Investing in Indonesia's New Era: Political Reforms and Economic Opportunities

Open for business?
Investing in Indonesia’s new era
A report from the Economist Intelligence Unit
Sponsored by Shell

© The Economist Intelligence Unit Limited 2015
Open for business?

© The Economist Intelligence Unit Limited 2015
Open for business?
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
Open for business?
Preface
Saying 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
Open for business?
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

Open for business?
Reform or conform:
Indonesia’s political landscape
Jack Hewson, contributing editor, the Economist Intelligence Unit
1
ThismayposechallengesforMrAldirightnow,
butinthelongtermit’sgoodnewsforIndonesia.
Thearchipelago nation needs massive investment
tocontinuethealmost6%averageGDPgrowth
rateithasexperiencedoverthepastdecade.
Thegovernmentestimatedthatthe2014fuel
subsidycutwouldsave120trnrupiah(US$9.6bn)
thatcouldberedirectedintoinfrastructure
spendingandgovernmentservices.Thisisa
goodstart,butJokowihassaidUS$500bnof
investmentwillbeneeded—mainlyfromthe
privatesector—toachievehistargetof7%
annualGDPgrowthby2019.1
Much to do
To 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.
Jokowihimselfwillneedtoclarifyhispositionon
“resourcenationalism”throughhishandlingofthe
unprocessedmineraloreexportban,whichwas
upheldbytheconstitutionalcourtinDecember
2014.Theimpositionofpunitivetaxesonthe
exportofType1minerals,likecopper,ironoreand
lead,hasbeensuccessfulinforcingforeignminers
tocommittobuildsmeltingfacilities.Butthemore
stringentcriteriaforminersofType2minerals,like
Aldi 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.
1
Moestafa, 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.

Open for business?
nickel,bauxiteandtin,appearstoodemandingto
bemetandseemlikelytoresultinlittlebenefitfor
eitherIndonesiaortheminingindustryasexports
declineandworkersarelaidoff.
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 gap
Despite 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.” McKinseyCompany, 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.

Open for business?
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 obstacles
Unless 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.

Open for business?
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

Open for business?
Promoting policy certainty, unlocking
investment potential
Wijayanto Samirin, co-founder and managing director of Paramadina Public Policy
Institute, and economic advisor to Indonesia’s Vice President Jusuf Kalla
2
attract global investment and to allow its
economy to flourish.
Unlocking Indonesia’s potential
Home 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%,halfthatofVietnam.Investment
facesthreemain 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%
Millions 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 FDI
South-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.

Open for business?
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.

Open for business?
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
discourseorregulardialoguewithpolicymakers
—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 ownership
Policy 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 gas
Agriculture forestry
Manufacturing
Telecommunications
Electricity
Banking
Insurance
Transportation
Average
Indonesia
98
72
69
57
95
99
80
49
77
Malaysia
70
85
100
40
30
49
49
100
65
Philippines
40
40
75
40
66
60
100
40
58
Thailand
49
49
87
49
49
49
49
49
54
Vietnam
50
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.

Open for business?
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.
Regulation
Lack 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.

Open for business?
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 years
The 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-mp3ei
8
Paramadina Public Policy Institute (PPPI) estimate

Open for business?
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

Open for business?
Regulation and economic nationalism in
Indonesia: The investment impact
Keith Loveard, senior analyst, Concord Consulting
3
Widodo, 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

Open for business?
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 means
Despite 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 ban
The 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.

Open for business?
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 direction
Fauzi 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.

Open for business?
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
nationalistline.However,thisdoesnotmeanthat
foreign investment will suddenly become easier.
Factors beyond central
government control
Lengthy 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
Whetherbydesignornot,
Indonesia’sbureaucracyis
complicatedandponderous
andattimesabarriertoentry.

Open for business?
Indonesia’s logistics services sector:
The key to boosting growth potential
Josephine Bassinette,manager, operations and portfolio, World Bank Indonesia
4
Jersey 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 of
logistics—moving goods around the country,
as well as imports and exports in and out of
Indonesia—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.

Open for business?
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 Singapore
Tanjung 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

Open for business?
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 and
the hinterland is also essential so containers
can be moved efficiently out of ports, and trucks
can enter with certainty and support rapid
unloading 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

Open for business?
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

Open for business?
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

Open for business?
AcrossIndonesia,portinfrastructure
isunabletohandledemandandthe
requirementsofmodernlogisticsfor
thecountry’sgrowingeconomy.

Open for business?
Moving up the value chain: Reviving
Indonesia’s manufacturing sector
Destry 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 up
South-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.

Open for business?
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 manufacturing
The 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.

Open for business?
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 change
Legislation 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.

Open for business?
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
manufacturing
Targeted 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.

Open for business?
Working towards a sustainable future
for Indonesia’s rural economy
QA with Steve Rhee, programme officer, natural resource governance, Ford Foundation
6
In 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.

Open for business?
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.

Open for business?
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.

Open for business?
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.

Open for business?
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.

LONDON
20 Cabot Square
London
E14 4QW
United Kingdom
Tel: (44.20) 7576 8000
Fax: (44.20) 7576 8500
E-mail: london@eiu.com
NEW YORK
750 Third Avenue
5th Floor
New York, NY 10017, US
Tel: (1.212) 554 0600
Fax: (1.212) 586 0248
E-mail: newyork@eiu.com
HONG KONG
6001, Central Plaza
18 Harbour Road
Wanchai
Hong Kong
Tel: (852) 2585 3888
Fax: (852) 2802 7638
E-mail: hongkong@eiu.com
GENEVA
Rue de l’Athénée 32
1206 Geneva Switzerland
Tel: (41) 22 566 2470
Fax: (41) 22 346 9347
E-mail: geneva@eiu.com

Investing in Indonesia's New Era: Political Reforms and Economic Opportunities

Recommended

Recommended

More Related Content

What's hot

What's hot (19)

Similar to Investing in Indonesia's New Era: Political Reforms and Economic Opportunities

Similar to Investing in Indonesia's New Era: Political Reforms and Economic Opportunities (20)

More from The Economist Media Businesses

More from The Economist Media Businesses (20)

Recently uploaded

Recently uploaded (20)

Investing in Indonesia's New Era: Political Reforms and Economic Opportunities