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Freedom Barometer ASIA

Indonesias economy in 2013

Freedom Barometer Asia

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A 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 the government and policy experts, 2013 will be equally pleasant. Obviously, the rather weak global economic growth affects Indonesia. But even according to the most pessimistic predictions, the economy will grow by a solid 6% in 2013, only marginally less than in 2012. (Some international banks and observers predict that by 2030 Indonesia will have become one of the ten most important industrial nations, outpacing heavyweights like France, Germany, and the UK.) The inflation rate of 2013 is projected to be around 5%, hence turning out comparatively low. Foreign investment amounted to about $27bn in 2012 (an alltime record), up from $20.3bn in 2011. The government reckons that the money will continue to flow in since growing domestic consumption, abundant natural resources, and a comparatively 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 total indebtedness 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 stable trade surplus, had to accept a deficit of about $2bn in 2012 the countrys highest to date. This has 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 the economy will grow by about 6%. To satisfy the needs, annual investments amounting to $8.3bn are required. But the national electricity producer barely manages to raise half of the needed funds from own resources. The government plans to connect 19 new coal-fired power plants to the grid in 2013 - later than originally scheduled. But even their additional capacity will not be enough to satisfy the growing demand.

In addition to the lack of available funds for investment, Indonesia faces another problem of the monetary kind: To put it bluntly, the government is bad at spending the money it has. Similar to the preceding years, the government had to assert at the end of 2012 that only 79.6% of the designated yearly means for investment were spent, mostly for infrastructure purposes. A whopping $3.7bn had remained unused. Political squabble, problems relating to the acquisition of land for public projects, environmental obligations and an increasingly self-aware civil society hamper a swift expenditure of funds. But a considerable amount of money goes into petrol and electricity subsidies. In the national budget of the year 2013 close to $30bn about a quarter of the national budget have been earmarked to that end. Beneficiaries are primarily those who can afford a car or a modern apartment. The problem is that because of the rapid economic development more and more Indonesians 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 electricity subsidies seems likely. Another irksome issue is corruption. In the Freedom Barometers last survey of corruption levels, Indonesia scored a mere 3 out of 10 points, slightly better than Vietnam but way behind the 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 the Democrat 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 lines and 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 in Indonesia. The rights of the other 14% (mostly Christians and Hindus) are protected by the Indonesian constitution. But frictions do occur. The Setara Institute, an NGO specialising in human 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 day media reports feature incidents of religiously motivated violence somewhere in Indonesia, spiced by the occasional discovery of a hitherto unknown Islamist terror group. Surveys see a substantial unease of the public regarding the stability of the constitutionally protected religious pluralism. More economic nationalism? In addition to above-mentioned challenges there are developments that point to a rising economic nationalism and - in the medium term - may scare foreign investors away. In 2009 the Indonesian government decided that beginning with 2014, foreign companies wont be allowed to simply extract and export a range of raw materials. Instead they will have to set up smelting plants in Indonesia in order to process raw materials before they are eventually shipped off. The rationale behind this rule was that by forcing foreign companies to process raw materials on location, Indonesia would increase the revenue gained from the exploitation of its

abundant natural resources. Virtually overnight a number of foreign companies anxiously started 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 an additional tax of 20% on the export of some resources (gold, nickel, copper, tin) and made obtaining export permits more complicated. In doing so the government wanted to prevent big scale raw material exports before the new rules come into effect in 2014. This spelled bad news for exporters, as the new tax came into effect just as the global demand for some resources started to decline. Hence some companies faced higher taxes in a more difficult economic environment. (The nickel industry estimates that the new policies have resulted in additional cost amounting to $676m.) Furthermore the government decided in March 2012 that, ten years into production, foreign firms may only hold a maximum of 49% of a joint venture with Indonesian mining companies1. A foreign John McBeth, The Straits Times, joint-venture partner might therefore find himself January 9th, 2013 reduced to a mere minority shareholder at some point, despite having shouldered the lions share of the initial cost. Regulations such as these are hardly the stuff that attracts foreign investment.
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.

Regulatory uncertainties add to these woes. In the context of decentralisation, the right to give out 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 are doled out rather lavishly in the run-up to elections. There is reason to suspect that local politicians 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 the National Ministry for Energy and Mineral Resources conceded in a report that out of 10,000 Indonesian mining concessions only about half were legally valid. Often, the consequences are conflicts between mining businesses and the local population when locals 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 Indonesian GDP 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 foreign investors. In November 2012 the court decided to disband the State Agency for the Exploration and Extraction of Crude Oil and Natural Gas (BPMigas).
1

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

BPMigas was set up in 2002 through a parliamentary decision after Pertamina, the state-owned oil and gas enterprise, had failed to boost the crude oil production in Indonesia. Pertamina lacked both the funds and the knowledge to extract oil from ecologically sensitive coastal and ocean areas. Furthermore, Pertamina was (and still is) utilised for political purposes which impaired its efficiency and thus its competitiveness. Hence BPMigas was commissioned to put drilling licenses for domestic and foreign companies out for tender. In the absence of serious domestic There is no way of avoiding foreign competitors - except for Pertamina - mainly big foreign companies in this nations oil and gas corporations such as Chevron or Total won the tenders. business sector. Exploration on a (Incidentally, Chevron and Total will be the biggest massive scale is needed to in-crease oil investors in 2013 as well.) and natural gas reserves. The offshore drilling needed requires a huge inSomewhere along the line a queasy feeling arose in vestment of at least US$20 million per Indonesia that the country was selling out its resources well. Each well in shallow waters costs to foreigners. A colourful coalition of Indonesian at least US$2 million. Only foreign organisations, economic groups, and individuals (among companies have the means to raise these them former administration officials and members of amounts of capital. parliament who initially had approved the creation of BPMigas) decided to take the matter to court. They The Indonesian journal Tempo in its argued that BPMigas issuing of licenses to foreign editorial of November 25th, 2012 companies was unconstitutional2. The Supreme Courts decision in that matter declared that BPMigas had indeed violated the constitution and was to be disbanded immediately. Its staff and responsibilities were transferred to the Ministry of Energy and 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 the government is problematic in several ways. Firstly, the government now has to outline a strategy for the Indonesian oil and gas industry. Foreign investors were assured that existing contracts 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 can trust the framework for doing business in Indonesia considering that important state agencies such as BPMigas can be disbanded from one day to the next, regardless of economic and legal consequences. Furthermore, the argumentation that BPMigas failed to fulfil the requirements of the constitution when it issued drilling licenses to foreign companies doesnt make much sense either if one considers related economic data. At the end of 2012 the Indonesian government estimated 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 be used to the greatest benefit of the people.

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 made the headlines because of its high degree of fragmentation and quarrels between rival associations. But young, university-educated functionaries have recognised that cooperation between the various umbrella organisations and single trade unions is possible and can be successful. They have identified two areas were the mobilisation and recruitment of members promises to be particularly successful. One area is the regionally varying minimum wage. Until now minimum wages were set on the provincial level through a mutual agreement between employers, employee representatives and state institutions. But the trade unions have recently mounted pressure on the employers representatives, drawing attention to a changed consumer basket and demanding an exorbitant increase of minimum wages. A number of provincial politicians tried to make some concessions to the trade unions demands, 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 some demands of the unions. The employers associations in turn cancelled negotiations and took the matter to the courts. Many provinces have enacted considerable wage increases for the lowest pay groups. In Jakarta, 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 do not reflect improvements in productivity. The textile industry, suffering from a decline in exports in 2012, complains that it stands in a tough competition with China on the domestic market. Businesses threaten to close plants and fire employees. They worry not only about higher 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 from relevant bodies. But this is not to say that the Indonesian authorities are particularly in favour of 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 employers associations. The unions view outsourcing as a mere tool of employers to weaken them (small businesses that take on outsourced jobs are only marginally represented in the unions) and to keep 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 held accountable for violations. Muhaimin Iskander, the labour minister, surrendered to the pressure of the unions and promised that the present legal conditions regarding outsourcing would be enforced. Employers understand his statement as just another proof of the preferential treatment of trade unions by the government prior to the election of 2014. The beginning of 2013 sees the continuation of this high-stakes conflict between unions and employers associations. The government is literally between a rock and a hard place as it may have considerable difficulties to act as a mediator in the light of strongly diverging, politically heated positions and to keep Indonesia interesting for foreign investors.

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 will present opportunities to well-qualified employees and those who are willing and able to learn new skills. A boost in prosperity and productivity may follow. However, those who are employed in the informal sector or in agriculture may lose out. Thus, even though the Indonesian government and international organisations are optimistic regarding 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 do business in the medium term. But some observers are pessimistic. They point to the fact that 2013 will be the year before the next parliamentary and presidential elections. Additionally, no less than 122 local and regional elections loom. Some politicians might feel compelled to resort to populist promises and policies to win the support of powerful interest groups. Nationalism and 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.