Indonesia looks to attract foreign direct investment

In an effort to push Indonesia’s annual GDP growth to a targeted 7%, President Joko Widodo has announced plans to improve the country’s position in the “Doing Business” report published by the World Bank, with the goal of reaching 40th position globally. Following a bold reform programme aimed at liberalising the economy and reducing investment barriers, Indonesia rose 19 spots to 72nd position in the 2018 survey, recording improvements in multiple categories, including paying taxes, getting electricity, starting a business and trading across boarders. This achievement follows a similar increase the previous year, with Indonesia rising 15 places to 91st position.

With the country now ranking among the world’s top-100 most competitive economies, Indonesia appears to be well on its way to reaching its goal over the medium term, supported by ongoing internal reforms. At the same time, however, a recent Constitutional Court decision granting more regulatory authority to regional governments could pose a challenge to ongoing investment climate improvements, and could slow progress towards a top-40 ranking.

HISTORIC RANKING: While Indonesia had previously consistently ranked below the top-100 economies on the World Bank’s annual survey, which measures a country’s regulatory performance across a host of categories, the country has seen its investment climate, operating environment and regulatory practices progress steadily in recent years, leading to an significant improvement in its ranking.

The survey’s distance-to-frontier (DTF) score, which assesses the absolute level of regulatory performance, shows Indonesia has made steady progress towards improving its business environment since 2010. The DTF is measured on a scale of 0 to 100, with 0 representing the lowest performance, and 100 representing the best possible performance based on the best performances across all economies and across time, like a long-term bell curve. According to the bank, Indonesia’s DTF score rose from 56.84 in 2010 to 57.46 in 2011, 58.39 in 2012 and 58.72 in 2013. It moderated in 2014 and 2015, falling to 57.32 and 56.68, respectively, before picking up to 58.51 in 2016, reaching 64.22 in 2017 and a high of 66.47 in 2018. Meanwhile, the country’s rank in the global “Doing Business” report moved into the top 100 out of 189 or 190 economies included in this period, with Indonesia ranking 120th in 2014, 109th in 2015, 106th in 2016, 91st in 2017 and 72nd in 2018.

INVESTMENT STIMULUS: The country shows particular room for improvement in categories such as enforcing contracts, starting a business, paying taxes and trading across boarders, where it ranked 145th, 144th, 114th and 112th, respectively, in 2018.

Recognising the barriers to market entry, President Widodo’s administration launched a series of stimulus and deregulation packages between 2015 and 2017 aimed at improving the business climate, boosting foreign direct investment (FDI) inflows and supporting the target of an annual GDP growth rate of 7%.

The first of 16 packages was launched in September 2015 and focused almost exclusively on attracting new investment, with plans to boost industrial competitiveness through policies emphasising deregulation, reduction of red tape and enhanced law enforcement activity to support improved business certainty. The first policy involved reducing regulatory arbitrage by restructuring 89 out of 154 regulations which were under investigation for being overly burdensome. The government announced it had prepared 17 draft regulations, 11 draft presidential regulations, two draft presidential instructions and 63 draft ministerial regulations on making the announcement.

The second new policy sought to reduce the amount of time necessary to acquire land and permits for new projects, as well as establish a framework for expedited procurement of goods and government services. Regional governments are set to play a more prominent role in developing infrastructure projects deemed strategically important. Later policies focused on expediting the business licensing process for projects in industrial estates, cutting energy tariffs for labour-intensive industries, a new soft loan programme for small and medium-sized enterprises (SMEs), new tax incentives for projects in a growing network of special economic zones, and income tax reductions for aviation manufacturers. The state also reduced or removed foreign ownership caps for 35 industries on its negative investment list (see overview), including e-commerce, and the 14th stimulus package was established to create an e-commerce industry roadmap, as well as new tax incentives for e-commerce entrepreneurs (see ICT chapter).

In August 2017 the government launched its 16th stimulus package, which seeks to attract more foreign investment by shortening and simplifying the process of obtaining a business licence in the country. A task force is being created that will work to oversee the process, and by February 2018 a building will be constructed in the capital, which will be dedicated solely to processing and issuing business permits.

SETBACKS: There have been some setbacks in the years since President Widodo’s deregulation efforts began, and in February 2017 the Institute for Development of Economics and Finance reported that the packages had been mostly ineffective, saying they were too “general” and failed to focus on the specificities of different sectors. Regional Autonomy Watch reported in the same month that according to a survey it conducted in the 32 regional capital cities across the archipelago, difficulty in obtaining the necessary permits was the single most significant impediment to business and investment growth.

The issue was exacerbated by an April 2017 legal reform: the Constitutional Court annulled four provisions of the 2014 Regional Government Law, which allowed the central government to scrap problematic by-laws, including those that hamper investment and create needless red tape. The revocation of by-laws is now only possible through the Supreme Court, with the Indonesian Employers Association (APINDO) reporting that the decision will create new headaches for investors trying to establish operations.

MOVING UP: The court decision could pose a problem for the administration’s ranking target in the “Doing Business” report. At a meeting of economic ministers and regional leaders hosted in Jakarta, the president said Indonesia will retain its recent focus on infrastructure development and regulation as it moves to attract new FDI, particularly in value-added manufacturing activities. It was announced at the meeting that there are currently 42,000 regulations and 3000 local laws in place, which have negatively affected FDI inflows to the country.

Although it did not reach 40th spot in the 2018 edition of the survey, Indonesia’s ranking improved dramatically, though it remained behind some of its regional peers, including Singapore (2nd), Malaysia (24th), Thailand (26th), Brunei Darussalam (56th) and Vietnam (68th). The country recorded its sharpest improvements in resolving insolvency, protecting minority investors, enforcing contracts and registering property, where it reached 38th, 43rd, 145th and 106th, respectively. It fell 10 spots in the paying taxes category, to 114th place, and four spots in the trading across borders category, to 112th, while simultaneously improving its ranking for all other categories.

Local media reported in October 2017 that reform efforts have seen business start-up fees fall from 19.4% of income per capita to 10.9%, while access to credit has improved, particularly for SMEs, along with a decrease in the cost of registering property from 10.8% to 8.3% of the property value. The time and cost of getting electricity also fell markedly, as did the use of online systems for tax, Customs and excise, and non-tax revenue, with an increase in both corporate and government transparency. All these factors were cited as having positively contributed to the countries improved ranking.

Moving forward, the government is planning to intensify its efforts to reduce investment barriers, and in February 2017 Thomas Lembong, chairman of the Indonesia Investment Coordinating Board (BKPM), told media that the country plans to conduct more internal reforms to improve the investment climate, addressing commonly cited challenges such as changing regulations, high taxes, lack of skilled labour, land acquisition and poor infrastructure. Tax reforms, for example, would see manufacturers’ tax burden shifted towards the services sector, with manufacturing currently accounting for 70% of the country’s total business tax income. In addition, BKPM has announced plans to establish a dedicated team to monitor Indonesia’s ease of doing business.

MORE COMPETITIVE: In addition to improving its ranking on the World Bank’s “Doing Business” report, Indonesia rose six spots on the “IMD World Competitiveness Rankings 2017” to 42nd place, demonstrating some successes in internal reforms. Although it was behind Singapore (3rd), Malaysia (24th), Thailand (27th) and the Philippines (41st), the country recorded improvements in logistics costs, as local ports rolled out reforms reducing the time and cost of obtaining certain shipping permits, facilitating expedited project launches. Furthermore, the country improved on its already high standing in the World Economic Forum’s “Global Competitiveness Report 2017-18”, rising from 41st in the previous report to 36th.

Nonetheless, investors continue to face obstacles in obtaining regional and local government permits, and while permits to incorporate a foreign company are relatively easy to acquire, specialised permits involving investment outside industrial areas are a challenge. Building permits and environmental impact analyses are some of the most difficult to obtain. Given the recent Constitutional Court decision, accessing non-industrial zone or special economic zone business permits could continue to weigh on planned competitiveness improvements, even as the country’s broader business environment records steady improvement.