Indonesia's regional cities embrace diversification

Stretching 5120 km from the shores of Aceh to the mountains of Papua, Indonesia is one of the world’s most diverse countries. An archipelago that reaches across time zones, 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.

Given this diversity, the country’s regional policy is crucial to sustainable progress. In the past, under Jakarta- and Java-based regimes, centralisation was seen as the best way forward. The post-Suharto era, however, has seen Indonesia move away from this concentration of power towards an approach that seeks to distribute authority and investment more evenly throughout the country’s many diverse regions. While this policy has not always lived up to expectations, it has seen a greater flow of investment into Indonesia’s second-tier cities, opening up new opportunities for investors. The current government is determined to advance the growth of these cities even further by dividing the country into six economic corridors, while also pursuing Indonesia’s maritime advancement via the Sea Toll Road strategy. The years ahead are set to see regions beyond Jakarta and Java playing a larger role in the country’s economic growth.

PROVINCES: Of Indonesia’s 34 provinces, five have special status: 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 reflect historical 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.

Other provinces are governed in a similar way, under the decentralisation scheme initiated in 2000 by the central authorities. This initiative gave increased financial autonomy and control over health and education to sub-provincial entities – also known as regencies or municipalities, which tend to be rural areas or urban areas, respectively. Both regencies and municipalities have the same standing in the local government hierarchy.

REGIONALISATION: Further laws regarding local government and decentralisation were enacted in 2004 and 2007. The dissemination of power to municipalities and regencies initially created some challenges: after so many years of centralised control they lacked the capacity to deal with issues, and overlapping authorities were creating contradictory rulings. Eight new provinces were created in the post-2000 period; between 2000 and 2013 the number of regencies rose from 268 to 413, while the number of municipalities grew from 73 to 98. There has since been a concerted political effort to rein in the creation of new local government units. According to OECD figures, there were a total of 508 regencies and municipalities in the country in 2015.

Regencies are headed by a regent, while municipalities are led by a mayor. Both officials are elected for five-year terms, which can only be renewed once. The last provincial elections were held in 2015, when 224 regents, 36 mayors and nine governors were elected. In early 2017 some 100 municipalities, regencies and provinces – including Jakarta – held ballots, and a further 39 municipalities, 115 regencies and 17 provinces will hold elections in 2018. Given the number of elections, local balloting had previously been staggered, but because this resulted in an almost continuous election cycle, they are being held in increasingly large groups until the first truly concurrent regional elections, scheduled to take place in 2024, are held.

FUNDING: 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. A minimum allocation grant comes from the General Allocation Fund. The rest of the funding comes from the Equalisation Grant, a tax-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. This makes certain districts wealthy, while others may be dependent on the Special Allocation Fund, which is a general-purpose grant issued to remote and less-developed areas.

According to the most recent figures available from the OECD, subnational government finance accounted for 6.8% of GDP in 2013, which also represented 36.4% of total government expenditure. Some 80.9% of this funding went to local authorities’ current expenditure, while only 19.1% was left for investment. Locally generated revenue accounted for 16.8% of total revenue obtained by the provincial, regency and municipal authorities.

POPULATION: According to World Bank figures, Indonesia’s population stood at around 260m in 2016. As much as 60% of the population lives on Java, making it the most populated island on earth. There are more than 1000 people per sq km in the Special Region of Yogyakarta, Central Java, Jakarta, Western Java and Banten. Java also accounted for 54% of Indonesia’s total investment in 2016, and its five provinces were the top-five domestic direct investment (DDI) destinations, while four of these were in the top-five foreign direct investment (FDI) destinations that year – the fourth spot went to South Sumatra. Central Sulawesi was in sixth place, Papua seventh, East Kalimantan eighth, Central Java ninth and North Sumatra 10th. While they did not stand out in FDI rankings, West and Central Kalimantan did better in DDI rankings, taking sixth and eighth places, respectively, while Riau made the number 10 spot. These are the main investment destinations in the country, but they vary widely in terms of population density: Central and Eastern Kalimantan and Papua have densities of fewer than 30 people per sq km, while South Sumatra has a density of 50-99 per sq km, and Central Sulawesi 30-49.

Average wages vary widely as well: the highest-paid Indonesians are in DKI Jakarta, with an average Rp3.98m ($300) per month in 2016, while the lowest pay rates were in Lampung, on the southern tip of Sumatra, with Rp1.85m ($139) per month. Other high-earning provinces included Banten, with Rp3.79m ($286); Papua, with Rp3m ($226); Riau, with Rp2.9m ($219); East Kalimantan, with Rp2.87m ($216); and West Java, with Rp2.7m ($204). The average monthly salary for Indonesians was Rp2.4m ($181), much lower than many provincial averages.

GDP BY CITY: In 2016 Indonesia’s GDP stood at Rp12,407trn ($935.2bn), at current market prices. In terms of gross regional domestic product (GRDP), the top contributor was DKI Jakarta, with Rp2180trn ($164.3bn), while the lowest was North Maluku, at the top of the Maluku island chain, with Rp29.2trn ($2.2bn). Other major powerhouses of the economy were East Java, with Rp1860trn ($140.2bn); West Java, with Rp1650trn ($124.4bn); Central Java, with Rp1090trn ($82.2bn); Riau, with Rp682trn ($51.4bn); and North Sumatra, with Rp628trn ($47.3bn).

Indonesia’s various regions are marked by an analogous diversity in population, income and GRDP, with a central core of provinces – mainly those on Java, Sumatra and Kalimantan – contributing the most to GDP. In recent times local and national governments have sought to change this pattern by encouraging investment and growth elsewhere in the country. Now, these efforts and their complementary local initiatives are beginning to yield positive results in several key emerging cities.

ROADS & CORRIDORS: With investment dispersal in mind, the government unveiled the Master Plan for Acceleration and Expansion of Indonesia’s Economic Development (MP3EI) in 2011. This set a target of making the country one of the world’s top 10 economies in terms of GDP by 2025, and it remains a central guideline for the government’s general vision for Indonesia. At the foundation of this bold scheme are six economic development corridors, each targeted at developing a specific economic area with a geographic focus: Sumatra is to be the centre for processing natural resources and the nation’s 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 play to their existing strengths, leveraging local competitive advantages to secure further investment and growth. Successive government programmes have pursued the goals of MP3EI, and President Joko 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 in relation to boosting maritime and transport infrastructure.

In terms of the corridors’ current shares of overall investment, Java received 53.6% of the total DDI and FDI, or Rp328.7trn ($24.8bn) in 2016; Sumatra had 19.2% (Rp117.6trn, $8.9bn); Kalimantan 11.2%, (Rp68.8trn, $5.2bn); Sulawesi 8.4% (Rp51.3trn, $3.9bn); Maluku and Papua 5% (Rp30.7trn, $2.3bn); and Bali and Nusa Tenggara 2.6% (Rp15.7trn, $1.2bn).

MARITIME: Set out in the National Medium-Term Development Plan for 2015-19, the Sea Toll Road scheme seeks to enable Indonesia to realise its maritime potential. Trade, transport and fisheries are given special focus, with the goal of strengthening the system of integration between islands and ports. Of Indonesia’s 111 seaports, 24 are currently being expanded, with 19 of these serving as feeder ports to support five major hub ports: Belawan/ Kuala Tanjung in Sumatra; Tanjung Priok/Kali Baru in Jakarta; Tanjung Perak in Surabaya; Makassar in South Sulawesi; and Bitung in North Sulawesi.

While all these ports will likely see more investment as their facilities are updated, the scheme also seeks to reorganise the operations of the shipping industry. For example, ports located in the west will become more competitive as destinations for international cargo, which often goes to either Singapore or Malaysia for trans-shipment on to Indonesia, or to Jakarta’s Tanjung Priok for break-up and distribution. Meanwhile, in the eastern part of the country, a boost in feeder and hub ports should help reduce the comparatively high transport costs, which will bring prices more in line with the western part of the country. Having five hub ports also concentrates international shipping in these places, allowing for more straightforward management and security. “However, an important aspect of this success will be clarity,” Sofie Tolk, South-east Asia representative for the Port of Rotterdam, told OBG. “It is not clear if the government wants to focus on a container port or more international connections for the North Sumatra project,” Tolk added.

In order to increase inter-regional connectivity, six new regular cargo routes are being introduced and 100 more routes are being optimised. In 2015 the president also announced plans to expand the fleet, with 609 vessels to be acquired or built by 2019, but this policy appears unlikely to be completed. “The government maintained its policy for around two years until the minister was replaced and the budget suddenly ran out,” Yance Gunawan, president director of Dumas Tanjung Perak Shipyard, told OBG.

These policies aim to reduce logistics costs from their present level of 26% of GDP to 19% by 2020, and to 9% by 2035. This would benefit Indonesia’s regions and emerging cities, as it would spread economic growth beyond the Javanese heartland.

PRIORITY PROJECTS: Meanwhile, the 2017 national budget also set aside funds for various strategies to directly affect particular regions. The budget saw a 5.5% increase in overall spending, with a record high of Rp387.3trn ($29.2bn) for infrastructure, up 22% from 2016. There were 30 projects prioritised in the budget for the 2016-19 period, the bulk of which are located outside of Java. For example, there are projects running from the East Kalimantan railway to the Trans-Sumatra toll road, and from the Makassar-Parepare railway line to the Bontang oil refinery. The power and energy sectors are also being enhanced through the installation of new power lines and plants, which will increase both the reach and the capacity of the domestic grid.

DIGITAL REVOLUTION: Inter-regional connectivity is about not only hard transport and logistics infrastructure, but also ICT. This sector is central to current plans, with a forward-thinking goal of creating smart cities across the archipelago by integrating the internet of things into infrastructure. Apart from Jakarta, several cities have made great strides in this regard, such as Makassar, Surabaya and Bandung. The latter was the first city in Indonesia to construct a smart city command centre.

Indonesia now has more than 300 public apps available to meet a host of different needs for residents and visitors. It is possible to access everything from live transport updates to local government licensing forms. Citizens can even push a panic button on their smart phones if they are in danger, which will send a message to the command centre within 10 seconds. Alarm functions like these enable city authorities to dispatch services rapidly as needed, increasing efficiency and providing better connectivity between the government and citizens.

In order to establish a favourable environment for tech start-ups, the Ministry of Communications and IT launched its 1000 Start-ups Digital National Movement Campaign in 2016, which aims to create 200 high-quality digital start-ups that solve real market problems each year until 2020, ideally reaching a combined capital of $10bn.

The campaign operates across Indonesia, with a special emphasis on developing the digital economies in Bandung, Surabaya, Yogyakarta, Semarang, Malang, Medan, Makassar, Denpasar, Pontianak and Jakarta. Surabaya and Makassar are two of the three cities that have completed the incubation stage, with online facilities for cattle ranchers, apps for health monitoring and dieting, tourist platforms and online job markets among the initial start-up cohort. Both local and national governments hope initiatives like this will encourage the development of cities throughout the country, enabling them to innovate quickly, leapfrogging into the digital age.

BANDUNG: Bandung is known particularly for its textiles industry and ICT sector. The city’s digital economy includes the Technopolis, a 6-ha site dedicated solely to technology. The ICT park has helped attract strong investments – such as that from UTC Aerospace Systems – to this 2.4m-inhabitant city, while talks were also under way with Apple in mid-2017. The city has 50 higher education (HE) institutions, with the aerospace and aviation sectors also finding their niches in its economic make-up.

The digital sector can benefit from prestigious local HE facilities, especially the Bandung Institute of Technology, and provide opportunities for young people. According to Ridwan Kamil, mayor of Bandung, 60% of the population is under 40 years old.

The mayor has also encouraged the establishment of more businesses through a variety of new initiatives. For example, he helped remove registration fees for small and medium-sized enterprises. He has also been a strong advocate for public-private partnerships (PPPs) as a means of securing funding for infrastructure developments. PPPs drove a number of recent projects, including the Bandung light rail transit (LRT) system, cable cars, buses, highways and hospitals. Transport is particularly important for the city, as it receives some 6m tourists annually. These visitors are drawn in by the cooler weather the higher altitude brings, and the wide array of restaurants, nightclubs, hot springs and outlet stores.

CITIES OF SUMATRA: The neighbouring island of Sumatra features two other cities that have been receiving a great deal of attention from investors in recent years. One of them, Palembang, is the island’s second-largest conurbation and one of the oldest in the region. In 2016 the region had a GRDP of Rp118.8trn ($9bn), with the 2010 census recording a population of 1.7m. Palembang hosted the 2011 South-east Asian Games, which places it, along with its co-host Jakarta, in good stead as one of the venues for the 2018 Asian Games. In 2017 the city is also hosting the third-most-popular festival in the country: the Sriwijaya Festival, which showcases dance, drama, art and culture.

Meanwhile, in preparation for the Asian Games, the city has created an extensive tourism campaign, launching nine tourism development programmes. These aim to beautify and restore the local environment, the Besak Fort and the Musi River area. The Al Quran Al Akbar religious site in Gandus has also been restored, and a pedestrian area has been created on Jalan Sudirman, the city’s main downtown shopping street. The city aims to receive 1.2m domestic tourists and 12,000 foreign visitors in 2017. In 2016 there were 900,000 and 9000, respectively.

The games have also provided impetus for Palembang to invest in its transport infrastructure. The new LRT was reportedly 40% complete in April 2017 and due for completion by January 2018. There will be five LRT routes in this Rp9.4trn ($708.6m) inter-modal scheme, with 23.5 km of line connecting the city to Sultan Mahmud Badaruddin II International Airport. At some of the 13 stops along this route passengers will also be able to transfer to other transport, increasing the city’s connectivity.

Further north, the island’s largest city, Medan, has been expanding rapidly. With over 2m inhabitants, it is now the fourth-largest city in Indonesia. Medan is ranked third among the second-tier cities in terms of value added, after Surabaya and Bandung. Traditionally, the city’s economy was based largely on agricultural products, such as coffee, tobacco, rubber and tea, but recent years have seen Medan also develop a stronger manufacturing base.

EYES ON TRANSPORT: Transport has been another recent focus for the city, with the local government and the Ministry of Finance signing a deal in June 2017 to cooperate on mass transit projects. As a result, an environmental impact assessment is currently under way for a Rp6.3trn ($474.9m) LRT in the city, which will be integrated with the existing bus rapid transit system. Contracting is due in 2018, financing closure in 2019 and construction should begin soon thereafter. Other major local transport projects include the proposed $10bn railway link between Medan and Parapat, which is in the north of the island. Investors from China and Russia have expressed interest in this project, and federal funds have allocated for its construction as well. The railway would cut current road travel time between Medan and Parapat in half. Another scheme is the Trans-Sumatra toll road, to run from Banda Aceh to the island’s southern tip and to the crossing to Java. Medan is an important node for this route, and work on 568 km of toll roads is scheduled for 2017.

Medan’s Kuala Namu International Airport is also undergoing development. Opened in 2013, and 26 km east of the city centre, it is already the country’s second-largest airport and was the first such facility in Indonesia to offer an integrated rail link. In January 2017 the Ministry of Transport formally invited investors to participate in the next phase of the airport’s development – the ministry foresees it becoming a hub for the whole of western Indonesia.

MANADO: The capital of North Sulawesi, Manado, is set to become a more noteworthy investment destination in coming years. After Makassar, it is the second-largest city on the island with a population of 675,000 as of 2010. The region has been identified as a key contender for the One Belt, One Road initiative, which could drive significant economic growth in Manado and the region in general.

The city has long acted as a jumping-off point for much of the rest of the island, with tourism quickly becoming a key pillar of the local economy. Manado offers impressive temples, and – because the majority of the region’s inhabitants are Christian – the second-tallest statue of Jesus Christ in Asia. Nearby lies a range of lakes, volcanoes and marine national parks, offering renowned snorkelling and scuba diving. The city is also a cultural destination, hosting the 2017 Indonesian Film Festival in November.

According to Statistics Indonesia (BPS), of all airports in the country, Sam Ratulangi International Airport saw the greatest year-on-year rate of increase in arrivals in May 2017: this figure was up 449% from May 2016, from 1018 to 5589. Many of these new visitors came from China, after a number of direct flights to various Chinese cities were introduced. Lion Air, for example, launched direct flights between Manado and Shanghai in August 2017.

NEW CAPITAL: Another city of note is Palangkaraya, which was being considered as a possible site for the new capital of the country. It is a relatively new city, with construction starting in 1957, on wilderness alongside the Kayahan River. It is now known as a centre for education, as has a variety of universities and colleges, while its river – the largest in Central Kalimantan – is an important highway for goods flowing from the sea to the heart of Borneo.

For many years the government has considered relocating the country’s administrative and legislative centre, with Jakarta increasingly suffering from overcrowding and environmental problems. Palangkaraya – currently the capital of Central Kalimantan – is not affected by the issues that Java has with tectonic activity and the Indonesian border, and it has far more room for expansion than Jakarta. President Sukarno was one of the first to name it as a possible site for such a metropolis.

Alternative cities that have been proposed include Banjarmasin, in South Kalimantan; Pontianak, in West Kalimantan; and Palembang, in South Sumatra. Sites for an entirely new city as the next capital have also been proposed, such as Kota Merdeka in Central Kalimantan, and a site between Balikpapan and Samarinda in East Kalimantan. As of July 2017 the National Development Planning Agency was reportedly conducting a feasibility study in three provinces, although the exact locations have not been publicly announced. Despite other locations in Java previously being seriously considered, the new capital will almost certainly be located elsewhere, and Kalimantan is a very strong contender to be home to the next capital city.

OUTLOOK: Indonesia’s secondary cities offer a wide range of opportunities, as the overall economic growth and decentralisation policies make municipalities and regencies increasingly important players. Although economic prospects were highly concentrated in Java in the past, the number of middle class and affluent citizens in other locations has significantly increased in recent years.

Many predict that the rate of growth among such populations will be higher outside of Java in years to come. By 2020 the number of cities with a middle class and affluent population of more than 1m is expected to jump from 12 to 22. Indonesia’s diversity is one of its strengths, and the sheer scale of the archipelago and its numerous possibilities make the country’s second-tier cities some of the most promising investment destinations in the region.