Investing in Indonesia’s new era · 2015-11-05 · President Joko Widodo, known locally as Jokowi, was elected in 2014 and represents a break for the world’s fourth-most populous

Open for business? Investing in Indonesia’s new eraA report from the Economist Intelligence Unit

Sponsored by Shell

© The Economist Intelligence Unit Limited 2015

Open for business? Investing in Indonesia’s new era

© The Economist Intelligence Unit Limited 2015


Preface 1

Author biographies 2

Reform or conform: Indonesia’s political landscape 3 Jack Hewson, contributing editor, The Economist Intelligence Unit

Promoting policy certainty, unlocking investment potential 7 Wijayanto Samirin, co-founder and managing director of Paramadina Public

Policy Institute, and economic advisor to Vice President Jusuf Kalla

Regulation and economic nationalism in Indonesia: The investment impact 13 Keith Loveard, senior analyst, Concord Consulting

Indonesia’s logistics services sector: The key to boosting growth potential 17 Josephine Bassinette, manager, operations and portfolio, World Bank Indonesia

Moving up the value chain: the rise of Indonesian manufacturing 23 Destry Damayanti, executive director, Mandiri Institute

Working towards a sustainable future for Indonesia’s rural economy 27 Steve Rhee, programme officer, natural resources, Ford Foundation

Contents

1 © The Economist Intelligence Unit Limited 2015


PrefaceSaying a country has entered a new era after an election is a familiar conceit. However, Indonesia has earned it. President Joko Widodo, known locally as Jokowi, was elected in 2014 and represents a break for the world’s fourth-most populous country from years of being run by political elite. Even before taking presidential office, he had won national popularity for his hands-on approach as governor of Jakarta, community walkabouts and humble origins. Before his political career, Jokowi, the son of a timber collector, sold furniture.

He also represents the political outsider who brings new perspective to Indonesia’s nagging issues that overshadow its budding promise. Woeful infrastructure, deeply embedded political corruption and growing wealth inequality are long-running problems that compounded the challenge of slowing growth and falling commodity prices in 2014.

The Economist Intelligence Unit (EIU) expects GDP growth to average 6.1% a year in 2015-19, compared with growth of around 5% in 2014. The rebound will come from an improvement in the business environment stemming from structural reforms initiated by Jokowi’s administration. In addition, as Indonesia becomes better integrated into global supply chains, its manufacturing sector can grow and boost exports.

At the November 2014 APEC CEO summit in Beijing, Jokowi closed his formal address by saying: “We are waiting for you to come to Indonesia. We are waiting for you to invest in Indonesia.” This report is focused on the opportunities and challenges of investing in the country, and the EIU asked experts from research, industry and academia on how long South-east Asia’s largest economy may have to wait.

Shell commissioned this project but had no editorial input into the report, which is solely the work of the authors. The editors of this report were Kevin Plumberg and Jack Hewson from the EIU. n

2© The Economist Intelligence Unit Limited 2015


Jack Hewson has produced video and written reports for a range of media organisations including The Economist Group, Al Jazeera English, the Guardian, and FRANCE 24, since first reporting on Indonesia in 2011. He holds a bachelors in politics and philosophy from the University of Manchester and a masters in investigative journalism from City University London.

Wijayanto Samirin is the vice rector of Paramadina University, and is also the co-founder and managing director of Paramadina Public Policy Institute. Before joining Paramadina in 2007, he worked in investment banking and the hedge fund industry for ten years. Recently, he was appointed as expert staff to Jusuf Kalla, Vice President of Indonesia. Mr Wijayanto, a Fulbright scholar, has published four books and more than 100 columns in national as well as international media.

Keith Loveard has been reporting on Indonesia since 1990. After a career in journalism in Australia, he became the Jakarta correspondent for Hong Kong-based Asiaweek magazine in 1990. He worked for the Indonesian government as an advisor on public affairs to the Ministry of Industry and Trade in the Megawati administration and for many years was a guest lecturer on media management at the Ministry of Foreign Affairs. Following the change of government in 2004, Mr Loveard joined Concord Consulting, where he is senior risk analyst.

Josephine Bassinette has been the manager of operations and portfolio for the World Bank in Indonesia since 2012. Prior to coming to Indonesia, she has had a long career in the World Bank Group including in Afghanistan, China and Mongolia, and many years in the Middle East region including projects associated with the challenges of trade and logistics between the West Bank and Gaza and its neighbours.

Destry Damayanti has spent more than eight years with Mandiri Group as a chief economist. In May 2014 she was also appointed as the executive director for the Mandiri Institute, an independent think-tank founded by Bank Mandiri. She was also recently assigned as chair of the Economic Task Force at the Ministry of State Owned Enterprises which reports directly to the minister. Before joining Mandiri Group she worked at Citibank, the British Embassy, and the Ministry of Finance.

Steve Rhee has held research and policy posts at several institutions, including the Center for International Forestry Research (CIFOR) and the US Department of State. He has worked on natural resource governance in Indonesia since 1996 and has also worked in mainland South-east Asia, Timor-Leste and Nepal. Mr Rhee has received broad recognition for his evidence-based policy work, including being selected as a Fulbright Scholar, a US National Science Foundation grant recipient, a postdoctoral fellow at Harvard and Columbia Universities, and the American Association for the Advancement of Science’s (AAAS) Science & Technology Policy Fellowship. n

Author biographies



Reform or conform: Indonesia’s political landscapeJack Hewson, contributing editor, the Economist Intelligence Unit

1This may pose challenges for Mr Aldi right now, but in the long term it’s good news for Indonesia. The archipelago nation needs massive investment to continue the almost 6% average GDP growth rate it has experienced over the past decade. The government estimated that the 2014 fuel subsidy cut would save 120trn rupiah (US$9.6bn)that could be redirected into infrastructure spending and government services. This is a good start, but Jokowi has said US$500bn of investment will be needed—mainly from the private sector—to achieve his target of 7% annual GDP growth by 2019.1

Much to doTo secure foreign investment, the new administration will need to address a number of long-standing regulatory and policy issues, including abstruse business licensing processes, widespread corruption and nationalist elites that have historically obstructed foreign-operated businesses.

Jokowi himself will need to clarify his position on “resource nationalism” through his handling of the unprocessed mineral ore export ban, which was upheld by the constitutional court in December 2014. The imposition of punitive taxes on the export of Type 1 minerals, like copper, iron ore and lead, has been successful in forcing foreign miners to commit to build smelting facilities. But the more stringent criteria for miners of Type 2 minerals, like

A ldi Pradono sits on a beat up sofa waiting for his next fare on Jalan Bangka Raya,

a busy street in south Jakarta. Working as a motorbike taxi driver he must pay for his own bensin, or gasoline. Despite a 30% fuel subsidy cut in November 2014, a policy of new President Joko Widodo, most of his old customers still want the old fares. “I only made three million rupiah (US$235) a month before the price went up, so it’s harder for me,” he said. “But, yes, I’m still glad I voted for Jokowi, we’re proud of him here.”

The ability of Jokowi to implement unpopular subsidy reform is a measure of the current strength of his political capital. But it may also be an early indicator of his apparent willingness to prioritise economic sense over approval ratings.

1Moestafa, Berni; Chatterjee, Neil and Mathieson, Rosalind. “Widodo targets Indonesian growth unseen since Asia crisis.” Bloomberg, July 23, 2014.

The archipelago nation

needs massive investment

to continue the almost

6% average GDP growth

rate it has experienced

over the past decade.



nickel, bauxite and tin, appears too demanding to be met and seem likely to result in little benefit for either Indonesia or the mining industry as exports decline and workers are laid off.

Despite the mineral ore export ban’s lack of nuance, carrots and sticks will be needed to guide Indonesia’s industries up the value chain. As global commodity prices fall, Indonesia can no longer rely as much on its resource extraction industries to drive GDP growth. Moreover, Indonesia’s weak position in global supply chains does not help its current account imbalance, as high-value imports flood in to feed a domestic consumption boom. With an additional 90m Indonesians expected to join the consumer class by 2030, reviving Indonesia’s manufacturing sector must be a priority for the incoming government.2

Widening gapDespite these bright economic forecasts, the divide between Indonesia’s rich and poor is widening. Between 2003 and 2010, the consumption of the richest 20% of Indonesians grew by 6%, but for the poorest 40% of households, it grew by only 1%. This inequality

is particularly pronounced in rural areas and Indonesia’s more remote eastern provinces where rural transportation infrastructure is hazardous and electrification ratios are as low as 30%. Access to healthcare and education can also be limited, of very poor quality, or non-existent. The over-development of industries, like coal mining, palm oil and pulp and paper, is also the main driver of Indonesia’s prolific carbon dioxide emissions, and is damaging rural communities—many of which have not benefitted from the resource-extraction and agribusiness boom.

Pushing his reforms through parliament may pose significant challenges for Jokowi. While his “everyman appeal” has earned the support of Mr Aldi and millions like him, this popularity

2 Budiman, Arief; Chhor, Heang; Razdan, Rohit and Sohoni, Ajay. “The new Indonesian consumer.” McKinsey&Company, December 2012.

2013

Indonesia Emerging Asia

201220112010

4

2

0

-2

-4

Mind the gap Current account balance, % of GDP

Source: EIU

Despite bright economic

forecasts, the divide

between Indonesia’s rich

and poor is widening.



For example, he has been able to cut subsidy funding without the approval of parliament. However, proactively diverting the funds into infrastructure will require a revision of the 2015 state budget, and he will not be able to do that without parliamentary approval.

is not reflected in the House of Representatives (DPR) where he is opposed by the Red and White Coalition (KMP), loyal to losing presidential candidate Prabowo Subianto, a former special forces commander and head of the Gerindra Party. The KMP is backed by Golkar, the former political wing of the military and Indonesia’s second largest party, which is regarded as a vehicle for Indonesia’s old political elites. Much of Indonesia’s establishment view Jokowi, who has campaigned on an anti-graft platform, as a threat to their supremacy.

Policy obstaclesUnless cracks appear in the KMP, Jokowi may struggle to enact his policy agenda.

Unless cracks appear in the

KMP, Jokowi may struggle to

enact his policy agenda.



The Democrat Party (PD), led by former President Susilo Bambang Yudhoyono, is considered the most likely organisaion that could be persuaded to leave the KMP over its opposition to a controversial bill to abolish direct regional elections. However, it is unlikely that KMP opposition will be uniform and the nuances of getting other legislation passed are likely to be complex and varied, depending on the content of the legislation.

Jokowi has a clear vision for Indonesia’s economic expansion over the next five years, but it remains unclear if this vision can be implemented. n



Promoting policy certainty, unlocking investment potentialWijayanto Samirin, co-founder and managing director of Paramadina Public Policy

Institute, and economic advisor to Indonesia’s Vice President Jusuf Kalla

2attract global investment and to allow its economy to flourish.

Unlocking Indonesia’s potentialHome to about 40% of South-east Asia’s population, land mass and economic capacity, Indonesia is a country with huge economic potential. But there is a disparity between potential and reality. For example, despite huge foreign direct investment growth over the past decade, Indonesia’s FDI to GDP ratio is still only 2.6%, half that of Vietnam. Investment faces three main obstacles: policy uncertainty, infrastructure reliability and quality of human capital. 3

Improving human capital and infrastructure will take time and will require mid- to long-term

Indonesia

Thailand

Malaysia

Vietnam

Philippines

Inward FDI, in USDbn (2013) Inward FDI/GDP (2013)

23.0

12.9

12.3

8.9

3.8

2.6%

3.3%

3.9%

5.2%

1.4%

M illions of spectators from all over the world—including thousands of

Indonesians, who stayed up until the early hours—tuned in to watch the Spanish football league’s premier fixture in October 2014.

The match, also known as El Clasico, is the faceoff between La Liga’s two greatest teams: Real Madrid and Barcelona. Like the British Premier League, or the German Bundesliga, La Liga is a multi-billion dollar enterprise— with millions of viewers drawn in by the quality of the football. And one reason why La Liga generates such skilled playing is because its referees stringently enforce the rules of the game. The world of investment is not so different and just like La Liga, Indonesia needs clear and fair rules to

Inward FDISouth-east Asian economies, 2013

3 Ernst & Young Indonesia, Gadjah Mada University and Paramadina Public Policy Institute. “Partners in Prosperity: The Impact of US Foreign Direct Investment on the Indonesian Economy.” AmCham Indonesia, 2013.

Source: UNCTAD, Indonesia Investment Coordinating Board.



solutions, but improving policy could have an immediate impact and should be a top priority for the current administration. Businesses can navigate fluctuating currency and high inflation by hedging currencies and sharing the impact of rising costs with consumers. However, companies are powerless in the face of policy uncertainty.

Fortunately improving policy is not expensive—which is convenient as the government faces a challenging fiscal situation—and will lead to solutions in all other areas, including infrastructure and human capital.

Lack of policy applicability Many issues can create policy uncertainty. One of the most troublesome in Indonesia is the lack of policy applicability, which can create unnecessary costs and limit the opportunity for the private sector to tap business opportunities.

For example, Government Regulation No.82 of 2012 on Implementation of Electronic Systems and Transactions (GR 82) mandates Indonesian businesses conducting electronic transactions

provide a public service and must set up localised data centres in Indonesia.4 Yet, the law has created confusion as it does not define what public service means.

GR 82 requires every electronic system provider operating in Indonesia to be registered and have a data centre in the country. This requirement aims to help the government locate and control data within Indonesia’s sovereign territory and protect against cyber-crime. But it is expensive and inconvenient for information and communications technology companies to meet this requirement, and it also has an impact on the banking and insurance sectors.

Policy cycle

Issue emergence Agenda Setting Policy Formulation

Policy Evaluation & Review Policy Implementation Policy Adoption / Enactment

Proper policy process

4 Government Regulation No. 82 of 2012 is the implementation guideline from Law No. 11 of 2008 concerning Electronic Information and Transactions.

To avoid the enactment of

poorly thought-out legislation

there needs to be more

consultation between business

and government.



policies, and their input and insights are valuable. In fact, according to Indonesian law, the business community and broader society are entitled to oral or written input in the discussion and formulation of draft laws and regulations.5

Business must take a more active role in the policy cycle by:

n Setting the policy agenda—through public discourse or regular dialogue with policy makers —to ensure that the concerns of the business community become government priorities;

n Participating in the formulation of policy by collaborating with think-tanks or universities to prepare evidence-based recommendations for the government;

n Reviewing policy to give input to the government on potential improvements based on industry changes.

Foreign ownershipPolicy on foreign ownership has been a recurrent issue in the Reformasi period, and public sentiment towards foreign companies

One major issue with GR 82 is the availability of a reliable power supply, with the sole provider being state-owned electricity company Perusahaan Listrik Negara (PLN). Even in Java, where the capital is located, power outages are common and many e-commerce businesses will be reluctant to rely on PLN as their sole source of electricity. This is bad news for small- and medium-sized technology firms that will be unable to afford their own data-centre, let alone a distributed power solution to protect it against outages. Renting space from a domestic data-provider would also create additional costs. Furthermore, cloud computing is being increasingly adopted around the world because of the efficiency it offers, and GR 82 will put Indonesian companies at a disadvantage.

To avoid the enactment of poorly thought-out legislation there needs to be more consultation between business and government. Ideally, the government should engage the business community in the policy-making process, and the business community should proactively seek dialogue with government. Ultimately, businesses are a part of implementing these

Mining, oil & gasAgriculture & forestryManufacturingTelecommunicationsElectricityBankingInsuranceTransportationAverage

Indonesia98

72

69

57

95

99

80

49

77

Malaysia70

85

100

40

30

49

49

100

65

Philippines40

40

75

40

66

60

100

40

58

Thailand49

49

87

49

49

49

49

49

54

Vietnam50

100

75

50

71

65

100

69

73

Maximum foreign ownership limits, %

Source: World Bank, 2010

5 Law No. 10 of 2004 concerning the Establishment of Legislation, article 53.



swings back and forth from negative to positive. Politicians often drum up support prior to legislative and presidential elections by pandering to nationalist sentiment.

Periodically, the House of Representatives (DPR) has come close to placing restrictions on foreign ownership of companies in various sectors in recent years. But despite these periodic threats, Indonesia is more open relative to its peers in the region. Ideally, limits on foreign ownership will need to be at a level that makes investing in Indonesia still attractive to foreign companies. Policy adjustment must be managed and executed properly, under fair business practices and in a realistic timeframe, to avoid deterring investment. RegulationLack of harmony in the regulatory landscape has become a serious issue since the decentralisation “big-bang” in 2001. Within one year more than 500 sub-national governments became autonomous with the authority to collect

revenues, formulate budgets, implement development plans and issue regulations.6 But problems have arisen as national and sub-national regulations have come into conflict, with the latter often-lacking coherence.

Paramadina Public Policy Institute’s new study, “Indonesia’s New Path: Promoting Investment, Nurturing Prosperity”, illustrates how companies operating across Indonesia have to comply with different local regulation in hundreds of districts. The complexities and costs are enormous.

6 Investing Across Borders, World Bank 2010. Excluding media industry.

Politicians often drum

up support prior to

legislative and presidential

elections by pandering to

nationalist sentiment.



and consequently may not align with each other, creating unnecessary complexity, costs and business uncertainty. Empowering MoHA should become a top priority of the government.

The next five yearsThe administration of President Joko Widodo must address a faltering economy due to declining global commodity prices. Commodities and commodity-related products represent around 40% of Indonesia’s exports and play an important role in the domestic economy; as a result economic growth has slowed from 6.4% in 2011 to around 5% in 2014. The government’s budget is targeting growth of 5.8% in 2015 and 7% or higher by 2019.9 Meeting these targets will be a challenge, and the Paramadina Public Policy Institute estimates that it will require investment of around US$290bn. Without massive private sector contribution this will not be achieved.

Fortunately, the administration is aware of this situation and is showing its commitment to improve the business environment in Indonesia by reducing red tape, improving infrastructure and simplifying the business approval process.10 It is very likely that during the first year of their term they will make various strategic policy reforms to take advantage of Jokowi’s strong political capital. The recent fuel price increase has proven his willingness to implement unpopular but important policies for the country.11

Good times create bad policy and bad times create good policy—and now Indonesia has the perfect combination.12 I anticipate a long

Another obstacle to investment opportunities is national infrastructure development. Each district has its own local government regulation regarding land use planning (RUTR) that may not be in line with national development plans. In instances when the central government has tried to implement an infrastructure project, such as a power plant, port or toll road, the plans have often conflicted with the local RUTR. Unfortunately, RUTR adjustment requires the approval of the given sub-national legislature. This involves a political process that is often lengthy, complicated and expensive. MP3EI, former President Susilo Bambang Yudhoyono’s programme to speed up infrastructure development, has experienced serious delays with many attributable to RUTR issues.7

The Ministry of Home Affairs (MoHA) has the authority to review sub-national government regulations. However, MoHA has a limited capacity and mountains of regulations to review. It is estimated that each year around 5,000 sub-national regulations are issued.8 Adding to the problem is a rule by which local regulations become effective if there is no comment from the MoHA within 60 days. This means that many local regulations become law without proper review

11 Kamis. “Bakal Naikkan Harga BBM Jokowi Siap Tak.Populer.” Kompas.com, 28th August, 2014.

10 President Joko Widodo statement at APINDO (Indonesian Employers Association) roadmap launch, September 2014.

9 5.8% is the minimum number to absorb young Indonesians who enter the job market every year.

12 Samirin, Wijayanto. Bridging the Gap: Mengurangi Ketimpangan, Meluruskan Esensi Pembangunan. Gramedia Pustaka Utama, October, 2014.

Policy reform will be key to

ensuring standardised sets

of rules make business in

Indonesia fair and profitable.

7 http://bappenas.go.id/berita-dan-siaran-pers/wakil-menteri-ppnwakil-kepala-bappenas-optimis-pemerintah-baru-lanjutkan-mp3ei8 Paramadina Public Policy Institute (PPPI) estimate



list of policy reforms over the next five years, particularly in priority areas like energy and food security, taxation and investment.

Right now Indonesia must make some tough decisions and the next five years is a period of make or break. Policy reform will be key to ensuring standardised sets of rules make business in Indonesia fair and profitable. The Middle East economies of the United Arab Emirates and Qatar are far more economically vibrant than other countries in the region because they have observed this lesson. The initial signs are that the current administration understands this too, and will seek to level the playing field to attract more investors. n



Regulation and economic nationalism in Indonesia: The investment impactKeith Loveard, senior analyst, Concord Consulting

3Widodo, may adopt a more welcoming approach to outside interests. Addressing the APEC CEO Summit in Beijing in November 2014, Jokowi declared to the world that “Indonesia is open for business” and promised a new law on land acquisition, less red tape, and a “one-stop shop” for investment and business approvals.

These are encouraging signs, but the likelihood is that pressures to maximise returns for Indonesian companies—and the elites that run them—will continue. For example, state energy company Pertamina has been seemingly successful at wresting the Mahakam gas block from France’s Total and Japan’s Inpex, who had faced years of uncertainty over whether or not their contract would be renewed in 2017. The Mahakam block was originally signed to Total in 1967 and was extended in 1997 for a 20-year period in partnership with Inpex. The partners have been investing US$2.5bn per year to maintain production at 1.7bn cubic feet of natural gas and 69,000 barrels of condensate per day. Naturally, Total and Inpex had been hoping to see a return on that investment.

However, a senior official with the Ministry of Energy and Mineral Resources, Widhyawan Prawiraatmadja, said in November 2014 that Pertamina would be the block’s next operator. Total has been invited to stay on

On January 15th 1998, during the height of the Asian financial crisis, former President

Suharto signed an agreement to bail-out Indonesia’s nose-diving economy. The bail-out, which yielded government power over economic policy to the IMF, was a disaster. GDP contracted by 13% that year and a sell-off of assets to foreign interests, including most of the nation’s banks, seemed to many Indonesians to be nothing less than the return of colonialism.

The iconic image of Michel Camdessus, IMF managing director at the time, his arms folded, standing imperiously over Mr Suharto as he signed Indonesia into austerity, would become a galvanising cause for the country’s economic nationalists over the following decade.

In recent years, particularly during the run up to the 2014 elections, nationalist tirades by politicians, such as failed presidential candidate Prabowo Subianto, have whipped up anti-foreigner sentiment. Many of the claims are focused on the country’s natural resources being stripped without Indonesia receiving a decent return. Media controlled by Mr Prabowo’s supporters have pushed this line, and even well-respected outlets like Kompas newspaper have engaged in foreigner-bashing.

Encouraging signs?However, the administration of President Joko



as a minority shareholder, partly in order to show Pertamina the ropes.

Nationalist elites winning out over foreign interests—particularly over expiring production sharing contracts—is likely to persist, but will need to be moderated if Jokowi’s administration wants to achieve its stated goal of at least 7% annual GDP growth by 2019. This will not be achieved without outside assistance: Jokowi said in an interview with the Wall Street Journal in December 2014 that Indonesia will need close to US$500bn in investment during his term in office. Meanwhile, the state budget for 2015 allocates only US$11.4bn for infrastructure investment.

Nationalism is beyond Indonesia’s meansDespite Indonesia’s need to attract foreign capital, the financial sector has in recent years become a target for those who see the current high level of foreign ownership as unreasonable.

The Indonesian parliament that finished its term at the end of September 2014 threatened to pass a banking bill that would have required all foreign-owned banks to divest all but 40% of their holdings to domestic interests.

This bill did not pass but the DPR then tried to include an immediate cap on foreign ownership in local insurance firms in a September 2014 insurance law. While legislators again drew back from a step that would have starved the growing industry of funds, they left the way open for tougher limits to be set in coming years.

Indonesia’s relative shortage of capital has made such nationalist policies impossible to implement. The Indonesian Bank Restructuring Agency sold so many banks in the wake of the 1998 meltdown that it would be impossible to find capital on the local market to pay off foreign shareholders. A failed takeover bid in 2012 by Singapore’s DBS for Indonesia’s Bank Danamon was valued at more than US$7bn. Of the top ten banks by assets, five have significant foreign ownership. At the end of the third quarter of 2014, those five banks had combined assets of 925trn rupiah (US$77bn). In the life insurance industry, the ten largest firms by premiums are dominated by joint ventures backed by multinational firms and, as with the banks, the capital does not exist to buy out the foreign shares, let alone finance expansion. The bill for divestment to local entities is thus beyond Indonesia’s means.

In banking – an industry in which Indonesia needs outside investment to grow – nationalist economic policies appear self-defeating. But in industries where the outside world needs Indonesia, such as minerals and rare earths, this has not been so clearly the case.

The mineral ore export banThe mineral ore export ban, now a punitive tax, has led the government into tough negotiations

Nationalist elites winning

out over foreign interests—

particularly over expiring

production sharing contracts

—is likely to persist.



Indonesia’s leverage is less powerful in copper, but it refused to budge with miners Freeport McMoRan and Newmont. After being forced to stop production because of the export ban, Newmont threatened to take its case to international arbitration, but then had to back down when the government threatened to revoke its license. Despite protestations that the government has walked roughshod over contracts, both companies have had to commit to funding smelters.

The new regulations have been criticised for being too tough—particularly for miners of Type 2 minerals—resulting in closures and lost tax revenues. But Indonesia can boast that it has broken the grip of regional rivals, primarily Japan and China, on Asia’s mineral processing industry. Jokowi has said he will not be reversing the mining policy, though he may ease some restrictions. In any case, hopefully his partial acceptance of this nationalist policy will be the exception and not the rule.

The new administration’s policy directionFauzi Ichsan, an economist at Standard Chartered Bank Indonesia, told Malaysia’s Star news in November 2014 that the country cannot afford economic nationalism. He said that the government will need credit growth of approximately 30% each year to realise Jokowi’s growth target, meaning that Indonesia’s banking capital must double every five years. “If local capital is not adequate to recapitalise the banking system, then Indonesia must be open to foreign capital in order to support the economic growth he has promised, ” he said.

with miners. The government insists that ore is processed within the country.

Companies that do not commit to building smelters are being hit with dizzying export taxes that will rise from 25% to as high as 65% by 2016. Miners of Type 1 minerals like copper, iron ore and lead are being permitted to continue to export unprocessed ore once they make a commitment to build processing facilities, but no such luxury has been granted to miners of Type 2 minerals such as nickel, bauxite and tin. The government is also introducing less favourable terms of contracts for new mining licenses.

However, Indonesia is so important to international mineral supply chains that foreign miners have little option but to comply.

UBS noted in an October 15th 2014 report that bauxite prices have rallied 30%-40%, to US$70 a tonne, since the export restrictions. Also in October 2014, Melbourne-based Alumina warned that the ban on bauxite exports could cause a supply shortage of 10m to 15m tonnes in China, while Citigroup said the global bauxite market will swing to a deficit of about 6.3m tonnes in 2014, from a surplus of 49.3m tonnes a year earlier.

Jokowi appears keen to attract

foreign investment,

as long as it provides

benefits for Indonesia.



The president appears to agree. In the weeks immediately after Jokowi’s accession to power, it was announced that six airports operated by state-owned Angkasa Pura II will be spun off to private operators. They are all major airports and include the country’s second biggest, Ngurah Rai International Airport in Bali, and Adi Sucipto Airport in Yogyakarta, another booming tourism destination. The airports will be transferred to new subsidiaries that can then absorb foreign capital and ownership.

Jokowi appears keen to attract foreign investment, as long as it provides benefits for Indonesia. His November 2014 APEC speech stressed that he wants to attract more foreign capital, particularly in infrastructure, and he promoted plans to construct 24 ports across the archipelago and various other infrastructure projects. But his enthusiasm is qualified, stressing that investments must be mutually beneficial.

Given these directions, it is unlikely that the administration will adopt a strongly economic

nationalist line. However, this does not mean that foreign investment will suddenly become easier.

Factors beyond central government controlLengthy bureaucratic processes faced by prospective foreign investors mean doing business remains challenging and time-consuming. Jokowi has pledged to reduce bureaucratic delays, but a lot remains to be done. In the past, red tape has tended to be used to tie up foreign investment approvals. Whether by design or not, Indonesia’s bureaucracy is complicated and ponderous and at times a barrier to entry.

There are only so many factors that the central government can control. Local administrations are also often keen to muscle in on negotiations over contracts, and may create obstructions if they fail to get what they want.

Indonesia’s economic nationalism will not disappear altogether. As the economy grows and as skills and access to capital increase, it is natural that Indonesian businesses will take on more work. In the meantime the machinations of domestic business elites, mobilised by anti-foreign sentiment, are still obstructing the investment that Indonesia needs. n

Whether by design or not,

Indonesia’s bureaucracy is

complicated and ponderous

and at times a barrier to entry.



Indonesia’s logistics services sector: The key to boosting growth potentialJosephine Bassinette,manager, operations and portfolio, World Bank Indonesia

4Jersey and Alaska—to know that President Joko Widodo’s emphasis on improving the country’s maritime logistics is essential to supporting economic development. Although shipping is an important part of this development, the solution is somewhat more complex. Tackling the challenges of logistics overall is needed to promote growth from which all Indonesians can benefit.

A World Bank estimate finds that the cost oflogistics—moving goods around the country,as well as imports and exports in and out ofIndonesia—is about 24% of GDP. Thailand, on the other hand, spends about 16% of GDP doing the same. For Indonesia, this difference amounts to some US$70bn a year. Looked at another way, preliminary estimates by the World Bank find that 17%-18% of the price of goods produced in Java (where logistics are the most efficient in Indonesia) is associated with logistics costs. In Malaysia, the equivalent figure is about 14%. This means that Indonesia’s private sector will have a difficult time competing with its neighbours even in areas where it should have a competitive edge in terms of labour costs or inputs. For foreign investors, the relatively high logistics costs in Indonesia will make them less likely to invest.

A number of interlinking factors contribute to this inefficiency:

Kampung Pulo is perched on the sandy shores of a tiny island just beyond the port

of Papua province’s capital city Jayapura. The village’s inhabitants are primarily fishermen, catching tuna and octopus. With tuna selling at the equivalent of about US$40/kg in the UK, one might think that the fishermen of Kampung Pulo would be well off. Unfortunately business is not that simple. The tuna caught in these waters will get no further than the local fish market in Jayapura, a city of about 320,000. There the tuna, in plentiful supply, sells for about US$4/kg —one tenth the price in Europe. If each tuna weighs 30kg, one could transport three fish in an economy class airline seat to sell in London and still make a tidy profit. So what has gone wrong?

One only needs to look at Indonesia’s sprawling archipelago—whose 17,000 islands span a distance equivalent to that between New

President Joko Widodo’s

emphasis on improving the

country’s maritime logistics

is essential to supporting

economic development.



n Port management and shipping: Tanjung Priok, the country’s busiest port in north Jakarta, has recently reduced the dwell time of a container in port to six days (March-September 2014 average), down from a high of about eight days in 2013. Yet this is still twice the time taken in Tanjung Pelepas, Malaysia, and nearly five times longer than in Singapore. Since each day a container sits in port costs a shipper US$700 or more, the private sector would save at least US$25m a week if Jakarta’s port cleared containers as efficiently as Tanjung Pelepas.

n Transportation to and from ports: Considerable spending on roads in recent years has not resulted in a commensurate number of additional kilometres of road stock. This combined with lagging investment in port access (i.e. roads and railways transport) and a lack of urban spatial planning, means that Indonesia’s ports are not able to clear containers and organise the transport of goods from the ships to distributors or end-users efficiently. For example, the movement of a truck carrying a container on the 56km from Jakarta’s port to the Cikarang industrial

area can take about six hours, compared to two hours for an equivalent journey in Malaysia. This means the truck can make no more than one trip a day. In addition, a survey conducted by the World Bank found that manufacturers in West Java said that 10% of their export goods miss their boats.

n Broken supply chains: A shortage of cold storage facilities throughout the country hampers the ability to maintain a cold chain for high value products such as fish and other produce. Yet the binding constraint isn’t necessarily the refrigerators—a shortage of adequate power across Indonesia, particularly severe in the east, means that even cold storage facilities built in Jakarta cannot operate efficiently.

n Regulatory inefficiency: A proliferation of rules and administrative procedures for imports (permits, recommendation letters, pre-verification reports), before goods even reach customs, adds to costs, causes uncertainty and increases room for corruption. For example, the Ministry of Trade mandates that pre-verification reports be issued by one

Indonesia - Thailand - Malaysia - Hong Kong SingaporeTanjung Priok Leam Chabang Tanjung Pelepas

8

6

4

2

0

Dwelling on it Shipping container dwell time in days, March-Sept 2014 average

Source: World Bank



reinforcing docks to accommodate cranes and loading areas to support more efficient handling of containers on and off ships, new jetties to separate cargo handling from passengers in more remote islands, and facilities for storage and the better movement of trucks.

Investment in the interface between ports andthe hinterland is also essential so containerscan be moved efficiently out of ports, and truckscan enter with certainty and support rapidunloading of ships once in berth. In locations like Ambon, containers sprawl over the port, with cargo being discharged piece by piece into trucks, while food carts and small shops operate inside supposedly secure premises. Overall, ships have to spend too long calling in Indonesian ports, raising costs and discouraging shipping lines from stopping at Indonesian cities.

The World Bank and Pelindo II, a state-owned port operator responsible for many of Indonesia’s biggest ports, are preparing a study of the potential investment needs of some 20 key ports. But if port infrastructure is looked at in isolation, investments like these will not make a difference to the big ports of Java, Sumatra and Sulawesi, much less places like Jayapura, Ambon, and Sorong. Rather, the entire supply chain needs to be considered in prioritising and aligning public infrastructure investment. This means coordinating investments that promote connectivity, including road connections, freight handling areas and energy supply for things like cold storage. These investments will result in higher rates of return, not only in the ports, but in port cities more widely. They are likely to produce better outcomes than investments focused exclusively, for example, on expanding ports to accommodate extremely large ships.

of two Indonesian companies in the port of departure. A ship leaving from Bangkok takes only three days to get to Jakarta; yet the verification report may be one week behind, leaving the ship idle in port. Likewise, laws and regulations, covering everything from the sale of marine fuel oil (currently about 25-30% higher than international market prices), dock workers and the nationality of officers and crew under Indonesia’s cabotage laws, are limiting competition, adding to costs and making it harder for more reputable shipping lines, both domestic and foreign, to compete.

n Process uncertainty and irrationality: Efficient port operators around the world use up-to-date computer systems and operational protocols that move goods in and out of ports quickly, securely and with certainty. These are yet to be fully embraced in Indonesia, meaning ports across the archipelago are congested, often chaotic and cause delays for both international and domestic trade. In one industrial estate in west Java, manufacturers report that they hold, on average, an extra US$1m in inventory compared to competitors in Malaysia to account for the operational uncertainties associated with receiving goods on time.

Invest or unblock? Clearly, there is an enormous need for investment in Indonesia’s ports. Across Indonesia, port infrastructure is unable to handle demand and the requirements of modern logistics for the country’s growing economy. As much as US$60bn of additional investment is needed from both public and private sectors over the next five to ten years. This includes dredging to support larger ships where appropriate, expanding and



In addition, from the largest to the smallest ports, there is a huge amount that can be done to improve regulatory frameworks that could have an immediate impact. In fact, these “soft” improvements are a necessary precondition to extracting more value from existing and future investments in infrastructure.

The new administration has announced its intention to streamline regulatory mechanisms and unnecessary processes that hamper business. These are but a few that could be rolled out relatively quickly:

n Wide application of the “berth window” system: Well-run ports have fixed times for ships to dock, unload and reload (similar to airports). These systems are linked with the necessary stevedoring and ground transportation. Putting this system in place would not only reduce the time that ships are in port and improve utilisation of port facilities, but would also force vessel operators to adhere to fixed schedules (or drop out of the business). This would improve supply chain management and reliability. State-owned port operators have begun to implement elements of this system in some ports.

n Finalise and institute the “one-stop” National Single Window (INSW), an ICT-based platform to facilitate more efficient, transparent and predictable border clearance processes. In practical terms, it would mean shippers would fill out one electronic form, rather than up to 12 forms all of which require direct interaction with different agencies.

n Set a mechanism to ensure alignment and integration of any new trade procedure

to ensure compliance with INSW and to screen out redundant or corruption- prone regulations.

n Change regulations which limit competition in areas such as dock handling, marine fuel supply, ship inspection. Many of these requirements are linked to provision of services by a single entity, often a state-owned enterprise, with predictable consequences on efficiency, cost and transparency.

Can the prices be the same in Java and Papua?Indonesia’s geography and demography mean the costs of shipping and logistics will always be higher in Indonesia’s east than in the bustling population centres of Java. In Iceland, the country generally runs efficient ports, but its cost of shipping is considerably higher compared to mainland European ports. This is because Iceland’s isolation and relatively small population mean ships calling at its ports are smaller and have to burn more fuel to make the trip. The reality of Iceland’s trade also means that ships will need to leave Iceland with relatively more empty containers, making the trip less profitable and imports more expensive.

Indonesia’s eastern islands will have lower shipping costs if they operate more like Iceland, but it will always cost more to get goods there and the bulk of trade will likely remain primarily one-way. However, shipping costs alone probably contribute less to the high cost of goods in the eastern islands compared with the lack of a pull supply chain. An unfriendly business environment, scattered communities, difficult land acquisition and a lack of energy infrastructure discourage businesses from setting



up in the region. Even if shipping were efficiently run and goods could reach Papua at the same cost as the central islands, consumers may not see much improvement without this pull. What then for the fishermen?For the fishermen of Kampung Pulo, the answer lies in the potential supply chains that could transport their tuna beyond Jayapura. Investment in physical infrastructure and more efficient port operations in the east would improve the flow of trade within Indonesia and could create an eastern Indonesian consolidation centre—enticing ships steaming past on the run from Australia to the north.

Trade in and out of the eastern islands could also be increased if other industries, like cattle, could be encouraged through a more friendly business environment and better trade policies. Energy investment is required to support cold storage for higher value-added farming and manufacturing. Much also depends on changing the regulations and restrictions which discourage higher-end Indonesian shipping and encourage corruption.

In the short term, the government could make it easier for well-equipped refrigerated Indonesian ships to carry fish from Papua and the Maluku islands to Jakarta, Singapore, Hong Kong and beyond. Recent high profile arrests of Malaysian and Vietnamese fishing fleets operating illegally in Indonesian waters imply that there is a good international market nearby. n



Across Indonesia, port infrastructure

is unable to handle demand and the

requirements of modern logistics for

the country’s growing economy.



Moving up the value chain: Reviving Indonesia’s manufacturing sectorDestry Damayanti, executive director, Mandiri Institute

5

the manufacturing industry has been forced to import growing amounts of raw materials and capital goods to keep up. Over the past six years, this trend has become increasingly pronounced. In 2013, the percentage of products

On the day of his inauguration as finance minister in October 2014, Bambang

Brodjonegoro told reporters that his priority would be to maintain Indonesia’s economic resilience by boosting industry. It is encouraging to see that such a key figure in the administration of Joko Widodo has his priorities right.

Over the past 15 years, Indonesia has experienced a period of de-industrialisation as manufacturing growth failed to keep pace with broader economic expansion. In turn, de-industrialisation has made the structure of the manufacturing sector increasingly fragile—pushing the current account further into deficit and weakening Indonesia’s position in global production networks.

Manufacturing has not kept upSouth-east Asia’s biggest economy has enjoyed rapid inflows of foreign investment since 2011, fueling economic expansion, but

De-industrialisation by the numbers

While Indonesia’s GDP growth has averaged just below 6% for the past decade, manufacturing growth has lagged at 4%-5%. In early 2000 manufacturing contributed 30% of GDP, but by 2013 this contribution had dwindled to just 24%. Indonesia’s manufacturing sector is consequently trailing behind its regional rivals. Indonesia’s export of manufactured goods as a percentage of GDP in 2012 was only 8%, much lower than Malaysia (46%), Thailand (44%), Vietnam (50%), China (23%) and the Philippines (17%).

Low exports of Indonesia’s parts and components, which account for 1% of GDP, compared with more than 7% for both Malaysia and the Philippines— further illustrate Indonesia’s failure to secure a strong position in global production networks.

Sources: EIU, WTO, UN Comtrade.

De-industrialisation has

made the structure of the

manufacturing sector

increasingly fragile.



manufactured from imported raw materials increased to 68% of total manufactured products, up from 62% in 2008. As investment inflows have increased concurrently with raw material imports, Indonesia has endured an ongoing current account deficit: reaching around 4.4% of GDP in the second quarter 2013, before it eased to 3.1% in third quarter 2014.

Exacerbating these difficulties is the fact that 93% of Indonesia’s manufacturers produce medium and low value-added goods, such as basic electrical products, textiles and ores-slag, while imports are dominated by medium and high value-added goods, such as technology products, machinery and iron and steel. It is not surprising then that the trade balance of the manufacturing sector continues to face pressure. As a consequence manufacturing is highly exposed to global economic conditions and exchange rate fluctuations. And the high dependence on imported raw materials means Indonesian exports are not more competitive when the value of the rupiah depreciates.

Theoretically a weak rupiah should make Indonesian exports cheaper and more attractive. But Bank Mandiri’s economic team concluded differently. We discovered that 1% depreciation in the value of the rupiah often results in a 1.3% decrease in manufacturing sector imports, as these imports became more expensive. However, we also noticed that exports decreased by 0.3% even though a depreciating rupiah should theoretically make export goods cheaper. It seems obvious from these findings that strengthening Indonesia’s processing industries is a very important part of the major structural reforms needed in the manufacturing sector.

Three strategies to improve manufacturingThe spirit of industrialisation must be re-embraced by Indonesia’s business community and regulators and there are three specific areas of manufacturing that Jokowi’s administration should prioritise.

n “Mother industries”, or manufacturing industries that have extensive links with other industries: These operations provide raw materials for more complex manufacturing. Economic development, accompanied by increasing demand for infrastructure, property, automobiles, consumer goods and food and beverages, will of course lead to growing demand for raw materials like steel and plastics. Meanwhile refining capacity needs to be upgraded to better meet domestic demand, both in the industrial and transportation sectors. This strategy must be supported by solid energy sector policies that enable the development of renewable energy and reduce dependence on energy imports. To this end the recent fuel subsidy cuts are a promising step and savings from the subsidy reforms should be diverted into incentives for investors to develop major manufacturing industries.

The spirit of industrialisation

must be re-embraced

by Indonesia’s

business community.



Much can be learned from China. In the steel industry Chinese manufacturing is supported to enhance their value chain and compete internationally through cash and land grants, tax incentives and encouraging companies to move from debt to equity. The Chinese petrochemical industry also has clear targets to boost the use of domestically manufactured raw materials.

In Thailand, the government encourages investment in the petrochemical industry in the form of land ownership and tax incentives, and there are reduced import tariffs for machines needed to support the processing industry.

Legislating changeLegislation targeting the expansion of Indonesia’s processing industries during the previous Yudohoyono administration included the Coal and Minerals Mining Law, which took effect in early 2014. The law placed an effective ban on the export of unprocessed mineral ore, unless miners build processing smelters to generate raw materials for domestic

n Labour intensive industries: These businesses are characterised by strong export competitiveness with high import dependency, like textiles, footwear and food and beverages. Of course, Indonesia should develop its high-tech industries to increase productivity and rise into the group of upper middle-income countries. But since unemployment remains high at around 6.3%, labour-intensive industries have to be promoted, especially those that are export competitive. In doing this, imported components should be replaced as much as possible, particularly in the textile and food and beverage industries where import needs are high.

n Industries that have entered into regional production networks yet have a high import dependency: This category includes automotives and electronics. Even though replacing imported components for these two industries is dependent on the policies of foreign companies and governments, creating a favourable investment climate, improving connectivity infrastructure, and enhancing the capacities of domestic businesses in the production value chain will lead to greater efficiency and competitiveness. This should serve as an incentive for foreign manufacturers to turn Indonesia into a main production base.

Execution of these three strategies will require a strong and consistent commitment on the part of Jokowi’s administration. Tax incentives, import duties and improved access to finance will be required, among other measures. The development of industrial areas would also help to support manufacturing expansion.



industries. The ban has forced miners to pay attention to the government’s demands and many are building processing facilities. In this regard the legislation has been partially successful, but the terms of the ban have been too harsh for some miners—particularly of Type 2 minerals, like nickel and bauxite— and many smaller mining operators may go out of business. Moreover, because the law has not been backed up by comprehensive policies in other sectors, the ban’s effectiveness has been diminished. The abruptness of the measures has also been perceived as jarring and unreasonable by many foreign investors. With the reduced tax and export revenues that resulted from the mineral ore export ban, many were surprised that the law was actually implemented. Going forward the government must learn from these experiences to ease transition to new policies to boost manufacturing.

Two challenges to reviving manufacturingTargeted measures are needed to encourage industrial development, but there are also broader challenges to be met. Firstly, the government must improve the quantity and quality of Indonesia’s infrastructure, which is considered the biggest impediment to doing business in Indonesia. According to the IMD World Competitiveness Yearbook 2014, Indonesia ranked 54 of 59 countries in infrastructure adequacy in 2014, far behind Malaysia at 25 and Thailand at 48.

Secondly, steps must be taken to improve the quality and availability of skilled labour. Labour productivity and technology capability are closely related to a country’s education and skill

levels. Unfortunately only 7% of Indonesia’s labour force has graduated at university level, compared with 29% in the Philippines and 17% in Thailand. Indonesia’s technological readiness is limited—ranking 77 on the World Economic Forum’s 2014 Global Competitive Index compared with Malaysia’s ranking of 60 and Thailand’s at 65. Indonesia’s labour productivity is also below Malaysia and Thailand.

Addressing these issues will be crucial to attract investors to Indonesia, particularly in the manufacturing sector. Indonesia should no longer rely too heavily on the primary resources sector, as falling global commodity prices are unlikely to recover in the next few years. Nor should Indonesia continue to suffer current account pressure at a time when the economy is growing and in-bound investment is rising. Jokowi must implement policies that will build on Indonesia’s resilience in the face of macro-economic turmoil and win Indonesia a more secure position in global production networks. It is time for the manufacturing industry to be revived and take a central role as an engine of growth and source of employment. n

Indonesia should not

rely too heavily on the

primary resources sector.



Working towards a sustainable future for Indonesia’s rural economyQ&A with Steve Rhee, programme officer, natural resource governance, Ford Foundation

6In September 2014, Asian Agri, Cargill, Golden Agri-Resources, Wilmar and the Indonesian Chamber of Commerce and Industry signed the Indonesia Palm Oil Pledge (IPOP). The signatories have committed to improve environmental stewardship, expand the social benefits of the industry and improve the competitiveness of Indonesia’s sustainable palm oil. What will be the key challenges in meeting this pledge?

Meeting “deforestation-free” and “conflict-free” requirements entails similar things, regardless of whether they’re the stipulations of IPOP or any other sustainability agreement. Companies are obliged to prove the traceability of a product back to the point of origin, monitor deforestation, and prevent and resolve conflicts with communities. Preventing conflict means that companies use a process of “free, prior and informed consent” with communities they want to contractually engage. Resolving conflicts means neutral, fair and transparent mediation.

The future competitiveness of sustainable Indonesian palm oil and market access to consumer-sensitive markets such as Europe and the US will be a major motivating factor to honour the IPOP commitments and with their resources it may be possible for them to meet them. However, this all remains to be seen.

Indonesia’s rural economy is dominated by the agribusiness and forestry sectors. Oil

palm and pulp and paper collectively account for approximately 7% of Indonesia’s GDP, and the nation is both the world’s largest producer and exporter of palm oil. But these industries face criticism on multiple fronts. Oil palm and pulp and paper plantation establishment are primary drivers of marginalisation of rural Indonesians and deforestation that threatens Indonesia’s endangered species and broader biodiversity. Moreover, Indonesia’s status as the world’s third largest emitter of carbon dioxide is chiefly attributable to its deforestation and the draining of peatland. Researchers from the University of Maryland concluded in 2012 that Indonesia lost 840,000 hectares of primary natural forest—the fastest rate of deforestation in the world, almost double that of Brazil in the same year.13

At the same time, rural Indonesians are voicing their dissatisfaction at the lack of benefits from the oil palm industry. Smallholder farmers and other groups complain that they are being marginalised by large plantations, and there are thousands of conflicts between companies and rural communities who say that their land has been stolen from them. The following is based on an interview conducted by the EIU in November 2014.

13 Margono, Belinda Arunarwati; Potapov, Peter V; Turubanova, Svetlana; Stolle, Fred; and Hansen, Matthew C. “Primary forest cover loss in Indonesia over 2000-2012.” nature climate change 4, 730-735, 2014.



What are the difficulties for smallholders and how may they be overcome?

Historically the playing field has been extremely inequitable for smallholders. For example, even when smallholders first engage in contractual relationships with companies, they are not aware that committing their land to oil palm means that their land may be transferred to the state at the end of the contractual relationship. Smallholders also face difficulties accessing credit, which in turn means they may struggle to purchase decent farming equipment or germplasm, among other things.

The legal requirements for large plantations to involve smallholders has also been reduced, and the recently revised Plantation Law is thought to have further weakened their position. Under the Perkebunan Inti Rakyat (PIR) or “estate-smallholder” schemes set up under Suharto in the 1980s, all plantations were legally required to help establish and purchase oil palm from what were termed “plasma smallholders”. If you imagine a human cell: the large plantation is the “nucleus” and it is surrounded by plasma smallholders, who typically have around two hectares of land per smallholder and have a contractual agreement to supply the nucleus. The nucleus-plasma ratio started off as 20:80 in 1986, but by the early to mid 2000s it had shifted to 80:20, as it is now.14

The Ministry of Agriculture and the newly-formed Ministry of Environment and Forestry, and Ministry of Agrarian Affairs and Spatial Planning, must develop mechanisms that prevent discriminatory practices against smallholders, and educate smallholders on what contractual terms are reasonable.

Also, there needs to be support to help smallholders participate in “deforestation-free” and “conflict-free” palm oil markets to get a fair return. This includes first gaining clarity on forest and land tenure so as to avoid conflicts between companies and communities or between communities.

The Ministry of Agriculture is also working with the Ministry of Finance to come up with a system to provide smallholders with easier access to credit. Implementation will be the key, especially in rural areas where local vested interests may interfere, and where permitting authorities and law enforcement are often riddled with corruption.

The monocultural development of palm oil has left some critics worried that Indonesia is too exposed to fluctuating prices. How can diversification help reduce these risks?

Adaptation to a mixed crop system may indeed be best, because farmers are always vulnerable to market prices, and increasingly vulnerable to erratic weather patterns due to climate change. In a sense having a mixed crop system is like hedging against these variables and the government ought to incentivise a shift towards that.

Historically the playing

field has been extremely

inequitable for smallholders.

14 Editor’s note: This shift in the nucleus-plasma ratio is documented in “The biofuel boom and Indonesia’s oil palm industry: The twin processes of peasant dispossession and adverse incorporation in West Kalimantan”, a paper by Claude Joel Fortin from Saint Mary’s University in Canada.



of these products and these are small but important steps up the value chain.

Progress has also been made in forestry. An organisation called Telepak has been working with villagers to secure forestry rights and help them sustainably harvest and manage those forests, as well as improve their organisational management. They have received certification from the Forest Stewardship Council (FSC)—an international non-profit organsation that guarantees sustainable practices and gives them export market access, and they are now able to sell at a higher price than they could before being certified. Right now they’re just selling certified logs but Telepak is exploring whether the communities can start manufacturing something at the village level, whether it’s furniture or other products.

There are a multitude of other smallholder crops and fruit trees that can be grown: candlenut, durian, coffee, cocoa, spices, and rubber are still big. There’s a real multitude of these products along with livestock—cows, goats, chickens. A lot of these crops are better suited to cultivation by smallholders than oil palm. You also have a whole number of home industries making confectionary and food items out

Education is very important

in helping people to

understand better business

and agricultural practices.



What additional services and infrastructure are needed to encourage sustainable rural development?

Education is obviously very important in helping people to understand better business and agricultural practices. Other than improving the basic education given to schoolchildren, the government also needs to invest more in agricultural extension services —which teach farmers better techniques and help them get access to better resources— and ensure that these services are actually provided, which has not been the case in the past. Healthcare has also been often non-existent out in the provinces, so the rollout this year of BPJS Kesehatan—a national health insurance program that is supposed to cover all Indonesians—should help, assuming health facilities are functioning in the provinces.

Road infrastructure needs to be radically improved for both local communities and the businesses operating in rural areas. Fortunately, the new administration seems to be moving fast on land and maritime infrastructure.

More electricity is also needed. The national electrification rate was 76% in 2012, according to the International Energy Agency, but in rural areas it’s far lower, sinking as low as 30% in West Papua. There’s huge potential for the use of distributed power using renewable feedstock, particularly small hydro and biomass from the waste products of the palm oil and other industries. There have been recent increases in the feed-in tariffs to encourage the construction of renewable power plants of 10MW or less but the government needs to do more.

One slightly less obvious aspect of infrastructure development that’s improving things for local communities is affordable mobile phone coverage. Even in the most remote areas that I go to now you can get some kind of cell phone signal. In the village where I used to live in Northern Kalimantan, near the Malaysian border—everybody’s on Facebook there. Broadband is still unobtainable, but at least you can get a decent signal on your phone, which has a lot of positive impacts.

If you’re a farmer and you’ve already gone to market then you either sell at a low price or you have to take it back home—which will cost you double. So with mobile phones people are much more aware of prices. But there are still problems with local elites controlling prices and the market—and this is where the government needs to step in. n

In the village where I

used to live in Northern

Kalimantan, near

the Malaysian border

—everybody’s on

Facebook there.



While every effort has been taken to verify the accuracy of this information, The Economist Intelligence Unit Ltd. cannot accept any responsibility or liability for reliance by any person on this report or any of the information, opinions or conclusions set out in this report.

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Investing in Indonesia’s new era · 2015-11-05 · President Joko Widodo, known locally as Jokowi, was elected in 2014 and represents a break for the world’s fourth-most populous