Supporting expansion of industry in Indonesia

Industrial development is perhaps the most important pillar of Indonesia’s long-term economic expansion strategy, and the nation has made significant economic strides in recent years as a result of its fast-expanding industrial sector. The country now is poised to outpace Thailand and Malaysia as a major regional manufacturing and export hub, and investors are increasingly choosing Indonesia over China, Thailand and Malaysia, drawn in by the country’s relative stability, sizeable low-cost labour pool and large domestic market. At the same time, however, sector growth is constrained by a number of challenges: an ongoing infrastructure gap has kept transport costs high and created frustrating supply-chain bottlenecks, while rising wages and a domestic skills gap have prevented growth in labour-intensive industries from reaching its full potential.

Industrial Nation

Increasing industrialisation, especially in labour-intensive industries, has long been a government priority, and industrialisation plays a key role in the Master Plan for the Acceleration and Expansion of Indonesia’s Economic Development (MP3EI), which targets reaching developed nation status by 2025 (see analysis). To achieve its MP3EI objectives, including reaching an annual GDP of $4.5trn-5trn, the government has highlighted industrialisation – especially in value-added processing and manufacturing exports – as a key growth driver. The nation’s manufacturing base in particular is poised for major growth in the medium term, with Bloomberg reporting in January 2015 that Indonesia will attract more new factories than any other country in South-east Asia over the next four years. According to the newswire, an estimated 54 new plants will be built by 2019 – a 68% increase over present levels, and easily outpacing both Thailand and Malaysia, which are now home to a combined 133 factories at present.

While all new factories will be built by companies already established in the region, a number of new players have also moved in recent months to enter the market. These include the Philippines’ Jollibee Foods Corporation, which announced plans to expand into Indonesia in August 2014, and Korea’s Samsung Electronics, which in the same month said it will open a mobile phone manufacturing facility.

Most notably, Taiwan’s FoxConn, a major supplier to American tech giant Apple, confirmed in 2014 that it will invest $1bn to construct a new factory in Indonesia, with company officials telling media they expect the facility will be built in Jakarta. Foxconn’s planned Indonesian investment had originally been reported to reach up to $10bn over the next five years, and while the company has not yet confirmed this, chairman Terry Guo has said that Indonesia has the potential to replace China as the world’s largest manufacturing hub – a sentiment echoed by other manufacturing investors, most notably within the country’s rapidly expanding automotive manufacturing industry (see analysis).

Food & Beverage Processing

Indonesia’s manufacturing sector is unique in South-east Asia in that it has traditionally focused extensively on food, tobacco and textiles, rather than electronics and metals. Rising domestic consumption – market research estimates food consumption will witness a compound annual growth rate of 7.6% between 2014 and 2018 – and a readily available supply of key inputs such as palm oil, cocoa and coffee, have allowed the food and beverage (F&B) processing industry to become one of the largest and most mature in Indonesia’s industrial portfolio.

Although the country’s F&B industry is dominated by thousands of small- and micro-sized companies, a rising number of large-scale firms have risen to prominence in recent years, including Indofood Sukses Makmur, one of the world’s largest instant noodle manufacturers; Wings Group, which manufactures noodles, sauces and powdered drinks; Mayora Indah, a major producer of coffee and biscuits; and Garuda Food, a snack food distributor. These firms have transformed the industry by introducing market-tailored, value-added products catering to changing consumer habits – for example, the rising preference for instant, frozen and snack foods.

Foreign F&B producers, including Nestlé, Kraft Foods and Unilever, have also expanded rapidly into the Indonesian market. An October 2014 report published by Agri-Hub Indonesia forecasts that large companies, both domestic and international, will dominate the F&B industry in the coming years. “Since the large businesses are better equipped to cope with cost increases or sudden policy changes and are in a stronger position to take advantage of an increasingly open export market in the South-east Asian region, Indonesia’s food and beverage industry can be expected to see significant consolidation over the coming years,” the report read.

The F&B industry plays an important role in Indonesia’s export market, particularly as it is largely focused on the type of value-added manufactured goods targeted by the government for development (see analysis). In 2013 processed F&B exports reached $4.83bn, according to Statistics Indonesia.

The Indonesia Food and Beverage Association projected that export growth would expand in line with the overall industry, reaching 11% in 2014. With the rupiah depreciating sharply, however, a rising import bill could negatively impact future growth as the segment remains dependent on imports – most significantly of wheat, sugar and soybeans. At the same time, the government’s move to limit foreign investment in frozen storage could impact international participation, although Indonesia’s economic fundamentals have so far kept expansion strong. Indeed, the Indonesia Investment Coordinating Board (BKPM) reports that foreign investment in the F&B sector reached $3.1bn in 2014 – second only to mining – while a number of foreign players have recently made investment commitments. Coca-Cola said it would invest $500m in October, and Danone Group announced plans to expand its water and early nutrition segments the following month.

Textiles

The textiles industry will also be a critical growth driver in the coming years. The country boasts a mature, vertically integrated textile production segment involved in almost every aspect of the textile supply chain, including production of man-made fibres such as polyester, nylon and rayon, man-made and cotton yarn spinning, weaving and knitting, dyeing, printing and finishing. The sector is the largest employer in the “medium and large” manufacturing sector, with total employment in the textiles and apparel production industries standing at 900,677 in 2013 – comprising more than 20% of the medium and large segment – while the Indonesian Textile Association reports that total employment in the textiles industry is currently 1.55m.

Growth in both exports and domestic textile consumption has risen in recent years despite a 55% increase in input costs for medium and large textiles manufacturers between 2008 and 2013. In 2013 textiles exports grew by 1.76% to reach some $12.68bn, with the US, Japan and Turkey comprising the nation’s three largest markets.

In April 2014 the Indonesian Textile Association reported that the value of textile exports was expected to reach $13.3bn in 2014, a 5% increase over 2013. This was largely a result of economic recovery in the US, the country’s largest export market, as well as surging demand in the wake of the FIFA 2014 Brazil World Cup. Textile sales in the domestic market, meanwhile, were projected to have risen 7% year-on-year to reach $7.5bn in 2014.

This has led several major producers to expand their operations. Garment maker Pan Brothers, for example, was due to open four new factories in 2014 after entering into a joint venture with Mitsubishi, with three more expected to open in the next two years: two in 2015 and one in 2016. The company’s total set-up capacity is expected to rise to 90m organic fabric garments by 2017, from 42m in 2014.

Trade Agreements

Free trade agreements (FTA) could help the Indonesian textile industry’s international consumer base expand, enabling the nation compete with Vietnam as a dominant regional exporter. Indeed, textiles stakeholders have identified planned FTAs with the EU and Turkey as lynchpins to future growth for the sector.

“The most important issue for the textiles industry is the bilateral FTA with the EU. In 2013 Vietnam became the world’s third-largest textile market – up from 82nd place in 2000 – while we have remained at sixth place worldwide since 2000,” Ade Sudrajat, the chairman of the Indonesian Textile Association, told OBG. “We’re losing our competitiveness, but an FTA with the bloc would allow us to regain some of our European market share.”

Indeed, rising competition from Vietnam has led to an erosion of Indonesia’s market share in recent years, with the Indonesian Textile Association reporting that the industry’s EU market share declined from 1.09% in 2007 to less than 1% in 2013. Vietnam’s global market share in textiles, meanwhile, has grown from 1.8% to 3.3% in the same period. If signed, these planned FTAs could see Indonesia’s textile exports triple within five years, according to estimates from the association.

Pharmaceuticals

The pharmaceuticals industry is also poised for strong expansion in the next several years, after the government’s most recent edition of its negative investment list further opened the sector to foreign investment. The country’s medicines market expanded by 85% between 2007 and 2013, and the industry was valued at $6.5bn in 2014, according to a report published by sector consultancy Pacific Bridge Medical. Pacific Bridge reports the pharmaceuticals market is currently expanding by an estimated 12.5% annually with double-digit growth expected to continue through to 2018, following the 2014 introduction of a universal health care programme, as well as rising personal and state health care spending (see Health chapter). The market is dominated by domestic manufacturers, which comprise 70% of the total, while 60 foreign companies control the remaining 30%. Foreign ownership and investment could rise in the near term; in 2014, Indonesia opened the pharmaceuticals market to further international participation, raising the maximum foreign investment in pharmaceuticals companies to 85%, from the previous cap of 75%.

Although universal health regulations stipulate the government will only purchase generic drugs from suppliers, and restrictive contracts stipulating minimum production levels without a purchase guarantee have frustrated producers, universal health care is nonetheless expected to lead to healthy long-term pharmaceuticals growth.

“Our huge population, our government’s decision to roll out universal health care, and a projected rise in health care spending, from 2% to 5% of GDP, demonstrate the opportunities Indonesia offers,” Jonathan Sudharta, business development director at pharmaceutical firm Mensa Group, told OBG. “Analysts project that from around Rp60trn ($5bn) today, the industry will reach a value of Rp450trn ($37.2bn) within 10 years, so there is huge potential.”

Wages & Productivity

Despite its strong prospects for growth, Indonesia’s industrial development remains constrained by a number of challenges, including dependency on imports and a major infrastructure deficit (see analysis), as well as rising wages and low productivity.

Indonesia’s productivity is among the lowest in Asia, with international consultancy McKinsey & Company reporting annual manufacturing output per labourer at $14,200 per worker in 2012, behind the Philippines ($16,500), Thailand ($21,200), Malaysia ($33,200) and China ($57,100.) At the same time, minimum wages have shown double-digit average annual expansion in recent years, to the detriment of labour-intensive industries such as textiles, automotive and electronic manufacturing.

“The growth in the textile sector, as in any other sector, requires building more human capital. The quality of education and training of skilled workers and managers has a direct impact on the efficiency and productivity in our garment sectors since they are labour-intensive. More needs to be done in this area from the public sphere to help us reach higher levels of business performance,” Anne Patricia Sutanto, the vice-president of the garment manufacturer Pan Brothers, told OBG.

Other sector players highlighted the same issue. “Over the last six years it has been very difficult to find skilled managerial staff, making it crucial for the textiles industry to work with educational institutions to address this shortage,” Jamal Ghozi, CEO of textile manufacturer Pisma Group, told OBG.

In November 2014 BKPM reported that total blended wage growth in the nation was set to reach 12.77% in 2015, following 19.1% growth in 2014. Each of the country’s 29 provinces is responsible for setting its own minimum wage based on the Decent Living Index, creating a level of internal competition in some sectors. In 2015 minimum wages across the country range from Rp1.33m ($110) in Nusa Tenggara B. to Rp2.7m ($223) in DKI Jakarta. “Minimum wage increases have caused some tobacco manufacturers to consider relocating their hand-rolled kretek production facilities to provinces with lower costs of production,” Ronald Walla, president-director of cigarette producer Wismilak, told OBG.

Faster wage gains will erode Indonesia’s competitive advantage against China, representing a critical challenge to future industrial expansion. Some stakeholders have criticised rapid wage hikes as detrimental to investment and, ultimately, employment. In February 2015, for example, BKPM reported that 16 foreign investors, mostly from Japan and South Korea, cancelled plans to established footwear factories in Indonesia last year as a result of uncertainty over minimum wage growth, while the Indonesia Textile Association reports that keeping wage increases moderate would help the textiles industry reach $40bn in value by 2019.

“Industrial players for the most part accept a gradual increase in workers’ salaries; however, drastic changes in wage levels may deter long-term investments in the country’s manufacturing base,” Hanafi Atmadiredja, president-director of ceramic manufacturer TOTO Indonesia, told OBG.

With labour costs rising by nearly a third in just two years, labour-intensive industries will continue to grapple with rising demands for higher wages, especially as real estate growth has driven up rents in major urban centres, while the cost of inputs for medium and large manufacturers rose by 53% between 2010 and 2013, according to Statistics Indonesia data, to reach Rp1829.4trn ($151.2bn).

Export Ban

Although many industries in Indonesia – including the textiles, automotive, and food and beverage sectors – are dependent on imports, the country has also long been dependent on commodities exports for economic growth.

With commodities comprising 65% of total exports, Indonesia has felt the pains of its dependence on global commodities markets in recent years, as prices dropped in mid-2012 and remained depressed into 2015. In a bid to build up domestic industry and reduce its dependency on raw exports, the government moved in the last year to enact a long-planned ban on the export of unprocessed minerals. Indonesia’s prohibition on such shipments went into effect on January 12, 2014 with the expectation that the move will spur investment in domestic processing. Indonesia is the world’s top nickel ore producer and third-largest bauxite miner, and a stronger local processing industry could further advance its goals to industrialise into a developed nation by 2025.

After winning the July 2014 presidential elections, President Joko Widodo reaffirmed his commitment to the ban in November 2014, confirming predictions that he would keep it in place to bolster value-added manufacturing and processing in the country.

“Prior to the ban Indonesia was earning over $200bn in annual exports, but more than half of those exports were raw materials with low value addition,” Didik J Rachbini, an economist at the Institute for Development of Economics and Finance, told OBG. “More than 50% of our exports were raw materials. We have a big problem with raw exports, and we will struggle to balance the budget without investment in domestic industry.”

Although raw exports accounted for an estimated $2bn in monthly revenues, the move will ultimately offer significantly higher long-term benefits, and dovetails the wider strategy of shifting the country’s export base to value-added, processed goods. The government hopes to raise the total export value to $458.8bn in 2019, up from $176bn in 2014, and estimates it will require $211.5bn of investment to achieve this target, presenting major new opportunities for investment in value-added processing.

There have been some concerns, however, about how the ban will impact supply and demand dynamics in a number of sectors, including mining. “There is a danger that the mandatory construction of smelters by mining companies, required by the recently enforced mining law, may lead to an excess of supply in the market,” Makoto Miki, president-director of PT Smelting, told OBG. “It is absolutely essential for the mining and smelting industries that the new government provide clarity regarding regulation, and predictability in its application, to create a higher level of legal certainty,” he added. In December 2014 Indonesia’s Constitutional Court decided to uphold the ban after a challenge by the mining industry, arguing prohibition of exports would ensure sufficient supply to domestic smelters.

Metal Facilities

Indeed, the ban bodes well for domestic processing, with a rising number of processing facilities expected to come on-line in the next several years, joining existing facilities to support vibrant growth in value-added production.

In August 2014, for example, BKPM announced that Mitsubishi Steel Manufacturing and Nippon Steel & Sumitomo Metal Corporation (NSSMC) will invest a combined $450m in Indonesia’s steel industry, with Mitsubishi Steel expected to acquire a 34% stake in local long steel producer Jatim Steel Manufacturing, worth an estimated $37m. NSSMC and Indonesia’s largest steelmaker, state-owned Krakatau Steel, will form a joint venture to produce flat steel for the automotive industry, supporting the government’s bid to manufacture completely built units domestically.

The following month, Krakatau POSCO began producing steel slabs and steel plates at its Cilegon factory, 100 km west of Jakarta. Established as a 70:30 joint venture between South Korea’s steel giant POSCO and Krakatau, Indonesia’s biggest steel maker, the factory is expected to become an important domestic supplier in the coming years. Daily production currently stands at 8300 tonnes of molten iron, according to company officials, although this equates to annual production of 3m tonnes presently, compared to 38m tonnes in South Korea’s largest steel facilities. Nonetheless, the company reports that Indonesia’s huge domestic supply of iron ore had reduced the supply price per tonne by $17, giving this facility a significant competitive advantage over major producers like South Korea and Brazil.

In October 2014 Russia’s Vi Holding announced plans to invest $500m in an alumina refinery in Indonesia, which is expected to be built within the next four years. Denis Manturov, Russia’s minister of trade, said the decision came after Indonesia’s mineral export ban drove global nickel prices up, creating a more favourable investment environment for the company. The plant is expected to have annual capacity of 1m tonnes when complete, the majority of which will be exported to China.

In the same month, China’s Fuhai Group and Ansteel Group announced plans to invest up to $1.2bn to build a new industrial estate in Jambi, Sumatra. The project’s first phase will include a steel plant, power plant, port and supporting facilities, spread over a 500-ha area. Construction is expected to be completed within two years, and production is due to kick off in 2016, with feasibility studies to examine future expansion possibilities currently under way.

Industrial Estates

This new estate will join a growing portfolio of industrial developments across the nation, which are expected to show stronger expansion in 2015, following a modest performance in 2014. According to a September 2014 Reuters report, land sales in the nation’s 61 industrial parks were weak during the first half of the year, despite listed companies’ growth outpacing the broader Indonesia benchmark. Bekasi Fajar reported selling only 11 ha of its 40-ha target during the first half of 2014, while Kawasan Industri Jababeka sold 10 ha of its 25-ha target during the same period.

Investment policies represent a challenge for prospective estate tenants. “Land acquisition remains the number one problem in the expansion of industrial estates. It is crucial that government streamline investment procedures to ensure more rapid development,” Peters Vincen, president-director of Kabil Integrated Industrial Estate, told OBG.

President Widodo’s election victory had raised hopes for reform, and shares in many listed industrial parks outperformed the Jakarta benchmark, which rose 22% during the first nine months of the year. Shares in Kawasan Industri Jababeka, one of the largest industrial operators, rose 50% during the same period, while Bekasi Fajar Industrial Estate rose 40.5% between January and September.

Lippo Cikarang, meanwhile, reported a 75% gain, with all companies reporting that share growth continued after Widodo’s election victory.

Indeed, it appears that investor sentiment has improved since Widodo’s peaceful transition to power. With dozens of new factories planned for construction over the next five years, industrial estate growth should continue to perform well in the medium term, although infrastructure deficiencies continue to present challenges. “The government has to boost manufacturing sector to spur economic growth amidst weakening commodity prices. As one of the major supporting sectors for manufacturing, the industrial property sector also needs government support to stimulate sector growth,” Erick Wihardja, chief financial officer of Bekasi Fajar, told OBG. “Significant improvement in some areas such as infrastructure will certainly attract more direct investment to Indonesia.”

Outlook

The rupiah’s ongoing depreciation will certainly have an impact on growth in 2015. While it will make Indonesian exports more attractive to the global market, many of Indonesia’s major industries remain import-dependent, and rising input costs represent the most significant challenges facing operators. Industry and manufacturing are nonetheless poised to continue on an upwards trajectory this year, with major sectors – including pharmaceuticals, automotive manufacturing, textiles and metals – all projected to expand on the back of solid macroeconomic fundamentals.

The government’s investor-friendly industrialisation strategy and a surge in planned manufacturing facilities should also spur the industrial growth necessary to drive long-term economic development.