In January to September 2019, however, construction sector growth declined to 5.8 percent year-on-year (yoy) compared with 6.3 percent in the same period a year earlier. A slowdown in the property and infrastructure sectors was a major contributing factor behind the decrease in growth in the construction industry. Infrastructure spending in 2019, which only grew 1.4 percent yoy, was lower than 3.8 percent yoy in the previous year.

Going forward, however, the Bank Mandiri economic research team predicts the construction sector will improve in 2020. We estimate the sector will grow 6.02 percent yoy in 2020. Some factors driving growth in the sector are infrastructure and property development.

The property sector would slightly improve in 2020. Loan growth for housing and apartments was quite high in November 2019 at 10.3 percent and 21.2 percent yoy, respectively. In the domestic banking sector, overall loan growth during this time was 6.53 percent yoy.

Infrastructure development continues to be the government’s priority. Infrastructure spending in the 2020 state budget has been earmarked at Rp 419.2 trillion (US$30.64 billion), a growth of 5.9 percent compared with the previous year.

Furthermore, the government has stated that infrastructure development from 2020 to 2024 will be focused on three fields: basic services infrastructure, economic infrastructure and urban infrastructure.

The National Development Planning Agency (Bappenas) estimated that the amount of investment needed for infrastructure in the 2020-2024 National Medium-Term Development Plan (RPJMN) was Rp 6.4 quadrillion. The private sector plays an important role in infrastructure financing, being the largest funding source for Indonesia’s infrastructure investment at 42 percent of overall funding. State budget and regional government budget funding follow at 37 percent share of overall infrastructure financing in Indonesia, while the remaining 21 percent of funding needs for Indonesia’s infrastructure projects are expected from state-owned enterprises.

Transportation is the sector with the biggest need for financing among other infrastructure projects, accounting for 60 percent of total financing needs. Energy infrastructure follows with 17 percent of overall investment needed in the RPJMN 2020-2024, while irrigation infrastructure accounts for 10 percent of total financing needs.

National strategic projects would also continue to support infrastructure development. Since 2016, the government of Indonesia has accelerated development of 223 national strategic projects and three programs based on Presidential Regulation No. 56/2018 on the acceleration of national strategic project implementation. The projects in this include toll roads, railways, airports, energy projects, ports, irrigation systems, special economic zones, industrial estates, dams, houses, sea dikes, clean water projects and many other projects.

According to data from the Committee for Acceleration of Priority Infrastructure Delivery (KPPIP), progress of the national strategic projects remains on track. As of September 2019, many infrastructure projects were under construction. The total value of these projects is Rp 2.7 quadrillion, consisting of Rp 1.35 quadrillion for projects that would only be operational after 2019 and Rp 1.35 quadrillion for projects that were scheduled to begin operations in 2019.

The national strategic projects are distributed in all regions across Indonesia with the largest proportion in Maluku-Papua with a total investment of Rp 395.6 trillion, followed by Java (Rp 394.8 trillion), Sulawesi (Rp 244.6 trillion) and Sumatra (Rp 225 trillion). Projects under construction are also allocated in some sectors, with the largest in the electricity sector (Rp 1 quadrillion), followed by energy (Rp 794.5 trillion) and roads (Rp 309.3 trillion).

From 2016 to September 2019, 81 national strategic projects were completed at a total investment value of Rp 389 trillion. The projects included toll roads, airports, seaports, railways, special economic zones and dams.

Of the completed projects, 18 involved the construction of toll roads and 14 involved dams. Most of the completed toll road projects were concentrated along the trans-Java toll road. Only three trans-Sumatra projects were completed, namely the Medan-Kualanamu-Lubuk Pakam-Tebing Tinggi toll road, Palembang-Simpang Indralaya toll road and Bakauheni-Terbanggi Besar toll road.

The construction sector in 2020 would not be free from challenges. Land acquisition remains a problem in construction, especially infrastructure development. Based on KPPIP data, land acquisition problems in national strategic project development constituted around 28 percent of the total 191 reported issues in March 2019.

The implementation of Law No. 2/2012, which specifically addresses land procurement for development for public interests, is still facing many obstacles in the field, mainly due to the absence of clear spatial determination. The delay of land acquisition then results in higher investment costs or overrun costs that must be borne by investors.

Low internal rates of return (IRRs), in addition, would also become a risk factor in construction going into 2020. The majority of projects slated for 2020 have a low internal rate of return, including toll road projects outside Java with IRRs of less than 10. This condition, consequently, requires guarantees and government support so that ideal investment rates of return can be achieved. In addition, toll road business entities would need to develop areas around toll roads, such as property, industrial estate and tourism development areas, to increase their IRRs.

Another challenge for the construction sector is negative cash flow during the initiation period of a project’s operation, commonly from the first year to the 10th. The infrastructure construction business is characterized by cash deficiency in the initial stage of operation. This period serves as a crucial point in infrastructure construction.

Builders are poised to face potential difficulties in paying debts and interests in the beginning of operation periods. This is largely because land acquisition is generally carried out alongside construction, even when construction revenue is not yet booked in the early stages of an operation. This condition could cause the debt-to-equity ratios of construction companies to rise. The burden of debts would limit construction companies’ cash flow, limiting their ability to expand elsewhere.

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The writer is senior regional analyst at Bank Mandiri.

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