Investor Considerations

Political Risk

Political Risk is the risk an investment's returns could suffer as a result of political changes or
instability in a country. Instability affecting investment returns could stem from a change in
government, legislative bodies, other foreign policymakers or military control. Political risk
is also known as "geopolitical risk," and becomes more of a factor as the time horizon of
investment gets longer. They are considered a type of jurisdiction risk. Political risks are
notoriously hard to quantify because there are limited sample sizes or case studies when
discussing an individual nation. Some political risks can be insured against through
international agencies or other government bodies. The outcome of political risk could drag
down investment returns or even go so far as to remove the ability to withdraw capital from
an investment. Aside from business factors arising from the marketplace, businesses are also
impacted by political decisions.

Indonesia has undergone a political transformation since the upheaval of 1998 which saw the
fall of General Suharto after 30 years of authoritarian rule and a collapse of the Rupiah. The
country is now a vibrant democracy that is continuing to strengthen its political structures and
deepen the enfranchisement of the population. Over past decade, varied experiments with
democracy has seen the rise and fall of extreme religious parties and an equilibrium found in
the direction of secular, reform minded nationalism. The 2009 election results signalled a
maturity among the electorate through the re-election of the incumbent president, Susilo
Bambang Yudhoyono who became the first Indonesian president to be democratically elected
for two consecutive terms which hugely boosted global investor confidence. His firm stance
on terrorism and national security is another welcome continuation of his tenure. Other
political reforms such as decentralisation of political power to regional and provincial
leaders, while still at an experimental stage, is serving to unleash the potential of Indonesia’s
less developed regions outside Java and fostering more even participation in the country’s
growth. The political situation is not without its risks; the speed of economic and political
reform under President Yudhoyono’s coalition has come under fierce criticism for its inertia
and pandering to vested interests of coalition members. Political noises towards greater
protectionism are regular occurrences that often result in overlapping regulations which
creates investor uncertainty. In the run up to the 2014 elections, party interests are coming to
prevail over that of political progression with a stalemate over many proposed new bills. The
gap between the rich and the poor is also widening while corruption continues to be a
persistent issue.

Source : Credendo Group

Indonesia from 2014 to 2019. The average value for Indonesia during that period was 2 index
points with a minimum of 2 index points in 2014 and a maximum of 3 index points in 2016.
The latest value from 2019 is 2 index points. For comparison, the world average in 2019
based on 224 countries is 3 index points. See the global rankings for that indicator or use the
country comparator to compare trends over time.T he short-term political risk classification
measures the likelihood of a risk caused by political and assimilated events connected to
cross-border transactions with a risk horizon of up to 1 year. In order to assess this risk,
Credendo uses a quantitative model, essentially focusing on the evolution of the liquidity
situation of the debtor/obligor countries. The aim is to assess the capacity of a country to
honour its short-term payment obligations. The model closely follows any deterioration or
improvement in the situation of the debtor countries.

Global Trade Integration

The link between trade and investment, particularly foreign direct investment, has been
extensively discussed in the literature. FDI can be a substitute for trade, e.g., when a firm
decides to invest and producein a foreign country to serve customers in that country. FDI can
also be a complement to trade as efficiency-seeking firms look for the best location from
which to produce and export their products. Indonesia has become a net importer of oil with
rising domestic consumption and stagnant oil production. Indonesia’s major exports are oil,
gas, electrical equipment and machinery and main trading partners include China, Japan and
the United Sates. A member of the Organization of the Petroleum Exporting Countries, G-20
and a driving force within the Association of Southeast Asian Nations (ASEAN), Indonesia
has become a leading economy at the regional and multilateral levels. The rise of production
networks in Asia has also impacted Indonesia‟s trade pattern. Indonesia and other Asian
economies have become suppliers of intermediate inputs, often with China as a hub for final
assembly, in the electronics and other industries. Indeed, in 2008 intra-Asian trade in parts
and components accounted for 55% of total trade. The shift toward more integrated
production networks in Asia is borne out in the data. In 1995, Indonesia exported
predominately to developed countries, four of which are located outside of Asia China was
the only developing country in the top 10 export destinations for Indonesia‟s goods in 1995.
In 2010, however, more developing countries make it into the top 10 (India, Malaysia,
Thailand), and the destination shifts markedly to Asia. In 2010, only 1 country is non-Asian
(the United States).
Source : UN Service Trade Statistic Database

A similar pattern emerges on the import side (Table 3, Panel B). In 1995, Indonesia
importedmore from higher-income economies, four of which are non-Asian (United States,
France, Germany andSaudi Arabia). China is the only developing economy in the top 10 list
in 1995. In 2010, the United States and Saudi Arabia are the only non-Asian country of
origin, and more developing, Asian countries are included (Malaysia, Thailand, and India
again become important trading partners). While the rise of production networks in Asia
partly explains the changes in Indonesia‟s main trading partners, other factors are also at
play. Indonesia‟s regional integration, in particular through the Association of Southeast
Asian Nations (ASEAN) framework, can also partly explain these shifts. The ASEAN Free
Trade Area (AFTA), the process to build the ASEAN Economic Community (AEC), the
ASEAN–China Free Trade Area (ACFTA), among other regional integration efforts, have all
pushed Indonesia to trade more with its Asian neighbours. Trade in services as a share of
GDP in Indonesia was about 6% in 2010, down from a little over 12.5% in 2000. On balance,
Indonesia shows a net services trade deficit. On the export side, travel services dominate with
almost half of Indonesia‟s services exports. Travel services broadly represent the tourism
sector, one of the three priority services sectors in ASEAN co-operation. Economy- wide
spillovers from tourism, which tend to increase demand in other sectors, may be one reason
to encourage further liberalisation in that sector (Geloso-Grosso et al, 2007). Transportation
services account for the second largest services export sector (18%) followed by other
business services (14%) and communication services (7%).

Labor Cost

The main employment law in Indonesia is contained in Law No.13/2003 on Labor (“Labor
Law”). There is also Law No.2/ 2004 on Industrial Relations Dispute Settlement; Law
No.21/2009 on Labor Unions and Law No.3/1992 on Workers Social Security. These laws
are designed to safeguard interests of employees. The main regulatory authority is the
Ministry of Manpower or “Manpower Affairs”. Employers generally consider the Labor Law
places onerous obligations on employers, particularly in respect of ability to terminate and the
level of severance and termination benefits payable. For companies operating factories in
highly labor intensive industries, this can make wage and benefit levels uncompetitive
compared to other neighboring countries. A lack of training, cultural background and
difficulty in terminating non-performing workers often means that staff numbers can reach
higher levels than an investor may initially anticipate. Attempts by governments in the past to
make aspects of the law more friendly to employers has led to street demonstrations and is
politically sensitive. Indonesia has a large pool of workers, with a reported labor force of
118.2 million people in 2014, and a labor force participation rate of 66.9%. These statistics
exclude the self-employed, informal sector. With the high birthrate in recent decades and the
drift away from traditional village life, the potential workforce has been growing at almost
1.5 million per year over the last decade. 64% of the Indonesian workforce is concentrated in
Java and Bali, and workers continuously migrate from rural to urban areas in search of jobs.
Once a year each provincial government adjusts the UMP based on a Governor Decree on
Minimum Wage. A Remuneration Council, a non-structural tripartite organization which
consists of government, entrepreneur associations and labor organization representatives (as
stipulated under Presidential Decree No.107/2004) makes recommendations on the UMP
based on a “decent living needs survey”. With regional autonomy fully implemented at
provincial level, there is a Regency Minimum Wage (“UMK”) for each city in every province
based on recommendations from the Regent Mayor and the Remuneration Council. In
November 2012, the Government of Jakarta raised the UMP for Jakarta by 44% to IDR 2.2
million (USD 228) based on Governor of Jakarta Regulation No.189/2012 concerning the
2013 Provincial Minimum Wage, recording its highest ever increment. Increases in 2014 and
2015 were 13% and 19%, respectively. The Confederation of Indonesian Labor Unions
(KSPI) is monitoring compliance with UMP (Under the Labor Law, an employer is
prohibited from paying below the minimum wage which covers basic salary and a fixed
allowance, the salary component comprising at least 75%. Working hours under the Labor
Law are 7 or 8 hour days depending on whether 5 or 6 days are worked per week, with
additional hours considered overtime which is calculated based on formulae in the law.
Employers and employees of private companies are required to make monthly contributions
calculated based on the following:

BPJS will monitor companies operating in Indonesia to ensure mandatory registration of

employees into the scheme is complied with, and will have authority to enforce the law and
proceed with litigation. Penalties and other sanctions now also apply.

Taxation

Virtually all governments are keen to attract foreign direct investment (FDI). It can generate
new jobs, bring in new technologies and, more generally, promote growth and employment.
The resulting net increase in domestic income is shared with government through taxation of
wages and profits of foreign-owned companies, and possibly other taxes on business (e.g.
property tax). FDI may also positively affect domestic income through spillover effects such
as the introduction of new technologies and the enhancement of human capital (skills). Given
these potential benefits, policy makers continually re-examine their tax rules to ensure they
are attractive to inbound investment. Tax policies may also support direct investment abroad,
as outbound investment may provide efficient access to foreign markets and production scale
economies, leading to increased net domestic income. At the same time, governments
continually balance the desire to offer a competitive tax environment for FDI, with the need
to ensure that an appropriate share of domestic tax is collected from multinationals. But while
tax is recognized as being an important factor in decisions on where to invest, it is not the
main determinant. FDI is attracted to countries offering: access to markets and profit
opportunities; a predictable and nondiscriminatory legal and regulatory framework.

A company with gross turnover less than IDR 50 billion is eligible for up to a 50% reduction
of the corporate tax rate based on the percentage of its taxable income which results when
IDR 4.8 billion is divided by its gross annual turnover. If gross turnover is below IDR 4.8
billion, the 50% reduction applies on all taxable income. Article 31E Law Number 36/2008.

In Indonesia, taxes are levied under three laws that were introduced in December 1983. These
cover

• General Tax Provisions and Procedures

• Income Tax

• VAT on goods and services, and Sales Tax on Luxury goods (STLG).
With certain exceptions, Withholding Tax (WHT) is imposed on payments to onshore and
offshore parties, including payments such as dividends, interest, royalties and fees paid for
services. The GOI also collects taxes on land and buildings, stamp duty and import duties.
Local governments collect various other taxes. The official tax year runs from January 1 to
December 31. Companies may adopt different year ends in their AoA and may change their
financial years with prior approval from the Indonesian Tax Authorities. A financial year
cannot exceed 12 months for tax purposes. Indonesia has a self-assessment system under
which returns are considered final if not queried by the Indonesian Tax Office (“ITO”) within
five years.