Ready or not: ASEAN integration will challenge the domestic construction sector

With the implementation date of the ASEAN Economic Community (AEC) set for December 31, 2015, Indonesia’s construction sector must take the right steps to ensure that it stays in the running. The AEC aims to create a single market and production base with free movement of goods, services and skilled labour. Such a development will enable greater access for foreign competitors looking to enter the Indonesian market to satisfy rising demand for construction services and building materials.

Increased Spending

Indonesia aims to be a top-10 global economy by 2025, but this ambition depends largely on realisation of its infrastructure projects. In line with this, a 10% rise in infrastructure and commercial development spending is planned for 2014 which will take the overall figure to Rp407trn ($41bn). While such spending will inevitably boost the domestic construction sector, many argue that the government must provide greater support to companies by improving access to finance and implementing more-favourable taxation conditions. ASEAN integration via the AEC should boost foreign direct investment (FDI) in Indonesia, which has declined since 2012, but the domestic construction sector must increase its competitiveness if it is to capitalise. Should it not, domestic companies will lose out to foreign competitors, as has occurred in the past. Such a failure could also damage Indonesia’s FDI attractiveness as investors target countries that are more prepared. The AEC is set to provide huge opportunities for construction companies all over the region, and Indonesian contractors must go on the offensive to seek these out. However, in an ASEAN marketplace with a combined GDP of over $2.1trn, higher domestic lending costs and internal taxes could mean Indonesian firms will struggle to be competitive. The chairman of the Indonesian Contractors Association, Sidarto, said recently that “Issues of interest rates and taxes could hamper local construction firms in expanding their businesses to neighbouring countries.” Indonesian firms currently pay 13.5% interest, compared to competitors in Malaysia, Singapore and Thailand, which only pay 3-4%. If the sector is to compete within the AEC, the government will likely be forced to reconsider these rates.

Domestic Drivers

As part of Indonesia’s commitment to the 2010 ASEAN Connectivity Master Plan, which will catalyse economic development beyond borders, large-scale infrastructure projects have become a strong driver of the domestic construction sector. Many such projects are part of the Master Plan for the Acceleration and Expansion of Indonesia’s Economic Development (MP3EI), which aims to foster economic development through six economic corridors that were chosen because of their ability to give Indonesia a competitive advantage.

One company to benefit was non-listed state construction firm Hutama Karya, which participated in the construction of Bali’s first toll road alongside another state-owned company, Adhi Karya. The 12.7-km road connected Nusa Dua and Ngurah Rai International Airport via Benoa Bay, and was inaugurated by President Susilo Bambang Yudhoyono in September 2013.

Investment

In terms of securing infrastructure investment, the MP3EI envisaged that the private sector should contribute 49% ($450bn), with 21% to be covered by public-private partnerships (PPPs). However, the viability of the model is yet to be proven, as no PPP has ever reached financial completion in Indonesia. At the start of 2014, Indonesia’s National Development Planning Board released a list of 27 projects worth $47.3bn to be made available to investors, but many are struggling to get off the ground. These failures have had a knock-on effect as less opportunities have materialised for private construction players.

Of the large-scale infrastructure projects already under way, the majority are dominated by contractors from Japan and China, which occupy over 60% of the market. Indonesian companies have lost out due to either a lack of expertise or technological capacity. While the government continues to work to improve regulatory certainty around Presidential Regulation No. 67 of 2005, which established only a basic legal framework for PPPs, progress is slow. It is hoped that eventual improvements will act as a catalyst for PPPs, allowing private firms more opportunities to participate. However, even then, their readiness to do so against tough foreign competition remains unclear.

Material Worth

In terms of providing materials for the projects that are boosting Indonesia’s regional competitiveness, some domestic manufacturers are leading the charge. For example, Semen Indonesia, the country’s largest cement maker, aims to boost its output to 31m tonnes in 2014, up from 27.9m in 2013. The firm is striving to compete with incoming operators by establishing packing plants closer to construction areas and improving logistics processes via its 11 seaports. Semen Indonesia has also teamed up with a state-owned steel maker, Krakatau Steel, to produce slag powder for specialised cement products. Named Krakatau Semen Indonesia, the joint venture is looking to invest Rp440bn ($44m) into building a blast furnace that will turn slag into a cement ingredient.

Another domestic company looking to compete in the ASEAN arena is Wijaya Karya (WIKA). However, having already become a subcontractor for infrastructure in Africa, the Middle East and East Timor, WIKA has raised concerns that domestic firms seeking to complete contracts abroad will have to pay tax in both Indonesia and the contract country. According to the Ministry of Finance, Indonesia has signed bilateral tax agreements exempting Indonesian firms from paying additional taxes outside Indonesia with most ASEAN countries, but this list excludes Cambodia, Laos and Myanmar. In addition to the risk of double taxation, domestic construction companies are also subject to a further fixed tax of 3% of the total project value.

Foreign construction firms are also looking to increase their presence in Indonesia and ASEAN, Thailand’s Siam Cement being one example. The industrial conglomerate aims to boost cement production across the region following infrastructure project delays stemming from social unrest at home. Currently constructing new cement factories in Indonesia, Cambodia and Myanmar, Siam aims to begin production at all factories within two years, which will boost current overall production of 24m tonnes per year by 20%.

Qualifications

Concerns over the sector’s ability to compete in the AEC have centred on the availability of qualified human resources, with criticism levelled at the government for failing to provide assistance in the form of adequate training. Data from the Ministry of Public Works indicated that only 10% of Indonesia’s 6.34m construction workers were listed as “experts”, while 60% were listed as “unskilled labourers”.

Indonesia has only 159 engineers who are recognised by the ASEAN mutual recognition arrangement on engineering services. Furthermore, Bobby Umar, the chairman of the Indonesia Engineers Association, told OBG, “The competencies we do have are mostly concentrated in Java, and must be integrated into outlying regions.” Such shortages of qualified experts, and their uneven distribution, mean Indonesia is unable to offer clients as many services as competitor countries like Singapore and Malaysia. According to Singapore’s Building and Authority (BCA), Singaporean companies have provided construction services to more than 270 projects around the world. Malaysian companies have also had notable success through construction projects in many countries, including Indonesia, Bosnia and Herzegovina, and South Africa.

Yet while Indonesia will have to work to hard to boost the sector’s overall HR capacity, there will be an increasing number of regional opportunities for companies – made easier through cooperation with local partners, a tactic utilised extensively by Japanese firms. The government aims to boost the construction sector’s contribution, at 10.5% in 2013, to levels similar to trade (13%) and agriculture (14%) over the next few years, and it must realise that HR is a key component. As the AEC looms, it appears that there is room for improvement in all areas of Indonesia’s construction sector.