BizCLIR

Foreign direct investment in Indonesia has begun to rebound following the Asian financial crisis, due largely to the resumption of growth in the region and to some reforms to the laws and regulations facing foreign and domestic investors. In the process, the origin of foreign investment has significantly changed, with more investment now coming from Japan, China, Singapore, and other Asian countries and less from Europe and North America. Some of that investment is quasi-foreign in that it represents Indonesian businesses repatriating domestic capital that was moved offshore following the financial crisis of 1997-98.

Foreign investors and those who provide support services to them cite the following impediments to Indonesia attracting the levels of FDI that could drive growth and employment to target levels.

Unstable policy/regulatory environment. Some investors are unnerved by increased uncertainty of the investment climate. However, most are hopeful that the enabling environment is generally improving and acknowledge that unpredictability is a necessary byproduct of democracy.

Modest commitment to an open economy. Although Indonesia does have some passionate advocates of openness and competitiveness, and the government does have stated goals of increased international trade and direct foreign investment, this agenda is not as high a priority as it has been for some the Asian “tigers,” who have aggressively promoted export-oriented growth as their engines of modernization. The difference may lay in Indonesia’s huge domestic market and in its recent tradition of oligopolies and state-owned enterprises. As a result, progress in reforming the investment climate is slow.

Corruption. Although corruption has long been endemic in Indonesia, investors find it more unpredictable now than it was during the Suharto years. A single bribe to a senior official might or might not suffice. Other demands can surface at any time. Such uncertainty is a business risk and makes Indonesia a costlier place to do business than several of its regional competitors. A number of respondents felt that Indonesia will solve its corruption problem only with comprehensive civil service reform.

Civil service reform. Indonesia’s civil service impedes business efficiency as often as it facilitates it. With poor pay and automatic promotions based on academic qualification, most officials show little initiative. And with the press increasingly covering corruption-related issues, risk-averse bureaucrats often avoid decisions, most commonly by pushing them up to the highest possible levels of the government, where they compete for the Minister’s attention with scores of other routine decisions. While reducing the role of government in business operations (for example, by eliminating some approvals and license requirements) will help, even the most basic, legitimate functions of government will not operate efficiently until salaries, incentives, business processes, and organizational structures are comprehensively reformed. This is not likely to happen before the 2009 elections, if at all.

Commercial dispute resolution. The court system is corrupt and unpredictable, so investors do not count on justice or even timely resolution of commercial disputes. As part of the IMF reform package following the financial crisis, Indonesia established a Commercial Court with regional branches, and extensive donor assistance has been provided for judicial training and staffing. Courts issue written opinions, which NGOs that focus on law reform monitor and publicize. It will likely be years before this problem disappears from the list of investment disincentives.

Tax administration. Investors find the administration of the tax system more of a disincentive than the tax rates themselves. Assessments appear arbitrary and subject to extortion, and a business can only pursue a refund or a protest by first posting the full amount of the assessment and then pursuing it doggedly through the courts.

Decentralization. Because it is still new, the administrative decentralization based on Law No. 32 of 2004 still causes misinterpretation of law and regulation. The business community alleges that there are 2,000 discrepancies between national laws and regulations and those promulgated by the local districts and municipalities, and that there are differences in law and regulation from region to region. However, most investors are optimistic that these inconveniences will be reduced and that they will learn to do business around the country.

Corporate governance. Development of a culture of corporate governance that protects the rights of minority investors is still in its infancy in Indonesia. Some businesses cite weaknesses in this area as an impediment to rapid growth in FDI.

Labor laws. Labor Law reform began in 1998 with technical assistance provided by the International Labor Organization (ILO) and the United States through an ILO/USA Declaration Project. This resulted in three Labor Laws, including Law No. 21 of 2000 regarding Labor Unions, Law No. 1 of 2003 regarding Manpower, and Law No. 2 of 2004 regarding Industrial Relations Dispute Settlement. In January 2006, the Industrial Relations Court was officially established as part of the implementation of Law No. 2 of 2004. The current labor law – in particular Indonesia’s excessive requirement for severance pay– increases the cost of business and discourages investment.

Infrastructure. Indonesia has made almost no investment in additional power generation, roads, or port capacity since the financial crisis of the late 1990s. Thus inadequate capacities continue to constrain operating efficiencies and discourage investors. Realizing the importance of this problem, Indonesia is planning its first substantial increase in public spending on physical infrastructure for 2008 and plans to encourage public-private partnerships in some of the resulting investments.