Still growing: Infrastructure plans and demand for property drive the sector forward

Increased government investment in infrastructure has helped to unleash a boom in Indonesia’s construction sector. With rapidly growing demand for residential real estate, office buildings, industrial estates and other property across the archipelago, the construction sector is tagging along for the ride.

The Indonesian Contractor’s Association (AKI) noted an increase in the construction and building materials sector from $25bn to $40bn between 2011 and 2013 as infrastructure development and property expansion continues to bolster the country’s GDP. The government’s Master Plan for the Acceleration and Expansion of Indonesia’s Economic Development (MP3EI) is driving much of the sector’s growth, as $185bn has been allocated for infrastructure development. In 2013 the construction sector comprised 10.5% of Indonesia’s GDP, having risen nearly 3% since 2009. However, 2013 brought significant rupiah depreciation, which, through increased building materials costs and subsequent project delays, was the year’s biggest challenge for the sector. Still, growth persisted as new contracts were signed and ground was broken for work across the archipelago. With more projects on tap for 2014, the sector’s contribution should increase further.

Finance & Development

State-owned firms have been reaping much of the benefits from infrastructure and tourism development since the government declared the sectors to be two of the six MP3EI corridors. By the end of the third quarter of 2013 Indonesia’s top nine construction firms reached a combined profit of Rp849bn ($85m). The top earner was Wijaya Karya, and Pembamgunan Perumahan recorded the second-highest profit, while Adhi Karya experienced the highest growth from the previous year at 135%.

Kuala Namu International Airport in Medan and the new Priok Port in Jakarta are two major recipients of investment that has been allocated through MP3EI and the state budget, and have contributed to significant year-on-year growth for Indonesia’s top construction companies. New hotel contracts, including those for a new JW Marriot in West Jakarta, Uluwatu Hotel in Bali and Plaza Tunjungan V in Surabaya were the main contributions to Pembamgunan Perumahan’s profit. The firm’s success in early 2013 led it to set a goal for a 27% increase from 2012 in new contracts for 2013.

Through the first semester of 2013, the top nine conglomerates contributed to 66.5% growth in the construction sector, with Pembangunan Perumahan, Nusa Raya Cipa, Nusa Konstruksi Enjiniring and Acset Indonusa following Adhi Karya in the top five at 121.2%, 120.1%, 106.9% and 98.4%, respectively.

Investment

Foreign direct investment (FDI) in the sector has declined since 2012, when the total fell to $240m from $618.4m in 2010. Although there are plenty of investment opportunities, funding for a significant amount of infrastructure development has come solely from domestic companies and the government budget. As Jennifer Frederika Yapply, a construction sector analyst at Bahana Securities, told OBG, “Private investment is a challenge to recruit, because projects are often being built in places that are under developed. Therefore, they don’t offer much return.” Private companies are also often left out of MP3EI project involvement. Ronnie Tan, president director of Acset Indonusa, told OBG, “Most large infrastructure and public sector construction projects are awarded to big state-owned enterprises, leaving private sector companies to compete outside of government tenders.”

The real estate sector offers more opportunity for private investment and ownership. Long-standing government restrictions on foreign ownership have been roadblocks for FDI (see Real Estate chapter), but recent laws show hope for ease in the near future. In May 2012 the government passed a new law that allows foreign nationals to purchase condominiums, which are in high demand in Indonesia’s major cities, in a move that could help drive up FDI for future construction projects. The private sector is vital to fulfilling MP3EI plans, particularly in infrastructure. The increase in spending on infrastructure projects drove up the construction sector’s overall GDP contribution to 10.5%, coming in behind the trade and agriculture sectors at 13% and 14%, respectively, but the Ministry of Public Works hopes that the construction sector will surpass the two within the next few years.

Project Delays

The most significant challenge to the sector in 2013 was rupiah depreciation against the US dollar, which drastically drove up the cost of building materials. As the rupiah weakened, the prices for asphalt rose 21% and concrete 20%. While much of Indonesia’s concrete is produced domestically, demand for the material is so high that significant import is necessary to fill supply gaps. Price hikes for asphalt and concrete have thus caused major delays in planned and active projects across the country, particularly toll roads, bridges and road repairs, with companies struggling to pay the hiked prices and contracts being renegotiated. By the fourth quarter of 2013, 60% of projects requiring asphalt were halted and the construction sector suffered a notable decrease in annual earnings. Many companies and contractors are waiting for the government to intervene so that projects can be restarted. Meanwhile, banks have begun to slow granting loans to construction companies, which could cause the sector to lose momentum. While the sector overall was hot in the beginning of 2013, mid-year budget cuts prompted a slowdown, which Bahana Securities analysts anticipate will affect the sector through the short to medium term, but does not imply a gloomy outlook for the long term. Aditya Eka Prakasa, construction research analyst at Bahana, told OBG, “After the election, later in 2014, we should see momentum pick back up again.” While firms and contractors wait for relief from the government, the wait period may extend well into 2014 after the new administration is elected and given a chance to weigh in on sector regulations.

In & Around Jakarta

While global sea levels are rising by an average of 1-2 mm per year, Jakarta has experienced a drastic increase in land subsistence rates over the past 40 years. The Jakarta Coast Defence Strategy (JCDS) predicts that by 2020 sea levels will rise by 60 cm along the northern part of the capital. If it continues at the current pace, 2050 would see Jakarta resting 2.2 metres lower than where it was in 2008. Some 40% of the capital is below sea level and another 10% could be added over the next one to two decades. This rapid increase in land subsidence can be attributed to a range of factors. In Jakarta construction works, as well as groundwater extraction, are often cited as main causes of land subsidence. Subsidence has caused some dikes along the capital’s coast to no longer be able to hold back water, leading to an increased risk for flooding as the city continues to fall below sea level.

Thus, there are plans to build a new embankment and improve the city’s existing embankment.

However, according to Doddy Tjahjadi, managing director of Prada Tata International, “The main challenge for international and domestic developers looking to Jakarta is finding available sites, where most land owners are not willing to sell.” A new land acquisition law was passed in 2011, which is expected to accelerate the implementation of infrastructure projects.

While Jakarta remains a hub for housing, office, and retail and commercial development, the public and private sectors are looking to tap into potential outside the capital. Edwin W Ng, CEO of Maxxis Indonesia, told OBG, “We are experiencing a shift in business opportunities from Jakarta to the regions as the real estate sector in Indonesia’s secondary cities and outer regions is rapidly expanding.” Bali is thriving with luxury real estate demand, and Java has become an increasingly appealing site for industrial property. “With over 140m people, Java is the manufacturing hub of Indonesia and continues to attract increased FDI,” Wilson Effendy, director of Bekasi Fajar Industrial Estate, told OBG.

Opportunity awaits beyond the capital, and while state-owned companies stand to benefit the most from infrastructure projects, private investors– domestic and foreign – are set to take advantage of the property development opportunities across the archipelago.

Bridging The Gaps

The construction sector is expected to spend a total of $39bn throughout 2014, and much of this will go toward transport and infrastructure development. Since the government has recognised that there is not enough infrastructure in Indonesia to support economic development across the whole country, it has boosted the number of projects in the pipeline in accordance with MP3EI targets.

Dams, roads and bridges comprise the majority of government projects currently under construction or planned for coming years. Toll roads and bridges will be the first investment areas and the recipients of the majority of state investment, as the government looks to tackle connectivity issues. Road projects planned for 2014 currently total Rp33.7trn ($3.4bn), and most are located in Java, Sumatra and Papua, according to the Ministry of Public Works. These projects will be followed by new ports, dams and other secondary infrastructure projects. Water projects, including Titab in Bali, Pandan Duri in West Nusa Tenggara, Jatigede in West Java, and Diponegoro in Central Java, are expected to total Rp11.4trn ($1.1bn) in 2014. In the meantime, MP3EI plans require the involvement of the private sector. Funding remains the main roadblock and many projects are facing delays due to inflation and insufficient investment. Many government projects are backed by state-owned enterprises (SOEs), because it is more attractive for bigger, private companies to invest in property and similar projects that offer more return. Furthermore, regulation can be a challenge to navigate, and potential investors often find there to be a lack of consistency in what the government allows.

SOEs will oversee airport and shipping port projects, which normally average three years to complete. Private companies are taking the lead in financing airport expansion projects, except for in smaller cities where the projects are funded by local governments. Shipping ports are also congested, causing vessels to rarely arrive on time. The government is planning to build a new port system, which promises to afford logistics companies better connectivity and reliability. In 2014 the nation ranked 53rd on the World Bank’s Logistics and Performance Index list, for which 160 countries were analysed. This was an improvement from 59 out of 155 countries in the previous index in 2012.

While an improved infrastructure system would relieve Indonesia of many of its development roadblocks, Yapply suggested that road systems in places like Jakarta will have to get worse in order to get better. Whereas regional neighbours, such as Singapore and Malaysia, or developed economies such as the US or UK, have more organised business districts and housing districts, Jakarta lacks a system of urban organisation that would keep new projects from causing major interruptions to traffic flows. Jakarta is already notorious for its traffic jams, so building new roads or bridges without tidy mapping is very challenging.

The government plans to move forward despite this, with new public transportation projects set to begin construction in 2014. Overall government spending on infrastructure and commercial development is expected to increase by 10% in 2014 to Rp407trn ($40.7bn), up from Rp369trn ($36.9bn) in 2013.

Air Traffic

The fastest and most efficient way to improve transport links between Indonesia’s 17,000 islands is via air travel, which is becoming more affordable for the rapidly expanding domestic consumer market. However, airports and airlines are struggling to keep up with the boom. While Asia’s budget airlines are driving growth in the overall sector, national carriers, such as Garuda, are expanding their fleets and opening new routes (see Tourism chapter).

Growth is overwhelming already congested airports, primarily Jakarta’s Soekarno-Hatta International Airport, which serves 50m passengers a year, though its capacity is 27m. The airport is the main entry point to the archipelago, and it has only two runways, leaving the airport capable of accommodating just 75 take-offs and landings per hour. Under the administration of President Susilo Bambang Yudhoyono, a Rp7.6trn ($760m) expansion project was kicked off in 2012 and is set for phase one completion in 2014. A second phase of the expansion will finish in 2015, just in time for the integration of the ASEAN Economic Community. Expansion projects have also started for the Bali and Medan airports, as both locations are trying to accommodate the surge in travellers. The government has also announced plans to build a second international airport in Jakarta, which will help relieve the congestion at Soekarno-Hatta. Plans are under review and the government intends to approach investors in 2014, with ground-breaking to begin immediately thereafter.

While the aviation side is making progress, the government’s focus is likely to shift to efforts to improve the roads in and out of the airports. Traffic lanes are already congested around the major airports and will worsen if additional roads are not built to accommodate for the increase in arrivals and departures.

Wage Woes

While many projects have been delayed or halted due to the effects of rupiah depreciation, companies are also factoring in increases in minimum wage while tightening their budgets. “Minimum wage has increased 44% in Jakarta, and skilled construction workers’ wages have increased between 50% and 100%. Compounded by creeping inflation in commodity prices and a fluctuating currency, end prices have gone up 100% in 2013,” Harun Hajadi, managing director of Ciputra, said. The regional minimum wage was increased by 44% in Jakarta and by a national average of 18.3% in 2013. Still, there is a demand for higher wages from workers, who are advocating to be compensated for higher transportation costs due to fuel price increases. Many companies, especially small to medium-sized firms, are being forced to lay off employees or hire foreign workers working for lower pay.

Meanwhile, more companies are reaching abroad to fill the sector with much-needed expertise. Due to competitive salaries and opportunities in the mining sector, some locations are experiencing a domestic brain drain in the construction sector. Yapply told OBG, “Especially in Java, it is getting harder to recruit construction workers. Following the commodity boom that occurred seven years ago, people began moving to places outside of Java, because the pay became much higher. In Java, construction sector work is a low-income job, so professionals with more advanced training and skills are moving elsewhere.” Though construction workers are paid above minimum wage, many find benefits in transitioning outside the sector to use their skills in another field. Mining companies often pay higher than construction firms because hazard premiums are added. That is attracting workers to the sector. However, while smaller companies are facing the bulk of the recruitment challenge, bigger firms claim that their workers are loyal and more often return for future projects.

Human capital development and a boost in industry standards will be vital for the sector’s goal of increasing overall GDP contribution. Hediyanto W Husaini, construction division head from the Ministry of Public Works, told reporters in January 2014 that as of the end of 2013 there were 117,042 contractors and 4414 consultants working in the construction industry, which has a total of 6.6m workers. Around 159 engineers have ASEAN certification, and this number is very low compared to what Indonesia’s neighbours can offer. Doddy Tjahjadi, managing director of Prada Tata International, told OBG, “Architectural local expertise within the domestic architectural sector is stretched by the current boom period. As a result, major architectural companies like ourselves have to look abroad for senior staff recruitment in order to service bigger and more complex projects.” Around 60% of the population is currently at a work-ready age, according to Bahana Securities, and skills development in the trade will be vital to ensuring that safety and quality standards are met. Considering that the industry is under high pressure to become more competitive in time for ASEAN single market integration, developing Indonesia’s human capital should be a key area of focus.

Outlook

Rupiah depreciation and the project delays it is causing are the biggest challenges to the sector. However, as rapid urbanisation continues and the government rolls out infrastructure development plans across the country, the construction sector should remain resilient over the long term. Indonesia’s middle class is expanding, driving up demand for housing as more Indonesians look to purchase their first homes. Meanwhile, the country’s young population comprises a sustainable labour source ready to carry out the plans if human capital development is prioritised.

These factors combined have led the government to forecast a 6-7% annual GDP growth through 2017. Spending across the sector is anticipated to reach $39bn in 2014, according to the Ministry of Public Works’ January 2014 estimates. Though the sector may slow in the first part of the year, it is expected to gain momentum once the new administration is elected and given time to establish new regulations. If it favours infrastructure development with similar fervour as the current administration, the sector will continue to benefit from increased government spending. Furthermore, it should make Indonesia a more competitive economy as it enters the ASEAN single market in 2015.