How Indonesia is decentralising prosperity and investment

Indonesia is characterised by substantial cultural diversity. The archipelago is made up of more than 17,000 islands, of which 6000 are permanently inhabited by 267m people. 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 and the country’s capital Jakarta. After the resignation of President Suharto in 1998, however, successive administrations have implemented a series of decentralisation policies, aiming to spread out authority and investment across the country’s diverse regions.

Among efforts to more evenly disperse investment, August 2019 saw the government announce that a new capital city would be built in the province of East Kalimantan on the Indonesia-controlled part of Borneo. The city will provide a more accessible economic and commercial centre for Indonesia’s eastern inhabitants, and is expected to attract major investment, transforming a region known for its agricultural and mining activities into the country’s administrative centre (see analysis). This, alongside the emergence of a number of cities as increasingly key economic players, is opening up a wealth of business opportunities beyond Java.

Decentralisation

Economic disparities exist throughout Indonesia, and the process of successfully devolving government authority is complex. A large population coloured by cultural, ethnic and linguistic differences means that the task of implementing effective regional governance while keeping the country on course to meet its overall development goals presents multiple challenges. Among the responsibilities now carried out at the regional level are some areas of tax collection, health and education services, and local infrastructure development – although the central government still directs major infrastructure projects.

A 2018 World Bank investigation into the success of Indonesia’s decentralisation process found that better coordination was required between national and subnational governments to ensure the appropriate allocation of state funding. Moreover, a lack of transparency has historically been a serious concern, with one media outlet reporting in 2017 that the decentralisation era had, up to that point, seen 343 regents and mayors, and 18 governors investigated on corruption charges. Policies to increase and enforce transparency and coordination, therefore, will be key to enabling more inclusive growth across the country.

Governance & Distribution

Regional government autonomy is enforced by Law No. 22 of 1999, with legislative updates issued in 2004, 2007 and 2014. There are 416 regencies and 98 municipalities – each assuming equal status in the regional government hierarchy – spread across the nation’s 34 provinces. Provinces are led by governors, regencies by regents and municipalities by mayors, with elected individuals authorised to serve a maximum of two five-year terms.

Around 57% of the population lives on Java. West Java is the most populous province, housing more than 48m people. Of the country’s 10-most-populous cities, eight are situated on Java and the remaining two are on neighbouring Sumatra, which is Indonesia’s westernmost island. This westerly concentration is also indicative of Indonesia’s economic activity, and the imbalance in human and commercial resource distribution.

Figures for gross regional domestic product (GRDP) indicate that Jakarta contributed Rp2599trn ($183.2bn), or 17.34% of the total in 2018, according to Statistics Indonesia (BPS). This was followed by East Java, which accounted for Rp2189trn ($154.3bn), and West Java with Rp1962trn ($138.2bn). To compare, the lowest performing regions of Maluku, Gorontalo and North Maluku contributed Rp43.1trn ($3bn), Rp37.7trn ($2.7bn) and Rp36.5trn ($2.6bn), respectively. While such figures illustrate regional economic disparities, GRDP growth for Maluku, Gorontalo and North Maluku stood at 5.9%, 6.5% and 7.9%, respectively, outperforming the national GDP expansion of 5.2% that year.

Industry 4.0

Decentralisation is part of a broader strategy to make Indonesia one of the world’s top-10 economies by 2030. To this end, the government unveiled its Making Indonesia 4.0 roadmap in 2018. The plan is geared towards helping integrate new technologies emerging as part of the Fourth Industrial Revolution (see Industry chapter). President Joko Widodo, better known as President Jokowi, has accordingly called for an acceleration of ICT skills development to enable the country’s young, digitally literate population to spearhead the modernisation of local industry. Vocational training facilities are being tied in with wider infrastructure and economic development initiatives, many of which are outside of Jakarta, with specialty colleges and polytechnics appearing on strategically developed business and industrial parks to improve access to high-quality training and education.

Shifting demographics also highlight the urgent need for nationwide skills training. Rapid urbanisation means 15 of Indonesia’s emerging cities will likely surpass the 1m-person mark by 2025. These second- and thirdtier cities are expected to provide vital linkages for rural communities, giving agricultural workers better access to markets, while offering opportunities for skills development and value-added processing. “Among the primary requirements for skills development in Indonesia is the improvement of local training centres,” Bhima Yudhistira, economist at the Institute for Development of Economics and Finance, told OBG. “Part of this improvement must involve tailoring curricula to the needs of local industry,” he added.

Strategic Zones

Special economic zones (SEZs) have become a major focus for the government. The proliferation of these is expected to attract $50bn of investment in the decade to 2030. Measures aimed at drawing capital to the zones include extended tax holidays, preferential utilities rates, exemption from value-added taxes and the removal of specific industries from Indonesia’s negative investment list. Upon approval from the National Council for SEZs, the government will grant tax breaks to investors based on the size of their investment. Legislative and regulatory procedures pertaining to SEZs are also significantly more relaxed, affording a smoother route to commencing operations and allowing investment capital to be more readily absorbed into the local economy. The strategic location of SEZs along the regional economic corridors and a focus on specific industrial sectors, such as manufacturing or tourism, is based on a range of factors. These include local access to natural resources, natural attractions, accessibility of logistics hubs and existing regional economic strengths. This allows for the provision of specialised infrastructure and can simplify value-added processes through the creation of business clusters and industrial estates.

The development of SEZs is not without challenges, however. Due to high demand, the cost of relocating to SEZs in Indonesia is high, and for those in early stages of development, the necessary infrastructure may not yet be in place. However, incentives can help to offset any initial outlay. Moreover, modern transportation and logistics infrastructure should help add to the medium- to long-term appeal. Although Jakarta remains the investment capital of the country, the emergence of innovative regional offerings is allowing second-tier cities to develop distinct economic roles.

Surabaya

Surabaya, the capital city of East Java, is Indonesia’s second-largest city, with a population of over 3m. Surabaya has also taken on a central role in the government’s infrastructure drive. The Port of Tanjung Perak – the country’s second-largest seaport – was named as one of five ports to be further expanded and modernised by 2045 under the government’s Sea Toll Road policy, while December 2018 saw the completion of the Jakarta-Surabaya section of the Trans-Java Toll Road. Furthermore, the announcement that a second international airport will be built on its periphery leaves the city well positioned to experience increased trade and commerce. The new airport is intended to complement ongoing tourism initiatives, which saw the national park in Bromo Tengger Semeru chosen as one of the designated 10 New Balis to attract tourists to new destinations (see Tourism chapter).

As East Java’s main population centre, and due to its convenient proximity to several busy domestic and international shipping routes, the Surabaya municipality will continue to be the fulcrum of the province’s economic activity. Preliminary figures from BPS show that Surabaya’s GRDP for 2019 amounted to Rp581trn ($41bn), up from Rp539trn ($38bn) in 2018. The top contributors to the local economy were wholesale and retail trade, auto sales and repair (27.8%); processing industries (18.8%); hospitality, food and beverage (16.5%); construction (9.8%); and logistics (5.4%).

Looking ahead, the government plans to open two new SEZs in Surabaya’s surrounding areas, while in September 2019 it was announced that construction would commence on a 715-km Jakarta-Surabaya rail link in 2022. Enhanced connectivity with Jakarta is intended to facilitate population dispersal along the aforementioned transport corridors and stimulate business between Indonesia’s two largest urban areas.

Bandung

With a population of 2.5m, Bandung is the capital city of West Java province. Traditionally, the city was characterised by a thriving textiles industry; however, Bandung has more recently developed its ICT sector. In 2017 it was identified as one of the flagship cities of the 100 Smart Cities initiative – a drive to implement smart technology in 100 urban centres. BPS statistics show Bandung’s GRDP stood at Rp289trn ($20.4bn) in 2019, up from Rp264.6trn ($18.7bn) in 2018. Wholesale, retail and automotive sales and repairs provided 26.5% of that figure, while processing industries, logistics and ICT contributed 18.7%, 10.8% and 10.3%, respectively.

Bandung’s status as a burgeoning digital economy is credited to the now governor of West Java, Ridwan Kamil, who attracted major investment in the city’s ICT industries during his 2013-18 tenure as mayor. The introduction of an online application process for small and medium-sized enterprises made the city highly attractive to tech start-ups and entrepreneurs, allowing them to circumvent bureaucratic processes. Since becoming governor of West Java, Kamil has proposed moving the province’s capital to another city, citing logistical inefficiencies as a hindrance to administrative productivity. The central government has, however, questioned the wisdom of such a move, and as of April 2020 no official ruling had been made.

Makassar

Makassar is the largest city on Sulawesi, with a population of 1.6m. A strong agricultural heritage, which has generated significant trade through farming and fisheries industries, means the city is well-positioned to contribute substantially to Sulawesi’s role as the processor of national agricultural, plantation, fisheries, oil, gas and mining resources. The municipality’s GRDP stood at Rp178trn ($12.6bn) in 2019, an increase on Rp160.2trn ($11.3bn) in 2018, according to BPS data. The contribution of the top-three industries was relatively evenly spread between wholesale, retail and automotive sales and repairs, which comprised 20.5% of the total; processing, with 18.3%; and construction, which contributed 18.2%. The ICT and education services segments also played an almost equal role, contributing 9.1% and 8.8%, respectively.

Building on its strong maritime tradition, the Rp89trn ($6.3bn) 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. As of January 2020 the first of four phases had been completed, with stacking capacity expected to grow from 500,000 twenty-foot equivalent units (TEUs) to 17.5m TEUs by 2022 and full completion planned for 2025. Improved interconnectivity with Sulawesi, Papua and Maluku is intended to help stimulate economic growth in the east of the country. Additional stages of Makassar New Port’s development will see it established as the nucleus of a new SEZ by 2022, which would further incentivise investment in the port and its surrounding areas.

Batam

Batam, one of the Riau Islands, is advantageously situated on the Malacca Strait, just 32 km from Singapore, which makes the island of prime significance to the strategic relationship between the two nations. Batam is a free trade zone, and goods produced there are exempt from some Customs rules, including taxes and levies. This has historically stimulated significant levels of trade, making the island central to value-added processing and manufacturing. However, dwindling investment in recent years prompted a streamlining of Batam’s governance structure and the approval of two upcoming SEZs – one surrounding Hang Nadim International Airport, aimed at boosting tourism-related business activity, and the other in the island’s north-eastern Nongsa area, intended to catalyse growth in digital and manufacturing economies.

Despite the recent dip in investment, Batam’s GRDP rose from Rp151trn ($10.6bn) in 2018 to Rp164trn ($11.6bn) the following year, according to BPS data. Processing industries and construction together accounted for nearly three-quarters of that figure, contributing 54% and 20%, respectively. ICT industries showed the strongest increase, at 12% over the period. This was followed by the hospitality, food and beverage sector, which was up 9.6%. The Riau Islands were Indonesia’s second-most-popular tourist destination in 2019, attracting 2.5m visitors, of which 80% came from neighbouring Singapore.

Signalling hope for increased investment in the future, Indonesia plans to connect Batam with its neighbouring island of Bintan through the construction of a 7-km sea bridge. Planned for completion in 2024, the Rp4trn ($282m) project would lower the cost of transportation between the islands and position Batam as an alternative shipping destination to Singapore. Further connecting the two countries, Nongsa Digital Park (NDP), which came on-line in 2018, is being developed as a digital bridge between Indonesia and Singapore. The 100-ha facility was proposed and developed by Singapore-based Infinite Studios, a subsidiary of Citramas Group. A creative industry vocational training centre is planned for the NDP, one component of which will see education non-profit Infinite Learning and US tech firm Apple establish an Apple Developer Academy, a no-cost education facility for developers and entrepreneurs. The 62-ha Nongsa D-Town will also be established as a digital centre for foreign start-ups. As Batam’s first large-scale commercial project, the NDP is set to create 10,000 jobs and attract more than $500m in investment in the digital economy and start-ups.

Inclusive Development

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. The imbalanced distribution of the population has inevitably skewed government funding in the same direction.

While infrastructure and tourism development is vital, eastern Indonesia, which comprises 13 provinces including Bali, Sumbawa, Flores, Sulawesi, Maluku and Papua, is home to over half of the country’s underprivileged villages but only 15.6% of its population. In 2019 UN human development index scores, which measure life expectancy, education and per capita income on a scale of 1-100, in Papua (60.84) and North Maluku (68.70) stood in stark contrast to those for Jakarta (80.76) and Yogyakarta (79.99). While infrastructure projects such as a dams, roads and rail corridors are being undertaken throughout Indonesia’s eastern provinces, the bulk of this development is centred on South Sulawesi – particularly Makassar. The rapid growth of South Sulawesi in recent years has widened economic disparities between it and other eastern provinces.

However, strides are being made through smaller projects. New roads on Flores in East Nusa Tenggara province have enabled farmers to access city markets, subsequently increasing both trade and income. In addition, the fishing town of Labuan Bajo was identified as one of the government’s priority tourism destinations. The town’s harbour is in the middle of a $2bn refurbishment, and in late 2019 the upscale Inaya Bay Komodo hotel opened its doors. Similar developments are also taking place in Papua and Maluku.

Furthermore, it is hoped that the government’s Omnibus Laws on taxation and job creation, which were submitted to Parliament in January and February 2020, respectively, can present a comprehensive reworking and streamlining of local investment, labour and taxation laws to further boost job creation and opportunities in underdeveloped regions.

Outlook

Ensuring the even distribution of economic and social opportunity across Indonesia is central to the aims of the government. The extent to which these targets are achieved will depend largely on the success of ongoing infrastructure development projects and ensuring the universal implementation of policies to support decentralisation. Human capital development will also play a role in achieving the goals outlined in the country’s Making Indonesia 4.0 strategy, enabling Indonesia to keep pace with evolving global workplace demands, and attract investment in the digital economy. In the short term, as global governments react to the spread of Covid-19, investment flows will likely be impacted, especially in the retail, travel and tourism sectors. As of March 2020 the government confirmed that the pandemic had reached all 34 provinces, emphasising the importance of ensuring adequate health infrastructure across the country. Relocating Indonesia’s capital from Jakarta to East Kalimantan should go some way towards easing environmental and social pressures on Java, although as of April 2020 infrastructure funds for this project had been reallocated to hospitals to support the country’s virus outbreak response.

In the medium term, the draft Omnibus Laws could remove long-standing barriers to investment. These actions are expected to continue narrowing regional disparities and affording additional opportunities for investors in the country’s emerging towns and cities.