Indonesia's new regulations expanding opportunities for foreign property ownership

With the sector booming and many more projects still to come as part of Indonesia’s drive to boost its infrastructure, foreign companies are also looking to take a slice of the country’s construction pie. In the past, entering the local market was sometimes considered challenging, but today moves to boost foreign ownership limits and major regional changes are easing the path to the Indonesian market. A. H. Marhendra, president-director of realty firm Springhill Group, told OBG, “Foreign ownership of real estate in Indonesia is not as strict as many tend to believe. There are ways in which this can be possible, but it involves a deep knowledge and understanding of the current legislation and regulations, which in some cases is lacking.”

New Realities

These changes are partly the result of the ASEAN year-end 2015 target for the implementation of the ASEAN Economic Community (AEC). This brings together ASEAN members Indonesia, Singapore, Malaysia, the Philippines, Brunei Darussalam and Thailand in round one of a trade liberalisation pact that will later also include Cambodia, Vietnam and Myanmar.

Yet the changes are also the result of government recognition that a more competitive construction sector, with a greater level of expertise and global financial backing, is a necessity if the country’s considerable infrastructure challenges are to be met. According to the National Development Planning Agency (Bappenas), the country needs some $550bn to finance infrastructure projects between 2015 and 2019 alone. Of this, the state budget can only provide some $97.3bn, meaning that state-owned enterprises (SOE) and the private sector will be looked to for the rest.

Foreign Parties

According to the Indonesian Contractors Association, Indonesia had around 131,319 companies in its construction sector in January 2014. Of these, some 302 were foreign, with 16 from ASEAN countries and 286 from elsewhere. The limited amount of foreign involvement is in part the result of Indonesia’s socioeconomic trajectory, which created a number of major state-owned construction companies, and led to many regulations designed to protect local industry from foreign competition. One of the main regulations is the “negative list” that outlines all the sectors that are either wholly or partially closed to private and/or foreign investment. The most recent list was that set out in Presidential Decree No. 39 of 2014, which reserved a number of construction sector-related activities, placing conditions on ownership and on the size of businesses that might undertake work.

For public works, construction services up to Rp1bn ($82,660), for example, are reserved for micro, small and medium-sized enterprises and cooperatives, while participants in projects over Rp1bn ($82,660) have a foreign ownership limit of 67%. At the construction consultant level for all public sector projects, the foreign ownership cap is set at 55%.

There are case-specific limits outlined in the decree. For example, the construction of terminals for land transport is limited to companies with a maximum of 49% foreign ownership, while building activities in the oil and gas sector have various limits such as the construction of platforms (75%), spherical tanks (49%) and offshore pipelines (49%). Meanwhile, in the electricity sector, firms involved in the construction and installation of electric power need just 5% local holding.

Open Door

With the AEC on the horizon, the government has come under increasing pressure to open many of the sectors on the DNI list to greater foreign participation. The AEC is to be a free trade area, with tariff barriers between members brought down to 0-5% by the previous ASEAN Free Trade Agreement and non-tariff barriers, such as the DNI, also seen as obstacles to the full working of the Community.

Yet there is strong political resistance in Indonesia to an increased foreign ownership cap in many industries. Under the 2014 revisions, for example, a new 33% foreign ownership limit was placed on warehousing, storage and distribution facilities, while in September 2014, Indonesia’s lower house of parliament, the People’s Representative Council (DPR), narrowly dropped a retroactive clause in a new bill that would have cut plantation ownership from 95% to 30%. The new president, Joko Widodo, however, is widely thought to be unlikely to support further limiting of foreign ownership. Nonetheless, the strength of protectionist views in the DPR continues to be a major risk factor.

Meanwhile, in 2014 officials from the Ministry of Public Works began floating the idea of raising the foreign ownership limit to 70% for construction companies and consultants involved in public works, “in line with the implementation of the AEC,” according to Deputy Minister Hermanto Dardak. Yet the AEC rules stipulate only that these limits should be not less than 55% for contractors and 51% for consultants, Hediyanto W Husaini, division chief at the Ministry of Construction, told reporters, suggesting that the 70% limit could be reduced in the future, if necessary.

Going Local

In August 2014, another set of new legislation was put forward that could affect foreign construction firms in Indonesia by setting the percentage of local workers and materials that must be used during a project. This followed concerns that while internationals were complying with the ownership limits for foreign companies, the Indonesian share of such entities existed sometimes only on paper. Much of the design work, for example, would be done abroad, with no skills transfer. Given that one of the main needs of the local sector is an upgrading in its capabilities and sophistication, this lack of transfer was holding back sector development. “Our local construction companies lack specialisms,” Hediyanto told reporters, warning that this might leave them over-exposed when the AEC and the government’s major infrastructure roll out begins. “The more construction projects we conduct within the next few years, the more foreign companies will eye the opportunities and try to enter the business.”

A further amendment then came in September 2014, when the Minister of Public Works issued new guidelines for granting permission to establish a foreign construction service representative office in the country. Previously, such offices had to undertake a joint venture operation with a 100% Indonesian-owned company in order to perform construction activities in the country. The new regulation added a condition to this, saying that the stipulation could be waived by the minister if certain conditions were met. These conditions include a reduction in the Indonesian shareholding of the Indonesian partner in the operation to 65%, with the requirement that the posts of managing director, finance director and human resources director in that company are held by Indonesian citizens. The Indonesian company must also show that it is engaged in activities that boost the production supply chain.

At the same time, the new regulations mandate that at least 50% of the construction work in a joint operation be performed in Indonesia and at least 30% of the value of the operation must be performed by the Indonesian construction company. The new regulation then sets out in detail the regulations for the implementation of knowledge transfer between the foreign representative office and the Indonesian company, something that had previously not been addressed by the regulation. A knowledge transfer plan must now be prepared, with other requirements including training, fieldwork and academic research by Indonesian workers, and defined community social responsibility projects. Statements by Indonesian workers on the amount of knowledge transfer must also be obtained.

Public & Private

Cognisant of the limitations of the negative list and the need for greater foreign investment and participation in the projected infrastructure roll out, in 2013 the government also decided to increase the limit for participation in one particular type of scheme – public-private partnerships (PPPs).

A revision to the DNI on these allows a 95% foreign stake in a PPP connected to the construction of port facilities – an area in which foreign participation without a PPP is limited to 49%. At the same time, construction of power generation projects over 10 MW in size can be 100% foreign owned through a PPP and 95% owned through other private projects.

Balancing Act

Clearly, many in Indonesia have had a wary attitude towards foreign ownership and involvement in the country. Protecting Indonesian jobs and businesses are often seen as priorities, with competition from foreign entities seen by some as unacceptably threatening. At the same time, many also acknowledge the important role foreign companies can have and the major benefits they can bring. Like previous administrations, balancing these two views is a political task.

Meanwhile, many foreign investors have no opposition to limits on ownership per se, nor to knowledge transfer or other moves that encourage development of the local industry. What is more concerning is the atmosphere of uncertainty that frequent rule changes engenders, with many businesses looking for longterm consistency, particularly in a sector that can require major, long-term financial commitments. However, confidence is growing that the period ahead is likely to see more regulatory stability, particularly as the AEC begins to take effect and region-wide rules are accepted.