indonesia are alsoavailable. PEs may be exempted from the imposition ofbranch profit tax (BPT) if they reinvest their after-taxprofits in Indonesia in one of the following forms: cap-ital participation in a newly established Indonesiancompany as a founder or participant founder; capitalparticipation in an established Indonesian company asa shareholder; or acquisition of a fixed asset or invest-ment of intangible asset used by the PE to conduct itsbusiness or activities in Indonesia. The above forms ofreinvestment must be executed no later than at theend of the tax year following the year when the incomesubject to BPT is earned by the PE. INCOME TAX CONCESSIONS: The Income Tax Lawprovides various facilities and incentives, such as apackage of concessions available for firms that investin certain qualifying sectors and/or regions. The mainconcession is a 30% investment allowance based onthe amount of the investment (which essentially appliesto investment in fixed assets), claimable over six yearsat 5% per year. The other concessions include acceler-ated depreciation of fixed assets (twice as fast as thenormal rate), a longer tax loss carry-forward period(extended from five years up to 10 years depending oncertain criteria) and a reduction of WHT on dividendspaid to foreign shareholders (from 20% to 10%).TAX HOLIDAY: The government provides tax facilitiesin the form of income tax exemption (tax holiday) orreduction to firms in pioneer industries which have awide range of connections, provide additional value andhigh externalities, introduce new technologies andhave strategic value for the national economy.

Five economic sectors currently enjoy this type oftax exemption: base metals, oil refineries and/or baseorganic chemicals sourced from oil and gas, renew-able energy, machinery and telecommunications.

OBG would like to thank PwC for their contribution toTHE REPORT Indonesia 2014.

TAX VIEWPOINT

Ay-Tjhing Phan, Tax Leader, PwC Indonesia

Indonesia has the potential to be Asia’s economic starof the next decade. That its long-term future is soundand promising despite the challenges is confirmed bythe views of some 500 prominent business leaders,polled in PwC’s APEC CEO survey 2013. Indonesia isemerging as one of their top investment destinations.Even so, Indonesia needs balance, coordination andfocus if it is to optimise its potential.

Over the last decade, Indonesia’s tax system is muchimproved, both in revenue collection and in adminis-trative processes. Yet its total tax take, about 12% ofGDP, is lower than in other Asian economies. Indone-sia continues to focus on ways to attract foreign directinvestment. With this in mind, policymakers need to con-sider carefully whether raising taxes is the only, letalone the best, way to increase tax revenues.

Supply-side economists have long argued that hightaxes discourage production. Tax cuts can thus resultin the government collecting more revenues not less,as this is proven globally to encourage compliance. Anyraising of Indonesia’s corporate income tax rate of 25%,its value-added tax (VAT) of 10%, or widening of its exten-sive tax net for withholdings, could thus render Indone-sia a less attractive place for investors. What could helpare further efforts to widen the tax base. Onerousadministrative requirements could also be streamlined.These steps, properly managed, can raise compliancewithout overly hampering economic activity. The taxauthorities are trying to do this by, among other meas-ures, setting up an e-filing system for taxpayers.

A policy, whatever its intent, is only as good as its exe-cution. Consistency of application is thus a chief virtue.In this light, the government’s efforts to simplify busi-ness regulations and relax restrictions on foreign own-ership, along with Vice-President Boediono’s 2013 pol-icy package to encourage investment, are commendable.Red tape remains a common barrier for investors. Reg-ulatory and licensing rules are not always clear, noreasy to comply with. Businesses’ experiences are incon-sistent. The myriad approvals, procedures and docu-

mentations, as well as lack of transparency, only addto the frustration. From tax holiday applications tolarge-scale business re-organisations, therefore, moreconsistency and coordination between governmentagencies would be much welcome.

A VAT was introduced to widen Indonesia’s tax basein 1983. Yet some of the regulations that accompaniedit have had unintended consequences. When business-es look for where to base their services and expertise,costs are a chief consideration. Limitations on a zero-rating of VAT for exports have put Indonesia at a dis-advantage to many of its neighbours. Unsurprisingly,few regional headquarters are set up in Indonesia. Oneway to improve this is to introduce a systematic andtransparent way for taxpayers to provide feedback andsuggestions to relevant authorities.

To gain the biggest edge, Indonesia should focus onits strategic advantages. Even if tax holidays are intro-duced for financial businesses, traction will likely be lim-ited. Indonesia’s financial market is still in its infancy,and it lacks the infrastructure, specialist talent and sup-porting ecosystem of developed neighbours like HongKong and Singapore. To further mature and attract theinterest of multinationals, it needs tax incentives forhuman capital development, infrastructure and strate-gic industries with large multiplier effects.

Taxes could also be better administered. Indonesia’spolicy of self-assessment for tax relies heavily on taxaudits to correct erroneous filings and collect under-paid tax. Under prevailing practice, a tax refund of anyamount triggers a tax audit. This is inefficient. Theforensic nature of audits, with tight deadlines for sub-mitting documents, is cumbersome to taxpayers. Taxauthorities’ efforts to clarify their focus are thereforeheartening. A recent circular, for example, clarified thefactors that may lead to transfer pricing audits.

Despite the challenges, Indonesia is moving in theright direction. Exciting developments abound. Withgreater balance, coordination and focus, we believethat its potential can be maximised on the world stage.

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Balance, coordination, focusAy-Tjhing Phan, Tax Leader, PwC Indonesia, on optimising potential


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Legal FrameworkA look a three recent corruption cases and their impactDefinitions in anti-corruption regulations require clarityOutline of related anti-money laundering legislationRules governing employee support in corruption cases

LEGAL FRAMEWORK ANALYSIS

Businesses must take into account the Anti-Corruption Law

People say that all is fair in love and war, and based onrecent examples, it would appear that this true ofbusiness in Indonesia as well. There are currently crim-inal proceedings against at least three big corporationsin Indonesia, including Chevron Pacific Indonesia –relating to an allegation of corruption in the firm’sbioremediation projects (“Chevron bioremediationcase”); Indosat Mega Media – relating to an allegationof corruption in the cooperation on broadband inter-net access 3G/HSDPA network with its holding com-pany (“IM2 case”); and Merpati Nusantara Airlines,relating to an allegation of corruption in the lease ofaircrafts from its business partner (“Merpati case”).

These cases have redefined the way businesses seethe application of criminal law in Indonesia and givesrise to potential business criminalisation practices.Companies are becoming concerned since the param-eters they previously believed to safeguard their oper-ations against criminal law are being reinterpreted. MISAPPLICATION: These concerns largely stem fromthe inconsistencies in applying the anti-corruptionregulations that redefine what has long been under-stood as the boundary between private and/or com-mercial matters and what amounts to criminal con-duct. Additionally, the issue of criminal law has escalateddue to recent practices of anti-corruption regulationsbeing applied simply because the transactions in ques-tion are connected with the state, despite the perform-ers being private entities.

In the Chevron bioremediation and IM2 cases, theAnti-Corruption Law has been enforced only withregard to the private sector defendants. There havealso been inconsistencies among the legislative, exec-utive and judicial authorities interpreting the law inthese cases. Thus, even government support on thelawfulness of a project or activity does not necessar-ily protect the project from application of criminal law. OVERLAP: The new trend of business criminalisationin Indonesia started with the wide interpretation ofArticle 2 and 3 of Law No. 31 of 1999 on Eradication

of Corruption, last amended with Law No. 20 of 2001(“Anti-Corruption Law”) by the law enforcement insti-tutions, particularly the Attorney General’s Office,which is one of the institutions with the authority toconduct inquiry and investigation at the initial stageof criminal proceedings and to prosecute the accusedin trial. Precedents show that the implementation ofArticle 2 and 3 have been expanded, overlapping pri-vate law, especially business transactions, by includ-ing loss caused by business risks as corruption crime,despite the fact that such risks are existent in com-mercial endeavours.

In the abovementioned cases, the corruption crimecharges were based on two main elements: (i) anunlawful act; and (ii) that such act caused state loss.The Attorney General’s Office established grounds toqualify an action or a business decision as unlawful byaccusing that the action infringed upon a law or reg-ulation, associating the materialised or potentiallymaterialised business risks with state loss. The arbi-trary interpretation of the law or regulation govern-ing such business, and disregarding the official inter-pretation of the ministry having the authority overthe sector, contributes to the growing anxiety of thebusiness community. GETTING IT RIGHT: The fight against corruption hasalways been part of Indonesia’s legal agenda. There-fore, its application must avoid capricious interpreta-tion of the Anti-Corruption Law, which threatens thecredibility of its enforcements and, at the same time,becomes a hindering factor for business activities andinvestment. In light of this development, the businessworld must learn the new rules of the game: alwaystake into consideration the reality of the Anti-Corrup-tion Law enforcement practices when calculating therisks in making a business decision. It is important torealise any business decision may have a risk of severecriminal sanction (corruption crime is a serious crime)imposed against the head of the company and/orthe employees related to the business transactions.

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Potential risksAnti-corruption measures may affect private business decisions

LEGAL FRAMEWORK OVERVIEW

The criminalisation of civil and commercial cases prompts worries

In terms of corruption, Indonesia performs poorly. In2012 Transparency International ranked Indonesia118th out of 176 countries, with a Corruption Percep-tion Index score of 32 on a scale of 0-100. Endemic andsystematic corruption is a major factor hindering devel-opment and is a bane to foreign investment.

Corruption has been responsible in crafting pande-monium in Indonesia, not only from an economic pointof view, but also because it encourages most Indone-sians to welcome corruption as a way of life. It is notdifficult to see how Indonesia’s past financial crisis wascaused by corruption, which has succeeded in increas-ing the country’s vulnerability to economic shocks.Since 1998 anti-corruption strategies have been amajor component of Indonesia’s official reform pro-gramme, in a hope to restore the nation to stability. AT ALL LEVELS: In Indonesia corruption can be foundat nearly all levels. There are many cases where high,middle or low-level government officials are found tobe involved in either petty corruption or grand-scaleschemes. The main weapon of the anti-corruptionstrategies is to reduce corruption through policychanges. Indonesia has ratified the UN Conventionagainst Corruption. The country has also issued sever-al regulations to eradicate corruptions, such as theAnti-Corruption Law, the Corruption Eradication Com-mission (Komisi Pemberantasan Korupsi, KPK) Law, andAnti-Money Laundering Law.

Despite the positive gains in combating corruption,there is a disturbing trend in the enforcement of theAnti-Corruption Law: criminalisation of civil and com-mercial matters. Most corruption cases prosecutedefendants from the public or private sector involvedin public sector projects, whereby defendants fromboth sectors will be simultaneously prosecuted andpunished. Nevertheless, in the recent Chevron biore-mediation case and Indosat Mega Media (IM2) case,the Anti-Corruption Law has been enforced only todefendants from the private sector. The Attorney Gen-eral’s Office investigated and prosecuted the alleged

corruption crime by employees of Chevron PacificIndonesia (CPI), a wholly owned subsidiary of Chevronand IM2, itself a subsidiary of Indonesia’s telecommu-nication giant Indosat — controlled by Qatar Telecom.Simultaneously, a criminal proceeding against MerpatiNusantara Airlines has also gained publicity for its crim-inalisation of business procedures.CHEVRON BIOREMEDIATION CASE: In the Chevronbioremediation case, the core issue has been a civil andcommercial matter: the procurement of bioremedia-tion work contracts and the recovery of the projects’costs under a production-sharing contract (PSC)between the government (represented by SKK MIGAS)and CPI. The PSC governed the cost recovery mecha-nism in this arrangement, in which the oil contractor– CPI – is entitled to the recovery of operational costsin the oil production. The recovery is deducted fromthe total oil production from the operation. The PSCalso regulates the mechanism for settling discrepan-cies or disagreement in the amount of recovered costs,from audit and correction, to arbitration.

The bioremediation projects are environmental proj-ects designed to mitigate the environmental effect ofcrude-oil-contaminated soil, which have been devel-oped and successfully implemented since 1998 by CPI.In the executions of such projects, CPI employed theservices of two independent contractors for the civilworks, however, the projects are under full responsi-bility and constant supervision of CPI. The projects arereported and evaluated regularly by the Ministry ofEnvironment, while procurement of the bioremediationcontractors by CPI, as well as the costs for the biore-mediation project, has always been reported andapproved by SKK MIGAS — as the supervisory body forupstream oil and gas business activities.

The Attorney General’s Office of Indonesia receiveda complaint that the bioremediation projects in 2006-11 were fictitious. Since the projects’ costs are recov-ered by cost recovery mechanism under the PSC, suchallegations would imply state losses were the projects

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Fighting corruption Strengthening the system for the sake of the whole



indeed fictitious. In the unfolding of the case, seven indi-viduals from CPI and the civil works contractors werenamed as suspects and later tried as defendants in theCorruption Court at the Central Jakarta District Court.However, the indictments carried no allegation of con-spiracy for individuals from the public sector. Individu-als from SKK MIGAS and the Ministry of Environment,the relevant authorised institutions, were only broughtin as witnesses. This and other irregularities in the dueprocess of law (i.e. that the facts the bioremediationexpert presented by the Attorney General’s Office hada conflict of interest) ignited fury that this case was acriminalisation of civil and commercial matters.IM2 CASE: On October 6, 2011, Denny AK, a non-gov-ernmental organisation activist, filed a criminal reporton the basis of suspected of corruption crime in thecooperation agreement between Indosat and IM2. TheAttorney General’s Office initiated an investigationbased on this report. On February 6, 2012, Denny senta letter demanding that the president director of Indosatmeet him and that if his demand was not met, he wouldproceed with his criminal report.

Indosat suspected Denny’s intention for blackmail-ing, which was later proven: Denny was caught by thestate police in an operation blackmailing Indosat man-agement. On October 30, 2012 the Central Jakarta Dis-trict Court convicted him of the crime.

Despite Denny’s blackmail attempts, the case againstIM2 proceeded. The president director of the firm, IndarAtmanto, was accused of having caused state lossesas the cooperation agreement between IM2 and Indosaton broadband internet access of 3G/HSDPA networkprogramme did not fully utilise permanent closed net-works pursuant to the permit that was issued to it bythe Ministry of Communication and Informatics. TheCorruption Court declared Atmanto guilty in its verdicthanded down on July 8, 2013.

The Ministry of Communication and Informaticsissued two official letters stating that there has beenno infringement in the cooperation between IM2 andIndosat. The ministry and the Indonesian Telecommu-nication Regulatory Agency reported in several pressreleases that there was a misunderstanding on the partof the investigators and prosecutors regarding regu-lations on telecommunications and technical aspectsof specific business activities and IT in general relatedto this case. Both stated the danger of such misunder-standing to the development of the telecommunica-tions industry in Indonesia. The biggest threat is posedagainst the 200 independent service providers thatimplement the same business model.MERPATI CASE: Merpati Nusantara Airlines, a state-owned firm, entered a lease agreement with an Amer-ican-based aircraft leasing company in 2006, by whichMerpati paid a refundable $1m security deposit in theevent the leasing company did not deliver the aircrafts.Following the leasing company’s failure to deliver theaircraft and refusal to return Merpati’s deposit, Mer-pati filed a claim before the US District Court for theDistrict of Colombia in March 2007. The court grantedMerpati’s claim for refund of the security deposit; how-

ever, the execution of the court’s judgment did not gosmoothly, and Merpati had to pursue the company’sassets through two periods of boards of directors. OnJuly 30, 2010, Merpati finally received a partial refund,but going forward the firm’s management decided todiscontinue the pursuit due to financial issues.

In 2011 the Attorney General’s Office indicted HotasiNababan and Hendra Yospin, the directors of Merpati,with corruption on the basis that their managementdecision not to pursue compensation had led to statelosses. Previously, the matter had been investigated bythe State Financial Audit Agency (Badan PemeriksaKeuangan, BPK), the Criminal Detection Unit of thestate police, the Junior Attorney General for SpecialCrime and the Junior Attorney General for Intelligenceat the Attorney General’s Office, and the KPK.

All previous investigations found no indication ofcorruption. The KPK even issued an official letter stat-ing that the aircraft lease agreement and the securitydeposit issues do not qualify as corruption crime. Nev-ertheless, the Attorney General’s Office insisted onprosecuting the defendants before the CorruptionCourt. However, the defendants were proven anddeclared not guilty on February 19, 2013. During theexamination, an ex-official from the Attorney Gener-al’s Office, the prosecuting institution, testified thatthe investigation of this matter should be terminatedsince it is not a corruption crime. FINDING A BETTER BALANCE: In Indonesia, defendantsin corruption cases generally receive little or no sym-pathy from the public. However, in the Chevron biore-mediation, IM2 and Merpati cases, much of the publicsympathised with the defendants and criticised theexamination process. The enforcement of the Anti-Corruption Law was perceived with suspicion as thecriminalisation of business as it involved the prosecu-tion of individuals from the private sector withoutinvolving or extending prosecution to public officials.

Additionally, there has been a tendency for the Anti-Corruption Law to be applied almost exclusively against

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Employees accused of corruption charges are entitled to remuneration throughout the trial period


the private sector in cases where business transac-tions involve losses to the state budget.

For example, in the Chevron bioremediation case,the main debate centred on whether the cost recov-ery for the bioremediation project was within the scopeof the Anti-Corruption Law. The first argument wasthat cost recovery in the oil and gas industry is notdeducted from the state budget, but from the total oiland gas production of the contractor’s operation. Sec-ond, a PSC is a civil contract between the governmentand a private entity that has provided the mechanismfor settling discrepancies or disagreements regardingitems and amount of cost to be recovered.

Therefore, even if there is a discrepancy in the futurecalculation of cost recovery for the projects, it shouldbe settled according to the dispute settlement mech-anism established under the PSC, i.e. through audit andcorrection of the calculation for the ongoing year. Fur-thermore, the examination of this case has led to scep-ticism regarding the authority and legitimacy of twogovernment institutions – SKK MIGAS and the Ministryof Environment – calling into question their clearance,approval and statement of compliance. NEED FOR CLARITY: In the Chevron bioremediation casethere was change in the understanding of a PSC. Therelationship between the state and the contractor isnot limited only by contractual relations, but also by thescope of the Anti-Corruption Law. In the Merpati case,a wrong business judgment was qualified as a crime.

This is contradictory with the principle that no oneshall be liable for a business judgment made with duecare. Whatever outcome of such judgment, simplebusiness risks shall not be criminalised. There are manyother corporations exposed to the same criminalisa-tion risk, but these cases have not yet escalated to courttrials. Judging from the wave of requests for legaladvice these businesses are seeking from local firms,more companies are losing confidence in the safetyof the business they are doing if it has even the slightest connection to the state and/or state funds.

Whether or not the abovementioned cases are crim-inalised, one fact remains clear: the anti-corruptionregulations lend themselves, and indeed have beenapplied, to the private sector, even without the simul-taneous targeting or involvement of the public sector.This appears to confirm the notion that as long as thetransaction could result in state losses, the anti-cor-ruption regulations are applicable, despite the fact thatthe transactions are under the control and supervisionof the authorised state institutions.

In the Chevron bioremediation case, officials from theMinistry of Environment and SKK MIGAS, which serveas the state’s supervisory institutions, have testifiedthat there was no infringement on the part of CPI. Asfor the IM2 case, the Ministry of Telecommunicationand the Indonesian Telecommunication RegulatoryAgency likewise stated that no violation had been com-mitted. Nevertheless, the cases have proceeded accord-ing to the legal interpretations of the prosecutors,which were later endorsed by the court, instead ofdeferring to the explanation provided by the institu-tions that issued the relevant regulations.

In light of these developments, it is important forinvestors in Indonesia to understand the implicationsof the anti-corruption regulations in the country, par-ticularly if the investments involve use of public funds.Anti-Corruption Regulations: The main regulationsused in corruption case proceeding are as follows: 1. Law No. 31 of 1999 on Eradication of Corruption, as

lastly amended with Law No. 20 of 2001(Anti-Cor-ruption Law);

2. Law No. 8 of 1981 on Criminal Procedure Law;3. Law No. 28 of 1999 on the Corruption, Collusion and

Nepotism Free State Governance;4. Law No. 30 of 2002 on Corruption Eradication Com-

mission (KPK Law); 5. Law No. 46 of 2009 on Corruption Courts (Corrup-

tion Courts Law);6. Law No. 8 of 2010 on Prevention and Eradication of

Money Laundering; 7. Instruction by the president, Law No. 5 of 2004 on

Acceleration of Corruption Eradication; and 8. Regulation No. 71 of 2000 on the Procedures of Pub-

lic Participation and Reward for the Prevention and Eradication of Corruption Crime.

DEFINING CORRUPTION: Needless to say, it is impor-tant to have clear and understandable definitions inordinances. But for a crime most loathed by the pub-lic, the law is conspicuously missing a clear definitionon what actions qualify as “corruption”. However, thespirit is clear, with the law intending to capture thesecreative white-collar criminal minds with their variousand ever-changing methods in corrupting state fund.To this extent, the Anti-Corruption Law does categorise“corruption acts” into several types, as follows:1. Acts that inflict a financial loss for the state, pursuant

to Article 2 of the Anti-Corruption Law;2. Bribery, pursuant to Article 5(1) part A and part B,

Article 5(2), Article 6(1) part A and B, Article 6(2), Article 11, Article 12 parts A through D, and Article 13;

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Private investment continues to be crucial for developing local infrastructure and building the economy



3. Embezzlement during services, pursuant to Article 8, Article 9, and Article 10 parts A through C;

4. Extortion, as per Article 12 parts E, G and H;5. Fraud, pursuant to Article 7(1) parts A through D, Arti-

cle 7(2) and Article 12 part H;6. Conflict of interests during procurements, pursuant

to Article 12 part I; 7. Gratification, pursuant to Article 12 B in conjunction

with Article 12 C; and 8. Conspiracy on corruption, pursuant to Article 15 and

Article 16. Moreover, the Anti-Corruption Law also governs oth-er crimes related to corruption, as follows:1. Interruption of the examination of a corruption case,

pursuant to Article 21; 2. Refusal of a person to provide information or to

deliberately provide misleading information regard-ing a corruption case, pursuant to Article 22 in con-junction with Article 28;

3. Refusal by a bank to provide information on the bank account of a corruption suspect, pursuant to Arti-cle 22 in conjunction with Article 29;

4. A witness or expert witness who declines to provide information or provides misleading information regarding a corruption case, pursuant to Article 22 in conjunction with Article 35; and

5. False information given by a person who holds occu-pational secrecy (rahasia jabatan) or where such person declines to provide any information, pursuant to Article 22 in conjunction with Article 36.

From the abovementioned categories, Articles 2 and3 get the most attention, as both are the easiest to inter-pret widely, and thus prone to the application for thecriminalisation of civil and commercial matters.

Aside from irregularities in the due process of law,the Chevron bioremediation, Merpati and IM2 caseshave one thing in common: their indictments are basedon Article 2 and/or 3 of the Anti-Corruption Law . Pur-suant to Article 2 and 3 of the law, to qualify someoneas having committed a corruption crime, the followingelements shall be met altogether:1. A person enriches himself or others or a firm;2. Where such act to self-enrich or enrich others is

considered as unlawful (Article 2); 3. The act demonstrates abuse of authority, opportu-

nity or means available to the actor with the inten-tion of enriching himself or others; and

4. The act could inflict a financial loss to the state. GRATIFICATION: Gratification is not an element ofArticle 2 and 3 of the Anti-Corruption Law, but is reg-ulated under dedicated provisions in Article 12B and12C of the law. Gratification is any kind of gift given toa public official or civil servant, including money, goods,discounts, commissions, loans without interest, traveltickets, accommodation facilities, travel expenses, freemedical treatment, or other benefits or facilities.

Gratification constitutes as a bribe if it has anythingto do with the recipient’s official capacity or is againsthis/her fiduciary duties and obligations. Gratificationhas been perceived as culturally acceptable in Indone-sia, and only became a crime after the enactment of

the amendment to the Anti-Corruption Law. Businessactors shall be aware of the risk in giving any kind ofgift to public officials. The KPK has provided a report-ing mechanism for any public official receiving gifts, inwhich KPK will determine the status of the gratifica-tion based on objective examinations. JUDICIAL AUTHORITY: The state police, the AttorneyGeneral’s Office and the KPK all have the authority toinvestigate corruption crimes. However, only the KPKand Attorney General’s Office have the authority toprosecute corruption crimes. The state police and theAttorney General’s Office also have jurisdiction oncrimes other than corruption, but the KPK is a specialbody with the main task and authority to coordinateand supervise corruption cases, including investiga-tions (penyelidikan dan penyidikan) and prosecutions(penuntutan) pursuant to the prevailing law.

On December 27, 2002, the government enactedLaw No. 30 of 2002, which was the legal basis for theestablishment of the KPK Law and the commissionitself. In carrying out the tasks and authorities grant-ed to it, the KPK must be independent and free fromthe influence of any power. According to KPK Law, theKPK is responsible for coordinating with the authori-ties to combat corruption and conduct supervisionover state institutions authorised to combat corrup-tion (i.e. the police and the Attorney General’s Office); COORDINATION & COURTS: Theoretically, the KPK andother law enforcement bodies with authority to inves-tigate and prosecute corruption crimes are partnersand meant to coordinate. However, there are cases inwhich the suspects/defendants are individuals from theKPK’s partner institutions, creating friction among theAnti-Corruption Law enforcement agencies.

The KPK Law is also the legal basis for establishmentof the Corruption Courts in Indonesia. The CorruptionCourts were established on the basis of the general courtenvironment (lingkungan peradilan umum), located inthe Central Jakarta District Court and covering jurisdic-tions of the entire area of the Republic of Indonesia.

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The state police, the Attorney General’s Office and the KPK all have the authority to investigate corruption


The Corruption Courts also have jurisdiction over cor-ruption cases conducted by Indonesians outside thearea of the republic. The Corruption Courts are furtherregulated by the Corruption Courts Law. CORRUPTION & MONEY LAUNDERING: The publicoften sees corruption as tied to money launderingactivities. This view is reasonably correct, as assets thatbecome the object of money laundering are oftenderived from corruption. Rationally, the corruptors tryto hide their corruption-derived assets through anypossible methods, making it difficult, if not impossible,for the law enforcers to track it down.

On October 22, 2010 the government enacted LawNo. 8 of 2010 to replace Law No. 15 of 2002 on Mon-ey Laundering, as amended by Law No. 25 of 2003. TheAnti-Money Laundering Law identifies three differentforms of money laundering:1. An action of a person or company to place, transfer,

assign, shop, pay, grant, deposit, carry out abroad, transform, exchange with other currencies or bonds, or other acts over an asset which is known or must reasonably be known to have resulted from the typesof crime set out under Article 2 of Anti-Money Laun-dering Law (including corruption), with a purpose to hide or dissemble the origin of such asset. This action is subject to imprisonment of up to 20 years or a fine up to the maximum amount of Rp5bn ($500,000);

2. An action of a person or company to hide or dissem-ble the origin, source, location, designation, assign-ment of rights or original ownership of an asset known or reasonably known to have come from cor-ruption. This action is subject to imprisonment of a maximum of 20 years or a fine in the amount of up to Rp5bn ($500,000); or

3. An action of a person or company to accept or con-trol the placement, transfer, payment, grant, dona-tion, deposit, exchange or usage of an asset that is known or must reasonably be known to have result-ed from corruption. This action is subject to impris-onment of maximum 20 years or fine in the amount

of up to Rp1bn ($100,000). However, this particular type of money laundering will not be applicable to the informants who conduct the reporting obliga-tions set out in the Anti-Money Laundering Law.

OTHER PROVISIONS: The Anti-Money Laundering Lawalso covers regulations on other conducts, such as theprohibition to carry cash abroad if it is of greater val-ue than Rp100m ($10,000). As a further step to com-bat money laundering, the government established theIndonesian Financial Transaction Reports and AnalysisCentre (Pusat Pelaporan dan Analisis Transaksi Keuan-gan, PPATK). The functions of this centre are as follows:a. To prevent and combat money laundering;b. To maintain data obtained by the centre;c. To supervise the compliance of informants; andd. To conduct analysis and investigation on reports and

information regarding financial transactions having money laundering or corruption natures.

In conducting its duties, the PPATK reports directly tothe president of the republic, and all persons are pro-hibited from interfering with the duties and authorityof the centre. The following rights are granted to thePPATK to carry out its task on the prevention and erad-ication of money laundering:a. To request information from government institutions

and/or private entities having authorities to main-tain data and information, including the ones receiv-ing reports from specific professions;

b. To stipulate the guidelines on identification of susp-icious financial transactions;

c. To coordinate the prevention of money launderingwith relevant institutions;

d. To provide recommendation to the government on the prevention of money laundering;

e. To represent the government in front of various organisations relating to the prevention and eradi-cation of money laundering;

f. To organise education and trainings programmes on anti-money laundering; and

g. To organise socialisation on prevention and eradica-tion of money laundering.

As part of its responsibility to provide legal protections,the authority and employees of the PPATK, includingits related investigators, prosecutors and judges, areobliged to protect the identities of any informants.

The Anti-Money Laundering Law grants investigators,prosecutors and judges the right to freeze those assetsknown or reasonably known to have been the result ofa crime conducted by a person who is a money-laun-dering suspect or defendant. The investigations andprosecution during a court proceeding, as well as theenforcement of a legally binding decision on a moneylaundering case must be carried out pursuant to thecountry’s prevailing regulations.OBLIGATIONS TOWARDS EMPLOYEES: Another mat-ter that must be considered when an employee of aprivate company is being investigated, prosecuted ortried on corruption charges is the said employee’srights as a worker. Law No. 13 of 2003 on Labour (the“Labour Law”) is the primary legislation at work inIndonesia that regulates such matters with Article 160.

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The dependents of an employee tried for corruption are entitled to support for up to six months



During the criminal proceeding (including investiga-tion, prosecution and court trial stages), the sus-pect/defendant is entitled to full and normal remuner-ations and benefits. The company’s obligation to paythe salary will cease and be substituted by the obliga-tion to provide support to the suspect’s family only ifthe accused is detained in the course of the criminalproceeding. Article 160 paragraphs (1) and (2) of theLabour Law provide that the amount of support is pro-portional to the number of the employee’s dependents.The family is entitled to receive support in the amountof 25% of the employee’s salary if there is only onedependent, 35% for two dependents, 45% for threedependents and 50% if there are four or more depend-ents. The suspect/defendant is also only entitled to suchsupport for maximum period of six months.

In sum, the rights of employees articulated in theLabour Law are the minimum standard that the com-pany must provide to its employees. However, the firmmay provide better rights to the employees under theemployment agreement and/or the collective labouragreement. This is confirmed in the General Elucida-tion and Elucidation of Article 61 paragraph (5) of theLabour Law. Accordingly, the collective labour agree-ment must not provide fewer rights to the employeesthan the rights under the law. In case the collectivelabour agreement provides better rights to the employ-ees, the firm is bound to fulfil the suspect/defendant’srights according to the collective agreement. NO WORK, NO PAY: Furthermore, in the event that thesuspect/defendant is found guilty by a final, bindingcourt judgment and therefore must serve imprisonment,the company may terminate the employment. Never-theless, if the company decides not to terminate employ-ment, there is no obligation to provide any remunera-tions and benefits as the suspect/defendant will notbe able to perform his or her work duties properlybecause of his/her faults (criminal offence). This is pur-suant to the “no work, no pay principle” of Article 93paragraph (1) of the Labour Law and its elucidation.NEED FOR COMMITMENT & CLARITY: Indonesia’scommitment to fight corruption is essential to createa favourable business environment. Such monitoringhas always gained industries’ full support, and the con-cern for business criminalisation does not at all sug-gest any resistance to the state’s commitment to fightcorruption. However, the fight must still establish itslegitimacy by drafting clear rules or parameters in qual-ifying corruption crime and applying enforcement it con-sistently, so that the Anti-Corruption Law does notbecome counterproductive to investment. In short, thenation’s business environment requires a clear rule oflaw and principles with consistent applications in orderto establish legal certainty for firms.

The disturbing trend of criminalising civil/commercialmatters is alarming to both current and potentialinvestors, which further engenders legal uncertaintyand increases the risk for public-private partnershipsin Indonesia. Furthermore, the negative impact of sucha trend is not limited to the investment. Following thedevelopments of the Chevron bioremediation case, oil

operations in Indonesia shut down their bioremedia-tion projects, which left crude-oil-contaminated soil –hazardous waste – untreated due to fear of criminalprosecution, creating additional environmental issues. NEGATIVE IMPACTS: Hopefully, the trend to crimi-nalise civil and commercial affairs will be outdated soonand replaced by a real effort to combat corruption bythe law enforcement agencies. Fear of criminalisationon cost recovery practices as in Chevron bioremedia-tion case may slow down the oil and gas business activ-ity in Indonesia, which is counterproductive to the gov-ernment’s plan to increase oil production. The IM2 casehas spread fear among the growing information tech-nology industry, and the Merpati case has made theofficers of state-owned companies reluctant to makebusiness decisions in fear of causing state loss. Publicprojects, which were once attractive projects becausethey carried government assurances, have become lessdesirable by private contractors as they involve statefunds — which could be an entry point for corruptioncrime charges. As for ongoing projects, some stakehold-ers are questioning and re-evaluating the possibility ofcriminalisation for the business judgments made.

This situation is equally dire for Indonesia as a whole.The country still requires investments to keep the econ-omy growing and build infrastructures. With this trend,investment frailty is an imminent threat, especially giv-en that neighbouring countries are promoting a moreconducive situation for investment. More importantly,the government is prone to be subject to investmentclaims due to the breach of investment protection war-ranties. This is ironic but true, given that the law enforce-ment agencies are part of the government structurethat requested companies to invest in Indonesia andhad promised to guarantee that their relationshipswould be governed by mutual benefit and the sancti-ty of the contractual relationship between the parties.

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The targeting of private sector workers and not public sector ones troubles business operators

OBG would like to thank Lubis, Santosa & Maramis for theircontribution to THE REPORT Indonesia 2014

LEGAL FRAMEWORK VIEWPOINT

Todung Mulya Lubis, Senior Partner, Lubis Santosa & Maramis

Corruption is not new. It is as old as the history ofhuman beings. And it will always be with us, becausethere will always be people who want to live in luxury,to be part of the jet set community, to be closer to thecentres of power. No one can eradicate corruptioncompletely, but there are ways to minimise it. In the caseof Indonesia, eradication seems of highest prioritybecause Indonesia still ranks among the most corruptcountries on earth, despite drastic action to combat it.

Non-compliance with the rules of good governancemay become a serious issue. It may cause both mate-rial and immaterial losses. Worse, it may degenerate intofraud, or even corruption. The Indonesian public hasalready witnessed many corruption cases unfold dueto non-compliance with the law and good governancepractices. Hundreds of civil servants, businessmen,politicians and high-ranking officials have been jailedfor their failure in these matters.

Almost every law enforcement agency in Indonesiais generally perceived not only as weak but as uncleanand partial. To report a criminal offense to the policecan cost the offended a great deal of money beforetheir report even gets past the filing stage. To ask a pros-ecutor to pursue a criminal offense requires a finan-cial transaction. To commence civil litigation in courtoften ends in bargaining for a favourable decision at ahuge cost. It is like a black market of justice. Those whoare unwilling or unable to pay often end up losing thecase. The lawyers who represent the plaintiff often playthe role of mediator, or even broker. Striving for justiceis like bargaining for the highest price. It is thereforeno surprise that the business community, and especial-ly foreign investors, refuse to settle their legal disputesin Indonesian courts unless forced to do so.

From a business point of view, a corrupt legal systemis not only discouraging. It also means investors face apredicament. They see investing in Indonesia as veryattractive due to the size of its market and the abun-dance of its natural resources. but they also know theywill have to do business in an environment where no

legal certainty is provided. This is a hard choice. How-ever, since the potential gain is greater than the poten-tial loss, no reasonable foreign investor wants to missthe opportunity of doing business in Indonesia, whichhas thus far managed positive economic growth despitethe financial crisis in the US and Europe.

In 2015 the ASEAN region will become a single mar-ket, and many trade barriers will be eased. The econom-ic logic is that doing business in this part of the worldwill be very attractive, and therefore the corrupt legalsystem will have to be dealt with. It may be a disincen-tive, and it may be a cost, but foreign investors will haveto make sure they are in compliance with existing lawsand regulations. Regular lobbying and deliberationsbetween the Indonesian business community and gov-ernment agencies must be conducted in the hope thatrecommended actions to clean up law enforcementagencies are pursued. Improvement of the legal sys-tem apparently has to be done gradually. It will take time,but at the moment there is no other choice.

This is an odd state to be in. But in a growing andborderless society, the responsibility to right the wrongs,perfect the imperfections, and clean up unclean gov-ernance falls not only to the host government but tothe community doing business there. Politically andlegally, it is not impossible or inconceivable. Multilat-eral cooperation and an engaged civil society would leadus to a condition in which reform is possible. Good gov-ernance both in government and in corporations, com-pliance with the law, and various audits – these seemto be the fruits of transnational and cross-sectoralendeavours. It is our conviction that in the future moretools will be introduced to bring about legal certainty.

We live in a world not only of national but of globalgovernance, and there is in fact a positive correlationbetween the two. In the end, business will not be amatter merely of national jurisdiction; it will go beyondtraditional boundaries. The legal uncertainty and judi-cial corruption surrounding it must therefore be dealtwith by all interested parties with wisdom and realism.

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Of bribery and businessTodung Mulya Lubis, Senior Partner, Lubis Santosa & Maramis, on corruption and legal uncertainty


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The GuideFrom dragons to diving, Komodo has a great deal to offerContact details for ministries, embassies and moreListing of accommodation across the archipelagoUseful information for first-time visitors to the country

THE GUIDE SIGHTS & SOUNDS

The giant Komodo dragon is the national park’s main attraction

Throughout his trip to Europe at the beginning of 2013,President Susilo Bambang Yudhoyono was intent on pro-moting Indonesia as a “complete tourism destination”with a host of interesting and unique places to offerother than Bali. Komodo National Park is such a desti-nation and one which has escaped the attention of manytourists. While more mainstream destinations retaintheir allure, this World Heritage site is becoming anincreasingly tempting option for travellers as tour oper-ator services expand and accessibility improves.

Indonesia received more than 8.8m tourists in 2013at a time when the global economy was still recover-ing, and as prospects now look to be improving inter-nationally, the Ministry of Tourism has set an ambitioustarget of 9.5m arrivals for 2014. There are high hopesthat unique local attractions, such as Komodo Nation-al Park, will do much to help achieve this target. HILLY ISLANDS: Located in the middle of the vastarchipelago, approximately 200 nautical miles east ofBali, the park is comprised of three main islands: Komo-do, Padar and Rinca, along with 26 others covering aland and sea area of more than 173,000 ha. Among thesevolcanic islands, whose vegetation is predominantlymade up of grass and woodland, Komodo is the largest.Its topography is characterised by a series of rolling hillswhose gradients grow steepest at the peak of GunungToda Klea to the north of the island.

Like the hills which shadow them, the plentiful sandybeaches, bays and coves of the island are varied inshape and often steep in terms of relief. To the east ofKomodo lies Padar, a smaller and narrower island, whosetopography is similar to that of Komodo, although it onlyrises to around half the 500- to 600-metre elevationof that island. Further in this direction lies Rinca, thesecond-largest island and situated only a few kilome-tres west of mainland Flores.THE PARK: While the national park was originally cre-ated in 1980 with the sole intention of protecting itsunique population of dragons, over the time the valueof this diverse ecosystem has become better under-

stood. The declaration of the park as both a biospherereserve in 1986 and a World Heritage site in 1991 byUNESCO has helped to attract attention to the wealthof its terrestrial and marine biodiversity.

However, appreciation has also extended to encom-pass consideration of the risk which threatens thisunparalleled natural haven and as such, greater effortsare also being made to mitigate the ever-increasinghuman impact. The local human population hasincreased 800% over the past 60 years, and associat-ed risks are quite rightly being taken into account aspart of the park’s long-term management strategy. WILDLIFE & ATTRACTIONS: The giant Komodo drag-on, or Varanus komodoensis, is arguably the park’sgreatest attraction. They are greater in number herethan anywhere else in the world, with around 4600 ofthem inhabiting the islands of Komodo and Padar, inaddition to mainland Flores and nearby Gili Motar. Thelargest lizard in the world, these dragons are great insize, typically weighing up to 130 kg in the wild and grow-ing as long as 3 metres in length. While concerns havebeen raised by some about the aggressiveness of thecreatures towards humans, ranger stations on bothKomodo and Rinca islands stipulate that visitors musthave a guide whenever they leave ranger-patrolledtrails to manage this risk and ensure that tourists donot come into direct contact with the lizards.

The dragons, however, are not the only terrestrialattraction as the island’s tropical deciduous forest habi-tat is also home to introduced species such as Javanrusa deer, wild buffalo and macaque monkeys, and 72species of bird have been recorded as well, includingthe yellow-crested cockatoo, noisy friar bird and thewhite-breasted sea eagle. In terms of fauna, of partic-ular note are the areas of quasi-cloud forest at altitudesof more than 500 metres; these are contain a range offlora, including many endemic species. UNDER THE SEA: Leaving the land behind, the sur-rounding seas’ richly oxygenated waters have a vibrantreef ecosystem and are home to some of the world’s

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Here be dragonsThe many attractions of the Komodo National Park


THE GUIDE SIGHTS & SOUNDS

best diving. With 67% of the 2321-sq-km park madeup of marine area, there are almost 100 notable divesites, 40 of which are used regularly for recreationaldiving. The abundance of underwater biodiversity islargely due to the consistent arrival of cold and nutri-ent-rich water from the Indian Ocean, which nourish-es the growth of the ecosystem, particularly to thenorth-east of Komodo.

While many will likely be happy with the standard divesites, there are also more challenging sites for moreexperienced and adventurous divers where one canswim among underwater currents. One such site is Cas-tle Rock, also known as Taka Toko-toko, where a sub-merged mountain is located in the northern part ofKomodo. With the open-water location exposing diversto underwater currents, under the supervision of theirguides, they must quickly descend to a minimum 5-metredepth to avoid being caught. Once below the draft, diversare then often rewarded with horizontal visibility ofover 15 metres. The site is well known as a location toview many different fish, including reef sharks, grouperand doctor fish. Manta rays are also common at thesite and can span up to 3 metres in width. As for thosein search of marine mammals, these are most commonnear the Gili Lawa Laut reefs, where blue whales andsperm whales have been sighted, in addition to up to10 species of dolphin and dugong. CONSERVATION EFFORTS: In light of increasing visi-tor numbers at the national park, conservation has

become a major priority. A 25-year management planwas completed in 2000 and acts as a roadmap to reg-ulate appropriate usage of the park and to addressthreats to marine and terrestrial life, while also max-imising benefits for local communities in a sustainableway. To support these goals, a conservation fund hasbeen in place under the Komodo Collaborative Man-agement Initiative since 2006 and all visitor contribu-tions will be used to benefit nature conservation effortsas well as local communities. ACCESSIBILITY & ACCOMMODATION: Flights runalmost daily from Denpasar, Bali to serve the airportsof Bima, on the island of Sumbawa, and Lubuan Bajo,on the western side of Flores. Airlines serving theseroutes include Indonesia Air Transport, Trans-Nusa Air-lines, Sky Aviation and Wings.

As the most popular jumping-off point for Komodoand home to the park’s visitor centre, western Floresfeatures an increasing number of accommodationoptions in Labuan Bajo. While predominantly consist-ing of low- to mid-priced hotels, a more luxurious optioncan be found in the form of the Jayakarta Suites Hotel.However, for those seeking perhaps the most authen-tic experience, live-aboard accommodation on fullyequipped vessels is also available. Offered by a num-ber of operators, the most popular trips generally offertwo- or three-day accommodation and dive orsnorkelling packages for between $200 and $450,depending on the duration and activities included.

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THE GUIDE HOTELS

JAKARTA

KERATON AT THE PLAZAJl. MH Thamrin Kav. 15 Jakarta 10350T: +62 (21) 5068 0000F: +62 (21) 5068 9999Luxurycollection.Keraton@luxurycollection.comwww.keratonattheplazajakarta.com

Rooms: 140 rooms in total, including grand deluxeand executive grand deluxe rooms, as well as juniorsuites, executive junior suites, Keraton suites andexecutive Keraton suites.Business & Conference Facilities: 24-hour businesscentre with all work services and equipment (copy& fax machines, printer and scanner, computers,flat-screen TVs and telephones), 2 executive board-rooms (for 12 people and 8 people, respectively)and high-speed internet access.Health & Leisure Facilities: 24-hour gym, indoorswimming pool and Keraton Spa, with 2 infraredsaunas, 2 steam rooms, 2 hot & cold plunge pools,and 7 treatment rooms, including a couple’s room.Guest Services: 24-hour butler service, early check-in and late check-out service at no extra charge,complimentary Wi-Fi, complimentary use of theboardroom (2 hours for 6 people), complimentarypersonalised welcome and turn-down service, andcomplimentary garment pressing (2 pieces per stay).Wining & Dining: Bengawan (Mexican), KeratonLounge (afternoon tea, cocktails), in-room dining.

THE AKMANI HOTEL JAKARTAJl. KH. Wahid Hasyim 91 Jakarta 10350T: +62 (21) 3190 5335F: +62 (21) 3190 [email protected]

Rooms: 117 rooms, including 84 deluxe and 24 granddeluxe rooms, as well as 5 suites, 2 grand suites and1 presidential suite.Business & Conference Facilities: 7 meeting rooms(with capacity for up to 150 people) and 1 ballroom(with capacity for up to 300 people). All rooms areequipped with Wi-Fi, screens, microphones and soundsystems. Business centre. Health & Leisure Facilities: Fitness centre with out-door swimming pool. De Fame Spa offers a varietyof massage treatments and aromatherapies. Guest Services: Free broadband internet access, LCDtelevision, air-conditioning, IDD telephone, tea andcoffee making facilities, concierge, 24-hour roomservice, airport pick-up service, car hire, laundry andvalet service, baby cots available, luggage storageand car park.Wining & Dining: Bel Piatto Restaurant (24 hours,Western, Asian and Chinese cuisine), Scarlatti Lounge(lounge), Rumah 91.

ALL SEASONS HOTEL JAKARTA THAMRINJl. Talang Betutu No. 02 Jakarta Pusat 10230T: +62 (21) 3042 2222F: +62 (21) 3042 [email protected]/8307

Rooms: 167 guest rooms offering views of modernJakarta. Non-smoking and handicapped-accessiblerooms are available upon request.Business & Conference Facilities: 4 conference roomswith seating for 15-30 people, depending on style.High-speed internet.Guest Services: Indoor and outdoor parking, Wi-Fi,porter.Wining & Dining: Skyloft Restaurant & Bar (all-daydining, local & Western cuisine), Streats Lounge(cocktails & snacks), room service.

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Someplace special

Keraton at the Plaza

The Akmani Hotel Jakarta

Artotel Jakarta Thamrin

All Seasons Hotel JakartaThamrin

THE GUIDE HOTELS

ARTOTEL JAKARTA THAMRINJl. Sunda No. 3, Menteng Jakarta Pusat 10350T: +62 (21) 3192 5888F: +62 (21) 3192 5999happening.thamrin@artotelindonesia.comwww.artotelindonesia.com

Rooms: 107 rooms.Business & Conference Facilities: Meeting room. Health & Leisure Facilities: Art gallery.Guest Services: 24-hour room service, free Wi-Fi.Wining & Dining: Roca Restaurant (open 24 hours,international fare, drinks).

ASTON RASUNA JAKARTAKomplek Apartemen Taman Rasuna Jalan H.R. RasunaJakarta 12960 T: +62 (21) 8370 5555, 9390 1000F: +62 (21) 8378 6244, 9390 2616Toll Free: [email protected]

Rooms: 224 luxuriously appointed guest rooms, com-prising 1-, 2- and 3-bedroom suites.Business & Conference Facilities: 5 function roomswith a capacity for up to 400 people standing, all ofwhich are equipped with microphones, sound sys-tem and screens. Business centre, Wi-Fi access.Health & Leisure Facilities: Swimming pools, basket-ball court, tennis court, 2 gyms, jogging track, chil-dren’s playground, mini-market, pharmacy, spa withmassage treatments.Guest Services: Free Wi-Fi access in the restaurant,24-hour room service, 24-hour front desk, 24-hoursecurity, concierge service, valet service, laundryservice.Wining & Dining: Mezza Café (international & Indone-sian cuisine), bar and lounge.

GRAN MAHAKAMJalan Mahakam, No. 6, Blok M, Jakarta 12130T: +62 (21) 720 9966 F: +62 (21) 725 [email protected]

Rooms: 158 rooms, including deluxe and super deluxerooms, as well as junior suites, Mahakam club suites,executive suites, deluxe suites, Gran suites andMahakam suites.Business & Conference Facilities: 11 function rooms. Health & Leisure Facilities: Spa with treatment roomsand steam rooms.Guest Services: High-speed internet, drugstore,executive lounge, library, swimming pool, fitness cen-tre, 24-hour room service.Wining & Dining: Le Gran Café (buffet and à la carte,Western, Japanese, Indonesian and Asian cuisine),Aoki Japanese Restaurant, Regal Bar and Lounge(cocktails, tea).

GRAN MELIÁ JAKARTAJalan H. R. Rasuna Said Kav. X-0, Kuningan, South Jakarta 12950T: +62 (21) 526 8080F: +62 (21) 526 [email protected]

Rooms: 407 rooms, including 217 premium rooms,99 deluxe rooms, 56 red level rooms, 33 suites and2 presidential suites.Business & Conference Facilities: A pillarless ball-room (with a capacity for up to 3000 people), 6 func-tion rooms of various sizes, business centre.Health & Leisure Facilities: Yhi Spa, fitness centre,swimming pool and 2 tennis courts.Guest Services: Complimentary high-speed Wi-Fi inrooms and public areas, airport pick-up service, 24-hour in-room dining, multilingual staff. Every room

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Aston Rasuna Jakarta

Gran Meliá Jakarta

Gran Mahakam

THE GUIDE HOTELS

features: spacious bathroom with walk-in showerand separate bathtub equipped with bath amenitiesand hair dryer; telephone; fax line and extra laptopconnection; complimentary high-speed Wi-Fi andwired internet access; bedside control panel withalarm clock; in-room safe deposit box; 42-inch LCDTV with national and international channels; in-roommini-bar, coffee and tea making facilities; desk.Wining & Dining: Café Gran Via (international cui-sine), Tien Chao Chinese Restaurant (Sichuan & Can-tonese cuisine), Yoshi Izakaya Japanese Restaurant,Lobby Lounge, El Bombón Gourmet & Pastry, La ViñaWine Cellar, Red Level Lounge.

HOTEL BIDAKARA JAKARTAJl. Jend. Gatot Subroto Kav. 71-73 Pancoran Jakarta Selatan, 12870T: +62 (21) 8379 3555F: +62 (21) 8379 [email protected]

Rooms: 174 rooms with 145 deluxe rooms, 15 exec-utive rooms, 11 junior suites, 1 moderate suite and2 family suites.Business & Conference Facilities: 31 meeting roomsincluding 2 spacious halls: Birawa Assembly Hall (witha capacity for up to 3000 people) and AuditoriumBinakarna (with a capacity for up to 1200 people).Health & Leisure Facilities: Fitness centre with pro-fessional instructor, yoga & belly dance classes, swim-ming pool, massage, medical centre.Guest Services: Concierge, Wi-Fi internet access,laundry, taxi service, valet parking, car park, airportpick-up, 24-hour room service, children’s play area,multilingual staff, shopping arcade, beauty salon,karaoke, bank.Wining & Dining: Mawar Restaurant (international& Indonesian fare), Anggrek Coffee Lounge (open 24hours), Lotus Executive Lounge (private functions,steakhouse), Kenanga Restaurant (breakfast buffet).

HOTEL BOROBUDUR JAKARTAJalan Lapangan Banteng Selatan PO Box 1329Jakarta Pusat 10710 T: +62 (021) 380 5555, 380 5000F: +62 (021) 383 [email protected]

Rooms: 229 superior, 178 premier deluxe, 115 exec-utive, 2 handicapped rooms, 18 junior suites, 13executive suites, 5 deluxe suites, 8 club deluxe suites,37 club suites, 1 Borobudur suite, 1 presidential suiteand 88 fully serviced garden-wing suites.Business & Conference Facilities: 21 multi-purposefunction rooms. Business centre is equipped with sec-retarial services, internet access, photocopy and faxmachines, laptop or desktop computer hire, as wellas a local translator.Health & Leisure Facilities: Klub & Spa Borobudur,swimming pool, 700-metre jogging track, 8 tenniscourts, 3 squash courts, basketball court, gymnasi-um, workout studio, sauna, steam, whirlpool, coldplunge, soccer pitch, kids’ club, and spa with 6 treat-ment rooms and 1 reflexology room.Guest Services: ATM, shopping arcade, 24-hourreception and security, 24-hour room service,concierge service from 07.00am to 11.00pm, Wi-Fi,taxi stand and car hire, laundry & dry cleaning, flowershop.Wining & Dining: Bogor Café, Teratai Chinese Restau-rant, Miyama Japanese Restaurant, Bruschetta Ital-ian, Pendopo Lounge, Churchill Wine & Cigar Bar,Borobudur Gourmet.

KEMANG ICON JAKARTAJl. Kemang Raya No. 1, South JakartaT: +62 (21) 719 7989 F: +62 (21) 719 [email protected]/kemangicon

361

Hotel Borobudur Jakarta

Kemang Icon Jakarta

THE GUIDE HOTELS

Rooms: 12 suites, including an inner courtyard suiteand an Edge suite.Business & Conference Facilities: The White Roomfor meetings (with a capacity of up to 40 people)and the Edge Bistro for social events (with a capac-ity for up to 250 people standing).Health & Leisure Facilities: Swimming pool.Guest Services: Business centre at the concierge.Wining & Dining: The Edge Bistro.

KOSENDA HOTELJl. KH Wahid Hasyim No. 127 Jakarta 10240T: +62 (21) 3193 6868F: +62 (21) 3193 [email protected]

Rooms: 60 rooms.Health & Leisure Facilities: Gym.Guest Services: Concierge, guest relations officer,guest service agent, telephone operator, 24-hourrestaurant.Wining & Dining: 127 Café (coffeeshop), WahaRestaurant (Peranakan cuisine) and Awan Lounge(Asian tapas, drinks).

MANDARIN ORIENTAL JAKARTAJL MH Thamrin PO Box 3392 Jakarta 10310 T: +62 (21) 2993 8888F: +62 (31) 2993 [email protected] www.mandarinoriental.com

Rooms: 272 rooms and suites.Business & Conference Facilities: 24-hour businesscentre, ballroom, boardroom, Esquire Room and Tan-jung Rasamala.Health & Leisure Facilities: Swimming pool, fitnessand wellness centre (gym and spa treatments).Guest Services: Concierge, club lounge, businesscentre, MO Shop.Wining & Dining: Lyon (French brasserie), Cinnamon(international all-day dining), Xin Hwa (Cantonese),MO Bar (cocktails, light fare), Azure (poolside casu-al fare), Cake Shop (pastries & afternoon tea).

MILLENNIUM HOTEL SIRIH JAKARTAJl. Fachrudin 3 Jakarta Pusat 10250T: +62 (21) 230 3636F: +62 (21) 230 [email protected] www.millenniumhotels.com/millenniumjakarta

Rooms: 401 rooms.Business & Conference Facilities: Business centre,15 function rooms.Health & Leisure Facilities: Swimming pool, gym andspa facilities.

Guest Services: Concierge, laundry and valet, sundryshop, parking facilities, currency exchange, businesscentre, outdoor swimming pool, fitness centre,whirlpool, sauna, steam rooms, spa treatments, 24-hour in-room dining featuring selection from ourrestaurants, Wi-Fi broadband internet connectivitywith a speed of 1024 Kbps.Wining & Dining: Café Sirih (Indonesian cuisine),Matsu Restaurant (Japanese cuisine), the LobbyLounge, Art & Bakery Corner (pastries, tea & coffee).

PULLMAN JAKARTA CENTRAL PARKPodomoro City Jl. Jend. S. Parman Kav. 28 Jakarta 11470T: +62 (21) 2920 0088F: +62 (21) 2920 0099reservation@pullmanjakartacentralpark.comwww.pullmanjakartacentralpark.com

Rooms: 317 rooms.Business & Conference Facilities: Business centre,1 grand ballroom for up to 5000 persons (can bedivided into 3 sections, each with a capacity for upto 1000 people), 6 meeting rooms (up to 140-per-son capacity) and Sky Terrace Garden (up to 500-person capacity).Health & Leisure Facilities: Fit & Spa Lounge, out-door swimming pool, Sky Terrace Garden, Zen Gar-den, hammam (Turkish bath) and Vichy shower.Guest Service: Airport pick-up service, 24-hour roomservice, multilingual staff, Central Park Mall locatedadjacent to the hotel, lounge areas, free Wi-Fi in allmeeting rooms and public areas.Wining & Dining: BUNK Lobby Lounge, CollageRestaurant and Executive Lounge.

PURI DENPASAR HOTEL JAKARTAJl. Denpasar Selatan No. 1, Kuningan Jakarta Selatan 12950T: +62 (21) 527 5542F: +62 (21) 527 5543www.puridenpasar.com

Rooms: 71 rooms, including superior, deluxe, premier,executive suites, presidential suites.Business & Conference Facilities: 14 banquet hallsand meeting rooms, the largest of which can holdup to 300 people. Health & Leisure Facilities: Gym, spa treatments,swimming pool, karaoke.Guest Services: 24-hour room service, shuttle.Winning & Dining: Gili Bar & Lounge, Padi Restau-rant & Café (Indonesian cuisine).

THE RITZ-CARLTON JAKARTA MEGA KUNINGANJl. Dr. Ide Anak Agung Gde Agung Kav. E.1.1 No. 1Kawasan Mega Kuningan, Jakarta 12950T: +62 (21) 2551 8888www.ritzcarlton.com/jakartahotel

362

Kosenda Hotel

Mandarin Oriental Jakarta

Millennium Hotel Sirih Jakarta

The Ritz-Carlton Jakarta Mega Kuningan


THE GUIDE HOTELS

Rooms: 333 rooms, including 298 guest rooms, 2grand spa terraces, 28 Mayfair suites, 3 Ritz-Carl-ton suites and 1 presidential suite. Business & Conference Facilities: 1600-sq-metreGrand Ballroom, 906-sq-metre Grand Mutiara, 13meeting rooms, 4 executive club boardrooms andexecutive business centre.Health & Leisure Facilities: Outdoor swimming pool,a fully equipped spa with 19 treatment rooms, fit-ness centre with free weights, massage, sauna, steamroom and whirlpool, cardio exercises, aerobic pro-grammes, jogging track.Guest Services: 24-hour in-room dining, twice-dai-ly housekeeping service, meet-and-greet service atairport, multilingual staff, IDD telephone, shoe shineservice, chauffeured limousine service, in-room guestregistration, suit pressing, complimentary wirelessinternet access in rooms and public areas.Wining & Dining: Asia Restaurant (buffet with Indone-sian, Japanese, Chinese & international fare), Lobo(Italian) and TEMPUS (bar & lounge).

THE RITZ-CARLTON JAKARTA PACIFIC PLACESudirman Central Business District Jl. Jendral Sudirman Kav. 52-53 Jakarta 12190T: +62 (21) 2550 1888F: +62 (21) 2550 [email protected]/jakartapacificplace

Rooms: 20 superior grand club rooms, 23 deluxegrand club rooms, 7 Mayfair club suites, 2 Mayfairspa club suites, 1 Ritz-Carlton suite and 1 presiden-tial suite.Business & Conference Facilities: A range of func-tion rooms, meeting rooms, private dining roomsand ballrooms are available. Health & Leisure Facilities: Spa and fitness centre. Guest Services: Complimentary Wi-Fi.Wining & Dining: Pacific Restaurant and Lounge,Level 8 Lounge.

SHANGRI-LA HOTEL, JAKARTAKota BNI, Jl. Jend. Sudirman Kav. 1 Jakarta 10220T: +62 (21) 2922 9999F: +62 (21) 2922 [email protected]/jakarta

Rooms: The hotel comprises 661 guest rooms, includ-ing 40 suites, 118 horizon club rooms and 60 inter-connecting rooms. Non-smoking floors and roomsfor physically disabled guests are available on request. Business & Conference Facilities: 24 rooms withboardroom, theatre, banquet and classroom capac-ity for up to 3000 people.Health & Leisure Facilities: Aerobics/dance studios,aromatherapy, fitness centre, jacuzzi, massage, reflex-

ology, sauna, spa, steam room, clinic, swimming pool,children’s pool and tennis courts.Guest Services: Limousine and car hire service, valetparking, complimentary weekend shuttle to shoppingmalls, gift shop, wedding boutique, 24-hour clinic,and complimentary Wi-Fi connection in all rooms,restaurants and public area.Wining & Dining: SATOO (international buffet), Rosso(Italian), Shang Palace (Cantonese), Nishimura (Japan-ese), B.A.T.S (Western), Lobby Lounge and SATOO DeliShop (beverages, pastries & bakery).

THE SULTAN HOTEL JAKARTAJl. Jend. Gatot Subroto, Jakarta 10002T: +62 21 570 3559F: +62 21 573 [email protected]

Rooms: 694 rooms, including an executive floor, and100 suites.Health & Leisure Facilities: 800-sq-metre fitnesscentre, 800 meters of jogging track, 13 tennis courts,semi-Olympic swimming pool, children’s swimmingpool, children’s playground, spa, and a CrossFit cen-tre.Guest Services: Free internet and free mini bar in allrooms, plus executive lounge, business centre withboardrooms, nine banquet rooms and a ballroom.Wining & Dining: Lagoon Café, Lagoon Lounge, Qilounge, Nan Xiang Chinese Restaurant, NipponKanJapanese Restaurant & Airman Lounge.

BALI

THE AKMANI LEGIAN BALILegian Raya 91 KutaBali 80361T: +62 (361) 300 9191F: +62 (361) 300 [email protected]

Rooms: 70 classic rooms, 60 grand deluxe rooms, 15pool side grand deluxe, 5 pool access grand deluxe,a 1-bedroom villa, 2 1-bedroom villas with rooftopgarden, 1 grand villa with 2 bedrooms.Business & Conference Facilities: Business centre.3 meeting rooms: Milan Room (up to 70 pax), TurinRoom (up to 30 pax) and Venice Room (up to 10 pax).Health & Leisure Facilities: Fitness centre with 2outdoor pools for adults and 1 for children, spa treat-ments including massage and aromatherapy.Guest Services: Free broadband internet access, LCDtelevision, air-conditioning, IDD telephone, tea andcoffee making amenities, concierge, 24-hour roomservice, airport pick-up service, car hire, laundry andvalet service, baby cot, luggage storage and car park.Wining & Dining: BelPiatto Restaurant (Western &Asian fare), Terrace Café, Vertical Point Lounge & Bar(drinks, live music on weekends).

363


The Sultan Hotel Jakarta

The Akmani Legian Bali

THE GUIDE HOTELS

JEEVA SABA HOUSEJl. Pura Anyar II No. 8 Pantai Saba – BaliT: +62 (361) 292669F: +62 (361) [email protected]

Rooms: 8 king-size ocean-view bedrooms.Health & Leisure Facilities: Billiard room, seasideopen-air living bale, dining bale with butler’s kitchen,massage room, gym, pool.Guest Services: 24-hour butler service, free Wi-Fi,Sonos Wi-Fi radio system, fully equipped kitchen within-house chef (choice of full or self-catering), com-plimentary breakfast, media room, 24-hour securi-ty, use of car and driver if exclusive rental.Wining & Dining: Professional kitchen with chef.

MAHATMA HOUSEJl. Pantai Seseh, Banjar Seseh, BaliT: +62 (361) 731 074F: +62 (361) 736 391www.mahatmahouse.com

Rooms: 5 bedrooms (2 master suites, 2 garden suites,1 junior suite).Business & Conference Facilities: The villa can accom-modate up to 100 people standing and 60 seated.Health & Leisure Facilities: Private 14-metre swim-ming pool, safety deposit box in all bedrooms, bil-liard table, media room with satellite TV, qualified spatherapists available upon request.Guest Services: Full-time staff including manager,butler, housekeeping staff and security, free Wi-Fi,satellite TV, air conditioning in every suite, baby cots,bicycles, fully equipped kitchen, iPod speakers, 3home entertainment systems with large flat-screenTVs, back-up generator, airport transfers (included),seven-seater Suzuki APV available (additional fee).Wining & Dining: Chef Barta always uses the finestand freshest ingredients, many of which come fromthe villa’s vegetable garden.

MERCURE KUTA BALIJl. Pantai Kuta No. 10x Banjar Pande Mas Kuta Bali 80361T: +62 (361) 767 411F: +62 (361) 767 [email protected]

Rooms: 130 rooms, including standard, superior,deluxe ocean view and junior suites.Business & Conference Facilities: 3 meeting rooms(maximum capacity 100 people), free parking. Health & Leisure Facilities: Outdoor infinity swim-ming pool, clinic.Guest Services: 24-hour room service & reception.Wining & Dining: Alang Restaurant, Lotus Lobby Bar& Sunset Pool Bar.

THE RESIDENCE, SEMINYAKJl Pangkung Sari No.1A, SeminyakKuta 80361 BaliT: +62 (361) 731 074F: +62 (361) 736 391www.theresidenceseminyak.com

Rooms: 1- to 4-bedroom villa rental options.Health & Leisure Facilities: There are a number ofexcellent spas within walking distance. Deluxe in-vil-la treatments from trained therapists.Guest Services: Staff can help with everything frombooking dinner reservations to arranging day trips.Seven-seater car and driver available.Wining & Dining: Chef Yus Abadi and his team oper-ate from a central kitchen within the villa complexand deliver breakfast to your door daily. They can alsoprepare barbecue buffets and special Balinese feastson request with advance notice.

ST. REGIS HOTEL BALI Kawasan Pariwisata Nusa Dua Lot S6, BaliT: +62 (361) 847 8111F: +62 (361) 848 [email protected]

Rooms: 123 rooms: 81 suites, 41 villas, 1 residence.Business & Conference Facilities: Business centre isopen from 8 am until 10 pm.Health & Leisure Facilities: 24-hour fitness centre,spa, swimming lagoon & pools, watersports onrequest, children’s learning centre. Guest Services: Butler service, travel and tour desk,concierge, high-speed internet.Wining & Dining: Boneka Restaurant, KayaputiRestaurant, Vista Bar, King Cole Bar, Gourmand Deli.

BOGOR

ASTON BOGOR HOTEL & RESORTThe Jungle – Bogor Nirwana Residence, Jl. Dreded Pahlawan, Bogor 16132T: +62 (251) 8200 300F: +62 (251) 8200 [email protected] www.AstonBogor.com

Rooms: Superior rooms, deluxe rooms, 1-bedroomunits, deluxe 1-bedroom units and 2-bedroom units.Business & Conference Facilities: Business centre,14 function rooms (up to 400 pax), ballroom (up to1000 pax), Wi-Fi.Health & Leisure Facilities: 3 outdoor swimmingpools, fitness centre & spa, bicycle hire, drugstore.Guest Services: Free Wi-Fi in all hotel areas, 24-hourroom service, front desk and security. Concierge,valet, massage & spa, laundry, car hire. Wining & Dining: Batutulis Coffee Shop, KatulampaLounge & Bar, Gading Café.

364

St. Regis Bali

Mercure Kuta Bali


THE GUIDE HOTELS

LOMBOK

JEEVA BELOAM BEACH CAMPJalan Pantai Beloam, Tanjung Ringgit Sekaroh, Jerowaru, Lombok TimurT: +62 (370) 693 035F: +62 (370) 693 [email protected]

Rooms: 11 individual Beruga pantai.Health & Leisure Facilities: Spa room, equipmentfor watersports and other sports activities.Guest Services: 24-hour reception, airport transfer,full board available, spa, library, 24-hour security.Wining & Dining: Tenda Restaurant.

SURABAYA

JAVA PARAGON HOTEL & RESIDENCESJl. Mayjend Sungkono 101-103 Surabaya 60256T: +62 (315) 621 234F: +62 (315) 613 [email protected] www.javaparagon.com

Rooms: 230 hotel rooms, including 2 floors of serv-ice suites and 3 floors of executive rooms, 62 2- &3-bedroom apartments.Business & Conference Facilities: Ballroom accom-modating up to 350 people, 8 fully serviced meet-ing rooms.Health & Leisure Facilities: 24-hour room service,banquet hall, meeting rooms, foreign exchange, Wi-Fi area, laundry service, parking, car hire & transporta-tion, tour & sightseeing, mini-bar, in-room safe depositbox, coffee & tea making facilities, high-speed broad-band internet access.Wining & Dining: The Café (all-day dining), theLounge, Citilites Skyclub & Bistro, the Cakery, Ah YatAbalone (Chinese), Sho Japanese Food Calligraphy.

MAJAPAHIT HOTEL65 Jalan TunjunganSurabaya 60275T: +62 (315) 454 333F: +62 (315) 454 [email protected] www.hotel-majapahit.com

Rooms: 20 deluxe rooms, 23 garden terrace rooms,89 executive suites, 10 majapahit suites and 1 pres-idential suite.Business & Conference Facilities: Business centre,14 different venues, including BalaiAdika (for up to600 guests) and garden venue (for up to 800).Health & Leisure Facilities: Fully equipped gymna-sium and aerobics area, tennis court, jacuzzi, steamroom, sauna, 25-sq-metre swimming pool, children’spool and 3 championship golf courses.

Guest Services: 24-hours in-room dining, dedicat-ed butler service, hair salon, babysitting on request,limousine and car hire, safe deposit boxes, lobbyshop, airport transfer service, laundry and valet, for-eign exchange desk, valet parking, shuttle service.Wining & Dining: Indigo Restaurant, Sarkies SeafoodRestaurant, Lobby Lounge, Toko Deli, the Maj Her-itage Pub & Dine, Café 1910 and Majapahit Execu-tive Lounge.

MERCURE GRAND MIRAMA SURABAYAJl. Raya Darmo No. 68-78 Surabaya 60264T: +62 (315) 623 000F: +62 (315) 678 [email protected]

Rooms: 125 including 109 superior rooms, 9 deluxerooms, and 7 suites with an executive ladies floor.Business & Conference Facilities: Banquet and meet-ing facilities equipped with 1100-sq-metre grandballroom (capacity up to 1000 people standing and70 round tables), 5 meeting rooms (from 10 peopleup to 70 people capacity), business centre, free Wi-Fi access in all meeting rooms.Health & Leisure Facilities: Spa and massage treat-ment up to 7 private rooms, sauna and whirlpoolroom, yoga & aerobic class, swimming pool, fitnesscentre with instructor.Guest Services: Airport transportation, shuttle serv-ices, car rental facility, valet parking services, 24-hourconcierge and front office, currency exchange, drug-store, city tour, safe deposit box, free Wi-Fi internetaccess in all rooms and public area, laundry & drycleaning services; 24-hour room services.Wining & Dining: Trimurti Restaurant, Ebisu Restau-rant, Lan Hua Restaurant, Café.

MIDTOWN HOTEL SURABAYAJl. Basuki Rahmat No. 76, SurabayaT: +62 (315) 315 399F: +62 (315) 315 389www.midtownindonesia.com

Rooms: 197 rooms.Business & Conference Facilities: Business centre and5 theatre-style meeting rooms.Health & Leisure Facilities: Massage service.Guest Services: Concierge service.Wining & Dining: Townhall Coffeeshop.

SHANGRI-LA HOTEL SURABAYAJl. Mayjen Sungkono No. 120 Surabaya 60256T: +62 (316) 003 8888F: +62 (315) 661 570www.shangri-la.com/surabaya

Rooms: 383 guestrooms, including 242 deluxe rooms,47 executive rooms, 65 horizon deluxe rooms, 11

365


Java Paragon Hotel & Residences

Shangri-La Hotel Surabaya

Jeeva Beloam Beach Camp

THE GUIDE HOTELS

horizon executive rooms, 10 executive suites, 6 res-idence suites, 1 Bali suite and 1 Surabaya suite.Business & Conference Facilities: Business centre,9 fully equipped function rooms and a ballroom (withcapacity for up to 1800 people).Health & Leisure Facilities: Health club, fully equippedgym and a spa with a range of treatments. Guest Services: Complimentary Wi-Fi, hair/beautysalon, parking facilities, safe deposit boxes, expresscheck-in & check-out, butler service in suites, laun-dry & valet service, car hire, taxi & limousine serv-ice, airport transfer, foreign exchange desk, drugstore,gift shop, postal & courier service, and 24-hour roomservice. Wining & Dining: Jamoo (all-day dining, Asian & Con-tinental fare), Shang Palace (Chinese), Desperados(Tex-Mex bar & restaurant), Pool Bar, Cake Shop(cakes, pastries, sandwiches), Portofino (Italian) andNishimura (Japanese).

SHERATON SURABAYA HOTEL & TOWERSJl. Embong Malang No. 25-31SurabayaT: +62 (315) 468 000F: +62 (315) 467 [email protected]/surabaya

Rooms: 348 guest rooms, suites and apartments,53 club rooms and 23 spacious suites. Sheraton Res-idence Surabaya consists of 45 apartments.Business & Conference Facilities: Well-equippedbusiness centre, 804-sq metre Sheraton ballroom(with a capacity for up to 800 people) and 7 meet-ing rooms. All meeting rooms include state-of-the-art equipment and wireless high-speed internet. Health & Leisure Facilities: Outdoor pool, fitnesscentre, tennis court, jogging track, massage service,Tunjungan Plaza (shopping centre) connected tothe hotel. Guest Services: Boutique, 24-hour front desk, 24-hour concierge service, medical service, bell-men/porters, multilingual staff, shoe shine service,luggage storage, dry cleaning service, safe depositboxes, express check-in & check-out, laundry & valetservice, 24-hour security, childcare service.Wining & Dining: Kafe Bromo (international), LungYuan Chinese Restaurant, Kawi Lounge (light fare),Java Café and La Patisserie (pastries & baked goods).

TS SUITES SURABAYAJl. Hayam Wuruk No. 6, Surabaya 60242T: +62 (315) 631 222F: +62 (315) 632 [email protected]

Rooms: A total of 126 rooms, including 68 execu-tive suites, 51 premium suites, 4 CEO suites and 3prominent suites.

Business & Conference Facilities: Business centre,5 meeting rooms, 2 boardrooms, 1 VIP lounge, and1 function hall with free LCD screen, free Wi-Fi in themeeting rooms.Health & Leisure Facilities: In-room spa, fitness cen-tre, hotel is attached to Townsquare Surabaya shop-ping centre, doctor on call.Guest Services: Complimentary mini-bar, free inter-net connection in the room using cable or Wi-Fi,Garuda city check-in, airline ticket assistance, com-plimentary valet & self-park, laundry & dry cleaning,airport transfer service.Wining & Dining: TS Café (American, Italian & Asian).

TWIN HOTEL SURABAYAJl. Kalisari I No. 1, SurabayaT: +62 (315) 312 527, 313 537F: +62 (315) 328 [email protected]/[email protected]

Rooms: 81 guest rooms. Business & Conference Facilities: 3 meeting roomsof various sizes (for up to 200 people) with profes-sional meeting equipment.Health & Leisure Facilities: Fitness facilities, out-door swimming pool, children’s playground, Sky Gar-den (on 11th floor), live music, billiard, spa & bodytreatments, variety of massage treatments and aro-matherapies.Guest Services: LCD television, air-conditioning, IDDtelephone, tea and coffee making facilities, TV chan-nels, free Wi-Fi access in public areas, concierge,24-hour room service, airport pick-up service(charges apply), laundry & valet service, bakery andcoffee corner, mini-market & drugstore, luggagestorage and car park.Wining & Dining: Bon Appetite Restaurant (Westerncuisine), Insomnia Pool Lounge and Café.

YOGYAKARTA

GRAND ASTON YOGYAKARTA HOTEL & CONVENTION CENTREJl. Urip Sumoharjo No. 37 Yogyakarta 55222T: +62 (274) 566 999 F: +62 (274) 553 [email protected]

Rooms: 140 rooms, including superior king/twin,deluxe rooms, suites and presidential suite.Business & Conference Facilities: 8 fully equippedmeeting rooms. Health & Leisure Facilities: Spa & health club. Guest Services: Concierge, butler and babysittingservices upon request.Wining & Dining: Saffron Restaurant, Vanilla SkyLounge, Cassia Lobby Lounge.

366

Sheraton Surabaya Hotel &Towers

Grand Aston Yogyakarta Hotel& Convention Centre

TS Suites Surabaya


THE GUIDE LISTINGS 367


Indonesia is a vast archipelago and flying is the pri-mary and fastest means of travelling medium to longdistances. The country has more than 230 airports,20 of which are international, with a number of domes-tic airlines offering regular flights at affordable prices.

Since January 2010 citizens from 63 countries are eli-gible to apply for a visa on arrival (VOA) at certain air-ports and seaports in Indonesia. The VOA is for leisureonly and allows visitors to stay in the country for 30days. The VOA can be extend one time for up to 30 days.

STATE MINISTRIES &AGENCIESCoordinating Ministry for

Economic Affairs

(021) 352 1835

Industry

(021) 525 2194

Trade

(021) 385 8171

Finance

(021) 381 4324

Communication &

Information

(021) 384 4227

Agriculture

(021) 780 4056

Foreign Affairs

(021) 344 1508

Culture & Tourism

(021) 384 9142

Energy & Mineral Resources

(021) 380 4242

Home Affairs

(021) 384 0058

Education

(021) 573 1618

Research & Technology

(021) 316 9960

Defence

(021) 345 6184

Maritime & Fisheries

(021) 350 0023

Forestry

(021) 570 3265

Health

(021) 520 1590

Manpower & Transmigration

(021) 522 9285

Public Works

(021) 726 2805

Immigration Office

(021) 522 4658

Transportation

(021) 381 1308

Justice & Human Rights

(021) 525 3004

National Development

Planning Board

(021) 334 811

House of Representatives

(021) 571 5346

Indonesia Investment

Coordinating Board

(021) 525 2008

Indonesia Stock Exchange

(IDX)

(021) 515 0234

CHAMBERS OF COMMERCEIndonesian Chamber of

Commerce & Industry

(KADIN)

(021) 527 4484

American Chamber of

Commerce

(021) 526 2860

British Chamber of

Commerce

(021) 522 9453

Indonesian-Australian

Business Council

(021) 521 1540

European Chamber of

Commerce

(021) 572 2056

FOREIGN MISSIONSAustralia

(021) 2550 5555

Brazil

(021) 526 5656

Brunei Darussalam

(021) 3190 6080

Cambodia

(021) 781 2523

Canada

(021) 2550 7800

China

(021) 576 1039

European Commission

(021) 2554 6200

France

(021) 2355 7600

Germany

(021) 390 1750

India

(021) 520 4150

Iran

(021) 3193 1378

Iraq

(021) 390 4068

Italy

(021) 3193 7445

Japan

(021) 3192 4308

Jordan

(021) 515 3483

Korea

(021) 2967 2555

Kuwait

(021) 576 4159

Laos

(021) 522 9602

Lebanon

(021) 525 3074

Malaysia

(021) 522 4947

The Netherlands

(021) 525 1515

New Zealand

(021) 570 9460

Papua New Guinea

(021) 725 1218

Philippines

(021) 314 9329

Russian Federation

(021) 522 2912

Saudi Arabia

(021) 801 1529

Singapore

(021) 2995 0400

South Africa

(021) 574 0660

Thailand

(021) 390 4052

Timor-Leste

(021) 390 2678

United Arab Emirates

(021) 520 6518

United Kingdom

(021) 315 6264

United States

(021) 3435 9000

REGIONAL ORGANISATIONSASEAN

(021) 726 2991

COUNSULTANCY,ACCOUNTANTCY &TAX SERVICESPwC Indonesia

(021) 521 2901

LEGAL SERVICESLubis-Santosa & Maramis

(021) 521 1931

CAR HIRETRAC Astra

(021) 650 8919

Eazyrent

(021) 624 6895

EMERGENCY SERVICESAmbulance

118

Fire Brigade

113

Information

108

Police

110

NATIONAL PRESSKompas

(021) 536 79909

The Jakarta Post

(021) 530 0476

The Jakarta Globe

(021) 5794 8600

Antara

(021) 380 2383

Tempo

(021) 725 5625

Media Indonesia

(021) 582 1303

Indonesia Finance Today

(021) 720 5139

RADIO & TVMetro TV

(021) 5830 0077

tvOne

(021) 461 3545

BBC

(021) 809 0474

THE GUIDE

ETIQUETTE: A handshake is usually the first introduc-tion in a business setting and is used for both greetingand farewell. It is recommended that men be addressedas Pak (equivalent to Mr) and women as Ibu (Mrs). Vis-itors should try to use the right hand when giving mon-ey and objects to others. Visitors are expected to showrespect toward religion, culture and local values. Onemay hear oneself being referred to as a boule – this issimply an Indonesian term for a white person or visi-tor and should not be taken as an insult. TRANSPORT: Flying is the primary and fastest meansof travelling medium to long distances. The country hasmore than 230 airports, 20 of which are internation-al, with a number of domestic airlines offering frequentflights at affordable prices. In Indonesia one drives onthe left side of the road, and an international drivinglicence is required to rent or drive a car. Traffic in largecities, especially in Jakarta, can be very heavy duringweekdays (Fridays in particular). Should traffic be par-ticularly severe or if you find yourself stuck in gridlock,one option is to get an ojek, a motorcycle taxi, whichusually shuttles short distances down alleys and roadsbut will also do longer trips for a negotiated price. Ojeksare relatively safe, however, the risks of riding a motor-cycle should obviously be taken into account. CURRENCY: The rupiah is the local currency in Indone-sia. As of April 2014 the exchange rate was at aroundRp11,360 to the dollar, Rp15,870 to the euro andRp19,230 to the pound. ATMs can be used to withdrawcash using internationally accepted cards. ATMs arewidely accessible, especially in larger cities. It is gener-ally advisable to carry spare dollars as they are usuallyaccepted by all banks and money changers. TIPPING: Hotels typically add a 10% service charge tothe bill on top of the 10% tax, while restaurants gen-erally impose a 5-15% service charge. If a service chargeis not applied, it is advisable to add 10-15% to the bill.For taxis and other services, tipping is appreciated, andit is common to round up taxi fares to the nearestRp10,000 ($1). Car hire drivers may receive a larger tip.

VISA: Since January 2010 citizens from 63 countriesare eligible to apply for a visa on arrival (VOA) at cer-tain airports and seaports in Indonesia. The VOA is forleisure only and allows visitors to stay in the countryfor 30 days. The VOA can be extend one time for up to30 days at a local immigration office; the applicantmust bring his or her passport when applying for theextension. Failure to renew one’s VOA within the 30-day period is not recommended and a charge ofRp200,000 ($20) per overdue day may be incurred. A30-day VOA costs $25, and the visa extension costsRp250,000 ($25). 20 airports, 23 seaports and oneland/border crossing issue VOAs. A one-year businessvisa can be issued for people with a work authorisa-tion and permission from the Ministry of Manpower.This visa must be obtained by the employer. HEALTH: Stomach upsets and dehydration can affectvisitors to Indonesia. If the worst happens make surethat you drink sufficient amounts of bottled mineralwater. If in regional or outer city areas, it is also worthutilising bottled water to clean your teeth. High-qual-ity health care is available in many hospitals in Jakarta,although in more remote regions and rural areas, find-ing a good health care service can be a challenge. Whenvisiting rural areas, visitors should carry plenty of mos-quito repellent to protect themselves from mosqui-toes, which can carry malaria and dengue virus.FOOD & DRINK: Throughout Indonesia, nasi (rice)remains the main staple and features within dishes ofmany types. The spice level of these dishes does varybut can often be relatively hot due to liberal applica-tions of chilli. Mi or mie (noodles) are the second mostcommon staple food. A pack of mie will generally costyou under Rp1000 ($0.10) in a supermarket or approx-imately Rp20,000 ($2) in a restaurant. Soto (soup) andcurries are also common. Although the country haslargest Muslim population in the world, alcohol is avail-able in most areas, particularly in restaurants and bars.Public displays of drunkenness are strongly frownedupon, however. The drinking age in Indonesia is 18.

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Facts for visitorsUseful information for first-time visitors


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