July 17, 2014 12:00 am JST

A strong domestic focus has foreign investors feeling excluded

SADACHIKA WATANABE, Nikkei staff writer

Crowds fill Pasar Benhil, a locally owned market in central Jakarta. Roughly half of Indonesia's 250 million people are under 30.

JAKARTA -- On the morning of July 9, Indonesian presidential candidate Joko "Jokowi" Widodo, accompanied by his wife, arrived at a polling station in central Jakarta and cast his vote amid a constellation of camera flashes. Wearing a relaxed smile and a traditional long-sleeved batik shirt, Widodo had an air of quiet confidence. That confidence was even more apparent at a press conference later the same day, when, citing figures from private "quick counts," he declared, "The result means victory."

     But Prabowo Subianto, his rival in the closely fought election, begged to differ. He declared that different quick count figures showed his side received "the support and mandate of the people."

     The election commission will not announce the official results until late July. In the meantime, Indonesia faces a period of uncertainty over who will run the country.

     The main campaign issue was how to provide the leadership needed to reduce poverty, promote infrastructure development and foster new industries. Indonesia is Southeast Asia's largest country in terms of economy, land area and population, but its legal system and infrastructure remain severely underdeveloped, mainly because of its sheer size. The most pressing issues the new president will face after taking office will be supporting the growth of domestic companies, increasing employment and fostering export industries.

     Achieving these goals, however, could prove tough. Even as the region's economies are poised to become more interconnected through the slated launch of the Asean Economic Community by 2015, Indonesia has grown increasingly inward-looking, as manifested by new legal and regulatory barriers against foreign investment. And both Widodo and Subianto have expressed support for these rules. The problem is, foreign investment has been one of the main drivers of the country's economic rise. 

Stemming the flow

"Our company was left with no option but to seek relief through international arbitration," Martiono Hadianto, president director of Newmont Nusa Tenggara, a local subsidiary of U.S. mining giant Newmont Mining, said in a press release on July 1. It was a declaration of war against the government.

     In June, Newmont halted copper concentrate production at its Batu Hijau mine on the eastern island of Sumbawa after its storage facilities were filled to capacity due to export restrictions. The miner invoked the force majeure clause of its contract and put 3,200, or 80%, of its employees on furlough. Believing that the controversial 2009 Mining Law was hurting its business, Newmont took its case to the International Center for Settlement of Investment Disputes, which operates under the World Bank.

     The Mining Law, enacted in 2009, stipulates that from 2014, miners must process minerals inside Indonesia prior to export to add value to outbound shipments. The government hopes the rule will lead to an increase in the nation's production capacity for refined metals, such as aluminum and stainless steel, and ensure an adequate supply for locally operating foreign manufacturers of vehicles and autoparts. Jakarta is preoccupied with meeting demand because Indonesia is on its way to becoming the biggest automobile market in the Association of Southeast Asian Nations.

     Alarmed by Indonesia's growing "resource nationalism," Japan and other nations that depend on mineral imports appear ready to file a complaint with the World Trade Organization about the country's ban on ore exports. Indonesia simply sees the new law as an effective tool for forcing local miners to build smelters. Both Widodo and Subianto have voiced support for the legislation and say it is what the public wants.

     The government has increasingly been promoting the domestic supply of locally produced oil and gas, as well as awarding exploration rights for oil and gas blocks to local companies. The contract for Indonesia's Offshore Mahakam Block -- a 50-50 venture between Japan's top energy explorer, Inpex, and French energy company Total -- is slated to expire in March 2017. Whether to extend the contract will probably be a key economic issue taken up by the new government. Some officials in Jakarta are considering granting part or the majority of the concession to state oil company Pertamina.

     Last September, Inpex President Toshiaki Kitamura visited Jakarta and asked Indonesian President Susilo Bambang Yudhoyono to extend the company's 20-year contract to operate at the Masela Block, which is expected to begin producing liquefied natural gas in 2018 at the earliest. Although the agreement is not slated to end until 2028, Inpex made the request out of concern that it may otherwise not get a sufficient return on the investment.

     Indonesia's accelerating economic growth has caused domestic demand for resources to jump. That has the government scrambling to ensure that more of the country's abundant natural resources go not toward exports but toward meeting local needs. Ironically, local opposition has hampered such efforts. Projects to build large power plants often involve expropriating large chunks of inhabited land. Pushback from local residents has caused construction delays, raising the specter of serious electricity shortages.

Restricted retail

When government representatives from Indonesia and Japan met in Yogyakarta in late June for policy talks on distribution, a senior Japanese official asked the country to ease regulations on retail operations. The Japanese side argued against restrictions on foreign investment in convenience stores. It also did not like the regulation requiring that at least 80% of products at stores be domestically sourced. At a public-private forum held later the same day, a representative from FamilyMart, a major Japanese convenience store chain, tried to win support from the hosts by spelling out measures the company is taking to contribute to the local economy, including hiring more locals.

     Because foreign businesses are not allowed to invest directly in convenience stores in Indonesia, Japanese retailers are running stores under licensing agreements with local counterparts. Midi Utama Indonesia operates a chain of Lawson convenience stores, a big franchise in Japan. Last August, however, the Indonesian retail heavyweight closed all 20 Lawson outlets on the resort island of Bali after its earnings were battered by failed attempts to expand its store network there.

     Big retailers are likely to remain under heavy regulatory pressure even after the new government comes to power.  In Jakarta, where Widodo serves as governor, the issuance of licenses for large shopping malls and convenience stores has been put on hold. Subianto, meanwhile, has vowed to shield traditional markets from foreign competition. Several regulations are already in place to protect mom-and-pop retailers.

     In recent years, rules on foreign investment in not only the retail sector but also in wholesale and warehousing have been tightening. For example, the government issued a new so-called Negative Investment List that puts a 33% foreign ownership limit on the wholesale and warehousing sectors and bans foreign investment in e-commerce companies.

Domesticating banks

After the Indonesian economy was pummeled by the Asian currency crisis in the late 1990s, the country explored avenues to recovery using foreign capital as leverage. This was especially the case in the banking sector. While ethnic Chinese-owned conglomerates such as the Salim and Lippo groups gave up control of their banks, Singaporean, Malaysian and other foreign financial institutions ventured into the Indonesian market.

     Now that the economy is back to stable growth and banks are in solid shape, however, lenders are seeking independence from foreign ownership. The government has helped them in this regard by lowering the ownership limit for a single foreign bank or other shareholder in an Indonesian lender to 40% from the previous 99%. But the country's financial market remains fragile. It is crowded with more than 100 small and midsize banks, and purging the market of overseas capital could destabilize the economy.

     Widodo pledged that as president, he would maintain the current cap on foreign banks' investment in Indonesian peers, heightening caution in the sector.       

Labor pains

Ties between government and labor are expected to grow stronger when the new president comes to power, potentially hurting corporate profitability. Indonesia's many labor unions have been active in spearheading demonstrations and offensives for wage hikes, and each has made clear which candidate it supports. In return for such backing, both Widodo and Subianto have suggested they will bring activists or labor leaders into their cabinets.

     In 2013, the official monthly minimum wage soared 44% on the year to 2.2 million rupiah ($189) in Jakarta. This hit employers, especially manufacturers, hard. For example, at a parts subsidiary of Astra International, which has a partnership with Toyota Motor, higher import costs due to a weaker rupiah, coupled with rising pay levels, caused net profit to slide 5% in 2013 despite a 30% increase in sales.

     Productivity is another area where manufacturers are expected to be challenged. There are two reasons for this. One is restrictions on outsourcing labor using temporary staffing services or hiring contract-based workers. Climbing labor costs, in addition to rules that make it harder for companies to fire employees, will probably result in higher fixed labor expenses.

     Foreign manufacturers in Indonesia are trying to offset steeper labor costs by further automating production. The government is not keen about this strategy, however, because it limits hiring.

     The second factor crimping productivity is delays in developing adequate infrastructure for logistics and power.

     "It currently takes two and a half hours for a one-way trip from the plant to the port. And that could more than triple to nine hours by 2020," said a Japanese executive at a Toyota plant east of Jakarta. The road linking the factory to the port of Jakarta is a logistical lifeline for the company, but traffic jams are becoming a serious problem due to congestion in the capital and heavy activity at nearby industrial parks.

     According to the World Bank's Logistics Performance Index survey for 2014, Indonesia ranked 53rd in logistics efficiency, behind Thailand, at 35th, Malaysia, 25th, and Vietnam, 48th.

     While campaigning, Widodo unveiled a policy to build 2,000km of roads. Subianto responded with a plan to construct 3,000km of roads and bridges. With both candidates making it clear they understand that underdeveloped infrastructure is stunting economic growth, their ability to implement their proposals will be a matter for close public scrutiny.

     The Indonesia Investment Coordinating Board said direct foreign investment in the country hit a record 270.4 trillion rupiah in 2013, up 22% on the year but down from the 26% logged in 2012. The growth for the January-March period was just 9.8%, substantially slower than the 27.2% seen a year earlier.

     Of the two major drivers of Indonesia's growth -- household spending and investment -- household spending appears to be losing steam amid rising interest rates and prices. If the new government is unable to keep investment flowing in by leveraging the massiveness of the market and boosting the country's appeal among foreign companies, Indonesia could revert to the bad old days of low growth, high unemployment and social unrest.