Building confidence: A steady stream of projects is driving rapid growth in the industry

With foreign direct investment (FDI) up, factories being built and real estate booming, the construction sector in Indonesia is expanding rapidly. The government is undertaking programmes to improve infrastructure, building roads, airports, railways and ports. This is partly the result of some long-delayed expenditure, with the country’s transport networks at capacity and in some places crumbling. The growth of the sector is also the consequence of fundamental, structural changes that seem to be occurring in the economy. While Indonesia remains more consumption-oriented than places like China, investment is an increasingly important part of the mix.

It is too early to tell whether this is just part of fixing the investment deficit or a sign of a permanent shift in the nature of the economy, but the numbers indicate activity that has great significance for the construction industry. Gross capital formation hit 32.8% in 2011, an all-time high and up 10 percentage points in a decade, and 20 percentage points in 15 years. Economic research firm CEIC estimates that the number was 33% in March 2012. This is a clear indicator of a growing emphasis on investment. As would be expected, much of this capital is going towards buildings, roads, power plants and rail. JP Morgan estimates that the construction sector now generates 10% of GDP, up from between 6% and 8% in the years 2001 to 2007.

STOCKS UP: Evidence of the recent growth in the industry can be seen in the stock prices of the relevant companies. State-controlled Wijaya Karya, a diversified construction and engineering firm that traces its origins back to the nationalisation of a Dutch company, has experienced a ten-fold gain on the Indonesia Stock Exchange since December 2008, significantly outperforming the benchmark Indonesia Stock Composite Index. Adhi Karya, founded along with Wijaya Karya in 1960 and in similar lines of business, has had an equally impressive run, and the shares of Total Bangun Persada have more than tripled over the past year. Analysts say the gains were the result of real increases in business. Not only are infrastructure projects being initiated and apartment and office blocks being built, but the strong economic climate has resulted in fewer cancellations and delays, meaning more of the planned and the promised is translating into construction.

The most visible and significant new spending will be coming from government investment. According to Ministry of Public Works figures provided by the Indonesian Contractors Association, official infrastructure funding will rise three-fold between 2010 and 2014. PwC, meanwhile, estimates that total infrastructure spending as a percentage of GDP will rise from 3.8% in 2010 to 4.6% in 2013. Long-term underinvestment in the country’s roads, rails, ports and power plants is being squarely addressed.

MP3EI: The major driver behind the growth is the Master Plan for the Acceleration and Expansion of Economic Development of Indonesia (MP3EI), a $415bn initiative that will commit an estimated $185bn to infrastructure. Major construction is to be undertaken. Some of the projects being contemplated under the programme are: the $16bn Sunda Straits Bridge; the $5.9bn Trans-Sumatra Highway; the $2.6bn Kertapati-Tanjung Api-Api Railway; the $4.3bn North-South Mass Rapid Transit Phases I and II; the $1.3bn Bali Railway Development; and the $5.3bn Trans-Papua Highway. It is estimated that of the total investment from the MP3EI budget, $35bn will go to roads, $34bn to rail and $12bn to ports.

PRIVATE INVESTMENT: While much of the MP3EI will be pursued under public-private partnership arrangements, purely private investment is also rising as risk decreases and opportunities are identified. Property is one major area of focus. Colliers International estimates that 1.3m sq metres of new office space will enter the Jakarta market in 2014, the largest increase in the city’s history. In the industrial market, foreign manufacturers are looking to locate facilities in the country, leading to an expansion of industrial estates and related infrastructure. Indeed, Indonesia has gone from being approached cautiously by international capital to being favoured by it. FDI hit a record in 2011 and possibly in 2012 as well, the third quarter of 2012 being the best quarter ever for the country in terms of FDI.

A number of major projects are coming on-line and will be contributing to growth over the next few years. Despite concerns over the proposed concession period, work has begun on the $2.3bn Tanjung Priok expansion programme, which includes a range of infrastructure construction: three container terminals, an oil and gas terminal and a 7-km road. Also, in late 2013 construction on two 620-MW power plants will begin near the Banko Tengah coal mine in South Sumatra. The project is valued at $1.6bn.

TRANSPORT: Transport is an area of considerable activity. In 2012 the tender for the 25.8-km Medan-Tebing Tinggi toll road was announced, and Jasa Marga has expressed an interest in bidding, while work is scheduled to begin in early 2013 on the $1.25bn, 116-km Cikampek-Palimanan toll road. Rail is also an area of intense focus, with Indonesia in the process of double-tracking its main rail corridor. Upgrading of the 700-km line between Jakarta and Surabaya is already more than 45% complete. When that is finished, parts of the 443-km line between Cirebon and Surabaya will be double-tracked.

Meanwhile, more ambitious projects are getting attention and might soon yield business for construction companies. The Mass Rapid Transit is moving ahead and the Jakarta Monorail, the troubled $1.25bn transport solution almost a decade in the making, is being discussed again. The new governor of Jakarta, Joko Widodo, has said that he would like the monorail project to be revived, while Adhi Karya has said it might lend its support.

OFFICE: A series of office towers are under construction or soon will be in Jakarta. Menara Prima 2 in the Mega Kuningan area is more than half complete and should be finished in 2014. Noble House Office tower in Mega Kuningan, Wisma Mulia 2 on Gatot Subroto and the Sahid Sudirman Centre are also set to be completed by 2014, according to Colliers International. Other projects under construction in the central business district include DBS Tower, 18 Park Tower, World Trade Centre 2 and Life Tower. The pipeline is strong, with the District 8 Office Tower and the Sampoerna Strategic Square complex on Sudirman set to begin. A number of apartment projects have also been launched, including Madison Park, Metro Park, Pluit Seaview, Green Central, Royal Office Residence, St Mortiz and Giannetti.

Indonesia’s ongoing transformation is of great significance to the construction sector. While it is and will likely remain a consumer-driven society, the balance is shifting from consumption to investment. In 2011 household final consumption as a percentage of GDP hit 56.8%, the lowest since 1989. It has historically been around 60%. In 2010 and 2011 the gross savings rate was above 30%, not at China’s 50%-plus levels, but still at record highs, and above regional competitors such as Thailand.

The change in attitudes is across the board. FDI is certainly increasing, but so is domestic private investment. In 2009 total direct investment from all sources was $14bn, of which 25% was from Indonesia. Two years later the total had jumped to $28bn, with 30% of this from domestic sources. The total is forecast to rise rapidly, with the proportion from the home market remaining high. Direct investment in 2013 is estimated to be around $38bn, 28% of which is seen coming from domestic sources.

NEW REGULATIONS: It is hoped that revised regulations will give the sector a boost. The new land acquisition law, passed in 2011 and followed with implementation regulations in late 2012, is seen as particularly significant. It sets out a precise schedule and dispute resolution process for public projects, and the hope is that this will result in many stalled projects advancing. Investors are sensitive to completion risk and will often turn down projects if land acquisition is uncertain. The law may remove this uncertainty and allow projects to move ahead. “With the presidential regulation, land acquisition will take around 319 days, to a maximum of 583 days,” said Agung Wiryawan, a director at PwC Indonesia and head of the Infrastructure Advisory Practice.

FROM THE TOP: Widodo is helping to push development relevant to the construction industry. With an emphasis on creating a balanced, sustainable and inclusive economy, he is committing funds to slum and village revitalisation and low-cost housing.

Widodo has also put his weight behind solving the city’s traffic issues, and particularly the building of public transport. While it is not yet clear how much will get done and how fast, the new governor is setting a new tone and politicians are listening. The imbalances in the Indonesian economy are too great at this point to be ignored, and solutions such as public housing and new rail lines are being met with interest by elected officials. Widodo was elected due to his effectiveness in carrying out plans for the greater good despite opposition along the way, and if he proves to be popular in Jakarta, his message and methods may begin to be applied on a national level. Projects long stalled for the lack of effective leadership could start to advance, and this will have real implications for the construction sector.

CAPITAL INVESTMENT: Further signs of strong fixed asset and construction industry investment can be seen in the cement industry. Semen Gresik, which is a market leader with a 41% market share, reported that its cement sales were up 13% in the first nine months of 2012 to 18.2m tonnes. The company also said that industry sales were up 14.5% over the same period to 44.6m tonnes.

The Indonesian Cement Association puts growth in the first 11 months at 15% year-on-year. Domestic demand has been especially apparent in the export numbers. Exports dropped 59% in 2011 to 1.2m tonnes, indicating that Indonesia needs the cement. Stock prices, too, are indicating a healthy industry. The shares of Semen Gresik are up five-fold since 2009. Those of Indocement Tunggal Prakasa have seen a four-fold rise over the same period.

In anticipation of increased demand, the cement industry is planning to invest $6.7bn by 2017 to lift production capacity by around 50%, from the current 60m tonnes a year to some 90m tonnes. In 2010 Nusa Prima Persada International Consulting predicted that the country will need to build 10 2. 5mtonne-capacity cement plants through 2020 if it is to avoid the need for imports.

Semen Gresik, which changed its name to Semen Indonesia in early 2013, is going to invest $2bn in cement plants in Java, Sumatra, Kalimantan and Papua, with total production capacity of 10m tonnes a year. Foreign investors are also fairly active, especially those from China. China Anhui Conch Group is investing in cement factories in East Kalimantan, West Kalimantan, South Kalimantan and West Papua, China Triumph International Engineering is building a $350m, 2m-tonne-capacity cement plant in Grobogan, Central Java, and State Development and Investment Corporation may establish a $200m cement plant in Manokwari, West Papua. SCG Group, Thailand’s largest building materials company, is investing $300m in a cement plant in Sukabumi, West Java. It also bought Boral Indonesia, a ready-mixed concrete company, from Boral Australia in 2012.

The cement business has largely tracked the fortunes of the country as a whole. By the time of the 1998 crisis, total capacity had reached 45m tonnes a year, but because of the economic collapse only 50% of capacity was utilised that year. Of the 10 cement plants on the drawing board in 1997 only one was built, according to Global Cement Magazine. As the economy recovered slowly over the next decade, production increased, only to drop back in 2009. It then recovered again to hit new highs.

While Semen Indonesia dominates, the industry has a number of players, many of them foreignowned, and they are ramping up production in anticipation of further growth. Indocement, which is majority-owned by HeidelbergCement Group, has a capacity of 18.5m tonnes. It sold 15.4m tonnes of cement in 2011, up 19% year-on-year, and was the first company in Indonesia to produce white cement.

Holcim Indonesia, originally an independent Indonesian company but now owned by Holcim of Switzerland, currently has an annual capacity of 8.5m tonnes, but that will increase to 12m tonnes by 2015. The new plants will be located in Tuban, East Java, and the company believes this will be a great advantage, as cement going to East Java currently has to be shipped from Central or West Java.

CHALLENGES: Just as the industry is booming, however, there are issues that warrant attention. Inflation is one of the most critical. With demand for building materials so high, prices are climbing.

Figures from Statistics Indonesia also seem to indicate that costs for building material are increasing roughly in line with inflation, but anecdotal evidence from developers suggests that their costs are rising by around 15% per year. In an interview published in early 2012, Tri Wedianto, the deputy chief of East Java’s Indonesian Real Estate Developers Association, said that housing prices had jumped 20% in the previous month, largely due to the increase in construction material costs. He also said that labour costs are rising rapidly. Minimum wages generally rise faster than overall inflation.

Progress on infrastructure is also far from certain. While the government has put its full weight behind the MP3EI and its other favoured projects, it is not yet clear whether they will be completed. Many need private participation, and some investors remain sceptical about the prospects for infrastructure. So many deals have failed in the past due to bureaucratic problems, land disputes and a lack of official support that the risks are still deemed high, and Indonesia will need to establish some credibility before foreign institutions are willing to participate. Strictly state-funded projects that do not require new land – as is the case with double-tracking – will almost definitely proceed, but much of the MP3EI requires breaking new ground and raising international funds, so reality might fall short of the projections. “It is hard to know how much is actually going on,” said Rizal Satar, a partner at PwC Indonesia.

Concern is also mounting over some parts of the housing market. While prices are still inexpensive on a relative basis, their rapid increase has resulted in the central bank requiring at least 30% equity for property purchases. A shopping mall ban was put into place in the capital 2011/12, and the Widodo administration, given its populist credentials and its desire to see sustainable development, might also take a dim view on so many high-end properties and so much conspicuous consumption.

In addition, the traffic problem is not going away soon. While much of the proposed spending will go toward alleviating them, the bottlenecks in the meantime are inhibiting economic growth. Macroeconomic issues will become especially worrisome should a slowdown in China become a reality, as Indonesia’s growth is at least partly commodity-related.

Structural issues also exist. While Indonesia is seen as one of the most promising construction markets in the region, it is also one of the least efficient. The industry suffers from low profitability and excessive competition – a study in 2006 placed the number of firms in the sector at 116,460 – and is short of capital. Public procurement, meanwhile, is inefficient, expensive, slow, can be corrupt, and has human resources and staffing issues. While the major contractors would like to work their way up the value chain and become engineering, procurement and contracting firms, and some already claim that capability, analysts say they still lack the human resources and technologies to compete internationally.

Land prices can also be a problem in some areas. “With hundreds of companies experiencing tremendous growth, finding cheap land is not easy. It is challenging to get land for industrial purposes,” Wilson Effendy, the finance director of Bekasi Fajar Industrial Estate, told OBG.

OUTLOOK: The construction sector will continue to expand rapidly over the next few years as the property market sees further rapid growth and MP3EI expenditure kicks in, with momentum alone carrying it forward. To guarantee future performance, however, the industry needs to fix bottlenecks, increase capacity and improve efficiency.

Growth alone is not enough; the industry must change. Much of this will be automatic. More money will lead to greater profits and that will lead to investment in technology, expertise, human resources and manufacturing. Planning will also be required. The industry must prepare for the consequences of growth, such as inflation, policy reversals, persistent logistics and transport problems, new risks and increased competition. The sector must evolve and institute practices that will help support its development and prepare it for the inevitable surprises.