Investors welcome: Concerted efforts to enhance regulations and incentives

Although the country has already made strides to improve its investment climate, further bureaucratic reforms meant to streamline procedures and encourage private investment are central to Indonesia’s ambitions over the next 15 years. After years of centralised rule under Suharto, the initial “big bang” of decentralisation in 2001 wrought its own set of challenges stemming from at times overlapping federal, provincial and district levels of governance. The number of kabupaten(districts) has grown from 292 in 1998 to 480 today, increasing the scope for delays and costs.

Since 2004, however, two successive administrations under President Susilo Bambang Yudhoyono have prioritised improvement of the investment climate, making Indonesia Asia’s most active reformer of business regulations since 2008, according to the World Bank. “The primary bottleneck in terms of the investment climate has been poor infrastructure, in part linked to land clearance challenges and the lack of timely completion of projects by local governments,” Fauzi Ichsan, senior economist and head of government relations at Standard Chartered Bank, told OBG.

AGENDA FOR REFORM: Beyond physical investments, attracting private capital is key to resolving infrastructure challenges. The government’s Master Plan of Acceleration and Expansion Economic Development of Indonesia (MP3EI) to 2025 sets out a clear reform agenda to improve the investment climate. “Incentives can be supporting policies on tariffs, taxes, import duties, labour regulations, licensing and permits, land procurement and so forth,” Hatta Rajasa, coordinating minister for the economy, told OBG. The areas of priority are reforming Indonesia’s bureaucracy, particularly legislature and judiciary; amending the tax code to provide systematic incentives; creating special economic zones for investment in each of the six planned corridors; and developing human resources.

The government has gone some ways in improving the economy’s soft infrastructure, the legal and regulatory framework for private investors. Jakarta has implemented 11 key reforms since 2005 in the areas of streamlining the procedures required to establish a company, expanding credit information as well as improving minority shareholders’ rights.

Since the 2007 Investment Law No. 25 provided for equal treatment of local and foreign investors, the administration has pursued a liberalising agenda for foreign direct investment (FDI), coordinated by the Investment Coordinating Board (BKPM). While the landmark regulation established a “negative list” of sectors in which a ceiling or ban on FDI was announced, this nonetheless clarified regulations on FDI. Although wideranging, the list, last revised in June 2010, is set to be reviewed in late 2011 to allow a greater scope for FDI.

Concrete recent reforms have been enacted on several fronts, ranging from a cut in the corporate income tax rate to 25% in 2010, an online national single window (NSW) to facilitate and speed up the processing of documents, new tax concessions on certain investments planned for 2012 and the lifting of ceilings on FDI in five sectors. In 2010, the time to start a business in Jakarta was cut by 16 days and the cost by 52%. The NSW for Investment (so-called SPIPISE) in particular, launched by BKPM in Batam in 2010, has established itself as a one-stop shop for investment licensing online, vastly improving the efficiency of the old system.

Following the cut in corporate tax rates to 25% in 2010, authorities are moving forward with more targeted tax incentives. A new tax holiday of five to 10 years, which came into effect December 1, 2011, will cover investments in excess of Rp1trn ($120m) in five industrial sectors: oil refining, petrochemicals, renewable energy, base metal and telecommunications equipment.

SOFT INFRASTRUCTURE: While the administration is making concerted efforts to boost investment in infrastructure, historically low levels of funding have resulted in inadequate support for business, particularly in toll roads, power generation and ports. A notable area of improvement in soft infrastructure was proposed in 2011 when the administration forwarded legislation to Parliament meant to facilitate land acquisition, particularly for infrastructure projects.

“The government also supports private business practice by increasing legal certainty and security for investment,” Agus Martowardojo, the finance minister, said. “With the bureaucracy reform programme, the government has committed to reducing various regulatory areas less conducive to the investment climate.”

Indonesia has been gaining kudos for its concerted efforts, despite remaining challenges in implementation. The World Economic Forum notched it up 10 places to 44th in its 2010-11 “Global Competitiveness Report”, while the World Bank upgraded it by five places to 115th in its 2011 “Ease of Doing Business” ranking. Key downside risks highlighted include potential legal uncertainties over land rights, contract sanctity and substandard corporate governance.

COORDINATING ALL THE PARTIES: A key challenge has been coordinating actions between federal government agencies such as BKPM and sub-national (provincial, district and municipal) authorities. A recent Regional Autonomy Watch survey found that 85% of local laws were inconsistent with national regulations, hampering potential investment. Although the formal institutional framework remains challenging, President Yudhoyono has taken steps to address such frictions by holding regular meetings with the three key levels of sub-national government and crystallising their support to improve the investment climate. Although still ad hoc, such measures have eased bottlenecks in project approvals and implementations.

One idea to address the issue on a more systematic basis is to establish an independent government-sponsored rating of all districts according to their investment climate, with this building on the World Bank’s yearly subnational “Ease of Doing Business” ranking. “This would encourage a kind of beauty contest, a race to the top, for all districts and we would likely see rapid improvements,” Purbaya Yudhi Sadewa, the chief economist at the Danareksa Research Institute, told OBG.

The World Bank published its first subnational investment climate report for Indonesia in 2010, ranking 14 cities and regions according to their ease of starting a business, handling construction permits and registering property. The disparities between provinces and even districts are certainly significant. While it takes eight procedures in 43 days to start a business in Yogyakarta, the top-ranked city, for instance, the same process extends to 11 procedures in roughly 60 days in Manado, the worst performer. Jakarta stands in the middle. Larger cities such as Bandung and Jakarta have more successfully streamlined procedures for registering property, making them the two top performers on this criterion. Crucially, none of the reviewed cities perform well on all three indicators. BKPM issues its own annual list of the most investor-friendly provinces, naming seven in its latest in October 2011: Aceh, Central Java, West Kalimantan, South Sulawesi, Central Sulawesi, North Sulawesi and West Sumatra. The World Bank estimates that significant improvements in the national climate would come from following best practices already in existence in certain regions.

Overlapping areas of jurisdiction between different ministries also presents challenges for investors. This points towards enduring regulatory challenges, particularly in the area of reforming the civil service, which the Yudhoyono administration has only slowly tackled so far. This may change going forward, however. “We intend to improve the level of business, governmental and judicial transparency and to ensure that bureaucratic standards meet international best practice,” Martowardojo, the minister of finance, said.

While corruption and legal uncertainties remain challenges, investors are affected to a greater or lesser extent depending on the sector. “Particularly if you are catering to less highly regulated middle-class consumption, investors are less affected by corruption issues,” Fauzi told OBG. “Of course investing in more regulated sectors such as mining, oil and gas and infrastructure, you will encounter governance issues.”

LABOUR LAW: Another issue is the restrictive labour law, last reformed in 2004. In particular, the 2004 law mandates strict rules for employee redundancies, with repercussions for labour-intensive industries such as textiles that have started moving from highly unionised urban areas including Jakarta, Medan, Bandung and Surabaya towards zones with less union activity such as Semarang, in Central Java. The political unpalatability of labour reforms may continue to hamper progress ahead of the 2014 electoral cycle.

Despite challenges in certain reforms, the administration has staked its ambitions for rapid economic development on streamlining investment procedures to attract private investment. As FDI flows have increasingly balanced portfolio inflows, markets are responding positively to the moves thus far. As the country works to attain investment-grade status, sustaining the rhythm of reforms will be crucial to supporting a wider shift from a consumption-driven economy towards an investment-driven one. All sides of the political spectrum agree foreign capital will be key to this.