Sectoral Economic Development Strategy

Indonesia’s Sectoral Economic
Development Strategy through FTA
Arrangement
Keywords: Sectoral targeting, FDI, FTA

Prayoga Wiradisuria
October 2007

Supervisor: Professor Shujiro Urata

RESEARCH

Determining future key FTA items between Indonesia and partner
Goal country through assessment of country’s priority sector and FDI spill-
over effect and hurdles.

Determining priority sector (re-assessment)
Method FDI spill-over effect assessment
Previous FTA assessment (incl. ASEAN FTAs)

Interviews of key government officials and experts
Data gathering Indonesia economic statistics (time series, sectoral, etc)
FTA data

Subject of Economic Development theories
reference FDI concept and impact analysis
FTA principles

CONTENT

Brief Statistics of Indonesia

Revisiting Sectoral Targeting in Indonesia

FDI and Its Spill-Over Effect

Impact to FTA Key Negotiation Items

INDONESIA
A quick glance

An Archipelago of ~17,000 islands

230 Million people

300+ languages

Multi-ethnic, multi-religion

Gained independence 60 years ago

Member of OPEC, APEC, ASEAN

Democratic systems

Resource-rich

KEY ECONOMIC INDICATORS

1997 1998 1999 2000 2001 2002 2003 2004 2005E 2006E 2007E
National Account
Real GDP (% yoy) 4.7 -13.1 0.8 4.9 3.8 4.4 4.9 5.1 5.4 5.4 6.0
Domestic demand (% yoy) 7.5 -15.3 -1.3 4.6 4.5 4.7 3.7 7.1 5.5 6.4 6.8

Working Draft - Last Modified 2/8/2006 10:40:49 PM
Real Consumption: Private (% yoy) 7.8 -6.2 4.6 1.6 3.5 3.8 3.9 4.9 3.5 4.2 4.5
Real Gross Fixed Capital Formation (% yoy) 8.6 -33.0 -18.2 16.7 6.5 4.7 1.0 15.7 10.9 10.3 12.2
GDP (USD Bils.) — nominal 213 96 140 166 164 200 239 258 275 341 370.4
GDP per capita (USD) — nominal 1,075 477 694 742 697 948 1,117 1,191 1,254 1,538 1,648
External Sector
Exports (% yoy, US$) 7.3 -8.6 -0.4 27.7 -9.3 5.0 8.4 12.0 19.5 3.0 0.8
Imports (% yoy, US$) -2.9 -34.4 -12.2 39.6 -7.6 15.1 10.9 27.8 23.7 6.2 6.7
Trade balance (US$ Bils.) 11.8 21.5 24.7 28.6 25.4 23.5 24.6 21.2 28.0 26.3 23
Current account (% of GDP) -2.4 4.3 4.1 4.8 4.2 3.9 3.4 1.1 0.6 0.2 -0.4
External debt (% of GDP) 64 157 106 86 81 66 57 53 49 39 36

Printed
International Reserves-IRFCL (US$ Bils) 16.6 22.7 24.4 29.4 28.0 32.0 36.3 36.3 34.7 33 31.5
Import cover (months) 4.3 8.5 9.6 8.7 9.7 10.8 11.0 8.4 6.9 5.5 4.6
Currency/US$ (period average) 2,952 9,974 7,847 8,389 10,247 9,315 8,573 8,936 9,711 9,315 9,750
Other
1M SBI Rate (% period average) 15.3 48.8 22.8 12.4 16.5 15.1 10.1 7.5 9.6 12.6 11.8
Consumer prices (% period average) 6.2 58.0 20.8 3.8 11.5 11.8 6.8 6.1 10.5 13.7 7.6
Fiscal balance (% of GDP; FY) -1.2 -1.7 -2.8 -1.2 -2.4 -0.9 -1.8 -1.2 -0.5 -1.1 -0.5
S&P's Rating - FCY BB+ CCC+ CCC+ B- CCC CCC+ B B+ B+
S&P's Rating - LCY BBB+ B- B- B B- B- B+ BB BB
Source: Citigroup

4

ECONOMIC PROJECTION

BI's Economic Prospects 2005 2006
Economic Forecasts:
I. Real GDP Growth (%) 5.3 - 5.6 5.0 - 5.7 Budget Assumptions 2006
1. Consumption: 3.3 - 3.8 4.0 - 5.0
a. Private Consumption 3.4 - 3.9 3.0 - 4.0 Economic Growth (%) 6.2
Inflation rate - eop (%) 8.0

b. Government Consumption 2.6 - 3.1 12.8 - 13.8
2. Investment 9.6 - 10.1 8.4 - 9.4 3M SBI rate - average (%) 9.5
3. Exports of Goods & Services 7.6 - 8.1 7.4 - 8.4 Vs. Exchange Rate - average 9,900
4. Imports of Goods & Services 10.5 - 11.0 9.1 - 10.1
Oil Price - ICP (US$/barel) 57.0
II. CPI Inflation Rate - eop (% YoY) 18 7.0 - 9.0
Oil Production/Lifting (MBCD) 1,050
Assumptions:
I. External Conditions:
1. World Oil Price (USD/barrel) 53 57
2. World Output Growth (%) 4.3 4.3
3. World Trade Volume Growth (%) 7 7.4 Medium Term Targets, 2005 - 2008 2004 2005 2006 2007 2008

Printed
4. World Interest Rate (%) 3.6 4.5 Economic Growth (%) 5.1 5.5 6.1 6.7 7.2
5. US tight money policy ends at 2Q06, thus stable IDR/USD
Quality of Growth:
expected in 2006 1. Open Unemployment:
II. Internal Conditions: a. Million of Persons 10.3 10.2 9.6 8.8 7.5
1. Wages/Salary increase and bank credit growth of around 15% - b. % of Labor Force 9.9 9.6 8.9 8 6.7
2. Manpower
20% in 2006 can partly offset the declining purchasing power due to
a. Labor Force (million of persons) 104 106 108 110 112.1
high inflation Additional (million of persons) 1.3 2 2 2 2.1
2. Tight "bias" monetary policy to help curb inflation b. Job Opportunity (million of persons) 93.7 95.7 98.3 101.2 104.6
3. Faster disbursement of government spending in 2006 Job Creation (million of persons) 0.9 2 2.6 2.9 3.3
4. Better investment climate, incl. Investment Law, Tax reforms, Labor
Law, etc. Source: Bank Indonesia, 16 Dec 2005, APBN 2006

5

INDUSTRY SECTORS CONTRIBUTION TO GDP

1Q05 2Q05 3Q05 YTD-05 Share 1Q05 2Q05 3Q05 YTD-05 Share
1. Agriculture 2.5% 1.1% 1.6% 1.7% 15.3% 4. Utilities 5.8% 8.9% 9.8% 8.8% 0.7%
a. Farm Food Crops 1.3% -0.6% 0.3% 0.4% 7.9% 5. Constructions 7.3% 8.1% 6.3% 7.2% 5.9%

b. Others 4.1% 2.8% 2.9% 3.2% 7.5% 6. Trade, Hotel & Rest. 10.0% 10.0% 7.9% 9.2% 16.7%
2. Mining and Quarrying 0.7% -0.8% -2.3% -0.8% 9.0% a. Wholesale & Retail 10.6% 11.1% 8.4% 10.0% 13.7%
a. Oil & Gas -6.6% -4.7% -6.4% -5.9% 5.3% b. Hotel 11.3% 1.8% 3.1% 5.3% 0.7%
b. Non Oil & Gas 16.5% 4.7% 3.3% 7.7% 2.8% c. Restaurant 5.9% 5.9% 6.0% 6.0% 2.2%
c. Quarrying 7.3% 8.1% 6.3% 7.2% 0.9% 7. Transport & Comm. 13.2% 13.9% 12.9% 13.3% 6.1%
3. Manufacturing Industries 6.5% 5.5% 5.6% 5.9% 28.1% a. Transport 10.6% 7.9% 5.1% 7.8% 3.8%
a. Oil & Gas -3.0% -2.0% -0.1% -1.7% 2.8% * Railways -4.9% -5.5% -4.9% -5.1% 0.0%
b. Non Oil & Gas 7.7% 6.4% 6.3% 6.8% 25.3% * Road 4.8% 5.3% 4.9% 5.0% 1.6%
* Food, Bev. & Tobacco 4.7% 3.5% 2.9% 3.7% 7.0% * Air Transport 20.4% 12.2% 7.2% 12.8% 0.6%
* Textile, Leath & Footw -0.8% 3.1% 1.2% 1.1% 3.1% b. Communication 17.9% 25.2% 27.5% 23.6% 2.3%
* Wood & Forest Prod. 0.3% -2.1% 0.5% -0.4% 1.2% 8. Finance 6.4% 9.8% 9.1% 8.4% 9.2%
* Paper & Printing 3.9% 4.6% 8.7% 5.7% 1.4% a. Banks 1.4% 9.9% 10.1% 7.1% 4.1%

Printed
* Fertilizer, Chem.& Rubber 17.6% 9.0% 6.3% 10.7% 3.4% b. Non Bank Financial 8.9% 9.2% 7.8% 8.6% 0.7%
* Cement/Non-Metal Quarry 10.1% 8.7% 2.6% 7.0% 0.9% c. Others 10.9% 10.2% 10.2% 10.6% 4.4%
* Iron & Steel -8.0% -4.2% -3.5% -5.2% 0.4% 9. Services 4.9% 4.4% 5.4% 4.9% 9.0%
* Transport/Machine Equip. 13.5% 11.7% 13.5% 12.9% 7.7% Real GDP 6.1% 5.8% 5.3% 5.8% 100.0%

blue figures mean average growth
Source: Badan Pusat Statistik
green figures mean better to excellent growth
red figures mean lower to dismal growth

6

SAVING RATIO AND INVESTMENT RATIO

Saving Ratio Investment Ratio
1994-1996 2002-2004 Change 1994-1996 2002-2004 Change

Bangladesh 20.1 23.5 -3.4 20.7 24.0 -3.2
China 41.3 45.8 -4.5 40.5 42.6 -2.1
Hong Kong 31.6 31.6 0.0 32.8 22.3 10.6
India 22.4 23.3 -0.9 23.9 22.8 1.1
Indonesia 28.4 23.3 5.1 31.2 20.4 10.8
Malaysia 34.9 34.0 0.8 42.1 22.7 19.4
Philippines 18.8 22.5 -3.7 23.5 19.2 4.3

Printed
Singapore 50.7 44.2 6.5 34.4 18.6 15.7
Korea 35.9 32.2 3.7 38.4 29.4 9.0
Taiwan 27.5 26.5 1.0 24.6 18.0 6.6
Thailand 34.3 30.5 3.8 41.4 25.3 16.1
Vietnam 18.2 31.1 -12.8 28.1 34.4 -6.3

7

DEFINITION AND BENEFITS OF SECTORAL TARGETING

Main benefits of targeting

• Mobilizes and focuses public resources (public funds,
Definition of sectoral administrations, political decisions) on a limited number of
targeting projects or sectors to gain a favorable position relative to
competitor countries (concentration vs. dispersion)

Identification by the state or • Identifies the fields of action that offer the most
region of activity sectors productivity for public investment to prioritize state
for priority resource intervention (economic vs. political approach)
allocation with the objective • Enables more effective, transparent public communication

Printed
of accelerating economic with international lenders, investors, and local economic actors
development
• Narrows the scope of state action so that sectoral
strategies can be defined in greater depth

9

EXAMPLES OF PROACTIVE SECTORAL-TARGETING STRATEGIES
SUCCESSFULLY IMPLEMENTED BY EMERGING NATIONS
Key comparative advantages

IT/business India • Low-cost, qualified, English-speaking workforce
process • Availability of world-class IT infrastructure (e.g.,

outsourcing (BPO) special IT parks)

Dubai • Geographic location
Logistics/light • Quality of port infrastructure
manufacturing • Free zone for light manufacturing (Jebel Ali)

Morocco • Climate/environment/culture

Printed
Tourism • Proximity to Europe
• Hotel infrastructure

Tunisia • Availability of raw materials (olives)
Olive oil • Availability of production, promotion, and
marketing

10

ILLUSTRATION: NATIONAL ECONOMIC STRUCTURE ANALYSIS
GDP, jobs, and exports (including informal sector) Industrial sector ratios

Jobs per mn Exports/
revenue revenue (%)
100% = 419bn 9.6mn jobs 136bn

39 39 Tertiary
14 19

Tertiary sector 54 sector

12
Industrial 4 33
Industrial secondary 9
16 secondary
sector 52
Other secondary 12 Other
40 16 11
secondary
Primary sector 18 4
5
Primary
GDP Employment Exports 52 8
sector

Printed
• The industrial sector occupies a position of • The industrial sector makes a relatively limited
medium importance in the local economy, with 16% contribution to job creation
of GDP and only 12% of jobs • A significant share of production is destined for export
• However, the industrial sector is the country’s
leading source of exports, accounting for more
than 50% of all exports

11

ILLUSTRATION: COMPARATIVE ANALYSIS WITH OTHER COUNTRIES
Industrial GDP in
$ bn

Country 1
High 44

Industrial GDP

Country 7
31
($ bn)

30

17
Country 2
Country 3
Country
11
Low

under study

Printed
6
Country 4
2
Country 6 1
Country 5

Low High

Relative weight of industrial sector
(industrial GDP/total GDP)

12

ILLUSTRATION: STATIC ANALYSIS OF CONTRIBUTION DISGUISED EXAMPLE

MADE BY DIFFERENT BRANCHES Large sector

100% = 52.1bn 467,000 jobs 70.8bn

Electronics 1% 2% 3%
Machinery and equipment 2% 2% 1% 0%
2% 2%
Furniture and other industries 2% 2% 1% 1%
4%

3%
Electrical appliances and machines 2%
5% 14%
Paper and board 7%
Automotive 2%
12%
5%
13%
Chemicals

19% • Textile and agri-food
industries play a
Building materials structuring role in
40%
the national

Printed
economy
20% 47%

Textiles and leather
• The automotive
sector is relatively
significant to exports

34% 32%
Agri-food* 21%

GDP Employment Exports

13

ILLUSTRATION: DYNAMIC ANALYSIS OF GROWTH IN MAIN BRANCHES

Average annual growth
rate (AAGR) of GDP
GDP GDP growth %, last 5 years

17.3 1.3 2.7
Agri-food*

Textiles and leather 10.3 0.3 0.6

Building materials 9.3 1.6 4.8
• Relatively low GDP
growth in absolute terms
Chemicals 6.6 1.8 8.3 **

• Average annual growth
rate of GDP is above 5%
Automotive 2.5 0.8 9.6
in only three sectors:
– Automotive and

Printed
2.3 0.03 0.4 electronics
Paper and board
(for export)
– Chemicals
Electrical appliances (for domestic market)
1.3 0.05 0.9
and machines

Furniture and other 0.9 -0.1 -2.6
industries

Machinery and
0.9 0.1 4.1
equipment

Electronics 0.7 0.1 6.0

14

FDI IS ASSUMED TO BRING POSITIVE TO INDONESIA ECONOMY
THROUGH INCREASED CAPITAL STOCK, EMPLOYMENT, AND
PRODUCTIVITY
Impact generated
Investments through FDI

Capital
Depreciation

stock
• FDI can have important positive
Existing stock effects on a country’s economic
development*

Job creation
• FDI impacts GDP through 3 key
GDP Employment Job destruction levers

Printed
– Increasing capital stock
Existing employment – Employment creation
– Inward transfer of skills and
Technology technology* leading to
increased productivity
Skills/Knowledge
Productivity throughout the economy
Scale effects
Geography, culture , etc.

16

SPILLOVER-EFFECT PROVIDES A GOOD ESTIMATE OF THE IMPACT AN
FDI HAS ON A LOCAL ECONOMY
Case example: Intel’s $300mn* investment in Costa Rica in 1997 created spillover in GDP
growth, trade balance, social conditions, and knowledge/productivity sector

Before Intel investment After Intel investment

Pre-1997 Post-1998

4.6 % (1990-1996) • 7%-8% (1997-1999; highest in Latin
GDP growth America)
• Five points of 8% attributed to Intel
(close to 60% GDP growth
attributed to Intel)
• $500mn deficit • $600mn surplus
• Trade concentrated in Latin America • Trade diversified to European and

Printed
Balance of trade
and U.S. Asian countries (export to Asian
countries almost tripled)

Knowledge/ • Not much interaction with • Exchange of curriculum, faculty, and
productivity cutting-edge research students through “Intel associate”
programs
• Rush toward technical education

Sources: Intel; Center for International Development, Harvard University

17

IN GENERAL, SPILLOVER CAN BE CLASSIFIED AS
QUANTIFIABLE OR NONQUANTIFIABLE
Quantifiable spillover effects Nonquantifiable spillover effects
Macroeconomic-related Health-related

Explanation Examples Examples Explanation

Spillover from Additional GDP created Emergence of a large Improvement in
Capital Social
led multiplier effects of because of investment software professional quality of life
annual opex spent middle class in
on local economy Bangalore
Increase in Know-
Indirect employment Chip-testing knowledge base ledge
Additional indirect knowledge in
Labor led created by main and capabilities
employment generated Singapore/Malaysia
investment

Printed
because of investment
Dresden in former Change in Brand
Effect on balance
Foreign East Germany country’s image image
of trade and Additional exports
trade as a high-tech
foreign because of investment
related knowledge hub
reserves
Increase in government Quantum Improvement in
Fiscal Increase in Infrastru-
tax revenue because of infrastructure local physical
related government cture
investment/new improvement in and business
revenue
employment southern China infrastructure

Source: McKinsey study

18

SOME SPILL-OVER EFFECTS QUANTIFICATION METHODS

Description Source or examples

• Created by U.S. Department of www.bea.gov/bea/dn2/home/
Commerce benchmark.htm
RIMS

• More than 300 industry aggregates
and I/O tables available for more
than 300 counties in 50 states

• Created by U.S. Forest Services and www.implan.com
University of Minnesota
IMPLAN • Now maintained by Minnesota-based
IMPLAN group

Printed
• Considered most accurate I/O table

Department of Statistics, government
• Created by the local statistical - Singapore
of
Others* organizations in each country
• Mostly country-level information

* Most countries have I/O tables, which are published either by the central bank or the central statistical body

19

FDI FLOW INTO THE COUNTRY, HOWEVER, IS FACED WITH VARIOUS
HURDLES PREVENTING INDONESIA FROM GETTING MAXIMUM SPILL-
OVER EFFECT BENEFIT
Typical hurdles Examples (Hypothetical)

• Land
• Energy

Scarce resources • Water

• Corruption networks
• Political issues
Hidden agendas • Unwillingness to give up
responsibility and control

Printed
• Long lead times between
steps of investment process
Slow and inflexible
processes
• Administrative and
bureaucratic hurdles
• Mentality issues

• Missing industry/
Lack of industry functional expertise
and functional • Focus on new sectors for
knowledge the economy

20

FTA

What negotiation items need to be incorporated in
FTA between Indonesia and partner country in a
respective sector

1. To help overcoming the hurdles to FDI from the

2. To multiply the spill-over effect of the FDIs

FTA NEGOTIATIONS SHOULD BE LEVERAGED TO INCLUDE ITEMS THAT
WILL HELP IN OVERCOMING VARIOUS HURDLES TO GENERATE FDI
FLOWS INTO THE COUNTRY
Typical hurdles Examples FTA items (hypothesis)

• Land • Transparent policy regarding pricing, allocation
• Energy and usage of key resources

Scarce resources • Water • Establish dedicated unit (e.g., land authority) that closely
works together with the Investment Agency to free up and
allocate resources for new investors

• Corruption networks • Agree on the cultivation of ‘transparency of the system’
• Political issues as guiding theme
Hidden agendas • Unwillingness to give up • Establish ‘round table’ culture to involve all relevant
responsibility and control stakeholders when problems and bottlenecks occur

Printed
• Long lead times between • Education of Local Investment Agency staff towards a
steps of investment process hands-on, consequent follow-up process with
Slow and inflexible
processes
• Administrative and stakeholders
bureaucratic hurdles • Agree on the removal hurdles and inefficiencies
• Mentality issues (‘From red tape to red carpet’)

• Missing industry/ • Regular training and coaching sessions to build up
Lack of industry functional expertise necessary skill set provided by the investor
and functional • Focus on new sectors for • Transparent recruitment of experts in key areas
knowledge the economy

23

IN SUMMARY

Indonesian Industries sectoral assessment

Non- Key Sectors Targeted Key Sectors
1. _____ 1. _____
2. _____ 2. _____
3. _____ 3. _____

Approach
Support

Printed
FDI Targets:
1. Tangible
FDI 2. Intangible
Hurdles:
1. Political agenda
2. Lack of knowledge
Support

Key items to be negotiated
FTA 1.
2.
3.
24

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