Freedom Barometer Special Report - Partly Cloudy

7/29/2019 Freedom Barometer Special Report - Partly Cloudy

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Freedom Barometer ASIA

Partly CloudyIndonesias economy in 2013


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Partly CloudyA Special Report on Indonesias Economy in 2013

by Rainer Erkens

In spite of positive expectations regarding the economic development in 2013, Indonesia faces a great many of challenges. In addition to long-term issues concerning infrastructure, the fight against corruption, the protection of religious pluralism and the reduction of state energy subsidies, new developments are noticeable. Measures influenced by economic nationalism as well as the rise of trade unions beg the question how attractive Indonesia will be for investors in the future.

In economic terms 2012 was a good year for Indonesia. And according to prognoses of thegovernment and policy experts, 2013 will be equally pleasant.

Obviously, the rather weak global economic growth affects Indonesia. But even according tothe most pessimistic predictions, the economy will grow by a solid 6% in 2013, only marginallyless than in 2012. (Some international banks and observers predict that by 2030 Indonesia willhave become one of the ten most important industrial nations, outpacing heavyweights likeFrance, Germany, and the UK.) The inflation rate of 2013 is projected to be around 5%, henceturning out comparatively low. Foreign investment amounted to about $27bn in 2012 (an all-time record), up from $20.3bn in 2011. The government reckons that the money will continueto flow in since growing domestic consumption, abundant natural resources, and acomparatively friendly investment climate make Indonesia fairly attractive.

Presumably, the tax revenue will not increase as strongly as expected just a few months ago.But the state finances are solid. New debt will only reach about 2% of the GDP , bringing totalindebtedness to approximately a quarter of the domestic output.

It seems then that despite a difficult global economic environment Indonesia can settle back if it were not for several worrying signals that the future might not be as blissful as expected.The difficult global economic situation has taken its toll: Indonesia, usually enjoying a stabletrade surplus, had to accept a deficit of about $2bn in 2012 the countrys highest to date. Thishas weakened the Rupiah at the international exchange markets. Adding to that, a number of home-made problems hint at new challenges for the economy.

Infrastructure, corruption, religious conflicts and energy subsidies pick one

Indonesias infrastructure remains the weak point as regards the economic development.Consumption of electricity will rise annually at a rate of 9.9%, based on the assumption that theeconomy will grow by about 6%. To satisfy the needs, annual investments amounting to $8.3bnare required. But the national electricity producer barely manages to raise half of the neededfunds from own resources. The government plans to connect 19 new coal-fired power plants tothe grid in 2013 - later than originally scheduled. But even their additional capacity will not beenough to satisfy the growing demand.


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In addition to the lack of available funds for investment, Indonesia faces another problem of themonetary kind: To put it bluntly, the government is bad at spending the money it has. Similarto the preceding years, the government had to assert at the end of 2012 that only 79.6% of thedesignated yearly means for investment were spent, mostly for infrastructure purposes. Awhopping $3.7bn had remained unused. Political squabble, problems relating to the acquisitionof land for public projects, environmental obligations and an increasingly self-aware civilsociety hamper a swift expenditure of funds.

But a considerable amount of money goes into petrol and electricity subsidies. In the nationalbudget of the year 2013 close to $30bn about a quarter of the national budget have beenearmarked to that end. Beneficiaries are primarily those who can afford a car or a modernapartment. The problem is that because of the rapid economic development more and moreIndonesians fall into this category. This leads to a continued rise demand for subsidised energy.The government will inevitably face a bottomless pit if it fails to increase petrol prices.Negotiations in this regard failed in April 2012, at present only the reduction of electricitysubsidies seems likely.

Another irksome issue is corruption. In the Freedom Barometers last survey of corruptionlevels, Indonesia scored a mere 3 out of 10 points, slightly better than Vietnam but way behindthe leaders Singapore and Hong Kong. A number of surveys suggest that the majority of Indonesians see corrupt politicians as one of the most severe problems the country faces today.One of the last scandals involved Andi Mallarangeng, the former minister for youth and sports.Once a celebrated young politician who was considered to be a possible future leader of theDemocrat Party, he now has to answer to charges of personal enrichment and illegal financing.He thus follows the footsteps of several other politicians and senior officials across party linesand different institutional levels.

Additionally, the often troubled coexistence of religions makes the headlines in Indonesia. With

a majority of 86% of the population, Muslims are by far the biggest religious group inIndonesia. The rights of the other 14% (mostly Christians and Hindus) are protected by theIndonesian constitution. But frictions do occur. The Setara Institute, an NGO specialising inhuman rights, recorded a total of 244 conflicts with a religious background in the year 2011.Evidence suggests that the situation probably didnt improve in 2012. Virtually every daymedia reports feature incidents of religiously motivated violence somewhere in Indonesia,spiced by the occasional discovery of a hitherto unknown Islamist terror group. Surveys see asubstantial unease of the public regarding the stability of the constitutionally protectedreligious pluralism.

More economic nationalism?

In addition to above-mentioned challenges there are developments that point to a risingeconomic nationalism and - in the medium term - may scare foreign investors away. In 2009the Indonesian government decided that beginning with 2014, foreign companies wont beallowed to simply extract and export a range of raw materials. Instead they will have to set upsmelting plants in Indonesia in order to process raw materials before they are eventuallyshipped off. The rationale behind this rule was that by forcing foreign companies to process rawmaterials on location, Indonesia would increase the revenue gained from the exploitation of its


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abundant natural resources. Virtually overnight a number of foreign companies anxiouslystarted building smelting plants in order to fulfil the guidelines in due time.

In the first half of 2012 the Indonesian government went one step further. It introduced anadditional tax of 20% on the export of some resources (gold, nickel, copper, tin) and madeobtaining export permits more complicated. In doing so the government wanted to prevent bigscale raw material exports before the new rules come into effect in 2014.

This spelled bad news for exporters, as the new taxcame into effect just as the global demand for someresources started to decline. Hence some companiesfaced higher taxes in a more difficult economicenvironment. (The nickel industry estimates that thenew policies have resulted in additional cost amountingto $676m.) Furthermore the government decided inMarch 2012 that, ten years into production, foreignfirms may only hold a maximum of 49% of a jointventure with Indonesian mining companies 1. A foreign

joint-venture partner might therefore find himself reduced to a mere minority shareholder at some point,

despite having shouldered the lions share of the initial cost. Regulations such as these arehardly the stuff that attracts foreign investment.

Regulatory uncertainties add to these woes. In the context of decentralisation, the right to giveout exploration and mining concessions was transferred to the provincial and district levels.This has led to legal uncertainty and arbitrariness. Surveys show that mining concessions aredoled out rather lavishly in the run-up to elections. There is reason to suspect that localpoliticians use the money from selling mining rights to beef up their campaign budget. But,

more often than not, these concessions are worthless. The scope of this became clear when theNational Ministry for Energy and Mineral Resources conceded in a report that out of 10,000Indonesian mining concessions only about half were legally valid.

Often, the consequences are conflicts between mining businesses and the local population whenlocals finally vent their anger over not having been involved in the allocation of concessions.State agencies have recorded about 900 such cases all over Indonesia, the potential harm of which becomes clear when one considers that mining generates about 12% of the IndonesianGDP and a considerable chunk of the countrys total export revenue.

The end of BPMigas

But a decision of the Indonesian Supreme Court could turn out to be equally bad for foreigninvestors. In November 2012 the court decided to disband the State Agency for the Explorationand Extraction of Crude Oil and Natural Gas (BPMigas).

1 Incidentally, as of last year similar restrictions apply to the Indonesian banking sector. Foreign financialinstitutions may only hold a minority share in Indonesian banks. Prior to 2012 there was no upper limit. It ishardly possible to shake off the impression that the climate for foreign businesses has become rougher.

After blowing like a wrecking ball through Indonesias mining industry,the winds of nationalism are now buffeting the oil and gas sector with a legislative revision raising fears of a

perfect storm breaking ahead of the 2014 legislative and presidential elections.

John McBeth, The Straits Times,Januar y 9 th, 2013


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BPMigas was set up in 2002 through a parliamentary decision after Pertamina, the state-ownedoil and gas enterprise, had failed to boost the crude oil production in Indonesia. Pertaminalacked both the funds and the knowledge to extract oil from ecologically sensitive coastal andocean areas. Furthermore, Pertamina was (and still is) utilised for political purposes whichimpaired its efficiency and thus its competitiveness. Hence BPMigas was commissioned to putdrilling licenses for domestic and foreign companies outfor tender. In the absence of serious domesticcompetitors - except for Pertamina - mainly big foreigncorporations such as Chevron or Total won the tenders.(Incidentally, Chevron and Total will be the biggestinvestors in 2013 as well.)

Somewhere along the line a queasy feeling arose inIndonesia that the country was selling out its resourcesto foreigners. A colourful coalition of Indonesianorganisations, economic groups, and individuals (amongthem former administration officials and members of parliament who initially had approved the creation of BPMigas) decided to take the matter to court. Theyargued that BPMigas issuing of licenses to foreigncompanies was unconstitutional 2. The Supreme Courtsdecision in that matter declared that BPMigas hadindeed violated the constitution and was to bedisbanded immediately. Its staff and responsibilities were transferred to the Ministry of Energyand Mineral Resources. The Supreme Courts decision was welcomed by the majority of Indonesians. They feel that national champions such as Pertamina have to be supported.Pertamina might indeed benefit from the new situation provided it manages to deal with its

own shortcomings.The Supreme Court decision although striking proof of its independence from thegovernment is problematic in several ways. Firstly, the government now has to outline astrategy for the Indonesian oil and gas industry. Foreign investors were assured that existingcontracts would be honoured. But the question is what will happen when renewal is pending.

Secondly, theres an issue of trust. Foreign investors might begin to ask themselves if they cantrust the framework for doing business in Indonesia considering that important state agenciessuch as BPMigas can be disbanded from one day to the next, regardless of economic and legalconsequences.

Furthermore, the argumentation that BPMigas failed to fulfil the requirements of theconstitution when it issued drilling licenses to foreign companies doesnt make much senseeither if one considers related economic data. At the end of 2012 the Indonesian governmentestimated that revenues from oil and gas will reach $36bn in 2013 a considerable share of Indonesias total state revenues of $158bn.

2 Indonesias constitution was written in 1945 and reflects in large parts the zeitgeist of that time. Article 33 (3)states: The land, the waters and the natural resources within shall be under the powers of the State and shall beused to the greatest benefit of the people.

There is no way of avoiding foreign companies in this nations oil and gas business sector. Exploration on a massive scale is needed to in-crease oil and natural gas reserves. The offshore drilling needed requires a huge investment of at least US$20 million per well. Each well in shallow waters costs at least US$2 million. Only foreign companies have the means to raise these amounts of capital .

The Indonesian journal Tempo in itseditorial of November 25 th , 2012


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On the advance - Indonesias trade unions

The rise of the trade union movement was possibly the most notable phenomenon of Indonesian politics in the last year. For years, Indonesias legal trade union movement madethe headlines because of its high degree of fragmentation and quarrels between rivalassociations. But young, university-educated functionaries have recognised that cooperationbetween the various umbrella organisations and single trade unions is possible and can besuccessful. They have identified two areas were the mobilisation and recruitment of memberspromises to be particularly successful. One area is the regionally varying minimum wage. Untilnow minimum wages were set on the provincial level through a mutual agreement betweenemployers, employee representatives and state institutions. But the trade unions have recentlymounted pressure on the employers representatives, drawing attention to a changed consumerbasket and demanding an exorbitant increase of minimum wages.

A number of provincial politicians tried to make some concessions to the trade unionsdemands, while at the same time trying not to make employers nervous. But a series of impressive strikes forced politicians (among them the labour minister) to cave in to somedemands of the unions. The employers associations in turn cancelled negotiations and took thematter to the courts.

Many provinces have enacted considerable wage increases for the lowest pay groups. InJakarta, for example, this has led to a 44% increase of monthly earnings which now reach $228.Employers point to the fact that such increases not only exceed the inflation rate, but also donot reflect improvements in productivity. The textile industry, suffering from a decline inexports in 2012, complains that it stands in a tough competition with China on the domesticmarket. Businesses threaten to close plants and fire employees. They worry not only abouthigher minimum wages for the lowest wage groups, but also about the impact on the total wage

structure of the industry. Employers are irritated that their arguments get no response fromrelevant bodies. But this is not to say that the Indonesian authorities are particularly in favourof the unions it is rather the unions that managed to bully them into accepting their demands.

Outsourcing is another issue central to the conflict between trade unions and employersassociations. The unions view outsourcing as a mere tool of employers to weaken them (smallbusinesses that take on outsourced jobs are only marginally represented in the unions) and tokeep salaries low. Indonesian law allows outsourcing only for some narrow domains (cleaning,security or catering), but some employers do not comply with the rules and have not been heldaccountable for violations.

Muhaimin Iskander, the labour minister, surrendered to the pressure of the unions andpromised that the present legal conditions regarding outsourcing would be enforced.Employers understand his statement as just another proof of the preferential treatment of tradeunions by the government prior to the election of 2014.

The beginning of 2013 sees the continuation of this high-stakes conflict between unions andemployers associations. The government is literally between a rock and a hard place as it mayhave considerable difficulties to act as a mediator in the light of strongly diverging, politicallyheated positions and to keep Indonesia interesting for foreign investors.


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To date the country was particularly attractive for foreign companies because of its low wages.But it seems that Indonesias time as a country of cheap labour comes to a conclusion. This willpresent opportunities to well-qualified employees and those who are willing and able to learnnew skills. A boost in prosperity and productivity may follow. However, those who areemployed in the informal sector or in agriculture may lose out.

Thus, even though the Indonesian government and international organisations are optimisticregarding Indonesias development potential in 2013, there are some issues to be dealt with. If the right decisions are made then Indonesia will continue to be an attractive place to dobusiness in the medium term. But some observers are pessimistic. They point to the fact that2013 will be the year before the next parliamentary and presidential elections. Additionally, noless than 122 local and regional elections loom. Some politicians might feel compelled to resortto populist promises and policies to win the support of powerful interest groups. Nationalismand union pressure may all too easily shape politics.

Clouds loom on the horizon.

Rainer Erkens is the Project Director of the Friedrich Naumann Foundation in Indonesia.

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Freedom Barometer Special Report - Partly Cloudy