Dirges, challenges of traders and investors

Dirges, challenges of traders and investors

Puspa Delima Amri

The past year has undeniably seen substantial improvement in
Indonesia's macroeconomic performance. GDP growth is moderate yet
encouraging, inflation and interest rates are declining, the
exchange rate is stable and the stock market is buoyant. To the
surprise of many, several external shocks, such as the war in
Iraq, the Marriott bombing and the SARS outbreak did little to
fundamentally change the resilient nature of the Indonesian
economy. Country-risk perceptions have also improved, as shown by
the recent upgrade in Indonesia's sovereign debt ratings.

However, the view seen from the micro side is not as pretty.
The real sector is still stagnant: trade and investment recovery
is slow and unemployment is at an alarming level. Why, then, is
the strong macroeconomic performance not translating into higher
real sector growth? Unlike in the other crisis-hit Asian
countries, Indonesia's growth has yet to get back to its pre-
crisis levels. Is there something fundamentally wrong with the
government's policies and efforts to restructure the economy?

One of the reasons behind Indonesia's poor performance vis-a-
vis its neighbors is the weak sources of growth. For the past
three years, private and government consumption has been the
backbone of economic growth. But how long can an economy be
propelled by consumption alone? While other crisis-hit countries
in Asia have turned to exports and investment as their engines of
growth, Indonesia is still reliant on consumer spending.

Indonesia's export performance is still weak, with variations
across industries and destinations. Total exports up to the third
quarter of 2003 increased slightly by 7.5% compared to the same
period of 2002, but non-oil and gas exports, especially
agriculture and manufacturing, are slowing down. This fragile
performance can be somewhat attributed to the slow down in world
demand, including in the US, Japan and Singapore, Indonesia's
main export destinations. These three countries together absorb
around 40% of total non-oil and gas exports.

The situation is equally discouraging as regards investment.
As shown in Figure 1, foreign investment realization has been
stagnant and even declining in 2003. FDI approvals may have risen
considerably in 2003, however one should note that total
investment approvals include a category termed "change of status"
that inflates actual investment figures. About 60% of total
approved FDI was a result of change in project status from
domestic to foreign, following the government sell-offs of state-
owned assets.

One cannot help but see this as being somewhat ironic,
considering that President Megawati proclaimed 2003 as the "Year
of Investment" in response to the growing concerns over lack of
investment in the country, particularly foreign investment. The
government's policy in this regard includes various investment
incentives, including the drafting of a new investment bill,
which proposes the opening up of all sectors of the economy to
foreign investors, reducing the negative investment list to a
very few protected areas, giving equal treatment to foreign and
domestic investors, and reestablishing a one-stop service center
for speeding up investment licensing procedures.

A number of fiscal incentives for investment in the oil and
gas sector, including a review of the VAT on exploration, are
also being proposed. The government has been actively offering a
number of new blocks for exploration as part of a new upstream
policy aimed at boosting oil and gas investment.

Yet investment remains virtually stagnant. Foreign companies
currently operating in Indonesia are not expanding their
businesses, as shown by the negative growth in imported capital
goods. Worse still, the list of those planning to relocate their
production away to lower-cost competitors like Vietnam and China
is getting longer and longer. By the end of this year, more than
one hundred foreign companies, 40% of which are Japanese firms,
have reported to the BKPM that they plan to leave the country.
Astonishing? On the contrary, who can expect these firms to stay,
when the cost of doing business here keeps rising?

Transaction costs, which include costs at ports, electricity
and communication costs, and labor costs remain high in
Indonesia. For example the cost/lift in Tanjung Priok port is
twice that of Port Klang in Malaysia, but its efficiency is
nearly half that of Malaysia.

Meanwhile, intangible costs, such as the cost of compliance
with complex regulations, security issues and labor disputes have
long been burdening the business community. A large number of
these are the result of distortive local government regulations
issued since the introduction of decentralization.

A recent survey conducted by JETRO reveals that Japanese
affiliated companies in Indonesia face a range of serious
problems in doing business. These problems are related to
taxation, manpower management, customs clearance and
export/import duties, and the costs involved in obtaining
approvals from government agencies.

The situation is aggravated by the fact that the banking
system has still not resumed its lending activities, a crucial
factor in moving the real sector. With next year's elections just
around the corner, investors are temporarily holding on to their
money to wait and see whether or not the results are encouraging.

Clearly, traders and investors perceive that doing business in
Indonesia involves great costs. Unfortunately, it will take more
than just tax breaks and other fiscal incentives to fix the
situation. The prevailing perceptions will not change until the
fundamental issues, especially those related to regulation, are
properly addressed. The fact that there are inconsistencies and
lack of clarity in regulatory provisions, which allows them to be
interpreted at will, is a major turn-off for traders and
investors.

How, then, can we restore the confidence of traders and
investors, and improve their perceptions of Indonesia?

Naturally, the change will not come overnight as it involves
resurrecting deep-rooted institutional issues. The process of
restoring security, political stability and legal certainty will
involve a time-consuming learning curve. Nevertheless, there are
still some bright spots that we can look to. The new investment
bill, an essential legal foundation for investors, is currently
being discussed by the national legislature. Efforts to revise
the autonomy law are being made. We can also capitalize on a
recovery in world demand, which appears to be just around the
corner

Finally, the big challenge lies in whether or not next year's
elections will produce a strong and disciplined government, one
that can build confidence, promote investment, maintain the
reform agenda and deal with lingering domestic constraints. A
successful outcome will be the first step to creating a
supportive investment climate, a necessary precondition for
significant economic growth in Indonesia.