Indonesia: Workshop of the world

A recent wave of investment in manufacturing in Indonesia could herald the country’s rise as an international industrial player. A rapidly growing domestic market of more than 230m people, as well as the potential for exports both regional and across the globe, are major draws for companies from around the world.

Billions of dollars of investment commitments were made by leading international firms during the World Economic Forum on East Asia on June 12 and 13. During the event, held in Jakarta, beverage firm Coca-Cola pledged $500m and said that it could increase its investment in the country four to fivefold, while India’s Essar Group discussed establishing steel manufacturing as part of a package totalling at least $5bn. Automotive firms Tata (from India), Daihatsu and Nissan (both Japanese) and US consumer good outfit Procter & Gamble, among others, also outlined plans for investment.

Nestlé, for example, is set to invest up to $200m in a new dairy product plant in Karawang, West Java. The Swiss firm will put forward an initial $100m to construct the factory, which is expected to produce Milo chocolate powder and drink, as well as Celerac baby food, and should open next year. This news follows another $100m investment by the firm in the country in 2010, the outlay in this case going to expand its dairy in Kejayan, East Java. That plant is particularly valuable for the local community as Nestlé works with 33,000 dairy farmers in the region to secure and develop supply.

According to Arshad Chaudhry, Nestlé’s president director for Indonesian operations, projects such as these will benefit from increased cooperation with local and government partners, with positive results for all involved. “By working directly with local farmers, cooperatives and government to improve technological and educational capabilities, together we can increase the productivity and quality of domestically produced raw materials available for the industry to source,” he told OBG.

Meanwhile, Unilever, the consumer goods giant, has outlined €300m of investments in capacity expansion in Indonesia between 2010 and 2012. Its latest move may be shifting some of its soap production from Germany to Java, according to Mohamad Suleman Hidayat, the minister of industry, though Unilever itself has declined to comment.

Hanish Manwani, the president for Asia, Africa and Central and Eastern Europe at Unilever, has described its business in Indonesia as one of his company’s “jewels”. He asserts that the BRIC (Brazil, Russia, India, China) grouping of major emerging markets should be expanded to BRICI, including Indonesia, a country with “fantastic potential, with such a large population base, great demographics and so on”.

On June 15, the global press reported that construction had started on a major new factory being built for South Korean tyre manufacturer Hankook. The firm is investing an initial $353m in the plant, which will consist of four large-scale production units. More than half the output is expected to be exported to the US, where the company is targeting sales of more than $1bn this year, with some production also due to be exported to the growing markets of the Middle East.

Soo Il Lee, the president of Hankook Tire America Corporation, identified several competitive advantages of Indonesia as a tyre manufacturing centre in that it services distant markets and has both abundant rubber supply and soaring local demand.

The strength of the domestic market is the single most important factor behind international firms’ expansion in Indonesia. With the world’s fourth-largest population and economic growth barely dented by the global economic crisis, a rising middle class and pent-up demand, Indonesia stands in contrast to slow-growth, ageing and saturated markets elsewhere.

Additionally, a technical regulation regarding tax exemption that will have ramifications for major new investments is expected to be published in the near future. While the regulation only applies to large investments realised in the third and fourth quarters of 2011, and the requirements for exemption are fairly steep – the industry must be designated as a pioneer industry, create a number of jobs, bring new technology into underdeveloped areas and provide value – it does represent a shift in thinking as Indonesia attempts to compete with its neighbours in the region in attracting large-scale foreign investment.

According to the minster of finance, Agus DW Martowardojo, the new regulation is still being reviewed at the moment. “Indonesia is still processing the legal base for providing a tax holiday,” he told OBG. However, certain principles regarding the measure are already clear, including non-discrimination for foreign enterprises. “Enterprises will not to be discriminated against on the basis that the capital is owned by a resident of a particular country,” Martowardojo added. “However, it must be noted that non-discrimination principle will be applied as long as the foreign enterprises mentioned fulfil the requirement or criteria to obtain the incentive.”

But potential is not just limited to the domestic market. As investments by Hankook and others indicate, there is also huge potential for exports. Indonesia benefits from its supply of raw materials and energy, its direct sea access to the Indian and Pacific Oceans (and thence the rising markets of Asia and Africa as well as the Americas), relatively low labour costs and enviable political stability. Indeed, the case for Indonesia may be getting even stronger, even against the world’s top industrial powers.

As the growth plan recently unveiled by President Susilo Bambang Yudhoyono acknowledges, more could still be done to drive the country into the league of the world’s biggest economies – a goal that will require sustained foreign investment and the development of the manufacturing base. Indonesia’s infrastructure is patchy in parts, red tape and bureaucracy hold back businesses, and some areas of the economy still limit private and foreign involvement. The Master Plan for the Acceleration and Expansion of Indonesia’s Economic Development seeks to address many of these issues, though sustained political will is needed to see it through, as Yudhoyono himself noted.

Over the medium term, Indonesia is also looking not only to increase its manufacturing output, but to push its production up the value chain, delivering higher returns to the domestic economy. This is expected to transform the country from being an importer of high-tech goods to being an exporter of them. It is far from the only nation in the region with this aim, which makes sharpening competitive advantages through pro-business reform and investments in infrastructure and education all the more important.

Indonesia is one of the world’s most popular markets for industrial investment at present, with good reason, and looks set to remain one over the next few years. If it is to achieve its potential, it can think even bigger.