What drives investment in Indonesia's construction?

In the years following the 1997-98 Asian financial crisis Indonesia’s economy experienced robust growth, a result of the commodities boom of 2001-12, spurred in part by the exponential development of both India and China. During this period the country averaged 6% annual GDP growth. However, by 2013 approximately one-third of the government’s budget was being channelled into unprofitable fuel subsidies, and the development of much-needed infrastructure was neglected. This meant that industry and transportation did not develop in line with economic gains, stunting growth of the construction sector in turn.

New Developments

Major infrastructure projects feature prominently in the government’s 2020 spending plans. The re-election of President Joko Widodo, better known as President Jokowi, was met with notable rises in the share prices of Indonesia’s construction companies, although these began to decline in March as the Covid-19 pandemic began to exact its economic toll. The initial 2020 state budget of Rp419.2trn ($29.6bn) for infrastructure development may be reduced as the government shifts focus towards fighting the spread of the virus. Though major projects like the construction of a new capital city in East Kalimantan will be put on hold, Indonesia’s construction sector should experience robust expansion in the medium term.

When the disruption caused by Covid-19 passes, more work will be needed to refine legislation and remove impediments to investment, including in public-private partnerships (PPPs). “The government, state-owned enterprises (SOEs) and the private sector should be in better synergy to have a mutual understanding of what needs to be achieved with PPPs,” Herianto Pribadi, president director of Skha Consulting, told OBG.

Structure & Oversight

The Ministry of Public Works and Housing (MPWH) is the government agency responsible for the oversight of housing development, improvements to residential areas, social housing finance and building arrangements, while the Ministry of Agrarian Affairs and Spatial Planning (MASP) is responsible for the execution of land reform initiatives. Both ministries operate in accordance with the National Medium-Term Development Plan (RPJMD) 2020-24, which represents the third phase of implementation of the 2005-25 National Long-Term Development Plan.

Thus far, infrastructure development has primarily been financed by SOEs, which continue to play a major role in the economy. The process of creating holding structures to consolidate and synergise SOE activity is ongoing, and Hutama Karya and Perum Perumnas have been designated the holding companies for infrastructure development and housing development, respectively. “There are now so many diverse SOEs in the country that they have become difficult to govern,” Jeff Tuttici, project engineering consultant at Aurecon Group Indonesia, told OBG. “They are not all operating at expected levels of profitability, and by grouping them into cohesive structures the government hopes to improve financial management and accountability.”

For any entity involved in infrastructure developments or even smaller-scale construction projects, land acquisition processes have long proved a hindrance, and the government has prioritised finding solutions to this problem. In 2019 construction on both Jakarta’s Mass Rapid Transit (MRT) network – sections of which are now operational – and the Jakarta-Bandung high-speed railway line was stalled as a result of land disputes. Efforts to eliminate such issues have been part of a broader government land reform programme, the core directive of which requires that MASP officially registers all of Indonesia’s land by 2025.

The sizeable task of registering such a vast amount of land has been made even more complex due to the ambiguity surrounding the government’s assertion that it will only recognise land ownership that is “clean and clear”. This means that disputed land or land that has been unofficially assumed and inherited through generations does not necessarily qualify for certification.

Omnibus Law

On February 12, 2020 the proposal for the president’s Omnibus Law on job creation was submitted to the House of Representatives. The bill constitutes an overhaul of the legislative and regulatory frameworks, presenting 73 laws for review and amendment in areas such as taxation, construction, labour, investment and land acquisition (see Legal chapter). The bill is seen by the president as key to the success of many targeted development initiatives.

Among the changes that will affect the construction sector is the planned abolishment of a requirement that simple projects must first obtain a building permit (IMB), the application procedure of which is slow and complex. As of November 2019 there were an estimated $123bn worth of construction projects in Indonesia’s pipeline that had been held up for between one and three years due to overlapping rules and bureaucracy.

In place of the IMB there will be a set of standards to be upheld by on-site supervisors. This is seen by the government as an efficient solution to a long-standing hindrance, yet concerns have been raised that without the IMB process, the country could see a reduction in transparency and potentially an increase in building projects that violate the law. In response, the government stated that any construction found to be illegal will be demolished and its owners will face sanctions – possibly even imprisonment. In addition, laws surrounding the need for an environmental impact assessment (AMDAL) are to be eased under the Omnibus Law. Only activities that substantially affect the natural, social, economic or cultural fabric of the country will require an AMDAL, and environmental experts will no longer be consulted in the process. This, again, has raised some concerns over a rise in irresponsible practices.

Size & Performance

The Indonesian construction sector grew by 5.8% in 2019, which marked a slight slowdown from its growth of 6.1% the previous year, and accounted for approximately 10.8% of overall GDP. As of May 2019 the combined value of mega-projects in Indonesia – that is, those valued at $25m or above – stood at Rp9000trn ($634.5bn).

SOEs have generally been successful in securing contracts for large-scale projects, and while some were largely on track to meet contract targets for 2019, others were slightly behind. According to DBS Bank, by August 2019 local construction and engineering firm Wijaya Kary and its subsidiary Wijaya Karya Beton reached 33% and 47% of their new contract targets for the year, respectively, while Pembangunan Perumahan had reached 51%. Across the industry as a whole, contractors achieved an average of 35% of new contract targets by August 2019, a year in which the election created an understandable degree of uncertainty.

Sustainability & Connectivity

The Jokowi administration aims to realise major construction projects worth $412bn between 2020 and 2024 to strengthen the economy and support the ongoing decentralisation drive. Initial projections valued the sum at 5.7% of GDP over the period, giving the investment the potential to contribute to annual growth by between 5.4% and 6%. However, the diversion of government funds to manage Covid-19 may ultimately reduce the sum. According to Bambang Brodjonegoro, minister for research and technology, the state budget will cover up to 40% of the outlay, while SOEs and the private sector will pick up 25% and 35%, respectively.

Optimising the country’s water supply, storage and dispersal capacity is among the key areas of focus for the administration, with 5% of the $412bn sum to be channelled into the building of dams and hydro-processing facilities, while 10% is earmarked for irrigation projects. Power plants remain a priority, with 12 wasteto-energy facilities planned for construction in strategic locations, including Jakarta, Surabaya, Bekasi and Solo, all of which were initially slated for completed by 2022.

The bulk of the budget – up to 60% – will be invested in transport and logistics infrastructure, with toll roads, ports and rail projects set to increase in number across the country. In addition, plans have been drafted for upgrades to 165 existing airports, airstrips and waterbased facilities. This aviation initiative will be pivotal in stimulating more inclusive growth and lowering logistics costs, which will be particularly beneficial to the archipelago’s more remote regions, such as West Papua.

Toll Roads

Between 1978 and 2019, approximately 1780 km of toll roads were constructed and brought into service, 985 km of which came on-line during the 2015-19 period. In November 2019 the government committed to building 1500 km of new toll roads by 2024. Wempi Wetipo, deputy minister for public works and housing, told local media in late 2019 that the projects would help bridge regional economic disparities, and facilitate the development of industrial zones and tourism destinations, as well as enhance connectivity to the new capital city in East Kalimantan.

A prominent business strategy used in the implementation of toll roads is that of divestment, where large conglomerates and SOEs, such as construction company Waskita Karya, secure contracts and land concessions for toll road construction projects before selling sections of the roads to investors. In some regions the volume of traffic flowing over toll roads makes their acquisition a lucrative and secure proposition, enticing interest from a broad array of international and domestic investors, both private and state-owned. Toll roads induce a range of economic multiplier effects: the logistical efficiency they create incentivises investment in commercial, industrial and residential premises in areas they service, which, in turn, stimulates job creation and helps raise standards of living.

Moving the Capital

August 2019 brought the announcement that a new capital city would be built on a 1800-sq-km expanse in the Penajam Paser Utara and Kutai Kartanegara districts of East Kalimantan, on the island of Borneo. In April 2020, however, the government announced the project was to be sidelined in order to reallocate resources to combat the Covid-19 pandemic. While a soft groundbreaking for the yet-unnamed city initially planned for July 2020 may be delayed, the construction of a new capital outside Java is likely to commence after the pandemic passes, as the idea has been touted by several of Indonesia’s past leaders. Public figures claim that the need to relocate the capital is urgent considering parts of Jakarta are now sinking at a rate of 10-20 cm per year, and that the city’s infrastructure can no longer withstand the burden of being the centre for business, commerce, governance, finance, trade and services.

The cost of building the new capital has been estimated at Rp466trn ($32.9bn), of which Rp265trn ($18.7bn) is expected to go towards the construction of schools, hospitals, housing and commercial districts; Rp156trn ($11bn) for basic infrastructure; and a further Rp33trn ($2.3bn) for government facilities. The state will provide an estimated 19.2% of the required funding, while 54.6% and 26.2% will be raised through PPPs and private investment, respectively. The mega-project has the potential to stimulate mass job creation for the country. East Kalimantan is home to around 6000 contractors and 12,000 certified construction workers who will likely be involved, and the government expects the move to spur a 2% rise in the baseline growth projection between 2020 and 2030. Prior to the outbreak of Covid-19, Japan’s Softbank Group offered to invest between $30bn-40bn in the project, and several state-owned and private Chinese infrastructure development firms also registered interest. While East Kalimantan residents have overall welcomed the announcement of the new capital, there are some concerns that high levels of foreign investment will bring an influx of foreign labour, including some unregistered workers alongside those with the right to work in Indonesia. It is important then that the correct policy framework is in place to enable the country to capitalise on interest from foreign investors in a way that does not excessively burden the government, while also ensuring that the domestic workforce is both prepared for, and included, in such an extensive development.

Satellite Towns

While relocating the country’s capital is an integral component in the president’s longterm development plan, Jakarta’s long-standing problems remain. The Jakarta administration has allocated Rp619bn ($43.6m) to the city’s outlying regencies in West Java, namely Bekasi, Bogor, Cianjur and Depok, as well as those in the province of Banten, which includes the Tangerang and Tangerang. The figure has been divided according to perceived regional requirements, and its constituent portions have been made available for infrastructure and human resource development initiatives that support the goals of the RPJMD. Regional governments are to submit proposals detailing how they will utilise the funds, with sustainability and mass-transit connectivity projects favoured over those that promote private transportation.

The number of vehicles entering central Jakarta from Bekasi has been identified as a prime contributor to the capital’s chronic traffic congestion, so the Bekasi regional government has proposed the development of park-and-ride facilities near commuter line train stations to make public transport use more convenient. The proposal is part of a broader Bekasi-Jakarta sustainable development plan, which aims to build health care facilities and waste transportation infrastructure, install street lights and renovate prisons – all of which should add to the construction project portfolio. This synergy between regional proposals and overarching development policy gives the sense of cohesion between national and sub-national government departments as the benefits of the national infrastructure drive become more apparent.

Cement Segment

Indonesia is the second-largest cement producer in South-east Asia, behind Vietnam, and is among the largest in the world. Domestic market leader, Semen Indonesia (SI), went some way to consolidating both the market’s regional position and its own standing by purchasing Holcim Indonesia in December 2018. Gross margins for both SI and its closest competitor, Indocement, improved by 3% and 5%, respectively, in the first half of 2019. These gains have been attributed to a fall in the price of coal, which is often used to fire domestic kilns, and a rise in the price of cement. This has resulted in increased sales revenues for both companies even though sales volumes for both have dipped. While domestic cement firms have the largest share of the market, Sika AG, a Swiss specialty chemicals company for building and motor vehicle supplies, opened its third Indonesian plant, in Bekasi, Greater Jakarta, in December 2019. The company aims to capitalise on the growing demand in the world’s fifth-largest construction market for high-quality building materials through its production of concrete admixtures and mortars.

In January 2020 the Indonesian Cement Association (ASI) requested that the government place a moratorium on the construction of new cement plants so that the industry can better manage current overcapacity, which, according to the ASI, stood at around 25m tonnes per year as of early 2020. Domestic sales volumes fell by 2.05% year-on-year (y-o-y) to 48.8m tonnes during the first nine months of 2019, a trend driven by the availability of low-cost imports, primarily from China. Aggressive pursuit of export sales has been adopted to offload oversupply, with cement and clinker exports rising about 15.4% y-o-y across the first nine months of 2019, from 4.1m tonnes to 4.8m tonnes.

Outlook

With major announcements having reinvigorated the sector throughout the second half of 2019 alongside the prospect of ratifying the Omnibus Law expected to ease barriers to investment, the future looks promising for Indonesian construction when the disruption caused by the Covid-19 pandemic subsides. In the short term the outbreak will slow progress on construction projects due to restrictions on supplies and labour. Looking further ahead, it remains to be seen just how far President Jokowi’s administration will be able to address the land acquisition and bureaucracy problems that have held up several major infrastructure projects. Concerns surrounding foreign companies doing business more freely are not without substance, though the onus will be on local firms to streamline and innovate in order to prepare themselves and their workforces for a more dynamic and competitive market.