JAKARTA - After years of policy confusion and political gridlock, Indonesia's Parliament this month ratified a government plan to establish full free trade zones (FTZ) for areas of three islands located near Singapore. The move represents the latest bid by President Susilo Bambang Yudhoyono's pro-business administration to attract more badly needed foreign direct investment (FDI) into the country.
His government fast-tracked the policy for the island of Batam, the country's main industrial center, and also parts of Bintan and Karimun, in response to growing regional competition, including from nearby Malaysia's ambitious Iskandar Development Region project, which envisions the establishment of a massive new regional manufacturing hub also aimed at forging linkages with Singapore.
So urgent were those competitive concerns that in June Yudhoyono's government issued a state emergency regulation to amend existing FTZ legislation. Indonesian law requires that any emergency law must be approved by the House of Representatives before it can take effect, while legislation enacted in 2000 stipulates that any area formally designated an FTZ must be backed by law.
Indonesia is ranked 15th, fourth among the five Southeast Asian countries included in the world's top 20 economies most attractive for FDI, according to the just-released World Investment Prospects Survey 2007-2009 FDI. The Investment Coordinating Board reported this month that FDI approvals were up almost threefold to US$33 billion between January and September compared to the same period last year, while actual FDI flows almost doubled to $8.54 billion from $4.29 billion.
Still, compared to its attractiveness with foreign investors before the 1997-98 Asian financial crisis, FDI to Indonesia continues to trail several regional rivals – not to mention China and India. Despite a new investment law passed this year that promises equal treatment for foreign and local investors, investor concerns over Indonesia still center on rampant corruption, red tape, poor infrastructure, powerful labor unions, local-autonomy problems and judicial unpredictability.
The new status for the strategically-placed islands aims to counteract some of those poor perceptions. The designation means import taxes, customs and excise duties, value-added tax and luxury goods sales taxes will be completely abolished. The government also plans to establish 11 more special economic zones (SEZ) across the country, using Batam, Bintan and Karimun as prototypes.
Batam has enjoyed limited FTZ status since 1978, entailing investment incentives that included exemption from import duties and income and value-added taxes for all export-oriented industries. Since then the central government's investment in infrastructure in Batam has run over hundreds of millions of dollars, while the island has attracted over 600 foreign companies and billions of dollars worth of foreign investment, including $4.5 billion last year.
Singapore's entrepreneurs, starved of land at home, have in particular been attracted to Batam's unique hybrid free-trade environment and its cheap land and labor. Those advantages afforded Singaporean entrepreneurs one of the best manufacturing, industrial and logistical environments in the region from which to export products globally. Some 70% of the island's economic growth since the early 1980s has come from the export-oriented manufacturing sector.
In 2003, an additional 25 Singaporean companies set up factories on Batam, attracted by tariff advantages in the then upcoming Singapore-United States Free Trade Agreement. The bilateral pact allowed for certain goods, manufactured or assembled on Batam, to qualify as of Singaporean origin and hence enjoy the preferential benefits accorded to a Singapore product. Batam attracted $22.6 million in new investments that year, of which at least half was contributed by the Singaporean companies.
However, by 2004 political opposition to Batam's special treatment had mounted with some Indonesian legislators claiming that formalizing FTZ status for the island would run contrary to the spirit of new local autonomy laws, which gave greater administrative powers to local governments.
Batam's investment incentives meant for export industries had been widely abused by local Indonesian companies with no products or services for export. Rampant under-invoicing, manipulation of import duty exemptions and tax breaks sparked resentment among domestic companies operating in areas without FTZ privileges.
President Megawati Sukarnoputri's administration, which held power from 2001 to 2004, promised business leaders in Singapore that Batam's crucial FTZ status would be formalized by April 2003, when Singapore was due to ink its bilateral free-trade pact with the US. Her government wanted official FTZ status to apply only to several separate enclaves or industrial zones that actually required import duty exemptions and tax breaks, to prevent the risk of smuggling into and out of the island.
Before the 2004 elections, which ushered in Yudhoyono, the House of Representatives unilaterally approved a bill that conferred FTZ status on the entire island of Batam. However, the legislation was never enacted as the country's constitution stipulates that both the government and the House must approve a law for it to come into force and the Megawati government rejected it.
Until now, Batam had no legal umbrella for investment activity. The new government had focused more on its own pet project of SEZs across the three islands and other areas, prioritizing local over foreign interests. Local media reports said in June Vice President Jusuf Kalla swung away from the 2004 stance of making the island only an enclave FTZ, and decided on full FTZ status for the entire island of Batam, against the wishes of a special government team dedicated to promoting SEZs.
Meanwhile, security concerns, labor disputes and until now delays in formalizing Batam's FTZ status have all conspired to erode the island's competitiveness. Although security concerns following a series of deadly terrorist attacks since 2002 have now largely abated, concerns about rising wages despite low productivity gains, have escalated not only in Batam but across the whole country.
According to Trade Minister Mari Pangestu, 26 companies shut down operations on the islands between 2004 and 2006, resulting in potential financial losses of $91.9 million and 23,140 lost jobs. Pangestu has been instrumental in pushing for a quick resolution to the prolonged uncertainties over the status of Batam.
More recently, however, Batam's prospects have brightened, particularly following last year's economic cooperation agreement with Singapore to help develop SEZs on the Riau Islands, a newly created province that includes the three islands. The local administration plans for Batam to act as a hub for mechanics, electronics, computing and shipbuilding industries; Bintan for textiles, footwear and tourism; Karimun for shipbuilding, metal, agribusiness and marine product industries.
Combined, the three islands exported goods worth a total of $4.24 billion during 2006, and during the first four months of this year exports soared to $2.19 billion from $1.86 billion in the same period the year before. The Batam Industrial Development Authority has also played a major role in the island's development.
Its pro-business chairman for several years, Ismeth Abdullah, is particularly upbeat about the three islands' economic future, predicting last week that the province would attract up to $15 billion in investment over the next five years, with Singaporean investors contributing some 60% of that total.
Singapore, known for its high standards for trade practices, has established similar free trade zones with China and India and is expected to play a major role in key areas of the bilateral cooperation for the FTZs, including customs and excise, immigration, manpower and institutional development.
Labor issues are to be addressed by the establishment of local tripartite labor committees within each FTZ. Kalla has been quoted as saying he wants cooperation between the government, employers and workers at the local level so that problems can be contained and resolved locally before spreading and damaging the overall investment climate.
Since the cooperation agreement with Singapore was inked, deals worth $1.8 billion with 22 companies, including some from Singapore, have been secured in the three SEZS, which are expected to create 50,000 new jobs. Recent news reports indicate another eight Singaporean companies plan to invest a combined $613 million in the areas.
With general elections less than two years away, this should all be good news for Yudhoyono, whose administration is being judging domestically by its ability to spur economic growth and create jobs. Increasing pressure from nationalistic elements in Parliament is likely to test this political will to the full, including from Megawati's faction in Parliament, which opposed the House's decision to pass the latest amendment on FTZ status.
The still powerful party which will challenge Yudhoyono at the next polls has claimed the government had created an investment crisis itself by deliberately postponing the introduction of bills designating the three islands as FTZs and the party has already promised to challenge endorsement of the emergency law in the courts.Bill Guerin, a Jakarta correspondent for Asia Times Online since 2000, has been in Indonesia for more than 20 years, mostly in journalism and editorial positions. He specializes in Indonesian political, business and economic analysis, and hosts a weekly television political talk show, Face to Face, broadcast on two Indonesia-based satellite channels. He can be reached at