Key regional cities transitioning into centres of diversified activity in Indonesia

Stretching 5120 km from the shores of Aceh to the mountains of Papua, Indonesia encompasses 17,000 islands – around 6000 of which are permanently inhabited – and comprises 34 different provinces, each with its own capital city. Within these islands, 300 distinct ethnic groups exist, speaking more than 742 languages between them. Until the turn of the new millennium, centralisation was seen as the best way forward, and economic development policies were strongly skewed towards Indonesia’s main island of Java at the country’s capital Jakarta. After the resignation of former President Suharto in 1998, however, successive administrations have implemented decentralisation policies, aiming to more evenly distribute authority and investment throughout the country’s many diverse regions.

While the bulk of financial investment is still centred on Java, emerging cities have benefitted from increased capital inflows over the past few decades, contributing to rises in household income and overall poverty reduction. Infrastructure development, which President Joko Widodo declared as his primary objective upon taking office in 2014, has been pivotal in the decentralisation agenda. By prioritising numerous strategic transport infrastructure projects, inter-regional connectivity has steadily improved and contributed to the development of Indonesia’s emerging cities.

Governance Structure

Indonesia’s 34 provinces are divided into 514 sub-provincial entities, 416 regencies and 98 municipalities – all of which have equal status in the local government hierarchy. Provinces are led by governors, while regencies and municipalities are respectively headed by regents and mayors. All elected officials serve five-year terms, which can only be renewed one time. The most recent regional elections in June 2018 saw 115 regents, 39 mayors and 17 governors put in power.

The enactment of Law No. 22 of 1999 established the autonomy of regional governments, and was followed by further laws on local government and decentralisation in 2004, 2007 and 2014. Decentralisation legislation has provided considerable autonomy to regencies and municipalities in a number of areas, including tax collection, education, health care, public works, environment and transport. The initial purpose, however, was mainly to serve local interests and to curtail central government autocracy.

Five provinces have special status permitting them a higher level of internal power: Aceh at the northern tip of Sumatra, which has a high degree of autonomy, including the power to implement its own sharia law; Yogyakarta Special Region, which has its own monarch who also serves as governor; Papua and West Papua, which also have considerable autonomy when it comes to domestic affairs; and the Special Capital Region of Jakarta, also known as DKI Jakarta. The special status of Aceh and the Papuan provinces reflects the history of conflict in those regions, while Yogyakarta’s status is the result of the monarchy’s symbolic role during the struggle for independence. Jakarta’s status comes from its role not only as the capital, but also as the largest and most economically powerful city.

Master Plan

In addition to legal changes, in 2011 the government unveiled the Master Plan for Acceleration and Expansion of Indonesia’s Economic Development (MP3EI) as a means to disseminate investment. The plan set a target of making the country one of the world’s top-10 economies in terms of GDP by 2025, and the blueprint remains a central guideline for the government’s general vision. At the scheme’s foundation are six economic development corridors, each focusing on a specific geographic area: Sumatra is to be a centre for processing natural resources and an energy reserve; Java, the driver for national industry and service provision; Kalimantan, the centre for production and processing of mining and energy reserves; Sulawesi, the processor of national agricultural, plantation, fishery, oil, gas and mining resources; Bali-Nusa Tenggara, the gateway for tourism and national food support; and Papua-Maluku Islands, the developer of food, fisheries, energy and national mining. The six corridors are designed to play to their existing strengths, leveraging local competitive advantages to secure further investment. “The Papuan economy in particular has seen increased investments from China,” Agus Yanuar, president director of Samuel Asset Management, told OBG. “Mining activities and fisheries have become important contributors to gross regional domestic product (GRDP). Even outer islands have become increasingly export-oriented towards China.”

Successive government programmes have pursued the goals of MP3EI, and President Widodo, following his election in 2014, confirmed that he would continue with the parts of the plan that aligned with his government’s vision, particularly those that related to boosting maritime and transport infrastructure.

Distribution

Following nearly 20 years of policies aimed at disbursing investment, however, Java’s dominance remains largely unaltered. The Greater Jakarta area, consisting of the municipalities of Jakarta, Bogor, Depok, Tangerang and Bekasi, carries significant administrative weight as all five municipalities are among the 10 most populated cities in Indonesia.

Economic gains are still centred in Java as well, with the island’s GRDP comprising 58.5% of national GDP at the outset of 2018. According to figures from the Indonesia Investment Coordinating Board, Java remains the top investment destination nationwide, attracting 56.3% of all domestic and foreign direct investments in 2017. Four of Java’s five provinces were in the top-five destinations for foreign investment, while all five provinces took in the highest domestic investment in 2017.

However, decentralisation efforts may be affecting development in Greater Jakarta due to the administrative challenges it creates. “Greater Jakarta comprises three provinces, incorporating 9 local governments, which makes it difficult to coordinate public functions and responsibilities between multiple levels of government. The region has to function as one ecosystem with one integrated plan. As an example, the Urban Community of Greater Lyon in France was established to ensure that Lyon and its surrounding local governments plan and manage together,” Bernadia Irawati Tjandradewi, secretary-general of the United Cities and Local Governments Asia Pacific, told OBG.

Funding

Tax powers still largely reside with the central government and are standardised for the whole country. Local governments are not authorised to collect or impose Customs duties, personal income taxes or corporate taxes; however, both regencies and municipalities receive income from relatively minor local taxes, such as property and local services taxes, in addition to funding from central government grants and the profits of their own enterprises.

The three general grants include the General Allocation Fund, which is a lump sum dispersed to all local governments and is intended to pay the salaries of civil servants; the Equalisation Grant, a revenue-sharing scheme under which a proportion of revenues received by the central government from each district – from taxes, mining, and oil and gas sales, for example – is returned to their respective districts; and the Special Allocation Fund, which is a capital financing programme targeting lower-income and rural areas. According to the Ministry of Finance, payment allocations to sub-national governments represented 34.5% of total government expenditure in 2018.

Regional Disparities

Despite efforts to redistribute national funds, economic disparities between Java and outer islands particularly persist with regard to human development. Many local officials were unprepared to take on added responsibilities after decades of centralised governance. Red tape and the misuse of state funds created barriers to development, and local authorities often issued overlapping regulations. At the same time, local concerns such as disaster preparedness did not fall under regional jurisdiction, and crucial central agencies remained underfunded.

With the island of Java accounting for more than half of GDP, its inhabitants have benefitted the most from rising wages and employment prospects. According to 2017 data from Statistics Indonesia (BPS), DKI Jakarta boasted a human development index score of 0.80 in 2017 – the highest in the archipelago – while the poorest provinces of Papua or East Nusa Tenggara are ranked at 0.59 and 0.64, respectively. In September 2018 the number of people living below the poverty line in Papua and West Papua was estimated at 27.4% and 22.7%, respectively, while the average poverty rate across Java’s five provinces was recorded at 10%. Within Java, DKI Jakarta had the lowest poverty rate at 3.6%, while Yogyakarta and Central Java were the highest at 11.8% and 11.2%, respectively.

Urbanisation

According to the latest figures from BPS, Indonesia’s population was 261.9m in 2018. As a result of rapid urbanisation, nearly 148m Indonesians now live in cities. In contrast to India and China, urbanisation in Indonesia over recent decades has been primarily driven by the densification of existing settlements rather than rural-urban migration. Urban growth has been particularly evident on the densely populated islands of Java and Bali, where nearly 60.8% of the population live in cities, according to the World Bank. With the population in 15 Indonesian cities estimated to reach more than 1m people by 2025, improved productivity in emerging urban areas has become a key focus of the Widodo administration. As numerous second-tier and third-tier cities boast closer linkages to the rural sectors – most notably agriculture and fisheries – the modernisation and optimisation of existing rural-urban ecosystems is crucial to help farmers and fishers to benefit from improved market access.

While the bulk of value-added industries, notably manufacturing, remain based in the five provinces of Java, in an interview with OBG, President Widodo reaffirmed his administration’s commitment to Indonesia-centric, as opposed to Java-centric, growth by developing downstream capacities within remote areas.

Regional GDP

According to the World Bank, Indonesia’s GDP amounted to Rp14,168trn ($1trn) in 2017. Preliminary figures on GRDP from the BPS indicate that DKI Jakarta contributed Rp2410trn ($170.9bn), or 17% to national GDP at in 2017. Other major contributing provinces included East Java, with Rp2019trn ($143.2bn), followed by West Java (Rp1786trn, $126.6bn), Central Java (Rp1187trn, $84.2bn), Riau (Rp706trn, $50.1bn) and North Sumatra (Rp684trn, $48.5bn). Meanwhile, the lowest contributors remain the provinces of North Maluku, at Rp32.3trn ($2.3bn) and Gorontalo, with Rp34.6trn ($2.5bn) in 2017. However, such cities hold the highest potential for growth. Gorontalo, while being the smallest contributor to GDP, was the fastest-growing province in Indonesia, expanding by 8.7% in 2017. This was followed by a 7.2% growth rate in South Sulawesi province, the ninth-largest regional economy with a GRDP at Rp419trn ($30bn).

Surabaya

Located in the lowlands around the Kalimas River and home to more than 3m people, Surabaya is Indonesia’s second-largest city and the capital of East Java province. Due to its proximity to major trade routes between the Indian Ocean, the Java Sea, the Straits of Malacca and the Maluku Islands, Surabaya has long benefitted from its prime location as a major port town. According to the latest figures from the BPS, the GRDP of the municipality was estimated at Rp495trn ($35.1bn) in 2017, up 9.7% from Rp451.5trn ($32bn) in 2016. Surabaya is hence increasingly benefitting from a growing middle class and higher consumption levels.

The main contributors to GRDP were wholesale and retail trade, auto sales and repair, which together accounted for around 27.6% in 2017. This was followed by processing industries, with 18.9%; hospitality, food and beverages (15.7%); construction (10%); ICT (5.4%); and financial services and insurance (5.3%).

Local media reported in November 2018 that municipal growth was spurred by reforms to the local bureaucracy and steady improvements to Surabaya’s business and investment climate. Since 2010 the local government has been headed by Tri Rismaharini, who is the city’s first directly elected mayor and its first female leader. Much of her policies focus on educational initiatives and sustainable city development, such as the expansion of public parks and green spaces. Surabaya has also taken on a central role in the government’s infrastructure drive, with its Port of Tanjung Perak – Indonesia’s second-largest seaport – named as one of the top-five ports to be further expanded and modernised by 2045 under the government’s Sea Toll Road policy (See Transport & Infrastructure chapter). Moreover, December 2018 saw the inauguration of the completed 741-km section of the Trans-Java Toll Road that passes through Surabaya and Java, further interlinking the country’s two largest cities and economies.

Bandung

With a population of 2.4m people, Bandung is known particularly for its textiles industry and ICT sector. The city’s GRDP reached Rp240.1bn ($17m) in 2017, according to figures from the BPS, with the wholesale trade, retail, auto sales and repair sectors contributing 26.6%, followed by processing industries (19.3%) and the ICT sector at (10.1%).

Bandung’s digital economy includes a 6-ha site dedicated solely to technology called Technopolis, which has helped attract strong investments such as that received from UTC Aerospace Systems. The city has 50 higher education institutions, including the Bandung Institute of Technology, that provide skilled human resources.

With Indonesia overtaking Brazil in 2016, the country is now the fifth-largest aviation market in the world, behind the US, China, India and Japan. Capitalising on this, Bandung has emerged as a domestic hub for aircraft manufacturing. “Local aerospace research centres, as well as major aviation and defence industries, have accelerated their development in Bandung,” Ludovic Boistot, head of country Indonesia at AIRBUS, told OBG. “Companies such as Dirgantara Indonesia continue to develop further their activities, and have successfully begun to expand their reach beyond their domestic markets to international markets.”

Medan

Situated in the North Sumatra province and home to some 2.1m people, Medan is the capital of Sumatra and Indonesia’s fourth-largest city. Traditionally, the city’s economy was based largely on agricultural products, such as coffee, tobacco, rubber and tea, but recent years have seen Medan keen to establish itself as a gateway for tourists exploring Sumatra.

South of Medan lies Lake Toba, the largest volcanic lake in the world. The site was identified as one of the 10 New Balis, a programme that is largely designed in order to attract tourists to new destinations in the country by upgrading airports and developing regional attractions (see Tourism chapter). Recent years have also been characterised by noticeable increases in manufacturing capacities.

Medan’s GRDP grew by roughly 9.8% to reach Rp204.3bn ($14.5m) in 2017, the bulk of which is made up of its wholesale trade, retail, auto sales and repair sectors at 25.2%, followed by construction (19.2%), processing industries (14.7%) and real estate (8.7%).

Makassar

As the largest city on Sulawesi and fifth-largest Indonesian city, Makassar is home to more than 1.5m people and has long been a prominent fisheries and agricultural centre for Indonesia. Building on its strong maritime tradition, Makassar is further looking to expand its role as a commercial capital of eastern Indonesia through significant investments in its port facilities. Makassar New Port is a flagship project of the Global Maritime Fulcrum policy, which set out a range of measures to strengthen the maritime and logistics sectors, with an emphasis on port infrastructure and connectivity. The port was expected to be inaugurated in the first quarter of 2019, although had yet to open as of March. Makassar has also succeeded in diversifying its economy towards value-added sectors such as industry, the digital economy and tourism.

Local GRDP grew by an estimated 11.4% from Rp128.4bn ($9.1m) in 2016 to Rp143.1bn ($10.1m) in 2017. A breakdown of GRDP by sector for 2017 was unavailable, but 2016 figures indicate that processing industries contributed 20.2% to GRDP, followed by wholesale and retail trade (19%), construction (17.1%), ICT (9%) and educational services (8.8%).

Batam

Located in the Riau Islands province off the coast of East Sumatra, Batam is home to more than 1.1m inhabitants. The city was declared Indonesia’s first free zone in 2007, and has grown in importance as an investment destination for foreign firms given its location in one of the globe’s busiest shipping channels. Since then, the city has played an important role in connecting Indonesia with the neighbouring economy of Singapore – Indonesia’s third-largest trade partner located some 30 km away – and other global economies by offering solid infrastructure, streamlined procedures for business licensing, flexible labour regulations, tax breaks and Customs duty exemptions.

The Port of Batam has been identified as one of the six ports to be developed under the Global Maritime Fulcrum policy and has been targeted as a key investment destination under the Chinese government’s Belt and Road Initiative. In December 2018 President Widodo announced that the Batam Industrial Development Authority would be incorporated into the local government, a move that is expected to pave the way in turning Batam into a special economic zone (SEZ).

The city is also fast becoming a centre of digital innovation. In March 2018 officials launched phase one of the 100-ha Nongsa Digital Park. As Batam’s first largescale commercial project, the park is aimed at attracting tech entrepreneurs from Singapore and Indonesia to create a private digital ecosphere for the mutual benefit of both countries. The park is expected to attract $500m in investments once it comes fully on-line; so far, the park is 30% complete. According to the latest BPS figures, Batam’s GRDP was estimated at Rp137.5bn ($9.7m) in 2016, with processing industries contributing 55.5%, followed by construction with 19.5%.

Strategic Infrastructure

Improving connectivity through infrastructure development has constituted the centrepiece of the government’s strategy to spur inclusive local economic growth. Central to this objective has been the institution of the Committee for Acceleration of Prioritised Infrastructure Delivery (KPPIP) in 2014. Using institutional data, KPPIP has identified a total of 277 national strategic infrastructure projects spread across a broad range of economic sectors. In line with the Widodo administration’s decentralisation goals, more than half of the KPPIP’s priority projects are being built outside of Java. While the programme has run into its share of issues, it was reported that 30 strategic projects are likely to be completed by the third quarter of 2019. “Planning issues, land acquisition, funding, construction and licensing have constituted the main challenges for Indonesia’s priority infrastructure projects,” Wahyu Utomo, chairman of the implementation team at the KPPIP, told OBG. “However, noticeable improvements have been made with regard to land acquisition over the last 12 months.”

A number of strategic infrastructure projects will be key in further connecting the economies of various provinces, as well as encouraging investment opportunities in emerging cities. With the Jakarta-Surabaya section of the aforementioned Trans-Java Toll Road completed in December 2018, various other road projects elsewhere on Java have been tendered as public-private partnerships (PPPs). Developers aim to complete the entire 1150-km network by end-2019.

The bulk of strategic infrastructure projects include 83 toll roads, 61 dams and irrigation networks, 28 SEZs, 14 railway projects, 10 seaports, the 10 New Balis programme, nine electricity infrastructure development programmes and four airports, among others. These projects have been identified in cooperation with regional governments, and the administration of President Widodo has actively encouraged the utilisation of PPPs to provide urgently needed funding, enable knowledge transfer and encourage completion on time.

Officials labelled the Trans-Sumatra Toll Road as a national strategic infrastructure project, although the 15 sections currently under construction have been contracted to state-owned enterprises (SOEs). Expected to be fully operational by 2024, the road will run from the northern city of Aceh to Lampung in the south, with the sections under construction set to cost Rp206.4trn ($14.6bn). “The Trans-Sumatra Toll Road will further interconnect the economies of Java and Sumatra and foster significant economic growth,” Darmawan Prasodjo, senior adviser to President Widodo and commissioner at state-owned electricity company Perusahaan Listrik Negara, told OBG.

Outlook

With Indonesia’s provinces and emerging cities seeing sustained expansion, public and private investments to improve inter-regional connectivity are likely to result in more balanced growth across the archipelago. In order to reduce regional economic disparities and foster inclusive growth, a decentralised policy mix is required to help address province-specific challenges. While incentives for small and medium-sized enterprises and employment-spurring policies are commonplace on Java, access to social assistance schemes and basic infrastructure remain more imminent needs in remote and lower-income areas.

Decentralisation has yet to provide balanced growth across Indonesia, thus, regional economic development must be further optimised through the provision of infrastructure and the strengthening of the manufacturing sector outside of the main cities. Regarding the latter, SEZs have proven effective in attracting investments in remote areas. Knowledge transfer remains crucial, as specialised workers are required in labourand capital-intensive industries. In this regard, the Widodo administration announced that the upcoming National Mid-Term Development Plan 2020-24 would particularly focus on human capital development – a focal point that is expected to nurture the growth of the private sector in emerging cities.

Despite clear progress and notable success stories, regional city budgets remain dependent on central government funding allocations, while local infrastructure projects are still largely contracted to SOEs. Thus, more investment will be needed to develop the business and investment environment in regions outside of Java.