Indonesia's plans to attract foreign direct investment

 

The Indonesia Investment Coordinating Board (BKPM) is targeting $64.7bn worth of foreign and domestic investment in 2020, which would mark an increase of 9.4% from 2019. Around 55% of the value is earmarked to come from foreign companies. However, this target is likely to be reassessed in light of the $50bn of investments that have been stalled across 24 projects – primarily in the energy, petrochemical and automotive industries – due to disputes over land acquisition rights and delays in the granting of licences. Furthermore, streamlining of regulations at the central and regional levels of government is required. The spread of the Covid-19 pandemic may lengthen existing delays; however, as of May 2020 the long-term effects of the virus on economies around the world remained unclear.

Plans on hold include the construction of a 3.5m-tonne-per-year naphtha cracker plant by South Korean company Lotte Chemical Titan, as part of a targeted investment goal of $4.2bn. This is part of wider efforts to secure $31.5bn of investment in chemicals by 2023 in order to help Indonesia meet its goal of reducing chemical imports by 30-40%. The Lotte plant has been repeatedly held up by land acquisition issues and is indicative of the battle the government faces to reduce red tape and encourage investment in downstream industries.

Riding the Omnibus

According to President Joko Widodo, better known as President Jokowi, the solution is to streamline investment procedures and relax hiring rules – while also improving fiscal incentives and restructuring Indonesia’s financial system. The proposed vehicle for these changes is omnibus laws that will streamline the complex legal structure governing economic activity. More than 100 bills will be revised, updating the legal system to meet the requirements of Indonesia’s increasingly vibrant and modern economy.

However, rumours have swirled around details of the legal revisions, highlighting communication issues that will be important for policymakers to address swiftly in order to avoid confusion or concern in the business and investment community. Key ministries, notably the Ministry of Finance, are firmly behind the push, and there is widespread belief in their capacity to execute. Moreover, President Jokowi had set himself a 100-day timeline to deliver to Parliament the draft of the first Omnibus Law, which was developed in consultation with key stakeholders. The bill was submitted to Parliament in early February 2020. Over the long term, improvements to accountability and transparency in the public sector are expected, although the short-term impact on long-standing issues such as private sector licensing, land acquisition and foreign labour are somewhat less clear. The omnibus laws will be vulnerable to adjustment as they pass through the legislature, although President Jokowi appears to have strong support for his agenda. “The president is supported by both the opposition leader in the Cabinet and successful entrepreneurs heading state-owned enterprises in the tourism, education and health sectors,” Arwin Rasyid, founder of venture capital firm TEZ Ventura Indonesia, told OBG.

Tax

One area covered by the omnibus laws is tax reform, with corporate income tax to be reduced from 25% to 20% by 2023. The reform agenda also includes the removal of a tax on dividends provided they are reinvested in-country, and a 10% value-added tax (VAT) on digital products sold by non-resident internet companies beginning from July 2020. Digital transactions were previously exempt from VAT, which disadvantaged brick-and-mortar competitors.

There are also plans to offer legal support for an existing presidential instruction that tasks BKPM with sole responsibility for handling the investment process, while also granting the body the power to review policies that are deemed unfavourable to investors. The move aims to improve Indonesia’s position on the World Bank’s ease of doing business index, from 73rd in 2020 to between 50th and 40th by 2021. “Our focus is not only to improve ease of business across all of the World Bank’s 11 metrics, but also to streamline licensing, promote investment based on focused sectors and countries, encourage large investments to partner with local entrepreneurs and help to realise large investment,” Bagus Hariadi, head of energy, mineral resources and forestry at BKPM’s Directorate of Investment Deregulation, told OBG. For example, BKPM intends to reduce the number of steps to open a business from 11 to three or four. These moves are widely viewed as positive, though there is caution over the extent to which BKPM will be able to follow through on its mission brief, particularly when it comes to implementing reform beyond Java.

Shift to Digital

Work to synchronise reforms has already begun, by conducting the investment approvals process via the online single submission (OSS) platform. According to BKPM, in the 18 months to December 2019 the system had issued more than 1m business licences. The OSS system allows companies to first obtain a business licence and operational/ commercial licence, and fulfil the requirements at a later date. OSS integration with other ministries’ licensing systems helps businesses identify which other licences are required. Businesses have also been relieved of obligations to narrowly define their scope of business and investment timelines, leaving them more flexible to adapt as they grow.

Moreover, in an effort to attract investment, BKPM expanded the number of business fields eligible for tax allowance from 145 to 183: hotels and leisure, as well as software programming and games, were added to the list of segments eligible for a 30% net income reduction on investment value over six years. Still, work remains to be done to ensure businesses leverage these opportunities. “The tax holiday incentives are there for steelworks, machinery and aircraft building, but since 2018 only smelters, chemicals, electricity generation and digital economy have had substantial numbers of applicants,” Hariadi told OBG. The government also plans to issue a positive investment promotion list. According to BKPM, the focus will be on small and medium-sized enterprises – specifically, on opening the door to wider foreign investment while obliging foreign entrants to engage and partner with local players.

Labour Reform

The area targeted for reform that has garnered the most opposition from vested interests is labour law. Regulations mandate relatively high minimum wages – which in January 2020 were increased by 8.5% – and make it prohibitively expensive to terminate employment, in some cases requiring up to 32 months of backpay. These regulations have been blamed for stagnating the labour market and deterring foreign investment. However, skills gaps are arguably the more pressing issue facing Indonesia’s investment environment. Currently, regulations prohibit or limit this gap from being addressed by talent from overseas. Meanwhile, a number of recent reforms have opened the door to foreign universities establishing campuses in Indonesia, with Australia’s Monash University becoming the first to pledge to do so. As of February 2020 the university planned to open its campus by the end of the year, but it remains to be seen if this timeline will be pushed back as a result of the Covid-19 pandemic. When the university opens, it is expected to lead the way for more international tertiary institutions to enter the market, expanding choice and raising educational standards. Furthermore, omnibus reforms may clarify any lingering ambiguities for foreign universities eyeing opportunities in Indonesia, particularly in regards to bringing in skilled faculty members from abroad.

According to the World Bank, the ratio of skilled foreign workers employed in Indonesia to the total workforce is 73:100,000. This relatively low density is the result of a number of restrictions related to work permits. The restrictive environment has led some of Indonesia’s most prominent digital players to import software talent from India on a rotational basis. The Ministry of Manpower is in the process of easing some of these restrictions and further clarity is expected in the omnibus reforms. More broadly, the political sensitivity inherent in these issues presents the possibility that government resources may remain focused on labour at the expense of more easily achieved victories in other areas, slowing reform momentum in the process. Further legal revisions, earmarked under the omnibus tag, are required to modernise Indonesia’s financial system and facilitate a planned $20bn sovereign wealth fund that will seek to invest both state and foreign capital in vital infrastructure projects.

While passage of the omnibus laws are expected to result in many targets being met, there is unlikely to be total clarity due to these reforms alone. Indonesia will remain a complex place to do business, but one with stronger and more modern legal foundations that will provide a more stable launchpad for future progress towards an enabling business environment.

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The Report: Indonesia 2020

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