Major projects support construction pipeline and domestic materials suppliers in Indonesia

Supported by strong fundamentals, Indonesia continues to break ground on major construction projects. Fuelled by a comprehensive public infrastructure agenda, large-scale developments have become the norm. However, while the construction sector remains an important pillar of the country’s economy, project development is still hindered by domestic obstacles, including a lengthy land acquisition process.

At the same time, local manufacturers of building materials continue to face pressure from cheaper foreign imports – mainly from China – with this hindering the development of the domestic cement and steel manufacturing industries. While the government’s pro-business efforts have not gone unnoticed, Indonesia’s roads, ports and airports continue to face congestion problems. Furthermore, access to reliable power generation and water sanitation systems is lacking in some regions beyond major urban centres. In addition, high logistics costs can weigh on major construction developments, particularly in remote areas.

Size & Performance

The construction sector is the third-largest contributor to the economy, providing a total of Rp1562trn ($110.7bn) to GDP in 2018, representing a share of 11.1%, according to Statistics Indonesia (BPS). This places the sector behind only industry and trading, which represent 19.8% of GDP and 13% of GDP, respectively. According to Cekindo, an Indonesian investment consultancy company, civil construction – covering all small- and large-scale infrastructure works – was expected to expand by 4% in 2018 to reach a total value of Rp293.83bn ($20.8m), accounting for 65% of all construction activity, excluding oil- and gas-related construction. Meanwhile, building construction – for both residential and industrial units – was expected to increase by 1%, to reach a total value of Rp157.51bn ($11.2m), accounting for 35% of construction activity for the year.

Structure & Oversight

A major public infrastructure programme, launched under the administration of President Joko Widodo, has driven several years of robust expansion. Since 2014 an emphasis has been placed on developing new transportation, utilities and social infrastructure projects, with state-owned enterprises (SOEs) taking the lead. While SOEs have played the leading role in construction projects, the government has made considerable efforts to entice private sector participation.

According to the World Bank’s “Private Participation in Infrastructure” report, released in April 2018, Indonesia was second only to China in attracting private funds for infrastructure projects in 2017, mobilising $15.4bn in private investment for 11 projects that year. 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. Of the Rp839trn ($59.5bn) government budget for 2019, the MPWH was approved Rp102trn ($7.2bn), an increase from Rp98.8trn ($7bn) in 2017.

The Ministry of Agrarian and Spatial Planning (MASP) – formerly the National Land Agency – was instituted by President Widodo as part of the country’s broader land reform process. It was established with the objective of certifying all land by 2025, thus improving the security of land tenure, a long-standing issue in the country (see analysis). MASP announced in February 2019 that it would register 10m new plots of land by the end of the year. As of 2018 it had certified a total of 13.5m plots since it began the process in 2015.

According to the country’s Construction Law, if work is carried out by an Indonesian company, a business entity certificate must be acquired from the National Construction Services Development Board. A construction services business licence from the regional government is also required. For local companies registered as a limited liability firm, certificates are issued by the Indonesia Investment Coordinating Board (BKPM). Meanwhile, construction professionals must obtain a work competence certificate after passing a competence test. If work is carried out by a foreign construction company, the relevant licence must be obtained from BKPM. There are three types of permits that need to be obtained prior to construction: a land utilisation permit, a building construction permit and an environmental permit. These permits are generally obtained from the regional government, though the time taken and costs entailed vary between regions.

One of the most important changes in recent years was the publication of a new law on construction services. In April 2017 the government implemented sweeping changes to the industry’s legal framework, with Construction Service Law No. 2 of 2017, or the New Construction Law, replacing the previous legislation promulgated in 1999. One of the more significant changes brought about by this law was an amendment to tender requirements for public services. Privately funded projects are no longer required to issue tenders for a construction contractor, though projects funded by the state are still required to issue tenders.

The procurement of construction contractors for government works is the responsibility of the Public Procurement of Goods and Services Agency. In 2017 there were 30 public procurement tenders with a combined value of Rp31bn ($2.2m), more than double the value undertaken in 2016.

In March 2018 amendments were made to the laws governing public procurement. These changes allow private sector specialists to assist in running highly complex procurement procedures and allow public bodies to delegate procurement activities – including construction projects – to qualified third parties. Furthermore, in September 2018 MASP announced it was preparing a bill regulating airspace and underground construction projects, aimed at providing legal certainty for investors within those areas.

Cement

Given the construction sector’s expansion rate, the demand for building materials – in particular cement – remains high. However, cheap imported materials from China continue to put pressure on domestic producers. As such, some industry stakeholders have called for higher duties on imported materials to protect local manufacturers.

“The cement industry is currently facing oversupply, as production outstrips demand,” Rizki Kresno, president director of building material supplier Conwood Indonesia based in South Jakarta, told OBG. “Despite this, demand is actually growing at a steady 5-6% per year, and there continues to be consolidation in the market to reduce the deficit.”

In 2018 cement consumption stood at around 200 kg per capita in Indonesia, according to Cekindo, following a 10% increase in domestic cement sales in 2017, to around 97m tonnes. On the back of growing demand, some domestic cement manufacturers have been able to scale up production despite facing strong international competition. State-owned Semen Indonesia (SI), Indonesia’s largest cement producer, expanded its yearly cement production capacity from around 33m tonnes in 2016 to 37m tonnes in 2017, representing an increase of 12.1%. As of March 2019 SI had a total installed capacity of 38.2m tonnes, and had plans to increase this to 53m tonnes in 2019, following its acquisition of Holcim Indonesia, which was previously one of the firms’ main domestic competitors, for $916m in November 2018.

While the construction pipeline bodes well for domestic cement demand, the segment has had to overcome a number of challenges. Since 2012 the industry has been plagued by oversupply, fluctuating domestic demand and an increase in raw material prices, such as coal, which have placed downward pressure on margins, contributing to a decline in returns. During 2017 SI’s net profit declined by 55.5% despite a revenue rise of 6.4%. However, in 2018 SI saw its domestic sales grow by 1.2% to 27.4m tonnes, while its export sales increased by 68.7%, to 3.2m tonnes.

Building Materials

In August 2018 the US government approved an exemption from new import tariffs for 19 types of steel products from Indonesia. The decision came after US President Donald Trump initially raised tariffs on imports of steel and aluminium products to 25% and 10%, respectively, in March 2018. Following the tariff exemption, Indonesia obtained exemptions for 142 applications for carbon and alloy steel products totalling more than 6780 tonnes. As of March 2019 there were 12 exemption requests waiting for a decision from the US government, including steel products with a quantity of more than 337,000 tonnes and 276 applications for aluminium products with a quantity of more than 367,000 tonnes.

In the first half of 2018 Indonesian steel exports to the US totalled $139m, an increase of 78% compared to the same period in 2017, while aluminium exports amounted to $147m, up 47%, according to BPS. Meanwhile, domestic demand for steel products has also steadily increased and was expected to be around 14m tonnes in 2018, up from 13.4m tonnes in 2017 and 12.7m tonnes in 2016. However, local steel manufacturers have been unable to fully benefit from an increase in demand due to increasing Chinese competition, which accounted for 45% of sales in 2018.

The ceramics segment has also struggled to compete with Chinese imports. Due to changing market dynamics, Indonesia went from the fourth- to the seventh-largest ceramic manufacturer in the world in recent years. Even with 20% import duties on Chinese ceramic products, they continue to enter a market that is growing at a rate of 22% per year.

With government plans to lower import duties to 5%, some Indonesian stakeholders are concerned that ceramic imports from China could be set to rise. High gas prices, which account for 30% of ceramics productions costs, have also hindered the segment, as has the slowdown of the property sector. According to the Indonesian Ceramic Industry Association, 10 out of 46 ceramic companies had ceased production by mid-2018, primarily due to high gas prices.

For its part, the paint and coatings industry has a number of strong domestic players. Propan Raya Industrial Coating Chemicals, the largest paint manufacturer in Indonesia, is the leader in wood paints and finishes, with Rp2.3trn ($163m) in combined sales in 2016. Other major players in the segment include Avia Avian and Akzo Nobel. The segment has notably rebounded since 2015, when the industry declined by 10% and only 60% of its production capacity was utilised. The country’s large-scale public infrastructure projects have helped the industry experience a recovery, growing by 9.7% in 2018.

Employment

While the construction sector remains an important provider of job opportunities, there are major skills gaps in the market. Since President Widodo more than tripled budget funding for infrastructure development in 2015, the authorities have struggled to deepen the talent pool with a sufficient number of qualified builders and engineers.

According to BPS, there were 8.1m construction workers as of June 2018, of whom only about 7% were properly certified. As a result, developers have found it difficult to meet their labour needs, particularly in rural areas. In the most recent OBG Business Barometer: Indonesia CEO Survey, published in November 2018, engineering was the third most popular choice among CEOs when asked to pinpoint which skills were most needed in the domestic workforce across all sectors.

Moreover, given the skills shortage, a large portion of projects across Indonesia do not meet international health and safety standards. According to research carried out by the Jakarta Manpower and Transmigration Agency in 2018, 80% of projects surveyed did not meet the required standards. The agency found that many of the construction workers who did have permits and licences still lacked the necessary skills. To remedy the situation, the agency planned to deploy 43 high-risk supervisors to oversee projects and improve health and safety standards.

Major Projects

A major development that is set to transform the logistics sector is the $3bn construction of Patimban Port on the north-west coast of Java, about 150 km east of Jakarta. With $1bn of initial funding coming from the Japan International Cooperation Agency, the project was agreed between Shinzo Abe, the prime minister of Japan, and President Widodo at the G7 Ise-Shima Summit in May 2016.

In May 2018 the Ministry of Transport announced that three Japanese and two Indonesian companies will build the port. The Japanese firms are Penta-Ocean Construction, TOA Corporation and Rinkai Nissan Construction, while the Indonesian companies will be Wijaya Karya – which is 65% state-owned – and Jakarta-based Pembangunan Perumahan.

Part of a broader effort to upgrade transport infrastructure, Patimban Port will alleviate congestion at Jakarta’s Tanjung Priok Port. It is also set to establish the site as an important regional trans-shipment centre, through a connection to the 750-km Jakarta– Surabaya rail line. Upon full completion in 2027, the port is expected to have an annual capacity of 7.5m twenty-foot equivalent units. According to local media, the port was on track to start soft operations by the end of 2019. A number of other high profile public-private partnerships (PPPs) have driven sector growth in recent years. Some of these include a 2000-MW, coal-fired power plant in Batang, valued at $3.8bn, and the $50.9m Bandar Lampung water supply project.

The construction of the long-awaited Mass Rapid Transit (MRT) Jakarta system promises to alleviate traffic congestion in the capital. The 15.7-km first phase of the project, which began trial runs in March 2019, connects Lebak Bulus in south Jakarta to the Hotel Indonesia traffic circle in central Jakarta. As of March 2019 MRT Jakarta was preparing to break ground for the second phase of the project, which extends across 7.8 km, connecting Hotel Indonesia traffic circle to Kota in the west of the city; this section is earmarked for completion by 2024.

According to local media reports, 28,000 passengers were expected to use the new transport service during the public trial run, while 65,000 people were expected to use it during the first few months of operation at a proposed fare of Rp8500 ($0.60) per 10 km. Upon completion of phase two, a total of 16 trains and 96 train cars will operate along the network. “The development of MRT Jakarta will enhance the urban space in the city and significantly reduce traffic, lower greenhouse gas emissions and promote pedestrian precincts,” Jusuf Setiadi, president director of domestic architecture firm Airmas Asri, told OBG. “Moving forwards, mixed-use projects will be an increasingly important component of urban development.”

Outlook

While a new presidential term may be accompanied by an adjustment of the policy agenda, a large proportion of government spending is still expected to focus on infrastructure projects. Therefore, the rapid pace of development in the sector is likely to continue for the foreseeable future, as significant efforts are required to fill big infrastructure gaps. While SOEs are likely to continue to play a key role in these developments, increased use of PPPs for major projects can also be expected.

Despite this broadly positive outlook, the sector will need to overcome some impediments to growth. Notable among these is the skills gap faced by firms building infrastructure projects. Significant improvements to training and accreditation systems could improve local human resources, which in turn would make projects more commercially viable and reduce the need for foreign expertise. More government investment is therefore required in vocational training, which will better equip the workforce for the demands of the labour market over the long run.

The industry has made considerable efforts to increase private sector involvement and improve the legal framework governing the sector in order to ensure legal certainty for investors. Nevertheless, certain hurdles remain that may dissuade international investors from engaging in the Indonesian market. Among these is a stipulation that requires that, in instances where a discrepancy occurs between an Indonesian and foreign-language contract, the Indonesian version will be accepted as the valid contract.