The Indonesian House of Representatives’ approval of the Omnibus Law on Job Creation on Oct.5 marks a significant enhancement of the business climate and a step forward for labor market flexibility, which should, over time, improve the country’s international competitiveness, provided the changes are well implemented.
The new law, whose scope is wide-ranging, should help to reduce longstanding impediments to doing business in Indonesia by reducing red tape, simplifying land acquisition processes, easing restrictions on foreign investment, loosening labor laws and providing more incentives to free-trade zones. Indonesia’s ranking for the World Bank’s annual survey of Ease of Doing Business has improved significantly in recent years, but at 73rd out of 190 countries in 2020, is still below the median for “BBB” sovereigns.
The reforms will put Indonesia in a better position to capitalize on shifts in global manufacturing supply chains. Many multinationals are exploring opportunities to diversify supply chains, including a shift in some cases from China as a result of rising labor costs in that market and the uncertainties created by United States-China trade tensions. Some have relocated operations to Indonesia in recent years, but the local business environment may have served as a dampener on investor interest.
As a comparison, a survey conducted by Japan’s trade organization JETRO shows that Indonesian annual salary levels (excluding severance allowances, but including base salary, benefits and bonuses) for manufacturing workers in 2019 averaged US$5,956, lower than China’s $9,962, Thailand’s $8,128 and Malaysia’s $7,041, but higher than India’s $4,466, Vietnam’s $4,041 and the Philippines’ $3,916.
Fitch Ratings believes that the law will bolster Indonesia’s longterm economic growth prospects. All else being equal, faster growth would have a positive effect on the sovereign’s public debt metrics, boosting fiscal inflows and reducing debt-to- GDP ratios. Perhaps more importantly, the potential boost in Indonesia’s manufacturing exports and FDI inflows could make the country less dependent on commodity exports and on portfolio flows to finance its current-account deficit.
Nonetheless, the effects of the reform package will take time to be felt. They are also unlikely on their own to drive changes in the near term to Indonesia’s ‘ BBB’ rating, which we affirmed with a Stable Outlook in August.
The reforms’ effects will depend on how they are implemented. The Omnibus Law stipulates that a number of additional regulations need to be passed in key areas such as labor legislation. Other measures may be challenged in the Constitutional Court.
Meanwhile, the new legislation has been met with protests by labor groups, which could prompt the authorities to water down its provisions.
Even if they remain intact, business regulation will still be complex and burdensome, relative to many other markets in ASEAN. Moreover, although maximum worker severance costs look set to fall by around 40 percent from levels that were previously among the region’s most generous, they will remain high enough to be a concern for some foreign investors.
More positively, the reforms signal that the Indonesian government remains focused on long-term economic development, even as it looks to address the health crisis associated with the coronavirus pandemic.
Investors are likely to welcome this sign, but will also be alert to the risk of negative policy surprises. The House is still considering proposals that would weaken the independence of Bank Indonesia, for example, which could undermine monetary policy credibility — although the government has made known its opposition to the proposals.
Fitch Ratings lead sovereign analyst for Indonesia
Disclaimer: The opinions expressed in this article are those of the author and do not reflect the official stance of The Jakarta Post.