Foreign investment in Indonesia : A big opportunity ( Part 2 of 2 )

Foreign investment in Indonesia : A big opportunity ( Part 2 of 2 ) Su Sian Lim  ;   ASEAN economist at The Hongkong and Shanghai Banking Corporation (HSBC) Limited, Singapore

JAKARTA POST,  30 September 2014

                                                                                                                       

As for government bureaucracy, during his campaign Joko “Jokowi” Widodo spoke about the need to restructure central and local government institutions to “trim fat”, ensure stronger legal protection for such measures, and improve the competence, monitoring and supervision of public services. He also hopes to set up a “one-stop service for investment” and reduce business licensing to a maximum of 15 days. Finally, there are big plans for infrastructure. In addition to renovating old ports, another 10 new ports will be built. Jokowi also wants to construct 2,000 km of new roads, and make extensive road repairs in Sumatra, Java, Kalimantan, Sulawesi and Papua. Energy infrastructure will also be a focal point. Apart from changes to the Oil and Gas Law, he aims to reduce the country’s reliance on oil, and replace it with more gas, coal and geothermal energy. He plans to remove up to 90 percent of Indonesia’s diesel-fired power plants within the next three years, saving US$7 billion in energy costs a year. Of course, for all of the above plans to materialize, the investment environment needs to be open and welcoming. In this regard, some aspects of the revised Negative Investment List issued in April, such as the loosening and even removal of restrictions on foreign investments in public-private partnership projects in large power plants, electricity transmission and distribution and seaport projects, seem aligned with Jokowi’s ambitions for the economy. But the same can’t be said about other areas of the Negative List. In particular, within the oil and gas sector, offshore and onshore drilling, offshore and onshore pipeline construction, onshore upstream production as well as onshore operation and maintenance services are now more restrictive, or closed to foreign investment altogether. This could impede Jokowi’s plans for developing the country’s capacity in this sector, which would in turn continue to represent a structural drag on Indonesia’s current account deficit. We have also not yet heard Jokowi’s thoughts on the ASEAN Economic Community (AEC), an organization which represents a significant opportunity for Indonesia to attract even more foreign direct investment (FDI). As the likes of Malaysia and Thailand leverage the AEC and move up the value chain, Indonesia, with its vast resources, youthful demographics, and competitive wages, will have the chance to showcase its own capabilities, particularly in areas such as manufacturing (see table). That said, if Indonesia wants to better capitalize on such an opportunity, further reforms may come in handy. One place to start could be the labor market. That the proportion of working-age adults in Indonesia will keep rising until around 2030 can potentially be a huge economic asset, but only if these workers are sufficiently educated and skilled. This may mean that, while Jokowi clearly prioritizes education, over time the policy focus will need to shift towards helping Indonesians develop deeper skills. It will also be important to inject greater flexibility into Indonesia’s rigid labor markets. According to the GCI, restrictive labor regulations rank as the fourth-largest impediment to doing business in Indonesia. If Indonesia gets it right on FDI, it is likely that portfolio inflows will follow. To be sure, over the past few months equity investors have been cheered by the prospect of a higher potential growth rate for Indonesia thanks to Jokowi’s plans to improve infrastructure and pursue reforms. His commitment to fiscal consolidation through a slimmer bureaucracy and fuel subsidy cuts has also brought optimism to the bond markets. For these portfolio inflows to be sustained over the longer term, it will be important for investors to have confidence that FDI flows are helping to finance the current account deficit, so that Indonesia’s BOP and the Rupiah are not at risk. Despite having a robust capital and financial account position last year, Indonesia was still one of two countries in Asia to record an overall BOP deficit in 2013 (0.8 percent of GDP). The other was Thailand, which reported an anomalous BOP deficit of 1.3 percent of GDP, largely because the political crisis had triggered large portfolio outflows. Indonesia’s BOP deficit, by contrast, stemmed from a current account deficit of 3.3 percent of GDP, the largest in its history. Investor confidence in the BOP position is crucial in the current context of the US’s gradual transition from quantitative easing towards a more normal monetary policy regime. As we saw with the “taper tantrum” in May 2013, emerging markets such as Indonesia that suffer from both a current account deficit and budget deficit can be punished by sudden portfolio outflows, as jittery global fund managers re-assess their portfolios for any signs of vulnerability. Investor confidence will hinge not only on how the current account deficit is being funded, but also on whether policy makers are making sufficient efforts to deal with the current account deficit itself. To this end, it will be important how quickly, and by what magnitude, Jokowi hikes subsidized fuel prices once he takes office. This will have a direct — albeit temporary — impact on the elevated level of demand for fuel imports. In the longer term investors are also likely want to see a framework that caps the costs of and demand for subsidized fuel in a more permanent way. Ultimately, a revitalization of Indonesia’s oil production capabilities will also be needed. Income repatriation by foreign companies operating in Indonesia — a significant but less-discussed source of leakage on the current account — must also be stemmed, perhaps through the provision of fiscal incentives, as mulled over by the outgoing government. This will, however, first require some fiscal space which the incoming administration may not immediately have. The 2014 budget deficit is currently projected at 2.4 percent — not far from the 3 percent legal cap — and with risks to the upside as consumption of subsidized fuel continues to run ahead of budget allocations. There’s no doubt that foreign investment represents a huge opportunity for Indonesia to move forward. The key is to make it broad-based and sustainable. ●