Indonesia Must Do More to Attract Much Needed Foreign Direct Investment

Foreign direct investment has been a part of Indonesia’s history for several hundred years. In the 16th century, spices such as cloves and nutmeg first brought European companies to Indonesia.

Today, thanks to growing sectors such as mining, transport and telecommunications, it continues to attract high levels of foreign direct investment. While Russia and India — rapidly developing BRIC economies — had declining rates of FDI in 2010, Indonesia enjoyed a 60 percent annual increase to $17 billion in 2010 and to $19 billion in 2011. In the first quarter of 2012, FDI was up 30 percent from the previous quarter to $5.6 billion.

Companies come to Indonesia lured by its vast natural resources, large domestic market and low labor costs. Once here, they stay for the relatively stable political environment and rapid economic expansion.

So far, Indonesia’s economy has managed to have these high rates of FDI despite conditions that might hinder capital inflows in other countries.

Indonesia is regarded as one of the most corrupt countries in the world, with Transparency International ranking it 100th out of 183 countries. Standard and Poor’s has pointed to policy slippages such as the reversal of a plan to cut fuel subsidies as factors in its decision not to upgrade Indonesia’s credit rating to investment grade.

On the bright side, both Moody’s and Fitch Ratings did upgrade Indonesia’s credit ranking to investment grade earlier this year for the first time in 14 years. Indonesia has come a long way from the net outflow of FDI it incurred after the Asian financial crisis. Some of the most sought-after investor nations such as Singapore, Japan, the United States, South Korea and the Netherlands are among its largest investors today.

However, to sustain FDI going forward, the government will need to further develop infrastructure capacity. Indonesia still lags behind competitors such as Malaysia and Thailand in terms of its basic logistics and physical infrastructure, adding to firms’ production costs. President Susilo Bambang Yudhoyono plans to double spending on roads, seaports and airports to $150 billion before his term ends in 2014.

Chinese Prime Minister Wen Jiabao has also promised $19 billion of investment credit and $9 billion of soft and commercial loans for infrastructure development in Indonesia. It remains to be seen whether these expenditures will translate into more efficient services for businesses that operate in the country, but the intention is right on the mark.

Indonesia’s regulatory framework also needs to be more conducive to investment. The World Bank’s Doing Business survey moved the country down three spots to 129th this year, pointing to the need for further reductions in the time and cost of starting businesses, dealing with construction permits, acquiring credit or assets and registering property in Indonesia. Untangling the country’s complex webs of bureaucratic red tape and licenses will help strengthen the formal economy.

These regulatory reforms should also aim to standardize practices around the country. Indonesia’s post-1999 decentralization has led to inconsistencies in business regulation at the national and sub-national level, resulting in further delays. Administrative bodies at different levels should engage in further dialogue to develop a clearer set of policies for companies that want to set up shops or factories in Indonesia.

Finally, in the long term, Indonesia would benefit from diversifying its investment, which is currently dominated by the extractive industries and palm oil.

According to Oliver Oehms, senior advisor on trade and investment at the Indonesian Chamber of Commerce (Kadin), Indonesia cannot sit back and relax, despite its natural-resource riches. Sectors such as mining, construction and commodity goods provide high returns, but they will no longer be growing as rapidly 20 to 25 years from now. So there needs to be more of a shift toward manufacturing, with growth in electronics, machinery and possibly the automotive industry.

Overall, the future does look promising. For now, Indonesia does seem to be working toward further improving its image in the eyes of investors. The government has announced tax concessions on investments of more than $120 million or Rp 1 trillion ($106 million) and the removal of ceilings on FDI in five sectors. The Land Acquisition Bill passed in December will speed up infrastructure projects, while services such as the One Stop Shop (PTSP) and the National Single Window (Spipise) to process documents and provide investment licenses online will allow for more efficient business operations.

It’s worth pointing out, however, that greater FDI is not a magic bullet for economic growth and development. Capital inflows can lead to pressures on a country’s currency, which in turn can have negative policy implications. FDI can also bring with it environmental degradation. Foreign companies have faced a backlash from local communities in Papua and northern Sumatra as workers have gone on strike to push for higher wages and better treatment.

But when done right, FDI can have significant spillover benefits in terms of improved productivity, technology and management practices. It can be a powerful force for growth and reform in Indonesia. Now is the time to harness its potential.

Aparna Bansal, a student at Brown University in the United States, is an intern at Strategic Asia, a consultancy promoting cooperation among Asian countries.