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Indonesia FDI: more coming, more needed

DBS Group Research June 14, 2011

FDI inflows to Indonesia have increased significantly However, FDI as a percentage of GDP remains unchanged from 2008 and continues to underperform that in regional peers The push factors on FDI are undoubtedly positive: the expansion in the global business cycle, the weak outlook for the G3, and Chinas waning competitiveness owing to higher wage costs Regarding pull factors, growth is strong, labor costs are low and economic stability is improving. But the structural hurdles remain

FDI data are encouraging

Consensus opinion is that Indonesia needs greater foreign direct investment to address the economys bottlenecks, strengthen its growth potential and boost employment. It is thus encouraging to see that FDI has expanded significantly in recent quarters. According to the central bank, FDI inflows into Indonesia have risen to more than USD 4bn for two consecutive quarters (4Q10 and 1Q11), compared to an average of USD 3bn in the first three quarters of 2010 and a previous peak of USD 3.4bn in 3Q08 (Chart 1). Moreover, the increase in FDI inflows since global recovery took hold in 2009 has been broad-based, spread across industries ranging from mining and manufacturing to services sectors such as wholesale & retail trade and transport & communication (Chart 2).

Chart 1: FDI inflows exceeding precrisis levels

USD bn
5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11

Chart 2: FDI inflows rising across sectors

USD bn
4.0 2.5 1.0 -0.5 1Q04 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10

FDI inflows (BOP)

Manufacturing Wholesale & retail trade Transport & Communication Financial Mining Agriculture Total FDI

Ma Tieying (65) 6878 2408

Indonesia FDI: more coming, more needed June 14, 2011

Chart 3: FDI realization increasing, too

USD bn
8 7 6 5 4 3 2 1 0 1Q05 4Q05 3Q06 2Q07 1Q08 4Q08 3Q09 2Q10 1Q11

Chart 4: FDI / GDP ratio still at 2%, however

% of GDP 7 FDI inflows (BOP) FDI realization (BKPM) 6
5 4 3 2 1 0 1Q04 1Q05 1Q06

FDI realization (BKPM)

1Q07 1Q08

1Q09 1Q10 1Q11

While the central bank data show new FDI from abroad, the data complied by the BKPM (the Investment Coordinating Board) also include investment by foreign companies already operating in Indonesia. The BKPM data show total foreign (realized) FDI grew to USD 4.6bn in 1Q11, also up from USD 4.0bn on average last year (Chart 3).

More FDI is needed

The scale of FDI has plainly expanded. If measuring FDI against the countrys economic output however, the FDI:GDP ratio of 2.3% has not improved much compared to the precrisis levels in 2008 (Chart 4). Among the neighboring economies with more successful FDI experiences, Vietnam sees FDI amounting to as high as 9% of GDP during the recent three years. In China, although the FDI:GDP ratio has fallen in recent years due to labor shortages and higher wages, the ratio currently remains significant at 3% (BOP measures are employed for cross-country comparison). Combining FDI and domestic investment, gross investment in Indonesia is not yet a key driver to economic growth. Gross fixed capital formation as a share of GDP recorded 24% in Indonesia in 2010, underperforming many emerging Asian economies like China (46%), Vietnam (41%) and India (35%). Even among Asias newly industrialized economies, Korea has a similar high investment ratio as Indonesia (27%).

The external (push) factors are positive

As regards the FDI outlook, we believe the external (push) factors are positive. The cyclical recovery in global demand is leading to the tightening of capacity and increase in capital expenditures. According to the World Investment Prospects Survey conducted by the UNCTAD, global FDI has recovered to USD 1.2trn in 2010 after plunging for two consecutive years in 2008-2009, and is forecasted to rise further to USD 1.3-1.5trn this year. Despite the ongoing concerns over a weak US recovery, European debt crisis and Chinas slowdown, there are no alarming signs of a double-dip in the global economy. The event risk related to Japans natural disasters has also proved to be short-lived. From a longer-term perspective, global enthusiasm about investing in emerging markets has grown with the generally weaker outlook for growth in the US, JP and EZ. Indonesia is attractive to foreign firms in terms of the growth (and also

Indonesia FDI: more coming, more needed June 14, 2011

the size) of domestic consumer market. Its population base is the worlds fourth largest, and the working-age population will continue to grow against dependent population (the so-called demographic dividend) over the next 15 years till 2025 (Chart 5). Working-age adults are able to earn higher incomes and have stronger capacity to spend as compared to the very old/young. Meanwhile, Indonesian consumers are largely debt free today (consumer loans to GNI ratio is less than 10%), and there should be great scope for consumer leverage to grow and maximize purchasing power. Meanwhile, China faces labor shortage and higher wages. MNCs in the labor intensive industries may increasingly seek alternative production bases in the region. Indonesia enjoys a cost advantage in this regard, as a large population base and a favorable demographic trend should allow it to continue to supply abundant and affordable labor forces in the foreseeable future. Average wages in Indonesia are only about one-third those in China and among the lowest in Asia.

Chart 5: Indo's demographic trend will remain favorable till 2025

90 80 70 60 50 40 30 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050

Dependent population (<age 15 or >age 64) / Working age population (age 15-64)


The domestic (pull) factors to watch

On the domestic front, the recent development is that Indonesias macroeconomic stability has improved and the sovereign credit rating outlook has turned positive. This should bolster investor confidence and mitigate some investment risks facing foreign firms including the risk of exchange rate fluctuation. But structural barriers still exist for foreign firms doing business in Indonesia, such as the infrastructure poorness, labor market rigidity, legal and administrative uncertainties, according to various international surveys. The governments reform agenda for this year focuses on improving infrastructures. The finance ministry has allocated more funds towards public infrastructure investment in the 2011 budget. But historical experiences showed that budget enforcement was not strong and the government consistently underspent the budget because of low efficiency and poor coordination. This year, growth in fiscal expenditures accelerated briefly in 1Q but fell again in April. The cumulative spending by the central government in the first four months of 2011 was equivalent to about 21.6% of the whole-year budget, still not a major improvement compared

Indonesia FDI: more coming, more needed June 14, 2011

to 20.5% in 2010 and 22.3% in 2009. And it remains unknown to what extent the budget has been spent in the infrastructure areas, given the fact that the subsidy expenditures on fuel and food have been lifted significantly early this year in order to stabilize consumer prices. Aside from public investment, Indonesia is also encouraging the private sector to participate in infrastructure construction. The government has been working with international organizations in recent years to offer financial incentives for private investors engagement in PPP (public-private partnership) projects, such as establishing the Indonesia Infrastructure Financing Facilities and Indonesia Infrastructure Guarantee Fund. Meanwhile, the BKPM has been appointed as the front office to offer PPP, and five priority projects totalling USD 4.4bn have been laid out for 2011. Barriers continue to challenge the realization of PPP the awkward and clumsy land acquisition process, is but one example. A reform-minded land acquisition bill was submitted to the parliament in end-2010 but is still pending approval. Implementation of this and other reforms remain key to the outlook for further FDI inflow.

Notes: All data from CEIC, Bloomberg, the United Nations and DBS Research (forecasts and data transformations).

Indonesia FDI: more coming, more needed June 14, 2011

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