World Bank Report stresses the urgency of opening up Indonesia

World Bank meeting with President Joko Widodo fuels debate on economic liberalization.

In Indonesia, there is a growing realization that there can be no further industrialization without more foreign direct investment.

A World Bank study on the risks of a global economic slowdown for Indonesia is driving the discussion on opening up the archipelago's economy. The report states that the US-China trade war could weaken real economic growth to 4.9% in 2020 and 4.6% in 2022. In a worst-case scenario, economic growth in 2020 could even fall to 3.7%. That would be a disaster for an economy that has been growing at an average of 5.4% since the turn of the millennium.

The scenarios come from the World Bank's September 2019 Global and Economic Risks and Implications for Indonesia study, the results of which were presented by the World Bank’s Country Director for Indonesia, Rodrigo A. Chaves, at the beginning of September, to Indonesian President Joko Widodo in Jakarta.

The main reason for Indonesia's vulnerability to repercussions from global economic shocks is low foreign direct investment (FDI) as a result of failed industrial policies. According to calculations by the World Bank, Indonesia only invests an equivalent of 1.9% of its economic output in FDI, placing it far behind its regional competitors Cambodia, Vietnam, Malaysia and the Philippines. (see chart above)

According to the World Bank, 33 Chinese companies planned to build and expand their factories abroad between June and August 2019. Out of these 33 companies, 23 will relocate to Vietnam, while the remaining ten will relocate to Cambodia, Thailand, Malaysia and India, among others. None is going to Indonesia. To put the matter into perspective, in 2017, 73 Japanese companies relocated their production to Vietnam, 43 to Thailand and 11 to the Philippines. Only ten went to Indonesia. The relocation of a factory to Indonesia then took at least a year. In contrast, a Korean washing machine factory was able to move from China to Vietnam and Thailand in 60 days when the US raised tariffs in 2016.

World Bank: Indonesia will not be an export hub for electric vehicles
According to the Washington-based organization, Indonesia – despite its plans for the coming years – will not be able to produce electric vehicles and then export them to any significant extent. The reason for this is its lack of integration into the global supply chain.

As causes, the World Bank lists non-tariff trade barriers that are too high, which are making the import of components more expensive. These include, for the automotive industry, pre-shipment inspections at the point of shipment for brakes, steel pistons and tires. Added to this is the requirement for an import permit from the Ministry of Industry that stipulates, under non-transparent criterias, how many steel parts or tires may be imported. In addition, parts such as windows or cables would need to be tested for compliance with the National Product Standard (SNI).

The export of locally produced automobiles is also not competitive because a large proportion of the imported components are overloaded with high import taxes (15% on tires, as well as 10% on gearboxes, ignition devices and gasoline engines). The bottom line in the World Bank’s report is: "No amount of tax incentives can offset the aforementioned problems and make Indonesia internationally competitive in the automotive, textile, electronics, pharmaceutical and other manufacturing industries."

However, the study overlooks the strong growth figures of Indonesia's production and export of automobiles. For example, car production has more than doubled to more than 1 million over the past ten years. And exports increased by 55% to 265,000 between 2013 and 2018. Responsible for this are almost exclusively the Japanese manufacturers with their established supplier networks.

Ongoing debate on better investment conditions The World Bank expects a massive flight of capital investment from Indonesia in the event of a global economic downturn. The consequence would be an enlargement of the current account deficit. Under normal circumstances, Indonesia would need US$16 billion to finance this deficit. In the impending crisis scenario, this sum could increase significantly. However, as a countermeasure to the impending economic downturn, the study does not recommend reducing the current account deficit through austerity measures, but rather encouraging the acquisition of export-oriented FDI.

The study is likely to be met in Jakarta with quite open ears for, in Indonesian politics, there is now a broad discussion about the problem of the industrial share of economic output, which has been in decline for almost two decades, the massive dependence on imports of primary products by the domestic industry as well as the low export quota.

The hopes of foreign companies of further improvements within the regulatory environment rests on President Joko Widodo as he moves towards the end of his first term in office in October 2019, which now has less consideration for internal resistance from his party and competitive domestic interest groups. According to reports, the country’s investment authority is currently working on a liberalization of the Negative Investment List, which defines the economic sectors closed to foreign companies.

In his first public speech following his re-election, in July 2019, Widodo named the third of his five priorities (after the expansion of infrastructure and a human resource development offensive) as to increase the attractiveness of foreign investment because they are the key to more jobs. "Everything that stands in the way of investment must be trimmed down. This include slow and complicated processes and, above all, shadow payments," Widodo said back then. "I promise that I will monitor and control everything and, if necessary, intervene." The President will be judged by these words in the next five years.