Dirges of traders and investors

Puspa Delima Amri Researcher Dept. of Economics Centre for Strategic and International Studies (CSIS) Jakarta

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.