Openness to Foreign Investment
Investors continue to encounter a wide range of business problems in Indonesia, including weak contract enforceability, poor infrastructure, labor market rigidities, the absence of a transparent and predictable regulatory environment, the inconsistent interpretation and enforcement of laws, irregularities in government procurement tenders, and improving but still weak enforcement of intellectual property rights. The uncertainty stemming from these conditions limits investment and Indonesia’s ability to achieve the higher economic growth needed to reduce poverty and unemployment. Labor reforms, in particular addressing the high cost of laying off workers, remain an obstacle to investment and competitiveness, but are viewed as too politically sensitive to achieve before the 2009 elections.
This mixed performance on investment climate is reflected in the results of the World Bank’s Doing Business 2009 study. The study found that it takes an average of 76 days to start a business in Indonesia. While a significant improvement over the previous year, at the same time Indonesia also nearly doubled the minimum capital requirement to start a business, negatively affecting conditions to start a business. While some improvements occurred, Indonesia’s overall Doing Business rank globally fell to 129 from 127 in 2008.
2008 was denoted as a building year in the government’s efforts to provide a more certain investment climate. The GOI has made progress in reducing bureaucratic delays in obtaining investment approvals, registrations and licenses, and simplifying and clarifying some regulations. In May 2008, the GOI issued a new Presidential Instruction, the most recent in a series of presidential initiatives to spur growth and investment.
Program activities included measures to improve the investment climate, accelerate infrastructure development, further reform the financial sector, state-owned enterprises and small and medium enterprises. After approval of an Investment Law in March 2007, the government issued a revised “Investment Negative List” which identified sectors closed to foreign investment or subject to conditions. In early 2008, the government conducted an initial review of the Negative List which provided additional clarity into the application of the Investment Law, particularly in its grandfathering provisions. In late 2008, the government was carrying out a subsequent review of the Negative List. The National Team for Promotion of Exports and Imports (PEPI), located in the Coordinating Ministry for Economic Affairs, has played an increasing role in advising the government on implementing regulations to the investment law and on possible revisions to the Negative List and in formulating policy recommendations to increase exports and improve the investment climate.
The GOI moved forward on establishing a National Single Window (NSW), part of a larger ASEAN endeavor, which provides one-stop service for processing import and export documents and integrating port clearance procedures. The NSW was extended (partially) to Tanjung Priok, Indonesia’s largest seaport, near Jakarta, in late 2008. The government plans to extend it to other main ports in 2009.
Indonesia's legislature passed a new mining law in December 2008. Although the implementing regulations have not been released, the Ministry of Energy and Mineral Resources indicated that it will accelerate procedures for drafting them. Under the new law, mining Contracts of Work (COW) and Coal Contracts of Work (CCOW) will no longer be issued. Under the new system, all mining companies, foreign and domestic, will require a mining license (IUP) or special mining license (IUPK), which will be issued by competitive tender by the local, provincial, or national government. Companies must obtain separate licenses for exploration and production phases of each mining concession; royalty and tax obligations will be subject to all changes in law; and foreign mining companies are again expected to divest an undefined portion of their holdings during the course of operations. The new law also requires that metal ore be processed in Indonesia, and smelted if the capacity exists. The new law also requires mining companies to hire local service companies, rather than international companies or subsidiaries, when available. The GOI is seeking to build 35 new coal-fired power plants generating 10,000 MW of electricity by 2010, which will require state electricity firm PLN to double its coal demand to 70 MT per year. PLN is considering a variety of methods to access this coal, including in-kind royalty payments and domestic market obligations for coal producers.
Indonesia became a net oil importer in 2004. Crude oil production has steadily declined over the last decade as new production failed to offset declining output from aging fields. State revenue from the oil and gas sectors soared to an estimated Rp.281 trillion in 2008 from Rp.185.1 trillion in 2007, due to a spike in global prices. According to the GOI, Indonesia produced around 970,000 barrels per day (BPD) through October 2008. The downstream market for fuels is technically open for foreign investment, although state-owned oil and gas company Pertamina remains the only authorized dealer for subsidized fuels in the country.
Natural gas production declined from its 2006 daily production level of 8.10 billion standard cubic feet per day (BSCFD) to 7.7 BSCFD in 2007, although it recovered slightly in the first three quarters of 2008 to 7.9 BSCFD. Although the government took some positive steps to reform the industry, the general oil and gas investment climate remained below potential in 2007 and 2008, due to problems with contract sanctity, regulatory issues, and uncertainty regarding contract terms and conditions. Some of the exploration blocks that the government put out for tender in 2007 and 2008 received no bids. A number of new regulations increased investor uncertainty in 2008, including regulations for cost recovery allocations in oil and gas production sharing agreements.
Tax policy, particularly Value Added Tax (VAT) reimbursement, continues to be an important concern. The Indonesian Petroleum Association (IPA) reported that as of the end of 2006, implementation of VAT and import duties reimbursements for old production sharing contracts (PSCs) were largely resolved except for those cases still in court. VAT reimbursements for PSCs signed after 2001 remain largely unresolved. In December 2003, the Ministry of Finance (MOF) issued a decree terminating the ability of PSC contractors to collect VAT on purchases they made from vendors. Instead, the MOF was required to verify that vendors were paying VAT to the State Treasury before reimbursing the contractors. Although normal VAT reimbursement should not take longer than 120 days, the revised system caused severe delays. The MOF replaced the 2003 decree in January 2005 with a new decree that reinstates PSC contractors as VAT collectors. In August 2006 the MOF issued a regulation on tax refunds that states that VAT should be refunded within two months from the receipt of each claim. The latest Investment Climate Monitoring surveys conducted by University of Indonesia's Institute for Economic and Social Research in June – August 2007 indicates that VAT refund time is getting shorter and the percentage of the initial claim refunded has increased.
As required under Oil and Gas Law 22/2001, the GOI created two new bodies to take over state oil and gas company Pertamina's upstream and downstream regulatory functions. The government formed the Implementing Body for Oil and Gas Upstream Activities (BPMIGAS). This nominally independent body reports directly to the President and is principally responsible for managing the PSCs. The government also established the downstream regulatory authority, BPHMIGAS. Like its upstream counterpart, BPHMIGAS is an independent body responsible for regulating the supply and distribution of oil fuel and natural gas, as well as setting tariffs for natural gas pipelines. According to the law, both authorities are termed "state legal entities" and therefore not government bodies.
Holders of PSCs laud BPMIGAS's success in streamlining the natural gas marketing mechanism, which has helped increase the number of gas sales agreements over the last three years. However, other companies are concerned over the lack of a coordinated LNG marketing mechanism, following the transfer of that responsibility from Pertamina to BPMIGAS. New downstream regulator BPHMIGAS has begun issuing licenses to local and foreign companies in the gas retail and sales markets as well as for gas pipeline construction.
The Oil and Gas Law 22/2001 ordered the liberalization of the downstream sector, ending Pertamina's monopoly and creating new refining, distribution and retail opportunities for private investors. As also required by the Oil and Gas Law, the GOI changed Pertamina into a limited liability company through a presidential decree. Shell became the first private company to open retail fuel stations, followed by Malaysian Petroleum Nasional (Petronas). The government extended Pertamina's monopoly over downstream wholesale fuel distribution and its public service obligation (PSO) to deliver fuel throughout the archipelago, until BPH MIGAS finds a suitable entity to carry out the PSO through a direct appointment or regular tender process.
Infrastructure and Transportation
The GOI said it plans to accelerate transportation infrastructure through the passage of four new bills in the transportation sector and provision of institutional guidelines for mass rapid transit (MRT) management in Jakarta. Parliament passed railway legislation in May 2007 and a maritime bill in May 2008. The Ministry of Transportation (MOT) also passed an aviation bill. Earlier legislation in the four sectors does not provide for an effective mechanism for private investments in the transportation sector or regional transportation planning after decentralization. Transportation projects have attracted few investors and the GOI has failed to provide tender documents for its model transportation projects. In step with the ongoing decentralization process, many regional governments have implemented transportation projects, but they have done so in a piecemeal fashion with little consideration for capacity, other infrastructure links, or transportation projects in neighboring districts. New legislation will focus on increasing opportunities for outside investment in the sector and streamlining the procedure to do so. The new bills also target better strategic planning and coordination for transportation links and infrastructure at the regional (provincial) level.
Jakarta's choking traffic lowers both quality of life and economic growth. To remedy these twin maladies, the GOI infrastructure acceleration plan called for the creation of a Jakarta Mass Rapid Transit (MRT) institution. The local Jakarta administration established the limited liability Mass Rapid Transit Jakarta company (PT MRTJ) which the GOI hopes will serve as a role model for MRT development authorities in other large cities. One of PT MRTJ's tasks will be to spur the controversial on-again-off-again Jakarta monorail project.
Conversion and Transfer Policies
The rupiah, the local currency, remains freely convertible, although Bank Indonesia (BI) imposed a new requirement for the submission of evidence of underlying transactions to support the purchase of a foreign currency against the rupiah through banks exceeding $100,000 per month (regulation 10/28/PBI/2008, effective November 13, 2008). For foreign parties (foreign citizens and foreign legal entities), this regulation governed the purchase of foreign currency against the rupiah in spot transactions. Currently, banks must report all foreign exchange transactions and foreign obligations to BI. With respect to the physical movement of currency, Article 16 of Law No. 15/2002 contains a reporting requirement for any person taking cash into or out of Indonesia in the amount of Rp.100 million ($11,000) or more, or the equivalent in another currency, which must be reported to the Director General of Customs and Excise (DGCE). BI regulation 3/18/PBI/2001 and the DGCE Decree No.01/BC/2005 concerning the Reporting Procedure of Cross Border Cash Carrying, launched on January 2005, contain the requirements and procedures of inspection, prohibition, deposit of rupiah into or out of Indonesia. The Decree provides implementing guidance for Ministry of Finance Regulation No.624/PMK.04/2004 of December 31, 2004, which requires individuals who import or export more than rupiah 50 to 100 million in cash (approximately $5,500-$11,000) to report such transactions to Customs.
In 2005 BI issued certain prohibitions and restrictions in conducting foreign exchange transactions with foreign counterparts. The regulation lowered the limit on transaction amounts for commercial banks engaging in derivative transactions with foreign counterparts from $3 million to $1 million. This limit covers all types of transactions involving foreign exchange selling and purchasing against the rupiah. However, the restrictions will not apply if the derivative transactions are conducted for hedging purposes within the framework of an investment in Indonesia that will last for at least three months. The regulation also requires foreign or domestic currency lending to foreign counterparts to be conducted in the form of a syndicated loan that engages a prime bank (commercial banks with a certain investment rating from a well know rating agency) as lead bank for the purpose of project financing in the real estate sector in Indonesia. The regulation allows for fines at a flat rate of 10 percent of the amount of the violating transaction. This is more stringent than under the previous regulation, which provided a fluctuating rate. BI hopes that the regulation will reduce foreign exchange movement that is not related to a genuine underlying purpose.
Under the new 2007 investment law, the GOI gives assurance to investors relating to the transfer and repatriation of funds, in foreign currency, on capital, profit, interest, dividend and other income, funds required for (i) purchasing raw material, intermediate goods or final goods, and (ii) replacing capital goods for continuation of business operations, additional funds required for investment project, funds for debt payment, royalties, income of foreign individual working on the invested project, earnings from selling or liquidation of invested company, compensation for losses, and compensation for expropriation.
Expropriation and Compensation
Article 21 of the 1967 Foreign Capital Investment Law stipulates that the government shall not initiate nationalization of foreign investments except by law and when such action is necessary in the interest of the state. The new 2007 investment law, which replaces both foreign and domestic investment laws, in broad terms opens up a major part of the economy with the guarantee that the government will not enforce nationalization. Foreign firms will be protected against nationalization by the government, except where corporate crime is involved.
According to BKPM, Indonesia respects a company's right to compensation if expropriated; however, the government has not expropriated any foreign investment since the passage of the 1967 law. In 1999, however, the Overseas Private Investment Corporation (OPIC) paid a claim by a U.S. investor after the government failed to honor an arbitration award. Indonesia subsequently agreed to repay OPIC. The government also paid $15 million compensation to the Multilateral Investment Guarantee Agency (MIGA) for its insurance payment to a power project.
The requirement of gradual divestment has been mitigated. Investment assurances such as the right to appoint foreign management and the prohibition to effect nationalization without indemnification (now against market value) have been retained. The same goes for repatriation rights. However, repatriation may now be suspended by a court for as long as the investor has not fulfilled its responsibilities under the Law.
Indonesia is a signatory to the Convention On The Settlement Of Investment Disputes Between States And Nationals Of Other States (ICSID). The new investment law ensures that disputes between the government and investors can now be arbitrated using international laws. It also retains the submission of disputes to ICSID arbitration. The Indonesian court system is seen as weak, lacking in transparency and corrupt by foreign investors. In an attempt to ease the backlog of cases, parties are required to undertake mediation before litigation, although courts do not necessarily fully enforce this rule. As a result, most law firms advise clients not to attempt litigation in the country, with arbitration in another jurisdiction being the preferred method of resolving disputes.
Although the Yudhoyono Administration had made judicial reform and anti-corruption top priorities, the court system does not provide effective recourse for resolving commercial disputes. The judicial system does not have the capacity to effectively decide on commercial cases. The judiciary is nominally independent under the law, and legal practitioners say irregular payments and other collusive practices often influence case preparation and the judicial ruling. GOI recognizes the need for judicial reform, but significant reform is still needed. In several instances, the local courts accepted jurisdiction over commercial disputes despite contractual arbitration clauses calling for adjudication in foreign venues. In addition, criminal laws and penalties may be applied in cases that appear to be covered under civil laws and procedures.
In August 2006 the Constitutional Court stripped the Judicial Commission of its oversight role, questioning its authority to monitor the Supreme Court and Constitutional Court and sent the matter to Parliament and the President to clarify. The Parliament is expected to make simultaneous amendments to three laws, Supreme Court Law, the Constitutional Court Law and the Judicial Commission Law, to restore the authority of the now-powerless Judicial Commission. A 2006 Indonesian Supreme Court decision upheld a lower court ruling that over US$1 billion in bonds issued by Asia Pulp and Paper were illegal and did not have to be repaid, harming investor confidence. In October 2008, however, the Supreme Court overturned its previous decision through a judicial review (the final judgment on the case), ruling that the bonds were issued legally and Asia Pulp and Paper was responsible for the debts. This was a positive development as the bonds in question follow a common format for international debt and have been used in several other Indonesian investments. So far, only one U.S. investment company has brought a case to the ICSID, which ruled in its favor. Indonesia's arbitration law recognizes the right of parties to apply any rules of arbitration procedure they may mutually agree upon, and provides default procedural rules that apply if no other rules have been designated. An Indonesian commercial arbitration board, BANI, is available if both parties agree. Companies have resorted to ad hoc arbitrations in Indonesia using the United Nations Commission on International Trade Laws (UNCITRAL) arbitration rules, as well as others. Other companies in Indonesia have used ICC arbitrations.
Performance Requirements and Incentives
The GOI notified the WTO of its compliance with Trade-Related Investment Measures (TRIMS) on August 26, 1998. The government issued on January 1, 2007 a regulation providing investment tax incentives to 15 industries: textiles, chemicals, pulp and paper board, pharmaceutical, products that use rubber as raw materials, iron and steel making,electronics, and component products for land transportation. The regulation allows qualifying investors to deduct up to 30 percent of their realized investment from gross taxable income (five percent of the realized investment per annum for the first six years of the project); carry forward losses for up to 10 years; utilize an expedited depreciation schedule; and reduce from 15 to 10 percent the income tax rate on dividends paid outside Indonesia. The incentives will apply to both domestic and foreign direct investors, either for new investment or expansion of existing plants.
The new 2007 investment law offers incentives to new investors and investors expanding their investment in Indonesia, provided that the investment projects satisfy at least one of the conditions listed in the law: create employment for a large number of workers; relate to the infrastructure sector; involve the transfer of technology; classify as a pioneer industry (the government will define “pioneer industry” in subsequent regulation); located in isolated areas, in areas bordering other countries likes Malaysia in West/North Kalimantan, or in developing areas; provide sustainable environmental development; involve research and development; involve partnership with micro-, small- or medium-sized enterprises; or use capital goods, machinery or equipment produced domestically.
Types of incentives that may be offered include: reduction of income payable by five percent of capital investment annually for six years; import duty exemption or tax relief for importation of capital goods, machinery or equipment not produced domestically; import duty exemption or tax relief for importation of raw materials or supporting materials within a certain period of time; exemption or suspension of imposition of value-added tax on imported capital goods, machinery or equipment not produced domestically within a certain period of time; acceleration of amortization; and reduction of land-building tax rates for certain sectors.
Indonesia expects foreign investors to contribute to the training and development of Indonesian nationals, allowing the transfer of skills and technology required for their effective participation in the management of foreign companies. Under Ministry of Manpower regulations, any expatriate who holds a work and residence permit must contribute $1,200 per year to a fund for local manpower training at regional manpower offices. As a general rule, a company can hire foreigners only for positions that the government has deemed open to non-Indonesians. Employers must have manpower-training programs aimed at replacing foreign workers with Indonesians.
At present, Indonesia does not have formal regulations granting national treatment to U.S. and other foreign firms' participating in government-financed and/or subsidized research and development programs. The State Ministry for Research and Technology handles applications on a case-by-case basis. However, the Ministry is currently drafting regulations to enable interested parties to participate in research and development programs in certain circumstances. Indonesia does not require investors to purchase from local sources or export a certain percentage of output. The government eased rules in June 1998 that encouraged investors to locate in industrial estates. Foreign firms are not required to disclose proprietary information to the government before investing.
Right to Private Ownership and Establishment
Indonesia recognizes the right to private ownership and establishment and relies on the private sector (albeit often protected), as a principal engine of economic growth. At the same time, State-owned Enterprises (SOEs) play a dominant role in many sectors, including oil and gas, electric power generation and transmission, infrastructure, banking, fertilizer production, and wholesale distribution.
In recent years, Indonesia has promoted competition in some sectors and has decreased the privileges enjoyed by SOEs. The State Ministry for SOEs notes that privatization is an important part of its mandate, but political opposition has effectively hindered attempts to privatize. Some provincial governments have improved management and transparency of provincially owned firms to stem losses and prepare them for possible privatization.
Protection of Property Rights
The USG improved Indonesia’s standing on the Special 301 Watch List after completion of an “Out-of-Cycle” review (OCR) in November 2006. The OCR concluded that throughout 2006, Indonesia bolstered implementation of its regulations designed to stop illegal production of pirated optical discs (ODs) such as CDs and DVDs by controlling the licensing of factories and conducting raids against pirate optical disc production facilities. Indonesia’s authorities conducted numerous raids on retail outlets selling pirated goods. During this period, the GOI activated its minister-level National Intellectual Property Task Force and its working groups to coordinate IPR enforcement strategy among agencies as well as to conduct public awareness campaigns. Indonesia also passed a new Customs Law no. 17/2006 in November 2006 that clarifies the authority for Customs officers to seize goods that infringe on IPR. However, the Ministry of Finance Directorate General of Customs and Excise are still working on the implementing regulations. The GOI has steadily improved the regulatory and legal framework for the protection of IPR. While the GOI has recently improved its enforcement, more effort in this area is needed to create an effective deterrent. U.S industry maintains that 90 percent of all CDs (audio, video, and software) sold in Indonesia are pirated. An increasing number of local factories produce most pirated CDs and DVDs, raising concerns that regional piracy syndicates are moving export-oriented production operations to Indonesia, and that Indonesia could soon become a major supplier of pirated ODs globally. Pharmaceutical companies claim imports of counterfeit and grey market drugs control up to 30 percent of the local market.
Indonesia's copyright law (Law 19/2002) allows fines up to Rp.500 million ($51,266) and provides for prison terms of up to five years for dealers of pirated materials. The law requires the commercial courts to try cases of alleged copyright violations and render judgments within 90 days. As part of the law's implementation, the Ministry of Industry and Trade issued optical disc regulations (ODR). Under the ODRs the Ministry of Industry has created and trained an optical disc factory monitoring team. This team has registered and begun random unannounced inspections of all 28 known OD factories.
Transparency of Regulatory System
Indonesia has a tangled regulatory and legal environment that causes many firms, both foreign and domestic, to avoid the justice system. Laws and regulations are often vague and require substantial interpretation by implementing offices, leading to business uncertainty and rent seeking opportunities. Deregulation has been somewhat successful in reducing barriers, creating more transparent trade and investment regimes, and has alleviated, but not eliminated, red tape. Still, U.S. businesses routinely cite transparency problems and red tape as factors hindering operations.
U.S. citizens involved in commercial or property matters should be aware that the business environment is complex, and dispute settlement mechanisms are not highly developed. Local and foreign businesses often cite corruption and ineffective courts as serious problems. Business and regulatory disputes, which would be generally considered administrative or civil matters in the United States, may be treated as criminal cases in Indonesia. It is often difficult to resolve trade disputes.
Efficient Capital Markets and Portfolio Investment
Banks continue to dominate Indonesia’s financial sector, holding an estimated 75 percent of the assets in the financial system. The government has encouraged development of Islamic banking, though Islamic banks contain less than five percent of total banking assets. Several conventional banks have also opened Islamic banks. Non-bank financial institutions (NBFIs) remain underdeveloped. A 2007 World Bank report on NBFIs found domestic retail investor accounts in the stock market barely reached 100,000 and only 250,000 persons held mutual funds. Stock Market: The IDX resulted from the 2007 merger of the Jakarta and Surabaya Stock Exchanges (see idx.co.id for more information). As of end-2008, IDX had 396 listed companies. There were 19 new listings in 2008. The Jakarta Composite Index (JCI) is a key measure of securities trading on the IDX. The Indonesia Stock Exchange (IDX) rode the global commodities boom in early 2008, before being hit hard by the global financial crisis. The JCI reached a record high of 2,830 on January 9, 2008, but closed the year at 1,355. The 50.6 percent (yoy) loss in 2008 followed two years of strong performance, when the Indonesian stock market was the second-best performing market in Asia (2007) and the third best performing market in the world (2006). Stock market capitalization declined by 46 percent (yoy) to Rp.1,076 trillion, at the end of 2008, after increasing by 59 percent in 2007.
In early October 2008, in the midst of financial markets turmoil, the IDX halted trading for two and one-half days. In late 2008, the IDX also temporarily banned short selling and implemented asymmetrical daily trading limits (the latter measure was subsequently rescinded). In October 2008, Bapepam-LK, the Capital Markets and Financial Institutions Supervisory Agency, issued a regulation easing conditions on the buyback of shares of publicly listed companies during market crisis conditions. This regulation (No. X1.B.3) provided for the authorization of share buybacks of up to 20 percent of total issued and paid up capital without prior approval from a general meeting of shareholders.
Government Bond Market:
GOI has made significant progress in building a strong foundation for its government bonds market. As of end 2008, the GOI had Rp.525.7 trillion of tradable, domestic, rupiah-denominated and US$11.2 billion of international, dollar-denominated sovereign bonds outstanding. Foreign investors recently have held between 17-20 percent on Indonesia’s government bonds. In August 2008, Indonesia issued its first sovereign Islamic bond (sukuk). The government postponed a planned autumn issuance of a U.S.-dollar denominated global sukuk, given unfavorable market conditions resulting from the global financial crisis. The MOF implemented a primary dealer system for government securities in the first quarter of 2007, as per GOI’s July 2006 Financial Sector reform package recommendation. In April 2008, the government addressed differences in the treatment of tax withholding on discounts of treasury bills and state bonds when it issued regulation 27/2008. The regulation provides for the same method of tax withholding, with the transfer of treasury bills at a discount from one party to another, other than by specified parties, subject to tax withholding.
In 2008, firms issued new corporate bonds in the amount Rp.52.87 trillion. Major issuers include financial institutions (banks and finance companies) and telecommunications firms. Total nominal listed bonds was Rp.145.9 trillion. Domestic mutual funds and pension funds hold a significant portion of corporate bonds. The secondary market is thin and plagued by shortages of investors and issuers. There is not yet any widely available pricing system for Indonesia's corporate bonds. A few corporate bonds from Indonesia's largest companies are dollar denominated such as (Medco Energy and Indosat.)
The Capital Markets Supervisory Agency (BAPEPAM) and Bank Indonesia established Pefindo, Indonesia's largest rating agency, in 1994. Pefindo is a private limited liability company owned by 96 domestic shareholders including pension funds, banks, insurers, securities companies and the Indonesia Stock Exchange. Pefindo is an affiliate of Standard and Poor's and adapts Standard and Poor's methodology in its rating process. Pefindo has begun to incorporate good governance as a sub-element of its rating methodology. In January 2007, Moody’s Corporation acquired a 99 percent stake in Kasnic Credit Rating Indonesia, incorporated in 1998, and changed its name to PT Moody’s Indonesia. Fitch Ratings opened an office in Jakarta in mid-2006 and is publishing assessments of credit quality on a variety of Indonesian institutions.
Foreign firms generally enjoy good access to the Indonesian securities market. A deregulation package in 1988 opened banking, securities and insurance to foreign investment. In line with its commitments under the WTO's Financial Services Agreement, the government equalized the capital requirements for domestic and foreign insurers. It amended the banking law in 1998 and removed restrictions on foreign bank branches outside Jakarta. In 1997, MOF lifted the 49 percent restriction on foreign purchases of shares in non-bank listed firms. In 1998, MOF removed discriminatory capital requirements on foreign securities. BI, the central bank, licenses banks and regulates banking activity. The Capital Market and Financial Institutions Supervisory Agency (Bapepam-LK) licenses new securities and insurance ventures, and regulates mutual funds and capital markets.
BI issued a ruling in 1999 allowing 99 percent foreign ownership of local banks. Such banks are allowed to designate foreigners as members of the board of directors and commissioners, but at least one member of the executive board must be Indonesian. In subsequent years, foreign investors bought large domestic banks such as Bank Central Asia and Bank Danamon. In addition, foreign banks may now open branches in Indonesia, but the government extends this privilege only to the world's 200 largest banks (in terms of assets) with minimum credit ratings of A from either U.S.-based credit rating agencies Standard & Poor's or Moody's.
At the end of 2008, 48 of Indonesia's 126 banks were under the ownership of foreign investors. An October 2006 BI regulation requires "controlling" shareholders of more than one bank (defined as ownership of 25 percent or above, or if below 25 percent where there is direct or indirect control in the bank operations) to comply with a “single presence policy,” via merger, divestment or through the use of an Indonesian financial holding company. The policy is not applicable to locally incorporated foreign-owned banks, or to JV banks, or to shareholders having a stake at two banks where one is Syariah-based. BI will give leniency for "complex" situations, apparently aimed at state-owned banks, if it is done in a way that is "objective, transparent, and acceptable for stakeholders".
Public reaction, including anti-U.S. demonstrations to events in Middle East continues to be limited to sporadic protests, mostly nonviolent. President Yudhoyono has demonstrated a strong commitment to combating terrorism. There have been successful police investigations (e.g. regarding 2005 bombing in Bali), and the discovery of evidence linking terrorist activities to radical Islamic beliefs have had a constructive effect in turning general public opinion against terrorism. Many leading members of Jemaah Islamiyah, however, are still active and they have a number of supporters.
President Yudhoyono’s anti-corruption campaign, the most significant since Indonesia’s independence, has made clear progress in 2008 through numerous, high-profile investigations and prosecutions of current and former GOI officials. The Corruption Eradication Commission (KPK) prosecuted six members of Parliament in 2008, a former Central Bank head, and other high-level officials. The KPK and other GOI anti-corruption bodies continue to increase their capacity and receive budget increases The KPK is growing increasing staff, training new investigators, and receiving robust technical assistance from donors. In 2008, the Attorney General’s Office established an elite 50-person Anti-Corruption Task Force to coordinate and prosecute cases throughout Indonesia. Regional prosecutors are busy with new corruption cases. Corruption watchdogs at the national and local level are proliferating: there are now 20 to 30 national groups and 200 to 400 local groups monitoring the police, the government, and the judiciary. Indonesia’s media also energetically report on corruption cases. While corruption remains a difficult problem in Indonesia, numerous sources report the atmosphere in the bureaucracy has changed with officials at all levels reluctant to take actions that could appear improper and land them in jail. Indonesia signed the United Nations (UN) Convention Against Corruption in December 2003 and ratified it in March 2006 via Law 7/2006. This will give Indonesia access to UN resources to assist it in improving its efforts against corruption including establishing codes of conduct for public officials.
Bilateral Investment Agreements
Indonesia has signed investment protection agreements with 60 countries, including: Algeria, Argentina, Australia, Bangladesh, Belgium, Bulgaria, Cambodia, Chile, Croatia, Cuba, Czech Republic, Denmark, Egypt, Finland, France, Germany, Hungary, India, Iran, Italy, Jamaica, Jordan, Kyrgyzstan, Laos, Malaysia, Mauritius, Mongolia, Morocco, Mozambique, North Korea, Norway, Pakistan, People's Republic of China, Peru, Philippines, Poland, Qatar, Romania, Saudi Arabia, Singapore, Slovak Republic, South Korea, Spain, Sri Lanka, Sudan, Suriname, Syria, Sweden, Switzerland, Thailand, The Netherlands, Tunisia, Turkey, Turkmenistan, Ukraine, United Kingdom, Uzbekistan, Vietnam, Yemen, and Zimbabwe.
OPIC and Other Investment Insurance Programs
The Overseas Private Investment Corporation (OPIC) has been the key USG agency encouraging American private business investment in developing countries, newly emerging democracies, and fledgling free market economies. OPIC has had some difficulty operating effectively in Indonesia for several years due to the lack of an updated bilateral agreement. Progress on a new agreement has been slow. Investors are urged to contact OPIC directly for up-to-date information concerning availability of OPIC services in Indonesia.
Indonesia has joined the Multilateral Investment Guarantee Agency (MIGA). MIGA, a part of World Bank Group, is an investment guarantee agency help investors and lenders deal with political risks that may accompany an investment in emerging markets, by insuring eligible projects against losses relating to currency transfer restrictions, expropriation, war and civil disturbance, and breach of contract.
Indonesian labor is relatively cheap by world standards, but the country's under-funded education system and overly rigid labor laws combine to make Indonesia's competitiveness lag behind other Asian competitors. Investors frequently cite high severance payments to dismissed employees, restrictions on outsourcing and contract workers, and rules on expatriate workers, as significant obstacles to new investment in Indonesia. Lack of education is especially problematic among unskilled and semi-skilled workers. Labor contracts are relatively straightforward to negotiate but are subject to renegotiation, despite the existence of a written agreement. Local courts are likely to ignore written contracts and side with locals in labor disputes. On the other hand, some socially responsible foreign investors view Indonesia’s labor regulatory framework and respect for freedom of association and the right unionize as an advantage to investing in the country. The GOI established in January 2006 a new Labor Court as part of a broader labor dispute resolution system. Expert local human resources advice is essential for American companies doing business in Indonesia, even those only opening representative offices.
Industrial relations at the factory level have improved in recent years and frequency of strikes declined. Following the October 2005 fuel price increases, unions demanded annual minimum wage increases (regional, district, or industrial sector) as high as 50 percent, but most settled for increases closer to 10 percent. Although demonstrations surrounding these negotiations were vocal, they were not perceived as a significant threat to civil order. Draft revisions to the labor law -- particularly reductions in severance payments and removal of restrictions on outsourcing and contract employment -- led to labor protests in 2006 that prompted the GOI to suspend efforts to amend the law, and to instead formulate regulations aimed at changing severance pay to ease the burden on employers while providing cushion to those unemployed. In 2007 and 2008, industrial relations at the national level remained calm.
Foreign-Trade Zones/Free Ports
The GOI offers incentives to foreign and domestic industrial companies that locate in any of Indonesia's seven designated bonded zones. The largest bonded zone is on the island of Batam, located just south of Singapore. Investors in bonded zones are not required to apply for additional implementation licenses (location, construction, nuisance act permits, and land titles), and foreign companies are allowed 100 percent ownership. These companies do not pay import duty, income tax, value-added tax (VAT), and sales tax on imported capital goods, equipment, and raw materials until the portion of production destined for the domestic market is "exported" to Indonesia, in which case fees are owed only on that portion.
Companies operating in bonded zones may lend machinery and equipment to subcontractors located outside of the bonded zone for a maximum two-year period. The companies have also enjoyed exemption from VAT and sales tax on luxury goods on the delivery of products to subcontractors for further processing outside of bonded zones. The Free Trade Agreement between the United States and Singapore, signed on May 6, 2003, allows special tax treatment for certain Singaporean exports made with components sourced in Indonesia.
In an effort to accelerate the pace of investment climate reform, the GOI announced in 2006 plans to develop seven special economic zones (SEZ) or regulatory “islands of excellence.” The GOI plans to establish these SEZs in strategic areas with existing supporting infrastructure, a cluster of supporting industries, and access to inputs of production such as skilled labor. Indonesia and Singapore in July 2006 formed a Joint Steering Committee to create the first SEZ on the islands of Batam, Bintan and Karimun.