Indonesia reforms: The waiting game

Two years from now, after more than two decades trapped in planning-stage limbo, the first trains on Jakarta's mass rapid transit (MRT) system will roll into stations. The city's proposed subway system has become a symbol of the chronic delays inherent to doing business in Indonesia. Now, thanks in part to the efforts of President Joko "Jokowi" Widodo - in his previous role as governor of Jakarta - the project is finally under construction.

Overseas investors hope that the MRT system will come to represent a new start for the country. Following his election last year amid much optimism from the investor community, Jokowi and his administration have taken steps to improve the local business environment.

However, this optimism is still tempered with caution. Most of the country's longstanding issues remain unresolved, and not all of the administration's moves have found favor. The rupiah remains weak, with the government appearing unwilling to step in, and foreign investors are wary of moves that seem to suggest a protectionist mindset.

Observers are, for now, willing to tolerate even the less popular actions as the products of a learning curve. "What's important is that they demonstrate that they're building up momentum in this area," says Benedict Bingham, the IMF's resident representative in Indonesia. "That's what investors want to see. I think investors are aware that this is a medium-term challenge, but they want to see in the markers this year that progress is being made."

Removing red tape

One early move that boosted confidence was the government's consolidation of its many regulatory agencies into a single permit board. The decentralized system is a frequent cause of delays to projects, due to confusion about the process and miscommunication between the various agencies. Indonesia's legislature plays a role as well, passing myriad vague or contradictory laws that must be reconciled by new regulations or even by presidential decree.

This dysfunction is one reason that the World Bank ranked Indonesia 114th out of 189 countries for ease of doing business in 2015. Indonesia ranks even worse in sub-categories such as dealing with construction permits (153rd) and starting a business (155th), with the latter process taking an average of 53 days to complete.

By comparison, Malaysia ranks 18th overall, and 13th and 28th, respectively, in the two sub-categories. Only six days are required to start a new business.

The government's proposed "one-stop-shop," and the president's promise to force regional governors to implement similar simplification measures, represent a significant step forward in cutting this red tape and getting projects off the ground. The active role taken by the president in starting construction on the MRT has been taken by some as an indication that his priorities are in the right place with regard to developing the country's long-neglected infrastructure.

"If basic road and other primary infrastructure doesn't get developed, this economic growth story will start to peter out," says David East, head of transaction services for KPMG in Indonesia. "Indonesian companies are paying 3-4 times as much to get product to port and to get imported goods from port to factory compared to Vietnam, Thailand and Singapore, to varying degrees. The lack of infrastructure increases logistics costs, weakening the competitiveness of domestic companies."

Indonesia's logistical difficulties can in part be blamed on its unique challenges as an archipelago. However, World Bank data once again show that Malaysia, which has a broadly similar geography, outperforms Indonesia in transportation and logistics. Since 2007, Malaysia has consistently scored higher in assessments of quality of trade and transport-related infrastructure, ease of arranging competitively priced shipments, competence and quality of logistics services, and frequency of on-schedule delivery.

The Jokowi administration is aware of the country's deficiency in this area. There are plans for infrastructure spending of $400 billion, to come from a mix of public and private sources. Furthermore, in the recently proposed budget the ministries with the largest increases in allocation were public works and transportation.

Funding will go towards improvements to 24 ports as well as the construction of roads and water treatment facilities, all of which is welcome news to investors. However, one industry source notes that the real test will be to see whether the government can follow through on its goals.

Another factor in the government's infrastructure agenda is a desire to improve the manufacturing sector. The country is still smarting from the commodities crisis, and one way to prevent another such collapse is to diversify the economy so as not to rely too much on production of a limited range of natural resources.

Indonesia's manufacturing sector as a whole grew by more than 5% in value-added terms between 2011 and 2013. That is a considerable improvement on the previous four years, when growth never reached higher than 4.74% and at one point dropped to 2.21%. In a bid to sustain and improve this growth rate, the government has in recent years announced its intention to attract greater overseas investment in manufacturing.

However, the administration might find its efforts hampered by its monetary policy. The value of the rupiah continues to fall, having reached 13,000 to the US dollar in February, and economists warn that if the depreciation continues, foreign investors will see no value in staying in Indonesia.

Although the government has downplayed the risk of a falling rupiah, it is not necessarily being lazy or complacent, as a weak currency is beneficial to the country in some ways. Finance Minister Bambang Brodjonegoro has indicated that government revenues for natural resources increase considerably with every drop in the value of the rupiah, although this is of little comfort to most investors with exposure to manufacturing.

Independence agenda

Another area of frustration is Indonesia's professed desire for self-sufficiency. The president has called for the country to be self-sufficient in food in three years, and tariffs and import duties continue in place for a wide variety of goods, including steel. The measures have worried some investors, who see in them a warning of protectionist and nationalist restrictions to come.

Others, however, contend that concern about the self-sufficiency program is misplaced. Edimon Ginting, deputy country director at the Asian Development Bank, says investors have misunderstood the reasoning behind the policy, which is to improve the productivity of domestic agriculture and aimed at a narrow range of products. He relates the program to the proposals for infrastructure improvement.

"Over 55% of the irrigation system is not working properly," Ginting says. "Imagine if they fixed that and improved productivity. They would be more self-reliant in terms of rice. They could process it, even export, for example." He adds that if the self-sufficiency measures do negatively affect the economy, the damage will be more than offset by the positive impact of simplified regulations, improved infrastructure and increased investment in manufacturing.

Despite the mixed signals sent by the government, the investment community seems willing to wait for the government to find its feet and commit itself to the new approach.

Though a major bounce back this year seems unlikely, there is consensus that the environment will continue to improve. And even without the sought-after reforms, the current climate still offers the chance for considerable reward for those willing to take the risk of investing in Indonesia.

"This large domestic consumption base and the well-documented emerging middle class provide a huge potential upside if you get the right target, pay the right price and partner with the right local shareholder or businessmen," KPMG's East says. "A not-uncommon story we hear is a multinational's Indonesia investment is their most favorite and profitable in Southeast Asia, provided they can get it all right - something that can be easier said than done."

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• Topics
• Southeast Asia
• Regulation
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• Southeast Asia
• Indonesia
• Economy
• regulation
• FDI