U

nder pressure from a widening trade deficit, the government is moving to bolster its carrot and stick approach to encourage new investment in strategic industries and curb dependency over imports of intermediary and capital goods amid booming domestic consumption.

Industry Minister MS Hidayat said last week that the government would expand its tax-holiday policy to include producers of machinery, equipment and tools.

Under the tax facility, investors providing funding of at least Rp 1 trillion (US$110 million) are exempt from paying income tax for five to 10 years, depending on the size of the investment, the location and the multiplier effect.

At present, the facility is available for four industrial sectors: base metals, oil refining and petrochemicals, renewable energy and telecommunications equipment.

The expansion of the tax holiday is the latest step in a fiscal campaign that began in December when the policy was first introduced. Since then, the government has also expanded the type of industries covered by a similar facility, called the tax allowance, to 129 from the previous 38. This facility allows a 30 percent discount on taxable income for a minimum investment of Rp 50 billion, with priority being given to industries outside Java.

The government has also introduced a 20 percent export tax on 65 types of raw minerals — excluding coal — in a bid to encourage investment in local smelting plants to increase and safeguard domestic supplies.

The export tax is also coupled with an obligation for mining companies operating under mining permits (IUPs) to obtain “clean-and-clear” status before they can export. The status indicates that their activities are in line with the government’s environmental policies and that all legal requirements, including those on land usage, have been met.

Hidayat said the series of fiscal measures was necessary to reverse the dependency of Indonesia’s manufacturing on imported capital goods and raw materials, which has persisted for more than three decades.

In line with Indonesia’s growing purchasing power, imports have recently led to three months of consecutive trade deficits with the latest figures for the month of June, at $1.33 billion, the largest for five years.

The deficit was attributed to lower global demand for Indonesian products and soaring imports, which rose by 15.35 percent to $96.41 billion, of which $70.26 billion consisted of raw materials and intermediary goods, and $19.38 billion of capital goods.

The increased growth of imports compared to exports affected in turn the country’s balance of payments, which recorded a $6.9 billion current account deficit for the second quarter of this year, more than double the $3.2 billion in the first quarter. This situation led to high rupiah volatility as the country turned into a net debtor to the rest of the world.

An alarmed central bank responded by raising the deposit facility rate by 25 basis points to 4 percent starting on Aug. 13. Bank Indonesia (BI) also decided to allow overseas investors to hedge foreign exchange transactions to as little as one week, down from the previous three month limit.

The rise in the deposit rate is expected to attract more foreign funds and help support the rupiah, while the hedging is aimed at creating more flexibility and lower risk for investors.

On the fiscal side, Coordinating Economic Minister Hatta Rajasa said recently that the government was committed to further extending both incentives and disincentives to encourage the proliferation of upstream industries and the creation of value-added products.

“For the medium term, government policy will be directed toward reducing dependency on imports and boosting exports,” Hatta said.

He added that in the future, manufacturing companies in Indonesia would be encouraged to rely more on domestically produced materials.

“We are happy to see so many manufacturers invest here, but we also need to watch out for their raw materials,” he added.

The Investment Coordinating Board (BKPM) expects Rp 390 trillion ($41.1 billion) in foreign and domestic investment value next year, up by 37.57 percent from the Rp 283.5 trillion targeted this year.