Speech Richard van der Schaar at Stadiums & Arenas Asia Summit 2017

With various high-profile events to come, Southeast Asian governments and stadium owners are currently in the midst of building new stadiums and venues or upgrading existing venues to meet international sporting standards. This also implies the need for urban planning to put in place the necessary infrastructure to support such big-scale events and to boost tourism. At the Stadiums and Arenas Asia Summit 2017 industry players and government officials from all around the world met to exchange ideas, knowledge and learn the best operational and commercial practices through case-studies of successful stadiums and arenas.

Indonesia Investments' Managing Director Richard van der Schaar was requested to present an overview of the Indonesian economy to the delegates, with a particular focus on foreign direct investment and infrastructure development in Indonesia. Below we present his speech:

"Good morning, ladies and gentlemen. Thank you Andrew James [Senior Principal at Populous who acted as conference chairman] for the introduction. I was asked by the organizers of the Stadiums and Arenas Asia Summit 2017 to present a brief overview of the Indonesian economy - explain the audience about the strengths and weaknesses of the economy - as well as to present an overview of foreign direct investment (FDI) and infrastructure development in Indonesia. Lastly, I answer the question whether private foreign investors are keen on investing in infrastructure development in Indonesia.

First please allow me to introduce myself. I am the managing director of Indonesia Investments, an online platform that serves to inform people about the possibilities and risks of investing in Indonesia. This platform is owned by Van der Schaar Investments B.V., a Dutch investment company and one that has a long history in terms of property development and management in the Netherlands. Thus we have experienced, first-hand, the key link between, on the one hand, property or infrastructure development and, on the other hand, accelerating local economic growth as a result of property and infrastructure development.

But first a brief overview of the Indonesian economy. Indonesia is the largest economy in Southeast Asia and the world’s 16th-largest economy with gross domestic product (GDP) gradually approaching the USD $1 trillion level. It is an emerging market that falls within the lower middle income category [World Bank]. But what makes an emerging market? In essence, an emerging market is a market that contains a rapidly expanding middle class. The increasingly wealthier population consumes more - and more luxurious - products and services due to its strengthening purchasing power. This then attracts investment and industrialization which subsequently generates employment opportunities, hence the middle class segment grows further.

Being an emerging market also implies that the nation still needs plenty of development. This applies to basically all sectors within the economy, such as infrastructure, property, consumer goods, agriculture, energy and so forth. For investors this context means that there are many lucrative investment opportunities, provided the nation can enjoy a relatively stable political system and has an open economy (meaning it welcomes foreign investment rather than being protectionist). In the case of Indonesia, democracy is relatively strong - despite being a young democracy (since 1998) and it therefore experiences some growing pains - while the government indeed welcomes foreign investment (although some sectors are closed or partially closed to FDI).

This is rather positive, indeed. However, you always have to be aware of the “high gain, high risk” principle. Investing in Indonesia can be a more lucrative experience compared to investing in an advanced economy. But it also brings along more risks. I will come back to this point a bit further on in my presentation. It is therefore key to try to reduce this risk element. First step for foreigners is to become familiar with the country, with its cultures, with the people's mindsets, and make a careful study of the sector you are aiming for. On our website www.indonesia-investments.com you can find plenty of information about these topics.

Why is Indonesia an attractive market for foreign investors? Firstly, it has a huge population (around 258 million people), the world's fourth-largest population. In combination with relatively high economic growth, this population form a great consumer force. Although per capita GDP is currently not rising as fast as it did during the 2000s commodities boom, households’ purchasing power is still growing in Indonesia, implying the middle class segment of the Indonesian population continues to expand. This population is the key engine of the Indonesian economy with household consumption accounting for almost 60 percent of Indonesia's total economic growth. This implies a boost to a wide range of sectors within the economy, for example property development, food and beverage industry, hospitality as domestic tourism rises, car sales and so on.

Indeed some of the sectors I mention - property and automotive - have been under pressure lately mainly due to the economic slowdown in the 2011-2015 period and Bank Indonesia's high interest policy in the 2013-2015 period. However, for the long term there remains ample room for further growth.

I want to add two more characteristics with regard to the population of Indonesia. Firstly, with regard to demographic composition I want to emphasize that Indonesia has a young population with around half of the population being aged below 30 years. This implies Indonesia has, potentially a large workforce. However, to tap this demographic bonus there needs to be enough employment opportunities and it is also vital that this large workforce is healthy (health care) and learns the necessary skills and knowledge through education to turn Indonesia into an innovation-driven nation. This is important home work for the government.

Secondly, as we basically see all across the globe, Indonesia too is experiencing a rapid process of urbanization. Currently, over half of Indonesia's total population resides in the country’s urban areas. This is important for overall economic development of Indonesia as research shows that urbanization and industrialization go hand in hand. The process of urbanization in Indonesia has been ongoing for several decades and is expected to continue in the decades to come.

Lastly, I need to emphasize that there exists a rather big gap in terms of geographic distribution of this population. We are now on Java, Indonesia’s most populous island and which also forms the centre of Indonesia’s political system and industry. Here about 150 million people live, or about 60 percent of the total Indonesian population, so this shows a very uneven distribution and also explains why most investors focus on Java as here they can find most consumers, the biggest cities and the best infrastructure.

Besides the big population another strength of the Indonesian economy is the availability of many natural resources, including agricultural commodities and minerals/mining commodities. Indonesia is a big exporter of particularly coal and crude palm oil and therefore these commodities are big foreign exchange earners. In fact, Indonesia’s economic growth in the 2000s was primarily supported by the commodities boom. High commodity prices led to big earnings. But this is also where there exists a vulnerability. The Indonesian economy is too dependent on the export of raw commodities. Thus, in times of low commodity prices (which we saw especially after 2011) Indonesia’s GDP growth fell considerably. This was reason for the Indonesian government to increase its focus on the development of the domestic manufacturing industry, including the establishment of downstream industries in the mining sector. Perhaps some of you have heard about the ongoing dispute between Freeport Indonesia and the Indonesian government. This issue it actually the result of the government’s new focus on the development of downstream industries thus reducing the country’s dependence on exports of raw materials.

These commodities are mainly found on the islands of Sumatra and Kalimantan. The local economies on these two islands are highly connected to commodities. Thus, considering Sumatra accounts for slightly over 20 percent of the total Indonesian economy, while Kalimantan accounts for about 8 percent of the economy, it implies that about 30 percent of the total Indonesian economy is directly related to commodities.

I want to add that the mining sector of Indonesia is also the sector where you can expect to find most corruption. Possible most of you know that Indonesia doesn’t score well on the Corruption Perceptions Index of Transparency International, currently being ranked at 90. When it involves the extraction of natural resources you will see a high degree of corruption because there is a high degree of government involvement, especially on the local level in the current era of decentralization; a process that occurred after the fall of Suharto’s authoritarian New Order regime in 1998. Regional governments have a much bigger say in the management of their natural resources compared to the past. With the decentralization of power, corruption also became decentralized. For certain mining permits you will still need to bribe local leaders, while on the central level many permit procedures are now done online in order to avert such misbehavior.

Lastly, in terms of commodity exports, Indonesia is conveniently located between India and China, two of the biggest commodity importers. Other big export destinations for Indonesia are the USA, Japan and Singapore.

So we have had (1) the big population, (2) natural resources and (3) its location near India and China. The next strengths of the Indonesian economy are political stability and prudent financial/fiscal management. After the chaotic period in the late 1990s when the Asian Financial Crisis evolved into a social and political crisis in Indonesia, Indonesia turned into a democracy in which the regions gained more power (decentralization). This was not an easy transformation, especially considering Indonesia is a huge and diverse country (cultural-wise), implying policy making and implementation is tough. However, despite growing pains, Indonesian democracy is relatively strong in the sense that this system will not collapse easily. Although there is still a long way to go for democracy to function 100 percent accurately in Indonesia, Indonesian democracy is strong as we can conclude from the fierce 2014 presidential election, a tight battle between Joko Widodo and Prabowo Subianto that in the end required a ruling from the Constitutional Court. Although filled with emotions the election did not result in riots, coups, etc. For the economy that was great (particularly the victory of market-favorite and reform-minded Widodo) as political stability is necessary to attract investment, especially foreign direct investment.

And Indonesia now now also offers prudent fiscal management, very different from the period before 1998. Whereas Indonesia’s central bank had no clue about money flows and the private sector's foreign debt in the Suharto era (which explains why Indonesia was the biggest victim of the Asian Financial Crisis), Indonesia’s financial system is now transparent ans stable with recent governments having to limit the budget deficits, while financial authorities also safeguard a healthy fiscal regime with low public debt, a sustainable current account deficit, a stable rupiah exchange rate, and so forth.

The last strength of the Indonesian economy I will mention in this presentation is Indonesia's low labour wages. Although Indonesia’s minimum wages have increased significantly in the 2013-2014 period, possibly the result of the election time, investors in Indonesia can still enjoy low minimum wages. But the sharp wage rises in 2013-2014 indeed worried investors and therefore Widodo capped the minimum wage increase in one the economic policy packages, a decision that was likened by investors. Low labour makes it attractive for investors to build production bases in Indonesia but - as I pointed out earlier - there has emerged an important change over the past decade: Indonesia is not just an attractive production base where you can produce and export your products, but due to rapidly growing per capita GDP the country is now also a good place to sell your product.

The aforementioned all explains why Indonesia is an attractive investment destination for private and foreign investors. But now lets take a look at direct investment in Indonesia. Total investment realization in full-year 2016 reached IDR 612.8 trillion (approx. USD $46 billion), up 12.4 percent compared to investment realization in the preceding year, and 3 percent above the investment target that was set by the BKPM for 2016 (IDR 594.8 trillion). For 2017 BKPM targets to attract IDR 678.8 trillion worth of direct investment.

More than half (IDR 397 trillion) of total direct investment in Indonesia in 2016 (IDR 612.8 trillion) was foreign direct investment, hence reflecting the importance of FDI toward the Indonesian economy. Most of FDI that year went to the metal, machinery and electronic industry, mining, and electricity, gas and water supply.

Although direct investment in Indonesia - both foreign and domestic - has been rising continuously over the past years in rupiah terms, we see a slightly different picture when we use US dollar terms. In US dollar terms FDI fell in, for example, the last quarter of 2016 (rupiah depreciation can disguise this when FDI data are presented in rupiah terms). In Q4-2016 the world was plagued by uncertainties due to the surprise victory of Donald Trump in the 2016 presidential election, while the Federal Reserve was coming closer and closer to an interest rate hike (something that could shock global financial markets). Meanwhile, ethnic and religious tensions were rising in Indonesia due to the blasphemy case of the Jakarta governor.

And what are actually the obstacles to investment in Indonesia? There are several important ones. Firstly, the lack of quality and quantity of infrastructure development. This causes high logistics costs and undermines companies' competitiveness (compared to foreign counterparts). Meanwhile, lack of a sufficient supply of electricity in the more remote areas (outside the bigger cities of Java and Bali) causes frequent blackouts and this is a big problem for businesses (in the remote areas in the eastern part of Indonesia investors will first need to build a power plant before establishing a factory).

Related to infrastructure development is the difficulty of land acquisition. This may be the biggest challenge to infrastructure and property projects in Indonesia. Whenever there is a plan to build a project, local land prices rise rapidly. When local landowners refuse to sell their land to the project developers the project is either postponed or cancelled altogether. Indeed Indonesia approved the Land Acquisition Act in 2012 during the presidency of Susilo Bambang Yudhoyono (SBY). This law was designed to make it much easier to obtain land for projects that benefit local society as a whole. SBY did not use this law, possibly because various corruption cases emerged in his party and cabinet during the last years of his rule. Forcing locals to sell their land would possibly damage his reputation further. Widodo, however, shows more commitment to infrastructure development. However, he has to rely on courts and they not always rule in favor of the project developers (in the Suharto era developers could rely on the army to solve this issue).

The third obstacle to investment in Indonesia is bureaucracy. There exists weak coordination and cooperation between the central and regional authorities and this is not unoften blamed on the weak quality of human resources at the local level. For example, it is very complicated to obtain environmental impact analysis certificates or land clearing permits. The situation is worsened by Indonesia's weak legal certainty with vague/unclear policies, and slow or half policy implementation. Next is corruption (there exist close ties between the political and corporate elite) and the last obstacle to investment that I mention here is high severance pay (causing local firms trying to avoid having formal contracts). Severance pay is a key difficulty as employees resigning voluntarily are also often entitled to separation compensation. Meanwhile, hiring skilled workers is a difficult matter because less than 10 percent of the Indonesian population reaches tertiary level education and this leads to a high share of informal workers.

Regarding infrastructure, Indonesia lacks much, both in terms of ‘hard’ infrastructure (such as roads, harbours, airports, bridges and the electricity supply) and ‘soft’ infrastructure (such as social welfare, healthcare and education). This situation arose as economic development (particularly during the 2000s commodities boom) was not joined by infrastructure development. The lack of quality and quantity of infrastructure leads to high logistics costs, high costs of doing business, hence undermining the competitiveness of Indonesian companies versus foreign counterparts. In World Economic Forum (WEF)'s Global Competitiveness Report 2015-2016, Indonesia only ranks 62nd out of 140 economies in terms of infrastructure development.

What explains the weak infrastructure in Indonesia today? Well, first it is necessary to emphasize the challenging context. Indonesia is a huge country, with around 17,000 islands, hence being the world’s largest archipelago (a focus on maritime infrastructure is therefore required). This context brings along massive costs and the need for advanced technology. Secondly, there is a lack of sufficient government funds and lack of private sector interest in infrastructure projects due to long-term and capital-intensive nature of these projects (which are often plagued by several risks amid Indonesia’s non-optimal investment climate such as the land acquisition process).

Read more: Infrastructure in Indonesia - Challenges

Indonesia's National Medium‐Term Development Plan (RPJMN) 2015-2019 targets a total of IDR 4,796 trillion (approx. USD $358 billion) worth of investment in infrastructure to achieve the government's targets by 2019. However, the central and local state budgets can only contribute 41 percent to the financing, while state-owned companies can only contribute up to 22 percent. This implies the remaining 37 percent of funds need to originate from the private sector. Hence, there is a big role for the private sector but I’m pessimistic about the actual realization.

Widodo seemingly also realizes this and therefore his administration not only allocates more and more public funds to the annual infrastructure budget (while reducing government spending on energy subsidies), but also appointed the state-owned or state-controlled companies as agents of infrastructure development (supported by capital injections from the state budget). There is no other option for the government because interest from the private sector (for infrastructure projects) is very limited, even when it involves financial schemes such as the availability payment mechanism or the viability gap finance mechanism. Also the public-private partnership projects (PPP), once being presented as the solution to all problems in the SBY era, turned out to be unsuccessful due to the lack of private sector interest. Hence, it is basically up to the government to solve this infrastructure gap. It needs to be more aggressive and innovative to find new sources to fund its ambitious infrastructure development program. It can find some additional funds by boosting tax revenue (there is actually still a lot to win from this sector as Indonesia's tax-to-GDP ratio is very low) and by focusing more on issuing bonds for infrastructure development. Meanwhile, for certain projects it cannot attract interest from the foreign private sector but it can attract interest from foreign governments or foreign state-owned companies (including loans from foreign state-owned banks), for example China and Japan are interested in certain railway lines.

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Susan Bennett | 26 March 2017 10:05

Thank you for this marvellous summing-up; the best I have read.
Susan Bennett, In Time Pictures

Misja Alexander | 27 March 2017 07:58

Haha... in other words: don't expect much from the private sector.... !
Sad but true....