Earlier this year, Indonesian President Joko Widodo announced the creation of 17 more special economic zones (SEZs) by 2019. Ten of these zones would be dedicated to tourism, with the remaining seven hosting a variety of different activities such as fisheries and extraction of mineral resources.Currently eight SEZs are under development in Indonesia, so the new zones would bring the total number to 25. In addition, four existing Free Trade Zones (FTZs) were originally created as SEZs and later made the formal transition to FTZs. Economic zones currently employ four million workers around the country, and the government is keen to increase job creation and facilitate technology transfer by attracting companies to the largest market in Southeast Asia.
The Original SEZs
Indonesia originally opened the first SEZ in Batam, Bintan, and Karimun in the Riau Islands to take advantage of their close proximity to Singapore, which is only 12 miles away. Singapore designated the zone as an SEZ in 2006, and in 2007 it achieved FTZ status after the Indonesian House of Representatives passed a new law. In addition to the Riau Islands, Indonesia also has the Sabang FTZ, which seeks to attract investment to the northern part of the country.
One of the objectives behind the FTZ designation was to create jobs. Another was to accelerate the transfer of technology by taking advantage of the archipelagic nation’s proximity to Singapore and Malaysia. Batam and the other Riau Islands possess traits that made them more attractive as FTZs, such as steady job and income creation, foreign exchange earnings, and credibility in the eyes of investors. Given their strategic location, the Riau Islands’ FTZ status allowed them to attract investment in the shipbuilding and shipyard industry. The booming of this industry allowed Batam to become the largest shipbuilding region in the country, with more than 150 major maritime companies operating in the province.
Assessing SEZ Performance Several Years On
In addition to becoming a success story, both for special economic zones and the shipping industry, the SEZ also has become the setting for the rise of the country’s electronics manufacturing industry. The increasing demand for electronics among Asian consumers has proven very attractive for foreign multinationals. Some of the firms that have been attracted to Batam include Sanyo, Panasonic, Siemens, Philips, and Sony. Proximity to Singapore has aided the success of the electronics industry, as has technology transfer facilitated by access to components
and expertise.
Despite the success of Batam and the other FTZs, some businesspeople as early as 2011 had called for caution in opening extra SEZs. The sentiment was that the government should avoid opening too many zones and instead wait to show outside investors tangible results before rushing to open more. One of the reasons for the cautious approach is that the success of Batam in shipbuilding and electronics manufacturing can be explained by its strategic location close to Singapore and from the technology transfer in the electronics manufacturing industry. Some of these factors cannot be transferred to other SEZs. For this reason, each SEZ’s natural and strategic advantages must be considered carefully when assessing their investment potential.
Additionally, most of the projects tend to suffer from inadequate infrastructure. This issue has plagued many of the recently announced SEZs and thereby slowed their growth. According to a report from the Center for Strategic and International Studies (a Washington, D.C.-based think tank) published last month, out of the eight SEZs decreed by the government, only two have actually started operations. One of them is Tanjung Lesung in Western Java, oriented toward tourism, and the other is Sei Mangke in North Sumatra, centered on palm oil production. However, the report found that Sei Mangke SEZ has only two factories in operation and that Tanjung lacks basic infrastructure, such as roads and railways.
Attracting Investors to SEZs
Factors such as excessive regulation and complicated licensing and establishment procedures have the potential to keep many would-be investors away. Additionally, as in the case of the Tanjung SEZ, a lack of infrastructure can adversely affect investment. The additional lack of ministerial coordination can be seen as a by-product of the excessive red tape and explains why some of the infrastructure needed for the demands of current SEZs is not yet in place.
However, the government has recognized these issues and is working to streamline the process, as well as offer new incentives to companies seeking to invest in the region. President Joko Widodo has made reforming the investment licensing process one of his top priorities. This may take some time given that every new measure being implemented must be assessed to make sure it doesn’t violate existing regulations—a manifestation of the bureaucratic complexity at work in Indonesia.
One of the incentives proposed to attract more investors involves longer-term land rights within SEZs. Under current regulations, companies can acquire land rights for 30 years and are able to renew them for 10 more years twice. Under the new proposed period, companies will be able to lease the land for 50 years and renew the lease twice for 15-year intervals. Indonesian authorities hope that this will help attract companies to build plants, hotels, and other facilities. Additionally, companies investing in the Sei Mangke SEZ in North Sumatra, which plays host to the palm oil and rubber industries, will automatically be eligible for tax allowances under a new decree.
Outlook
As the government moves forward with plans to open an increasing number of SEZs, reforms will be needed to make sure the application process becomes less complex. Adequate infrastructure and ministerial coordination also will be needed for the success of these new investment initiatives. In this respect, the government may heed the advice of some business leaders and make sure the current SEZs are performing to capacity before plans about new zones are made.
But as the case of Batam shows, both infrastructure and excessive regulation issues can be overcome, and in turn attract more investors. For example, a study by Political and Economic Risk Consultancy showed that despite some initial shortcomings, Batam now lays claim to the best infrastructure in Indonesia, and ranks favourably compared with investment zones in Thailand, Vietnam, and India. Additionally, as the longest-standing FTZ, Batam has streamlined the application process by making it a one-stop process managed by a single governing body. Thus, if ministries work together and remove some of the hurdles, they will be able to attract investment to some of the newly proposed SEZs.
As the largest economy in ASEAN, Indonesia offers investors an immense potential upside—a fact which only becomes more apparent as the country develops further. However, as the saga of Indonesian SEZs and FTZs illustrates, penetrating the market’s complex legal and bureaucratic needs can pose a challenge to even the most seasoned investor.
Since its establishment in 1992, Dezan Shira & Associates has been guiding American investors through Asia’s complex regulatory environment and assisting them with all aspects of legal, accounting, tax, internal control, HR, payroll and audit matters. As a full-service consultancy with operational offices across China, Hong Kong, India and emerging ASEAN, including liaison offices in Boston and Waltham specifically established to support our American clients, we are your reliable partner for business expansion in Asia and beyond. For inquiries, please email us at [email protected]. Further information about our firm and how we can support American investors in Asia, please visit our North American Desk.