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Senin 19 Oktober 2009
Strengthening domestic economy
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Carunia Mulya Firdausy

The Deputy for Societal Dynamics, at the State Ministry for Research and Technology


"In the future, we need to strengthen our domestic economy and domestic market, and not rely too heavily on exports as our main source of growth. Therefore, a strategy that is only oriented for exports certainly is not our choice ...," President Susilo Bambang Yudhoyono said in his speech before the House of Representatives on Aug. 14, 2009.

This statement was very encouraging. However, a lack attention towards exports could also jeopardize the domestic economy, for at least three reasons.

First, to strengthen our domestic economy it is almost impossible to rely on the domestic market alone. This is because the domestic market has limited ability to absorb commodities produced by Indonesia. This situation is worsened since there are substitute commodities of other countries as a consequence of globalization.

Second, Indonesia has to earn foreign exchange to buy commodities or resources that are not available locally. These foreign exchange credits can be obtained from exports as well as from investment.

Third, exports are a critical component of GDP, thus affecting consumption, investment and government spending.

Thus, what matters seems not to be policies that rely too heavily on exports, but policies that strengthen our domestic economy and domestic market without reducing exports. One of the many economic policies needed to encourage the domestic market without losing export markets is the promotion of foreign direct investment (FDI). The importance of FDI in relation to domestic investment can attributed to the structure of Indonesia's direct investment - now dominated by FDI, which accounts for almost 80 percent (annual average) of the direct investment total.

In 2008, for instance, the total number of realized FDI projects (based on the number of permanent business licenses issued by the Investment Coordinating Agency *BKPM*) was more than five times the number of realized domestic direct investment projects. There were 1,029 FDI projects with a realized investment value of US$14.2 billion, while there were only 210 domestic direct investment pro-jects with an investment value of around $1.7 billion (excluding investment in the oil and gas and financial sectors).

Also, it is because FDI has increased both domestic and export performance. For the latter it is because FDI firms have access to a better international network compared to their non-FDI counterparts. In fact, FDI has also become a major source of employment. In 2008, FDI projects employed 220,775 workers. This is far more than the employment contribution of domestic direct investment, which employed 58,784 workers.

Another advantage of FDI is that it facilitates the transfer of technical and managerial skills. This means that FDI is useful to stimulate domestic enterprises to improve their productivity and efficiency in production processes. And hence, domestic enterprises can produce competitive products for both domestic and export markets at competitive prices.

However, in terms of the development of FDI in general, Indonesia still lags far behind neighboring countries. Consequently, four key regulations were issued in 2007-2008 by the government, which are directly related to the development of FDI.

These were the 2007 Foreign Direct Investment Law, the 2007 government regulation on "income tax facilities for investment in certain sectors in certain regions", the 2007 presidential regulation on "criteria and requirements for investment", and the 2007 presidential regulation on "the negative and positive list of investment".

The 2007 Foreign Direct Investment Law in particular was issued to replace a 1967 law and its amendment, the 1970 Foreign Investment Law, as neither was perceived to be suited to current investment needs.

The 2007 presidential regulation on "the negative and positive list of investment" and its amendment were issued to list all restrictions on direct investment, in a single document. This was intended to give certainty to investors by preventing line ministries or other officials in charge of investment approvals and licensing from making their own ad hoc rules.

The 2007 Investment Law aims to accommodate Indonesia's need for investment by providing legal certainty and national treatment for all investors regardless of their nationality. It provides a guarantee that the Indonesian government will not arbitrarily nationalize or take over foreign invested firms.

It also permits foreign investors to freely transfer their profits and dividends or repatriate their capital. The law prohibits foreign investment in defense-related industries, such as in the production of weapons, ammunition, explosive equipment and arms, which could jeopardize the security of the nation.

Again, in June 2009, the government issued a presidential regulation on "a national single window for investment". This was meant to provide detailed measures to implement a "one-roof investment policy" as stipulated in the 2007 Investment Law. With this new regulation, the BKPM was given a big mandate to provide "investor-friendly" services with regard to license and non-license provisions.

However, many observers have argued that all these laws and regulations have not been sufficient to encourage more FDI inflows into the country because they do not really address key obstacles to investment here. There are several "long-established" problems that have reduced the competitiveness of Indonesia's investment climate and therefore discouraged foreign investors from investing here.

Problems associated with high risks and costs of business arising from social and political insecurity, macroeconomic instability, policy and regulatory uncertainty (conflicting regulations), poor governance (lack of coordination among government ministries and cumbersome bureaucracy) and infrastructure bottlenecks all need to be addressed.

In relation to conflicting regulations, the introduction of local autonomy or decentralization to some extent has had a detrimental effect on the competitiveness of Indonesia's investment climate. This has happened because under local autonomy, local governments frequently introduce new taxes and charges that have little or no legal basis. In fact, these local charges often overlap similar charges imposed by the central government. These conflicting rules in turn have led to poor contract enforcement and aggravated corruption.

Another example of regulation that constrains the development of industry is the 2003 Labor Law. Many investors and observers believe this has caused numerous industrial disputes and disruptions to production since it is "too labor-friendly". The law has been blamed for not being sensitive to the industrial concerns of unequal growth between labor productivity and increases in wages, in which the former grows slower than the latter.

The government's inability to provide good-quality infrastructure is another serious problem that has increased the cost of doing business in Indonesia. A World Bank (2008) report indicated that transportation bottlenecks caused by poor infrastructure and frequent power shortages or outages had cost firms a significant profit reduction (up to 10 percent of their total sales). The report also revealed that nearly 40 percent of 9,000 firms surveyed relied on their own power generators.

All the above problems have made Indonesia's investment climate one of the worst in the Asia-Pacific region. A survey conducted by the World Bank in 2009 ranks Indonesia 129th out of 181 countries in terms of the overall "ease of doing business in 2009" - below Vietnam, Thailand, China and India. A huge challenge ahead for the government is to attract more FDI inflows into the country. (The Jakarta Post, 17 October 2009/humasristek)

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