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Is Indonesia still an attractive destination for investment?
Consistency and more profound reforms are needed to make Indonesia a more investment-friendly country.
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Smoke rises from a nickel smelter belonging to Chinese miner Virtue Dragon Nickel Industry (VDNI) in Morosi, Southeast Sulawesi, in this photo file. The facility was part of the huge rush among domestic and foreign enterprises to mine the critical component used in electric vehicle (EV) batteries in Indonesia, the world's largest nickel producer. (AFP/Adek Berry)
This question may be spinning in the heads of capital market and greenfield investors.
Overall, Indonesia is an attractive investment destination for foreign direct investment (FDI), primarily because of strong domestic demand, abundant natural resources, a stable political situation and prudent macroeconomic and budget policy. However, the latter has recently become a big concern for foreign investors. Although these are still important factors, we are becoming less dependent on foreign money in the capital market as our domestic source of funds has started to fill the gap.
Reports of a slowdown in our economic performance have dominated recent news. This trend was set in motion by the underperformance of household consumption, which was lower than expected. Household consumption growth used to beat or at least be on par with GDP growth before the pandemic. From now on, we need to be cautious about that figure in terms of anticipating consumers' purchasing power and behavior to understand whether this trend will be temporary or permanent. On the other hand, we can be 100 percent sure that the contribution of household consumption to Indonesia's economy will never get close to 60 percent again.
From the supply side, news about the shutting down of several factories in the textile industry brings dark clouds over Indonesia's manufacturing sector. Textile manufacturing, which many regard as a sunset industry, continues to suffer because it cannot compete in either the domestic or export markets. Many firms have tried to adjust their operation by moving their factories to lower-wage provinces, such as Central Java. The government needs to investigate in detail the problems and provide supporting policies to help the industry become at least more competitive. Besides the lower demand, we believe the cost structure of the textile industry needs to be brought down.
It is interesting to see the unemployment rate in Central Java recently. We must appreciate the government’s efforts to successfully reduce the unemployment rate from 7 percent, when COVID–19 hit our economy hard, to just 4.8 percent in February 2024. However, we must note that some provinces in Java have consistently higher unemployment rates. Jakarta, West Java and Banten had unemployment rates above 7 percent last year, especially Banten, which scored a similar figure this February. We hope that all stakeholders understand that raising the minimum wage to more than businesses can afford will cost the economy instead. Perhaps making an investment attractiveness index across provinces in Indonesia would help deliver the message.
Next year, the new administration's challenge will most likely be switching from targeting higher economic growth to keeping it above 5 percent. The headwinds in our economy come from continuous external economic fluctuations and slower consumer confidence in the domestic market. A new round of the trade war has started between China, the European Union and the United States because of China's subsidy and domination of electric vehicle (EV) sales to the rest of the world. The government must carefully assess the impact on Indonesia as we may become the target market if there is trade diversion.
On the domestic side, the shrinking size of the middle class in Indonesia could be the root of the slowdown in household consumption. When compared with 2019 before the pandemic, the size of the middle class in Indonesia had fallen by 4 percent in 2023. The percentage seems small, but it means about 11 million people now fall into the category of aspiring middle class or vulnerable. It will not be easy for the next government to recover the figure back to the pre-pandemic level and boost consumer confidence.
