INVESTING IN INDONESIA CURRENT TRENDS AND PITFALLS

Indonesia at a glance

Indonesia is South East Asia's largest economy and a stable  democracy. Its economy has grown impressively since the Asian financial crisis of 1998, with a nominal GDP estimated at USD 1.074 trillion in 2018 and with an annual growth rate of 5.06% in Q1 2018...

It currently ranks as the world's 16th largest economy and fourth most populous country, with a population of approximately 261 million¹.

Indonesia's economy has traditionally relied on natural resources and agriculture, but in recent years, it has also seen strong growth in the consumer, e-commerce, fintech, infrastructure projects, logistics, manufacturing, and service sectors.

This has been led by a combination of factors, including a relatively young population, a rapidly growing middle class, increasing Internet and smartphone use, increased government spending and private sector participation in infrastructure, and a recovery in commodity prices.

Some recent deal trends

Digital economy

In 2016, Indonesia had 132.7 million Internet users, of which 106 million were active social media users and 92 million were active smartphone users². Around 9% of the country's population, comprising 24.74 million people, made online transactions in 2016, with a total transaction value of USD 5.6 billion³.

This spurred significant investments in Indonesia's digital economy. Some recent landmark deals include:

• Go-Jek:

  It recently raised USD 1.2 billion from investors including Tencentat a reported valuation of about USD 3 billion. Originally starting as a ride sharing app for motorbike rides, the company has expanded its offering into car rides, delivery, shopping, food, and even cleaning, massage, and beautician services delivered to the residences of Indonesian consumers.

• Tokopedia:

  It operates a platform that allows small-and medium-sized retailers to sell to consumers online. Tokopedia's investors include Alibaba, Softbank, Sequoia Capital, and East Ventures.

• Traveloka:

  It received USD 500 million funding in two rounds. Traveloka's investors include: Expedia, East Ventures, Hillhouse Capital Group, Sequoia Capital, JD.com, and Global Founders Capital.

Deal activity in this sector is expected to continue, particularly as a start-up culture takes root with strong private equity and venture capital interest.

Infrastructure projects

Indonesia is an archipelago, comprising more than 17,000 islands. Lack of adequate transportation infrastructure has created logistical barriers to trade and increased the costs for businesses. Indonesia's current government has embarked upon an infrastructure development program aimed at accelerating 265 infrastructure projects in sectors ranging from roads, ports, railways, and economic zones. Of these, 26 have been completed since the program started in 2016 and a further 145 are under construction.

While state and state-owned enterprises have stepped up spending on such projects, the bulk of the investment has come from private investors, including from China.

However, the implementation of these projects remains fraught with challenges. The proposed $6 billion Jakarta to Bandung high-speed rail, which is billed as the highlight of Indonesia's push to upgrade its infrastructure, is proceeding very slowly, with only about half of the land needed for the 142-kilometer railway having been cleared as of September 2017⁴.

Consumer sector

While Indonesia's large population and growing middle class present a significant and growing opportunity for consumer-focused companies, serving consumers across the vast archipelago presents logistical challenges and increases costs.

Recent high-profile deal activity in this space includes the following:

• PT Trans Retail:

  The retail group received S$ 546 million from Singapore sovereign wealth fund GIC.

  The company operates hypermarkets, supermarkets, and cash and carry stores under the Carrefour and TranSmart brands.

• Lulu:

  The United Arab Emirates' hypermarket chain has opened it second hypermarket in Indonesia and has announced plans to invest up to USD 500 million in Indonesia over the next five years.

Healthcare

Indonesia, by Asian standards, has relatively low healthcare market penetration and spending per capita. However, Indonesia's per capita healthcare expenditure should increase as the government seeks to implement universal national healthcare coverage.

In 2014, the government launched its universal national healthcare program (JaminanKesehatanNasional). Its deployment, via the Healthcare and Social Security Agency (BadanPenyelenggaraJaminanSosial), has already improved public access to health services, which has expanded to reach the majority of the population.

This sector has seen significant interest from private equity funds and healthcare companies.

Natural resources

Indonesia possesses vast natural minerals and resources, including large deposits of coal, natural gas, petroleum, gold, bauxite, tin, copper, and nickel. However, with the end of the global mining boom in 2013 and various regulatory changes, this sector has been adversely affected. 

In an effort to increase value-added exports of natural resources, the Indonesian government banned the export of certain unprocessed (or insufficiently processed) mineral ores in January 2014. This was with a view to kick-starting a domestic mineral-processing industry. While this hit exports, it also resulted in approximately USD 15 billion in investments in downstream-processing projects – mostly from China.

However, in early 2017, the ban was reversed, subject to certain conditions. This has negatively affected investors in downstream-processing facilities.

Indonesia has also sought to require large international mining companies like Freeport-McMoRan Inc to switch from "contracts of work" to "special mining licenses" before they can apply for new export permits or operating permit extensions. This would require Freeport to agree on new taxes and royalties that it is currently exempt from and divest up to 51% of its Indonesian unit (from 30% under current rules). Negotiations with the Indonesian government are ongoing in this matter.

General challenges and pitfalls

Despite the opportunities outlined above, various challenges remain:

Legal system

Indonesia's legal system is based on civil law, with origins in Dutch colonial law. Foreign investors from common law jurisdictions may find some aspects of it unfamiliar. For example, judges in Indonesia are not bound by precedents, trusts are generally not recognized, and contracts are generally subject to an overriding obligation requiring parties to act in good faith. Other issues with the legal system include:

• Unclear laws and sometimes conflicting laws issued by different authorities;
• Lengthy court proceedings that are likely to take many months, or even years, to complete; and udges have a high level of discretion in deciding matters. Corruption is a concern, particularly in lower courts.

Corruption, transparency, and ease of business

Corruption and bureaucracy are often cited as the largest barriers to investing in Indonesia. Indonesia ranks 96th in Transparency International's Corruption Perceptions Index 2017. Local authorities have significant powers, which affect the ability to secure approvals in a timely and transparent manner.

However, progress is being made. In recent years, Indonesia's Corruption Eradication Commission (KomisiPemberantasanKorupsi), an independent and autonomous authority, which aims to investigate and prosecute corrupt and criminal government agencies and public servants, has taken several actions and achieved significant successes.

Indonesia has also made significant progress in making it easier to conduct business. In recognition of these efforts, the World Bank has upgraded Indonesia in its 2018 ease of doing business report by 19 points - to the 72nd position.

Foreign investment restrictions

Direct foreign investment in Indonesia is highly regulated. Not all business fields are "open" to foreign investment. The direct foreign investment regulations include an Investment Negative List which details whether a business sector is "closed" to investment or "conditionally open" (meaning that they are subject to foreign ownership limits or conditions). 

Many foreign investors have structured their investments in Indonesia through Indonesian individuals, so as to not violate foreign investment limits. However, new regulations introduced this year require Indonesian companies to determine who their beneficial owners are and report such information to the authorized agencies. The regulations are very broadly worded, and it is possible that shareholding arrangements with Indonesian individuals may be disregarded in determining the ultimate beneficial owner of shares. Such ownership structures, therefore, need to be re-examined and restructured if necessary to ensure compliance with laws.

About us

Investing in any foreign country is a complex and challenging process. We regularly advise clients not only on their strict legal requirements but also on the practical steps they need to take to avoid pitfalls and risks that arise when investing in Indonesia.

Stephenson Harwood is an international law firm headquartered in London with over 1000 people worldwide, 10 international offices and more than 170 partners.

The firm has extensive experience advising on transactions relating to Indonesia. Working with our associated leading Indonesian law firm Christian Teo & Partners, we offer enhanced technical expertise on Indonesian law matters.

Disclaimer

– The views expressed in this article are the personal views of the authors and are purely informative in nature and are not to be construed as legal advice.