Industrious Indonesia

Author: | Published: 24 Apr 2015
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Hilton King, legal counsel at Sampoerna Strategic, discusses the key trends in key industries – from telecommunications to palm oil


Sampoerna Strategic is an investment company with a diverse range of interests from agriculture, finance, and property to telecommunications and timber. As such, the company's general counsel, Hilton King, is well placed to discuss the trends, taxation and legislation affecting numerous Indonesian industries from the booming mobile phone market, the millions of micro, small and medium enterprises in need of financing, a forestry industry struggling with environmental costs, and a slowing property market.

Indonesia seems to be experiencing a mobile telephone boom at the moment. What is driving growth in the industry?

Mobile phone penetration as a whole exceeds 100%, meaning more than one phone per person.

The key growth drivers have been consumer behaviour trends, increasing smartphone penetration and a lower cost internet service.

Indonesian consumers prefer and are very active in social media such as Facebook, Instagram, Twitter, and Path. Indonesia is one of the largest Facebook markets in the world with 70 million user accounts. Nearly 50% of users access the internet through their mobile phones.

Smart phone penetration is increasing rapidly due to low-cost smart phone proliferation. A Nielsen survey showed that more than 50% of mobile phone users plan to buy smart phones in next 12 months. By end 2017, smart phone penetration is expected to exceed 50%.

And, due to tight competition, internet services are cheap, although quality continues to lag behind that of many other countries.

What is the climate like for micro, small and medium enterprises?

Such enterprises are said to number greater than 50 million in Indonesia, the vast majority of which are tiny, labour intensive, in rural areas, and without access to capital, technology and markets. Prospects have generally been limited because of access to and costs of finance, but many programmes including several led by established Indonesian banks are changing this landscape. Start-up costs and red tape however are more of a hurdle for smaller businesses to pass than larger or established businesses. Many financing programmes targeted to assist small businesses also provide start-up advice. More small to medium businesses are taking advantage of rapid growth in Indonesians' propensity to engage in online buying.

Indonesia is one of the world's leading wood exporters, but the industry has come with an environmental cost. How are the challenges of a sustainable forestry industry being met?

There are good initiatives in place although not well reported, especially at community levels. We frequently hear that the government of Indonesia is "working on a number of initiatives" towards reducing the illegal timber trade and non-sustainable practices in the forestry sector. High-profile initiatives include the deal with Norway for a moratorium on new forestry concessions. This initiative aims to conserve unallocated primary forests and peat swamp forests across Indonesia's national forest estate, for which Indonesia could receive significant financial rewards. Some say the moratorium is not broad enough, but at least it ring-fences some large and ecologically important forest areas.


"The logistics sector is one with good long term potential. We see more international investors starting to focus on this sector"


From 2005, it was recognised that the Indonesian forestry industry needed a push into sustainable forestry, and some of the voluntary forestry certification standards were recommended to be harmonised into the existing national forestry regulations. These standards for sustainable production forest management and verification of timber legality in the supply chain were embedded in regulations by 2009 and revised in 2011 and 2014. By mid-2014, significant progress was made toward compulsory certification standards, however with the deadline for achieving the compulsory standards having now passed, there are concerns that the government is too lenient on the many companies that have not made efforts to comply. Many challenges are being addressed but criticism at the rate of progress in meeting the challenges is fair.

How is the government's tax regime changing Indonesia's palm oil industry?

Not significantly. Tax on palm oil exports applies a progressive system – the higher the export price, the higher the export duty rate. Presently the export tax is 0 if the international CPO price is less than $750 per tonne.

Indonesia assesses the export tax monthly, paying attention to international and domestic prices, and keeps a close eye on Malaysia's export tax policy. A key objective of the export tax was to ensure domestic supply, and to encourage downstream industry, although the latter is yet to flourish. Fresh fruit bunches have recently been made subject to VAT; this clarified a grey area and is of benefit to producers as VAT input costs are passed on.

Transfer pricing is under renewed focus from the tax authority, given known practices in the industry. Improved tax collection was a key election policy of the new government. Remote area development of palm oil processing facilities may qualify certain capex as deductible, although not all regional tax authorities have been consistent in applying this. New investment in downstream facilities such as bio-fuel may qualify for tax holidays.

With the property market apparently slowing, what should investors look out for?

There are certainly sectors of the market which have reached their cyclical peaks. The office sector stands out in this regard. That's not to say that further investment in this sector is speculative, rather that investors and developers need to exercise caution as we enter a period where supply will likely exceed demand. Office leasing space is likely to be the most competitive sector in the coming few years.

Strata office for sale has been very popular in recent years and prices rose strongly. Projects in good locations with proven demand should remain popular although further strong price growth should not be expected.

The residential condominium sector is one which stands out with long-term strong potential, simply because of the growing middle class, growing incomes, and undersupply of affordable housing across all sectors. Lack of infrastructure is forcing developers to look to more high rise projects, and those in mixed use (superblock) developments or popular suburbs should fare better than most.

Retail growth opportunities are more selective and strategic, with secondary and tertiary cities now being targeted by developers following a moratorium and perceived oversupply of malls in Jakarta.

The logistics sector is one with good long term potential. We see more international investors starting to focus on this sector. Clearly, government investment in strategic infrastructure will help.

Indonesia never dipped into recession during the financial crisis and its aftermath. What has contributed to the strength of its economy?

Important factors in avoiding the recession were a healthy balance of payments with a commensurate level of foreign currency reserves, and a strong central bank policy which showed flexibility through its free floating exchange rate, lowering interest rates, ensuring liquidity in the system, and a stimulus policy. Local banks were solid with low NPLs, healthy LDRs and high CARs – these had adjusted following the prior Asean economic crisis of 1998 and helped lead a consumer borrowing and spending boom. Export markets were robust – although export and commodity prices fell, export volumes remained strong.

What does the abolition of the fuel subsidy mean for investors and businesses?

Businesses depending on fuel are more competitive, and the abolition of the subsidy has assisted to curtail inflation – although the oil price has fallen in any event. For investors there is encouragement that the government has now freed up expenditure on infrastructure and other sectors of the economy that require support. In 2014 the subsidy consumed about 15% of the state budget. Savings in 2015 should be about $15 billion, which is particularly timely given the recently widening current account deficit.

Indonesia's new government is looking to increase revenue with greater scrutiny of corporate tax affairs and transfer pricing. How do you think this will affect multinational companies looking to invest in the country?

As a policy, multinationals welcome this because an improved tax take benefits the country as a whole, and the government did flag this as a key election policy. Multinationals are more concerned – as is often the case with Indonesia – as to how new rules and scrutiny are applied, and that this be done in a fair and non-discriminatory manner. The resources of the tax authority to investigate and understand industry practices have increased markedly.

Does Indonesia's infrastructure prove a barrier to investment?

Definitely. For the umpteenth time an Indonesian government now says it will commit to focusing on infrastructure development, and makes clear statements of recognising the need for private and foreign sector funding.


"Comprehensive structural reforms to develop the manufacturing base and draw away from the dependence on commodities are essential"


Regulations that encourage private sector participation, such as those on land acquisition, are in place, but as is so often the case, implementation of regulations requires political will. And local government authority, which inordinately throws up barriers to and increases the costs of infrastructure projects, is often at odds with central government policy. Even in the case of projects or types of projects that the government has prioritised, for example roads, ports, and power plants, the wheels of bureaucracy and the preference for avoiding mistakes – the gaze of the anti-corruption body is an important factor – rather than pushing projects through, particularly where large infrastructure projects mean the bureaucracy is dealing in novel territory, means infrastructure spending budgets often fall short.

Greater coordination is required among government ministries, and there is hope the new Presidential Working Unit – established to better give effect to President Jokowi's imprimatur – will make a difference.

What are the biggest risks for companies looking to invest in Indonesia today?

Regular rule changes, weak and inappropriate legal enforcement, insufficient infrastructure causing a lack of competitiveness in product cost and delivery, the implementation of regional (local) government autonomy meaning additional uncertainties and licensing costs, inconsistent tax treatment, and less than sufficient flexibility in the labour market and regulation.

A declining Rupiah is not necessarily a major risk so long as it is managed and demonstrates stability rather than volatility.

What reforms would you like to see to enhance Indonesia's investment climate over the coming years?

Comprehensive structural reforms to develop the manufacturing base to draw away from the dependence on commodities is essential, and to that end major infrastructure development is a key ingredient.

Coordinated approach amongst ministries to enticing investment is essential. The new cabinet has a mix of experience and in many respects do not appear to be a natural fit, and it is hoped the Presidential Working Unit improves cabinet effectiveness. Regulations are usually well meaning in intent but need to show long term strategy and avoid short term nationalist prone reaction.

Reform of and trust in the legal system is a longer-term fix. A stronger central government needs to take the lead in infrastructure projects that tie in several ministries, local government and local communities. Tax reform and initiatives towards a more flexible labour market (one that reduces costs of labour transfers) require the same focus.

About the contributor
 

Hilton King
General counsel, PT Sampoerna Strategic

Indonesia
Web: www.sampoernastrategic.com

Hilton King has worked in Indonesia for 26 years, and is currently general counsel to PT Sampoerna Strategic, a diversified Indonesian investment group, with interests in palm oil (and other crops including rubber and sago), timber processing, microfinance, telecommunications, and property.

PT Sampoerna Agro Tbk is listed on the IDX and Samko Timber Pte Ltd on the SGX.

The highly-regarded Putera Sampoerna Foundation is dedicated to improving access to and quality of education in Indonesia, notably through the Sampoerna School System. Hilton began legal practice with the Australian firm Freehills, first in Melbourne and then in Singapore.

For 19 years from 1989 he was foreign legal consultant to the Indonesian law firm Makarim & Taira S. Hilton specialised in project finance, M&A, investment and commercial law. In particular, he focused on infrastructure, energy & resources, foreign investment, manufacturing and financial services.