Indonesia’s Economic Policy Package Implications

Series of Economic Policy Packages and Their Implications

　In 1H2015, Indonesia’s economy decelerated to its slowest pace since 2009. GDP growth decelerated in two consecutive quarters to 4.72% in 1Q2015 and 4.67% in 2Q2015 respectively, due to weaker commodity exports (down 12.4% in 1H2015), delays in government spending (an estimated drop of 7.2% in 1H2015) and a decrease in foreign direct investment realisation (down 2.5% in 1H2015), in addition to softer consumer spending. These factors, coupled with a high rate of inflation (average of 8.4% over the past 2 years) and depreciating currency (ytd down 8.3%), resulted in the government being left with little room to ease monetary policy.

　As Indonesia’s ambitious infrastructure projects have witnessed slow progress, the government is planning to boost its short- to medium-term growth by diversifying into productive sectors such as manufacturing and agriculture, and thus wean itself off its reliance on natural resources, which have been affected in recent years by falling commodity prices.

　As a result of this slump in economic performance, the Government of Indonesia released three economic policy packages within the span of a month (9th Sep to 7th Oct) to help boost the economy through deregulation and fiscal stimulus. The first economic policy package focused mainly on deregulation involving the revision of 120 ministerial regulations and some other government regulations. As such, we present below an analysis of the concrete measures outlined in the second and third packages.

　The second package of the economic policy (issued on 29th September 2015) comprises a much smaller number of measures concentrating more on stabilising the rupiah and accelerating both domestic direct investment (DDI) and foreign direct investment (FDI) realisation in the manufacturing and agricultural sectors.

Summary of the Second Economic Policy Package
1. Reduce the tax on interest accrued on foreign exchange earnings to bring in additional foreign exchange reserves.
2. Speed up the decision making process for tax allowances and tax holidays in order to attract FDI.
3. Ease investment services in the country to speed up the process of investment realisation and promote faster job creation.
4. Improve industrial logistics facilities to reduce logistics costs of the manufacturing sector and its reliance on imports of raw materials, capital goods and intermediary goods.
5. Provide tax incentives for the production of transportation equipment to increase local manufacturers’ competitiveness.
6. Simplify business permits in the forestry sector to use forest area for productive activities such as logging and mining.

　Meanwhile, the third economic policy package (released on 7th October 2015) aims mainly to reduce production costs and help both micro establishments and large scale industries survive amidst the sluggish economy.

　The government has also just issued the fourth economic policy package on 15th October 2015 in an attempt to boost employment. The fifth package is expected to be announced by the end of the month.

Summary of the Third Economic Policy Package
1. Reduce the energy costs of the industrial sector.
2. Extend credit/Kredit usaha rakyat (KUR) to micro establishments.
3. Faster issuance of land utilisation permits to facilitate infrastructure and property development.

　Tax Discount Expected to Bring in Additional Foreign Exchange Reserves

　In order to attract more capital from foreign investors, a stable currency is a prerequisite. As of the end of September 2015, Indonesia’s foreign exchange reserves had declined to USD 101.7 billion from USD 105.3 billion in the previous month. The interest rate tax cuts policy is intended to encourage exporters to deposit their export proceeds onshore, thus increasing the quantity and liquidity of the country’s foreign exchange reserves. The Government of Indonesia will reduce the tax imposed on the interest that exporters generate when they deposit their foreign exchange earnings (Dana Hasil Ekspor/DHE) in local banks. The magnitude of the tax cuts will depend on the duration of the deposits, and whether the deposits will be in USD or IDR denominated accounts. The interest tax rate will be made lower for longer duration deposits and even lower still if the export proceeds are converted and saved in IDR denominated deposit accounts. Interest earned on DHE is currently taxed at a flat rate of 20%.

Duration	DHE in USD	DHE in IDR
< 1 month	20.0%	20.0%
1 month	10.0%	7.5%
3 months	7.5%	5.0%
6 months	2.5%	0.0%
> 6 months	0.0%	0.0%

　There is also a reporting mechanism in place requiring exporters to report the details of their foreign exchange earnings. This is to ensure that the tax discounts apply only to foreign exchange earnings from exports. As a result of the tax discount policy, the government has anticipated that exporters of natural resources, in particular, would be very interested in maintaining their DHE in local banks— especially considering that Indonesia’s deposit interest rate net of tax is 1% to 2% higher compared to that of neighouring countries such as Singapore.

　According to the Central Bank, not all of the proceeds from export activities are deposited in local banks at present. This is because exporters need to use part of their proceeds to purchase raw materials, which are often imported from abroad. With the new regulations, the Indonesian government hopes that exporters will deposit the difference between their export proceeds and the funds needed to purchase raw materials from abroad in local banks for longer periods of time in order to take advantage of the tax discount.

　In the past, this excess of DHE over the funds needed to purchase raw materials was around USD 30 billion per year. At conservative estimates, the Central Bank anticipates that the new tax discount regulations could potentially bring in an additional USD 12 billion per year or USD 1 billion per month to the country’s total foreign exchange reserves. Previously, around 90% of export proceeds were denominated in foreign currencies.

　On the other hand, large exporters of palm oil such as Sinar Mas and Indofood have stated that they cannot keep their DHE for too long in the deposits as they need the cash for working capital and other operational purposes. Hence, only those companies which procure their raw materials locally are likely to park their money in local banks, while companies that source their raw materials from abroad are likely to park their DHE overseas.

　One day after the announcement of the second package, the Central Bank also issued a press release to support this policy.

　Faster Handling of Tax Allowances and Tax Holidays to Attract Direct Investment

　The regulations for whether to grant tax allowances and tax holidays to a particular investment are currently under review, but the government is keen on hastening the decision making process. After an application is submitted and all requirements are met, the government will have 25 days to decide whether a particular investment is subject to a tax allowance or not. Since Government Regulation No. 18/2015 became effective on 6th May 2015, two companies have been granted tax allowances: one in the tyre industry (Hankook) and another in the lubricant industry (Shell).

Summary of Tax Allowance Regulations
1. For the purpose of tax calculation, net income can be reduced by 30% of the total amount invested by deducting 5% per year from the annual net income, over the next 6 years.
2. Eligible for 144 business segments. This was expanded from 129 business segments in the previous regulation. As of 2012, the businesses that are eligible for this tax allowance were mainly in these sectors: Agriculture, Forestry, Maritime and Fishery, Energy and Mineral Resources, Industrials, Public Works, Culture and Tourism, Transportation, Communication and Information, and Healthcare.
3. A tax allowance will be granted if certain requirements are met. These requirements include a minimum investment value and/or a minimum number of workers being employed, or the projects’ location (with a preference for areas outside the island of Java).
4. Accelerated depreciation and amortization.
5. Imposition of 10% income tax on dividends which are subjected to foreign tax, or a lower income tax rate according to the avoidance of double taxation agreement, where one exists.
6. Tax losses can be carried forward for longer than 5 years but not more than 10 years if certain conditions are met.

　As for whether a tax holiday will be granted to a particular investor, the Ministry of Finance will now finalise their decision within 45 days after all requirements have been met, down from 125 days previously. In addition, to be eligible for a tax holiday, a new investment plan of minimum IDR 1 trillion in a pioneer industry is required. The pioneer industries include basic metals, oil refining, petrochemical, agriculture, forestry and fishery. There is one company, PT Ogan Komering Ilir Pulp (a subsidiary of Sinar Mas Group), which has been granted a tax holiday since Government Regulation No. 159/PMK/10/2015 became effective on 16th August 2015.

Summary of Tax Holiday Regulations
1. A taxpayer can be granted a tax relief facility for a period of between 5 and 20 years, starting from commencement of commercial production.
2. After the expiration of the tax holiday, the taxpayer will be entitled to an income tax reduction of 50% for a further 2 years.
3. Whether an industry is a pioneer industry is determined by considering the purpose of maintaining the competitiveness of national industries and the strategic value of certain business activities. The duration of the tax relief and reduction can be extended based on a decision by the Ministry of Finance.

　As of 1H2015, both DDI and FDI realisation in the manufacturing sector accounted for the largest proportion of total DDI and FDI realisation in the country, at 39% and 50% respectively. While DDI realisation, in IDR terms, continued to increase significantly (by 85.5% in 1H2015 and 15.4% in 2014), the FDI realisation in the manufacturing sector declined by 20% in 1H2015 and 18% in 2014.

　The government believes that by revising the tax allowance and tax holiday provisions, it will be able to achieve its target of attracting direct investments (DDI and FDI) totalling USD 270 billion over 2015-2019. This figure is 1.6 times larger than the total direct investment generated over 2010-2014 (USD 168 billion).

　Many companies in the petrochemical industry have shown interest in capitalising on these two fiscal incentives, since petrochemical businesses generally begin to break-even only after 10 years of operations. Indonesia is currently constructing two upstream petrochemical centres, which will become operational by the end of 2016. Through this, the country will reduce its dependence on imported petrochemical products.

　Easing of Investment Services to Attract Direct Capital Investments and Create More Jobs

　This policy, which includes a 3-hour investment service, is meant to speed up the process of investment realisation in the country and consequently promote faster job creation. For businesses to be eligible for this fast-tracked issuance of business licences, a minimum investment of IDR 100 billion and/or the absorption of at least 1,000 workers is required.

　Investors, together with their passports and other supporting documents, are advised to go directly to the Indonesia Investment Coordinating Board’s main office to take advantage of this fast service as all three main business licenses—business entity name approvals, principle business licenses, and the tax identification numbers (NPWP)— can be issued right there on the spot within just 3 hours, from 8 days previously. In addition, the process of obtaining business permits for mining and geothermal industries are to be reduced to just 15 days, from up to 4 years previously.

　Once licenses are obtained, investors can immediately begin their construction activities as long as the industrial estate is located within an industrial park. This means that investors are now exempt from having to obtain the 11 construction-related permits that could take up to 526 days just to get an approval.

　BKPM has finalised the standard operating procedure for the 3-hour licence issuing targeted at businesses investing in industrial economic zones, and is currently in the latter stages of selecting two notaries that will be stationed in its office. The target date to implement this policy has been set as 26th October 2015.

　Although the new policy should speed up the investment realisation process in the country, the question remains whether professional standards and practices can be safeguarded when these permits are being processed within such a short period of time.

　National Bonded Logistic Centres to Reduce Logistics Costs of Manufacturing Sector

　This policy is intended to help the manufacturing sector reduce its logistics costs by providing more efficient industrial facilities such as bonded logistics centres.  The plan is to have two bonded logistics centres begin operations by the end of 2015, one in Cikarang (West Java) and another in Merak (Banten). These two bonded logistics centres will become a hub for obtaining input goods such as raw materials, capital goods and intermediary goods that are essential for production. The Cikarang logistics centre will be developed to fulfil the logistics-related needs of the manufacturing industry, while the Merak logistics centre will serve as a storage facility for fuel logistics. The government has also invited private investors to construct more bonded logistics centres to store various commodities such as cotton, oil and gas, and milk.

　As of 1H2015, raw materials accounted for the largest proportion of the total imported goods into the country at 70%. This was followed by capital goods at 17%. The construction of bonded logistics centres may shift some of the stockpiling of these goods to Indonesia from Malaysia and Singapore, which have been the main logistics hubs in the Southeast Asia region for quite some time now. This should in turn reduce the freight costs of the manufacturing sector as companies will no longer need to import their input goods from abroad; they may simply acquire such goods from domestic bonded warehouses.

　In addition, the existence of local bonded warehouses will also reduce the need for local manufacturers to convert their IDR into USD when sourcing for input goods, which should in turn help to stabilise the rupiah.

　Other issues that need to be addressed include poor road infrastructure and poor seaport/airport handling, which have traditionally resulted in high logistics costs for the country. Currently, logistics costs account for 27% of Indonesia’s GDP.

　The government will also offer a number of taxation incentives in these bonded logistics zones, thus increasing their appeal. These taxation incentives include the exemption of the VAT and sales tax on intermediary goods that are imported into the country, and the opportunity to delay the payment of import duty on stockpiled raw materials prior to leaving the centres to enter the domestic market. For imports of aircraft equipment and their associated components, the VAT is eliminated entirely to support companies operating in the aviation industry.

　There is currently no mention of whether these two bonded logistics centres will be connected to other Special Economic Zones (SEZ). Government Regulation No. 32/2009 regarding bonded area is currently under review and is expected to be released and implemented by the end of October 2015. However, it is important to note that the development of SEZs in Indonesia has been very slow, and hence it is likely to take at least several years for these two national bonded logistics centres to be connected to other SEZs. Indonesia’s SEZ committee has approved eight SEZs to be developed but only two SEZs, in North Sumatra and West Java, have been constructed so far, with a completion rate of less than 10%.

　VAT Exemption on the Production of Ships, Rolling Stock and Aircraft to Increase Competitiveness of Local Manufacturers

　Government Regulation No. 69/2015 regarding VAT exemptions on the import and production of transportation equipment has already been signed by the President on 16th September 2015, and became effective immediately.

　The policy covered here is designed to help increase the competitiveness of local manufacturers in the transportation industry. The government will not levy VAT for the production of certain transportation mediums such as trains, planes and ships or the import of their associated parts and components. It is hoped that the regulation will make Indonesia’s shipbuilding industry more competitive in producing a variety of ships such as fishing ships, navy patrol ships, customs and excise ships, transport ships and others. Owners of docks in Indonesia have been waiting for this incentive for several years now.

　Over the next 5 years, Indonesia is planning to build a total of 24 seaports, and this should be the main demand driver for ships which are produced locally. Shipyard businesses in the Batam Special Economic Zone thrived when tax exemptions were applied in the zone, and the second economic policy package is expected to bring about a similar boost that could be more widespread across all shipbuilding manufacturers in Indonesia.

　In 2014, the other transportation equipment sector’s indirect taxes as a percentage of value of gross output (VGO) were estimated to be 9.4%. This figure was much larger than the large and medium manufacturing sector’s average of 2.4% in 2014.

Other Transportation Equipment	Value of Gross Output (VGO) (in IDR billion)	Indirect Taxes (in IDR billion)	Indirect Taxes as a % of VGO
2012	106,835	1,279	1.2%
2013	100,764	844	0.8%
2014	102,368	9,631	9.4%

　Simplifying Permit Issuance Required for Use of Forest Area for Productive Activities

　This policy aims to simplify and reduce the number of permits required to use forest area for activities such as mining and logging. The Ministry of Environment and Forestry has reduced the number of permits required for such activities from 14 to 6 permits. Furthermore, the issuance process for permits for forest exploration will be reduced to 3 to 5 days, while the issuance of permits for the use of forest area will be reduced to 12-15 days. This goal is somewhat ambitious considering the issuance of permits in Indonesia’s forestry industry used to take around 2 to 4 years before the release of the second economic package.

　The Minister of Environment and Forestry has stated that the existing regulations pertaining to business permits of the forestry sector, which were issued in early 2015, will be revised immediately to support this policy.

　Reduction in Energy Prices to Lower Input Costs of Industrial Sectors

　The Ministry of Energy released several measures that aim to reduce production costs in the industrial sector. Firstly, diesel fuel prices will be reduced slightly to IDR 6,700 per litre from IDR 6,900 per litre, a measure which has been in effect since 10th October 2015. Gasoline prices will remain at IDR 7,400 per litre until the end of 2015. This stimulus is unlikely to increase consumers’ purchasing power, as gasoline accounted for 63% of the total subsidised fuel consumed in the country while diesel accounted for a much lower proportion (35%). Hence, this measure is more likely to reduce transportation costs of the industrial sector.

　Secondly, effective 1st January 2016, the price of gas for the fertiliser industry will be set at USD 7 per MMBTu, while the price of gas for other industries, such as petrochemicals and ceramics, will be adjusted in accordance with the buying power of each respective industry. This reduction in gas price is made possible by increasing the efficiency of gas distribution and by reducing the non-tax revenue of the state government. Over the period of 2011-2013, gas revenue accounted for an average of 4.3% to 4.8% of the total revenue generated by the government. The government also added that this gas price reduction would not, in any way, impact the top line of upstream gas contractors.

　Lastly, the Ministry of Energy will reduce electricity tariffs for medium industry (I3) and large industry (I4) by IDR 12 – IDR 13 per kWh, and apply a discount of up to 30% to electricity usage between 11 pm to 8 am. Labour intensive industries are also allowed to postpone payment on up to 40% of their electricity expenses for the first six to ten months, and gradually pay them in instalments.

　The overall impact of energy price reductions should be lower input costs for companies. In 2014, it is estimated that gas, fuel and electricity costs accounted for 6.2% of total input costs of large and medium manufacturing companies. As of 2014, the top five industries that consume the most fuel, gas and electricity were food products, textiles, rubber and plastic products, chemicals and chemical products, and paper and paper products. Players within these industries are expected to benefit the most from energy price cuts.

　Extending Micro Credit Access to Productive Sector

　The third economic package also aims to extend micro credit/Kredit Usaha Rakyat (KUR) to a much broader audience, in particular to micro establishments in the manufacturing, fisheries, and agriculture sectors. Any family that generates regular income is eligible for KUR, as long as the loan proceeds are used in the production of goods.  This measure aims to increase the number of small entrepreneurs in the country. Currently, a large proportion of KUR is given to the retail and trade sectors.

　Since KUR’s interest rate was slashed by nearly half to 12% in July 2015 from 22% previously, KUR’s loans outstanding has reached IDR 5 trillion or around 25% of total outstanding loans targeted by the end of 2015. The government is planning to reduce KUR’s interest rate further to 9% in 2016 if it gets cheap funding of IDR 50 trillion from Japan, increasing KUR’s outstanding loans to IDR 100 – 120 trillion by the end of 2016. This year the government has set aside IDR 1 trillion to subsidise KUR’s interest rate cuts from the state budget.

　The most profitable KUR lender in the country, Bank Rakyat Indonesia (BRI), presently controls a market share of 70%. BRI’s NPL stood at 0% in September 2015 and 2.3% in September 2014.

　The value of gross output per establishment for the micro manufacturing sector increased at a strong CAGR of 24% to IDR 78 million per establishment in 2014, from IDR 51 million per establishment in 2012.

Micro Manufacturing Sector	Number of Establishments	Value of Gross Output (VGO) (in IDR million)	VGO per Establishment (in IDR million)
2012	2,812,747	143,461,238	51
2013	2,887,015	162,791,677	56
2014	3,220,563	252,449,229	78

　Faster Permit Issuance for Commercial Use of Land to Facilitate Infrastructure and Property Development

　Meanwhile, in order to facilitate infrastructure and property development in the country, the Ministry of Agrarian and Spatial Land Planning has revised Ministerial Regulation No. 2/2015 to simplify the process of obtaining permits for the commercial use of land. The revisions specify that potential investors would have more legal certainty when purchasing land, and the government has just 3 hours to inform investors whether a particular piece of land can be acquired, down from 7 days previously.

Types	Before	After
1. Commercial Use Right (HGU)	30 WD (up to 200 ha) and 90 WD (more than 200 ha)	20 WD (up to 200 ha) and 45 WD (more than 200 ha)
2. Extension/Renewal of HGU	20 WD (up to 200 ha) and 50 WD (more than 200 ha)	7 WD (up to 200 ha) and 14 WD (more than 200 ha)
3. Building Usage Right (HGB) Request	20 WD (up to 15 ha) and 50 WD (more than 15 ha)	20 WD (up to 15 ha) and 30 WD (more than 15 ha)
4. Extension of HGB	20 WD (up to 15 ha) and 50 WD (more than 15 ha)	5 WD (up to 15 ha) and 7 WD (more than 15 ha)
5. Land Right	5 WD	1 WD
6. Dispute Settling	5 WD	2 WD