The challenging task for the government has switched from targeting higher economic growth to keeping the growth above 5 percent. The headwinds to our economy come from external economic fluctuations as the end of the trade war is still uncertain and major economies experienced slower growth in early 2019.

The deepening trade tension between the United States and China are still the main source of instability. Looking at the latest data of the two largest emerging economies, China’s economy only grew 6.2 percent in the second quarter of this year. India has lost the title of world fastest growing economy as its GDP growth was slower at 5.8 percent in the last quarter ended in March.

The government is aware of the higher risk from external shocks and instability. Therefore, it has been launching a number of measures and policies to ensure our economy can maintain its momentum of higher growth trajectory since 2015. Examining the GDP component in the last two years, we understand that the component that makes our economy run faster is investment.

Since 2017, gross domestic capital formation or net investment has performed better than others with growth of 6 to 7 percent. With a steady growth of private consumption and limited fiscal space due to the moderate performance of tax revenue collection, boosting investment is the key strategy to achieve economic growth higher than 5.2 percent.

However, the question now is how attractive Indonesia is for investment and ultimately for foreign investors. In comparison to other ASEAN countries, the performance of foreign investment places Indonesia second in terms of foreign direct investment (FDI) inflow in the region. The Investment Coordinating Board (BKPM) recorded that the realization of FDI was US$29.3 billion in 2018.

This outcome is the result of significant progress made in many areas with regard to the investment climate. Indonesia is ranked 73rd in the World Bank’s Doing Business Report and 45th in the WEF Global Competitiveness Index. Recently, Standard and Poor’s upgraded Indonesia’s sovereign rating to BBB with a stable outlook as the result of strong economic growth prospects and policies to support growth.

Examining investment policies during the first term of Joko “Jokowi” Widodo’s presidency provides an overview that the government relies on deregulation and investment incentives to improve the investment climate. On the tax holidays policy, Indonesia has relaxed the criteria of the incentives and has broadened them to 18 pioneer industries. The minimum investment criteria have also been lowered to Rp 100 billion ($7.16 million) and the tax holiday duration is extended to 20 years if the business meets certain criteria.

Other than tax holidays, there are other tax incentive policies such tax allowance and import duty exemption.

Back to the question above, it seems FDI growth is responding positively with all those reforms and tax incentives as supported by the data. However, the government needs to examine the data carefully and review some literature as well as other countries’ experiences before making such conclusions. The examination is conducted based on the cost-benefit of investment incentives.

For the benefit, there are additional revenue and social benefits as a result of increased investment. On the other hand, the foregone revenue and indirect cost of incentives due to administrative and distortion costs should be calculated on the cost side.

Moreover, other countries’ experiences in implementing tax incentives suggest that the policies are not effective in attracting investors in developing economies. When choosing investment location, investors’ priority would be macroeconomic factors and investment climate. Investors will connect those factors to long-term company operation stages, from planning, sourcing, to producing and delivering.

An assessment of tax incentives policy from the Philippines can be useful for our government to improve its tax incentives policies and administration. The Bureau of Internal Revenue Philippines (2015) estimates that the foregone revenue from fiscal incentives in the Philippines was 157 billion peso ($3.4 billion) in 2012. This is equal to 1.49 percent of GDP, 10.23 percent of government revenues and 8.84 percent of government expenditure in the same year. Zero import duty and tax holidays were the two biggest sources, contributing 69.8 billion peso and 64.4 billion peso, respectively, to the estimation.

The challenges faced by the Philippine administration included reviewing the receivers of tax incentives. There was a tendency for investors to switch to short-term investment projects so they could maximize the use of incentives. In other words, before the tax holiday ended, investors would close the business and then reinvest to access another 8-year tax payment exemption.

That evidence implies that investment incentives must be applied carefully so it would not create distortion and moral hazard in the economy. There are other determining factors for investors in choosing investment location that need to be addressed by the government to improve the investment climate.

On the production factor, infrastructure development has contributed improvements in logistic cost and flow of goods. Labor productivity improvement is the next target of the government as Indonesia is not in a favourable position compared to its peers in ASEAN or other emerging countries.

While deregulation with regard to investment policies and institutional strengthening of government agencies have been under way, it is worth mentioning that the government could also push the effort to sign a new Free Trade Agreement (FTA) and Comprehensive Economic Partnership Agreement (CEPA) with more countries. Currently, there are only eight bilateral and regional FTA/CEPA that Indonesia is involved in.

The presence of FTAs and CEPAs does not only benefit export performance. The exclusive preferential tariff applied by Indonesia will attract global companies to make Indonesia a part of the global production network and boost investors’ confidence.

For sure, it will take time to beat Singapore as an important investment location in ASEAN. However, if Indonesia can improve all aspects in production, regulations, institutions and international cooperation, it can happen sooner.

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The writer is senior analyst at PT Bank Mandiri (Persero).

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