Indonesia: Productivity rise sought to fund pay hikes

Strong domestic demand, combined with a recovery in export orders, is boosting growth in Indonesia’s manufacturing sector, although the prospect of rising labour costs has also highlighted the importance of ensuring efforts to increase productivity are maintained.

Indonesia’s sizeable market and competitive advantages, which include its location, costs and incentives, have long attracted international investors, supporting its bid to secure its position as an industrial hub.

Manufacturing production grew at the fastest rate for a year in October, according to a survey by global bank HSBC and UK-based research firm Markit Economics. Order volumes also reached a 12-month high, rising for the fifth successive month and playing a key part in driving growth.

The seasonally adjusted purchasing managers’ index (PMI) for manufacturing reached 51.9, up from 50.5 in September, confirming that the sector had expanded. Growth prompted manufacturers to take on more staff, according to the survey, helping to reduce Indonesia’s unemployment rate, which fell from 6.6% last year to 6.1% in August.

The past months have created challenges for exporters, however, with the eurozone crisis, the US debt situation and slowdowns in major emerging markets combining to weigh heavily on the export industry.

News that orders from abroad are on the up will bring relief to both the industrial sector and the government. HSBC economist Su Sian Lim pointed out that the contribution to growth made by new export orders in October was its first in seven months. “It’s heartening to see that manufacturing sector expansion has picked up pace again,” she said in a note.

Strong demand from the country’s vast internal market of 240m people and government investment have bolstered Indonesian manufacturers considerably during recent months, helping to cushion the industry from the impact of falling exports. Retail sales in September were up 22% year-on-year, according to international press reports.

Rising demand in the domestic market is proving to be an important draw for international industrial investors in segments such as the automotive industry. The Association of Indonesian Automotive Manufacturers (Gaikindo) expects new car sales in the country to reach a record 1m this year, rising to 1.1m in 2013.

Japanese automotive firm Toyota told OBG recently that it is planning to invest Rp26trn ($2.7bn) in Indonesia over the next three to four years, starting in 2013. Toyota Motor Manufacturing Indonesia (TTMMIN) will invest $31m in two plants in Karawang, just west of Jakarta. Investment will be channelled into an existing plant, which will help the firm increase capacity from 110,000 units to 130,000 units by the end of 2013, and a new factory due to open in March next year. Plans are also in the pipeline to construct a new engine manufacturing line in Karawang.

According to Chatib Basri, the head of Indonesia’s Investment Coordinating Board (BKPM), foreign investors are moving beyond “traditional” investments in natural resource extraction towards value-added manufacturing. International press reports cite the recent activity of Toyota, US truckmaker Caterpillar and Korean steel firm POSCO, for example. French cosmetics company L’Oréal has also chosen west Java for the location of its largest global factory, which will export 70% of its manufactured products and keep 30% for the domestic market.

Aside from supplying Indonesia’s domestic market, manufacturers are also keen to capitalise on the potential for exports and leverage increasing government support. In June, the local press reported that the government was allotting Rp547.66bn ($57m) in duty-free incentives this year to import-intensive industries.

Concerns are mounting, however, that rising labour costs could put a squeeze on labour-intensive segments. The Jakarta government is contemplating a 44% increase in the monthly minimum wage next year to Rp2m ($208), under pressure from unions and demonstrators who are protesting rising prices.

A November report by financial services group Religare suggested that wages would rise next year as salaries play catch-up with Indonesia’s growing GDP per capita. The news has sparked concern among business representatives such as Suryo Sulisto, the chairman of the Indonesian Chamber of Commerce. “Ultimately, unions and workers need to understand that companies will shut down operations and lay people off if it becomes more profitable to set up manufacturing elsewhere,” he told OBG.

While the minister of industry, Mohamad S Hidayat, played down concerns, saying he had no knowledge of industrial investors planning to relocate, the government also faces the challenge of ensuring that wage growth is matched by an increase in productivity.

Indonesia has already made significant progress in boosting productivity, which accounted for 60% of economic growth over the past two decades, but speedier improvements of the sort investors want to see will necessitate bolder pro-business reforms.

Sulisto told OBG that a BBC survey listed Indonesia as the best place for entrepreneurs to start a business. “We have to continue improving our business and investment climate so that not only are businesses opened, but they should also grow bigger and become the backbone of communities throughout the country,” he said. “We need more flexible hiring and firing practices and an effective benefits scheme, including unemployment benefits.”