Learning from its competitors: how Indonesia can increase foreign direct investment

05 Jul 2019
By Callum Murray
Learning from its competitors: how Indonesia can increase foreign direct investment
Growing at an average of 5.4% of GDP annually over the last decade, Indonesia’s economy is booming. However, this rate of growth has been limited by an infrastructure gap, requiring an injection of up to $600 billion in investment over the next ten years to rectify. Indonesia is looking to foreign investors to help fill this void, but they are not alone in this pursuit. Several ASEAN nations have similar infrastructure gaps. Vietnam’s is $600 billion; Thailand’s $500 billion, and the Philippines at $500 billion. This begs the question: What policies should Indonesia implement to secure foreign direct investment (FDI) against its competitor nations?
Problems with existing policies

Indonesia has great potential to increase its FDI. However, at present, this is undermined by existing government policy. Since 2009, Indonesia has increased barriers to investment through tariff and non-tariff measures, which has raised costs and reduced the availability of inputs. This contrasts with other Southeast Asian nations, which have undertaken trade liberalisation. Indonesia also restricts FDI through regulatory measures. Foreign equity is limited to a maximum 15% in all sectors; the government reserves numerous sectors exclusively for Indonesia’s own micro, small and medium enterprises; special licenses are required for foreign operators; and there are minimum local content requirements. Consequently, such measures have contributed to Indonesia having the third highest degree of regulatory restrictiveness of the 68 lower-middle income countries surveyed by the OECD. It is little wonder that FDI, as a share of Indonesia’s GDP, is one of the lowest in the region.

Nonetheless, there has been some effort by the Indonesian government in recent years to produce more favourable conditions for foreign investment. For example, Indonesia and Australia recently signed the Indonesia-Australia Comprehensive Economic Partnership Agreement (IA-CEPA), which aims to facilitate greater investment and economic cooperation between the two nations. That said, economic nationalists in politics and government often meet such measures with harsh criticism. Their public condemnation of free trade agreements appears to have significant influence over the government policy agenda. During the recent 2019 election campaign, for instance, both President Joko Widodo and his opponent Prabowo Subianto announced protectionist policies as part of their campaigns. In particular, Widodo promised higher import tariffs and supported nationalising natural resource projects - both of which would discourage FDI in those key economic sectors. It seems that while Indonesia has made steps towards introducing new policies promoting FDI, it is susceptible to nationalist influences.
Learning from its competitors

To ensure Indonesia is not left behind, it should examine policies implemented by their regional competitors. For instance, in 2017, as shares of import value subject to new import restrictions, Indonesian barriers to trade and investment were a little over 50%. In comparison, barriers in the Philippines were less than 5%; Thailand less than 10%; and Vietnam approximately 15%. It seems that extant Indonesian government policy imposing import barriers is creating a substantial challenge to FDI by regional standards. To become more attractive for investments, tackling import barriers like their neighbours have done would be a first step.  

Indonesia’s foreign equity limits are also problematic. It currently sits at 15%, a considerably lower level than similar economies in the region. For instance, Vietnam and Thailand both cap foreign equity at 49% (although Vietnam plans to remove restrictions by the end of 2019), and the Philippines allows up to 100% in some sectors. The World Bank estimates that the removal of Indonesia’s foreign equity limits could produce an extra USD 4 billion in FDI. When compared to its regional competitors, Indonesia may be missing out on potential FDI due to restrictive foreign equity laws.

Furthermore, Indonesia should complete existing Free Trade Agreements (FTAs) and consider beginning negotiations with its economic partners. As of writing, Indonesia has only nine ‘signed and in effect’ FTAs, which is less than Vietnam (13) and Thailand (14), but more than the Philippines (eight). Nevertheless, 27 FTAs are currently under study or negotiation by the Indonesian government. Participation in multilateral and bilateral FTAs is important because they provide an external mechanism to accelerate domestic reforms and increases opportunities to key economic markets, which further encourages FDI flow into the nation.  For instance, Indonesia’s neighbours, Australia, Malaysia, Vietnam, Singapore, and Brunei, are part of the ambitious Comprehensive and Progressive Agreement for Trans-Pacific Partnership (or CPTPP) which has created a highly competitive economic bloc, which attracts high levels of FDI. Indonesia is a signatory to the proposed Regional Comprehensive Economic Partnership (RCEP) encompassing the ASEAN nations and the six Indo-Pacific states which ASEAN has existing FTAs with (Australia, New Zealand, India, China, South Korea, and Japan). Before the RCEP is implemented, Indonesia ought to promote economic stimulating investment rules which would give would-be investors greater confidence in Indonesia as a viable investment option.
Indonesia and China’s Belt and Road Initiative

In order to boost trade and stimulate economic growth across Asia and the world, China has vowed to invest nearly a trillion dollars in its controversial Belt and Road Initiative (BRI). Indonesia intends to capitalise on this policy by seeking to secure up to $91 billion in investment. However, China’s BRI comes with risks relating to debt sustainability and foreign influence. The Centre for Global Development reports that vulnerable countries accepting BRI loans are prone to ‘debt traps’ in which nations become dependent on China as a creditor, thereby providing an avenue for China to increase its strategic global influence.

Sri Lanka is a cogent example of such risks. After the country was unable to pay back its debts, China secured a 99-year lease of Sri Lanka’s Hambantota port and subsequent access to strategic commercial and military waterways in the Indo-Pacific region. Due to such concerns, in 2018, the new Malaysian government stopped $22 billion worth of BRI projects after Malaysia’s Prime Minister, Mahathir Mohamad accused China of trying to secure influence over the country through debt-funded infrastructure schemes.

Ostensibly, Indonesia should be cautious in the coming years to ensure it does not allow its infrastructure gap to draw it into similar ‘debt traps’. Instead, Indonesia ought to consider adopting policies similar to those implemented by its neighbours who also simultaneously need and are wary of Chinese investment in infrastructure. For instance, Vietnam’s historical circumspection of China has meant that it took two years before Beijing and Hanoi agreed to terms in regards to the implementation of the BRI in Vietnam. Similarly, Vietnam continues to seek possible alternatives to the BRI to fund its infrastructure development, including through Japan’s Partnership for Quality Infrastructure (PQI) initiative.
Concluding remarks

Indonesia requires billions of dollars’ worth of FDI to fund its infrastructure gap and accelerate economic growth. However, its current policies and regulatory settings are hindering its ability to diversify multiple sources of FDI. Indonesia has a template for reforms and policy settings from the very neighbours it will have to compete with investment. For instance, Indonesia can use Vietnam, Thailand and the Philippines as a model for lowering new import restrictions and allowing substantially higher foreign equity limits. Indonesia can also consider negotiating more FTAs and pushing for investment rules in regional trade agreements like the RCEP to give would-be investors more confidence. When it comes to the BRI Indonesia should instead follow Vietnam’s lead by carefully considering loan proposals, whilst continuing to seek investment from other sources.


Callum Murray
Callum Murray
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