pestle analysis indonesia

PESTLE Analysis

PESTLE Country Analysis Report: Indonesia ML00002-041/Published 10/2014

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PESTLE ANALYSIS

Summary

The election of Joko Widodo in 2014 presidential elections is a strong testament to Indonesia's democratic values as it

marked the first time when a twice-elected president handed over power to a successor directly elected by the people.

However, the passage of a bill, which will scrap direct elections for regional heads in favor of indirect elections held by

regional assemblies, could prove to be a regressive democratic step. Although the previous President Susilo Bambang

Yudhoyono signed a presidential decree to repeal the bill, it will need approval from the newly elected parliament, which

is unlikely due to continued dominance of the Red-White coalition (opposition) in the legislative assembly. This

dominance could also hinder passage of institutional reforms proposed by the newly elected President Joko Widodo

(who belongs to rival coalition led by Widodo's PDI-P).

Another problem faced by Indonesia is that of corruption with a number of politicians, bureaucrats, policemen and

members of the judiciary tainted with corruption scandals. The country faces terrorism threats from both domestic and

international militant groups. On international front, Indonesia is improving its relations with other Association of South-

East Asian Nations (ASEAN) countries as the 10-member regional group aims to establish an EU-style single market by

2020.

On economic front, the Indonesian economy has recorded annual growth of above 5.0% in all years except one (2009

during 2004-13. In 2013, GDP growth came in at 5.8%, which is expected to fall to 5.5% in 2014 partly due to the macro

stabilizing monetary and exchange rate policy measures taken during June-November 2013 to arrest further depreciation

of Indonesian rupiah and control further widening of its high current account deficit. The country's banking sector remains

strong, government finances remain sustainable and foreign companies such as General Motors and Cargill have

continued to invest in the country with an ambition to tap into its large consumer market.

Major challenges affecting economic growth continue to be underinvestment in infrastructure and over-reliance on

commodity exports; the latter being a major reason for widening of Indonesia's current account deficit during 2012-13.

Another major hindrance to economic growth is the underdeveloped nature of Indonesian financial markets, which create

funding problems for firms, especially startups and deters the economy's ability to withstand global financial shocks.

On social front, Indonesia has implemented cash transfer programs for poor households to mitigate the impact of fuel

subsidy reduction, and to provide them with healthcare and education facilities, effectively raising their standard of living.

The government is also playing its part by aiming to provide social insurance to the entire population by 2029. However,

the country has witnessed many instances of human trafficking since 1991, which is a cause for concern. Rising ethnic

violence and religious intolerance could pose a risk to social harmony in Indonesia.

Indonesia has recorded marked improvement in technological and innovation parameters; albeit from a low base. The

country placed 34th out of 148 economies in the Global Competitiveness Index 2014-15, 21 places up from its 2008-09

rank of 55th. However, low R&D expenditure has taken a toll on the number of patents granted. Indonesia's proportion of

high technology exports in manufactured exports is also way below peers such as Philippines, Malaysia, China and

Thailand. In addition, the country has one of the worst records in the world in terms of software piracy, and while the

government has initiated measures to reduce the problem, there is still much work to be done.

The country has an effective competition law; besides, the total tax rate is lower than regional average. However, the

country's legal environment remains affected by an inefficient bureaucracy, rigid labor laws and a weak judicial system,

which can easily be influenced and manipulated by the political and business elite. Further, foreign companies face risks

from the arbitrary intervention of the Indonesian government, which has often created problems for foreign entities by

PESTLE Analysis


© MarketLine. This report is a licensed product and is not to be photocopied Page 14

either not honoring deals or imposing new conditions after an agreement has been signed.

Indonesia's biodiversity is one of its greatest assets. The country is among the top five in the world in terms of plant

diversity, with an estimated 38,000 higher plant species. Indonesia leads the world in terms of palm diversity. However,

large tracts of Sumatra's forest have been destroyed to make way for palm oil plantations, with companies clearing trees

and burning the stumps that remain. A 2008 Greenpeace report suggested that around 1.4 million hectares of virgin

forest in Riau have already been converted to plantations to provide cooking oil and a further 3 million hectares are set to

be used for the production of biofuels. Further, the government's heavy energy subsidies have been contrary to its

environmental initiatives.

PESTLE Analysis



Political analysis

Overview

The election of Joko Widodo in 2014 presidential elections is a strong testament to Indonesia's democratic values as it


However, the passage of a bill, which will scrap direct elections for regional heads in favor of indirect elections held by

regional assemblies, is a regressive step. Although the previous President Susilo Bambang Yudhoyono signed a

presidential decree to repeal the bill, it will need approval from the newly elected parliament, which is unlikely due to

continued dominance of the Red-White coalition (opposition) in the legislative assembly. This dominance could also

hinder passage of institutional reforms proposed by the newly elected President Joko Widodo (who belongs to rival

coalition led by Widodo's PDI-P).

Another problem faced by Indonesia is that of corruption with a number of politicians, bureaucrats, policemen and

members of the judiciary all tainted with corruption scandals. Restoration of indirect elections for regional heads could

aggravate this problem as it is believed to have fuelled corruption and nepotism during 1999-2004.The country faces

terrorism threats from both domestic and international militant groups. The latter could be a consequence of reawakening

of dormant networks as more than 100 Indonesians are suspected of fighting for the radical Sunni cause of the Islamic

State of Iraq and al-Sham (ISIS) in Iraq and Syria. To tackle terrorism, Indonesia has improved its security ties with the

likes of the US, Russia, China and South Korea.

On international front, Indonesia is improving its relations with other Association of South-East Asian Nations (ASEAN)

countries as the 10-member regional group aims to establish an EU-style single market by 2020.

Table 3: Analysis of Indonesia's political landscape

Current strengths Current challenges

▪ Transition to democracy

▪ Strong defense cooperation policy

▪ Corruption

▪ Dominance of opposition coalition in the parliament

Future prospects Future risks

▪ Deeper integration with ASEAN allies ▪ Terrorism threats

▪ Scrapping of direct regional elections

Source: MarketLine MARKETLINE

Current strengths

Transition to democracy

Indonesia made a successful transition from authoritarian rule to democracy in 2004 after it held its first-ever direct

presidential elections. Indonesia has since built an institutional framework capable of forming the basis of a successful

and eventually thriving democracy. Since its transition to democracy, most Indonesians have enjoyed freedom of

expression. A system of checks and balances has been brought between the executive and the legislative branches of

government and the armed forces have been depoliticized.

PESTLE Analysis



In the years following the fall of President Suharto, Indonesia has had five presidents: B.J. Habibie, Abdurrahman Wahid,

Megawati Sukarnoputri, Susilo Bambang Yudhoyono and the incumbent Joko Widodo, all of whom assumed power by

democratic means. In fact, the election of Joko Widodo as the Indonesian president in 2014 presidential elections


Although administrative flaws characterized the most recent legislative and presidential elections, which were held in

2014, they were assessed to be transparent and broadly fair.

Strong defense cooperation policy

In order to strengthen its military prowess, Indonesia has improved its security ties with the likes of the US, Russia, China

and South Korea. During late 2009, the US Pacific Command (USPACOM) was installed in Indonesia. In 2011, the US

also agreed to deliver 24 used F-16 C/D Block 25 fighter jets to Indonesia, free of cost. In addition to the US, the country

also has strong military ties with Russia, from which it has received 16 Sukhoi fighters since 2003. Military ties with China

are largely focused on obtaining the technology that the C-802 missile is based on. The two countries are also

negotiating a technology transfer mechanism for C-705 missiles to be used by the Indonesian navy. Indonesia is also

engaged in a technology transfer agreement with South Korea to build its first indigenously-built Chang Bogo-class

diesel-electric submarine (SSK) by 2018. In addition, it is expected to receive Chang Bogo-class SSKs from South Korea

by 2017. In addition to these countries, Indonesia also has cooperation agreements with the UK, India, Saudi Arabia and

the Netherlands.

Current challenges

Corruption

Like other countries with authoritarian history, Indonesia continues to have problems with high level of corruption. The

country secured a poor rank of 114th out of 177 countries in Corruption Perception Index 2013 as it witnessed various

instances of corruption involving politicians, bureaucrats, policemen and members of the judiciary. In the political arena,

the Democratic Party (PD) remained tainted with corruption issues in 2013-14 with a number of its high profile members

such as Anas Urbaningrum, Andi Mallarangeng, Angelina Sondakh and Jero Wacik either convicted or arrested for

involvement in bribery scandals. Corruption in police and judiciary also remain points of concern for the newly elected

President Joko Widodo, who won the 2014 elections on an anti-corruption platform. Previously, in 2013, a senior

policeman was jailed for money-laundering in a case involving the procurement of driving simulators for the police, while

the chief justice of the constitutional court was detained for bribery. The country needs to adopt stronger anti-corruption

legislation to weed out graft from the administrative and political machinery—this will also enhance its business

environment.

Dominance of opposition coalition in the parliament

The Red-White coalition (led by Golkar Party and Gerindra Party), which controls around 56% of the seats in the

legislative assembly, could hinder passage of institutional reforms proposed by the newly elected President Joko

Widodo. A prime example of potential instability that could affect lawmaking came to the fore on the first day of the new

parliament's five-year term in office on October 2, 2014, when members of the five parties that comprise the opposition

coalition grabbed five most important positions (one Speaker and four Deputy Speakers) in the People's Representative

Council (DPR). The coalition followed it up by managing to gain full control of the People's Consultative Assembly (MPR),

which has the power to amend the constitution and impeach the president, in the following week. The opposition

coalition, which was formed to support Prabowo Subianto's presidential bid in 2014, could thus render lawmaking

ineffective and affect political stability.

PESTLE Analysis



Future prospects

Deeper integration with ASEAN allies

The coming years will see Indonesia improve its ties with other Association of South-East Asian Nations (ASEAN)

countries as the 10-member regional group aims to establish an EU-style single market and production base with a free

flow of goods, services, investments and skilled labor by 2020. In the near-term, the South-East Asian group aims to

establish ASEAN Economic Community (AEC) by end-2015, which will almost entirely eliminate tariff barriers on goods,

liberalize trade in services, integrate customs procedures and allow freer movement of capital in the region.

As the largest economy in the region, Indonesia has much to gain from this integration as its large population lends it

demographic advantage in terms of both sale and manufacture of goods and services. While the former will improve

consumption demand in a country, where the number of people belonging to the middle-class is expected to almost

double by 2020 (from 74 million in 2014); the latter will help generate manufacturing jobs and help the government revive

the struggling small- and medium- enterprise sector. The alliance could also help the country address its infrastructure

bottlenecks as it would make it easier for foreign companies to bid for contracts and reduce logistics cost.

Future risks

Terrorism threats

Although terrorist attacks in Indonesia have largely subsided since the country witnessed major attacks against the JW

Marriot and Ritz-Carlton hotels in Jakarta in 2009, the country still faces risks of renewed terrorism threats. Domestic

threat mainly stems from the release of more than 100 convicted terrorists from Indonesian prisons in 2014, most of them

were associated with 2002 Bali bombings. On the international front, Indonesia faces threats from reawakening of

dormant networks as more than 100 Indonesians are suspected of fighting for the radical Sunni cause of the Islamic

State of Iraq and al-Sham (ISIS) in Iraq and Syria. Such a phenomenon was previously seen in the 1980s and 1990s,

when returning jihadists from Afghanistan brought back new terrorist associations, improved funding and ammunition

expertise. The country's counter-terrorism unit must counter both international and local threats to maintain the long-term

stability and prospects of the country.

Scrapping of direct regional elections

The passage of a bill, which will scrap direct elections for regional heads such as governors, district chiefs and mayors in

favor of indirect elections held by regional assemblies, could pose a setback for Indonesia's democracy. The bill restores

the system followed during 1999-2004 and is believed to have fuelled corruption and nepotism during the five-year

period. Although the previous President Susilo Bambang Yudhoyono signed a presidential decree to repeal the bill, it will

need approval from the newly elected parliament and this is unlikely due to continued dominance of the Red-White

coalition.

The Red-White coalition considers the elections very costly and argues that scrapping the elections will save the country

around $3.5 billion. On the flipside, since direct elections were introduced in 2004, the accountability of the government

has increased and many political figures outside the political elite have come into limelight in Indonesian politics,

including the current President Joko Widodo (who is a carpenter's son and used to run his family's furniture business

before joining politics). Overall, the abolition of the elections could bring political influence in appointment of local leaders,

which could be a setback to Indonesian democratic values.

PESTLE Analysis



Economic analysis

Overview

Since 2004, the Indonesian economy has recorded annual growth of above 5.0% in all years except 2009. In 2013, GDP

growth came in at 5.8%, which is expected to fall to 5.5% in 2014 partly due to the macro stabilizing monetary and

exchange rate policy measures taken during June-November 2013 to arrest further depreciation of Indonesian rupiah

and control further widening of its high current account deficit. The country's banking sector remains strong, government

finances remain sustainable and foreign companies such as General Motors and Cargill have continued to invest in the

country with an ambition to tap into its large consumer market.

Major challenges affecting economic growth continue to be underinvestment in infrastructure and over-reliance on

commodity exports; the latter being a major reason for widening of Indonesia's current account deficit during 2012-13.

Another major hindrance to economic growth is the underdeveloped nature of Indonesian financial markets, which create

funding problems for firms, especially startups and deters the economy's ability to withstand global financial shocks.

Table 4: Analysis of Indonesia's economy


▪ Healthy banking sector

▪ Sustainable public debt

▪ Shallow financial sector

▪ Underinvestment in infrastructure


▪ Rising investments from American companies

▪ Demographic dividends of a vast labor pool

▪ High current account deficit


Current strengths

Healthy banking sector

Despite a slowdown in economic activity, the Indonesian banking sector remains sound with strong capital adequacy and

profitability indicators in 2014. Although the NPL ratio of the sector increased from 1.90% in January 2014 to 2.30% in

August 2014, commercial banks have been able to maintain a system wide capital adequacy ratio of around 20.0%,

almost double the statutory requirement of 10.5% required under Basel III norms, according to data from Bank Indonesia.

The quality of capital maintained by the banks is good as around 92% of the capital is Tier-1, the most liquid form of

capital. Return on assets, a measure of banks' profitability, averaged 2.9% in the first seven months of 2014. Although

banks' profitability and non-performing loans (NPL) have taken a hit in 2014 due to risks stemming from higher interest

rates and the adverse effects of commodity prices, the Indonesian banking sector continues to remain among the most

profitable in Asia and capable of absorbing shocks from slowdown in economic activity.

PESTLE Analysis



Figure 2: Indonesia banking indicators, May 2013 - August 2014

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Source: Bank Indonesia MARKETLINE

Sustainable public debt

Prudent macroeconomic policies coupled with high economic growth have helped the Indonesian government in

maintaining debt sustainability since the turn of the millennium. According to MarketLine, Indonesia's public debt reduced

to 24.2% of GDP by the end of 2012 from levels as high as 96.8% of GDP in 2000. Moreover, during the 12-year period

to 2012, the country's fiscal performance outperformed its peers—Thailand and Malaysia. While Thailand's public debt,

as a percentage of GDP, reduced from 57.3% in 2000 to 44.5% in 2012, Malaysia's public debt, as a percentage of GDP,

increased from 34.3% in 2000 to 53.8% in 2012.

The International Monetary Fund (IMF) expects Indonesia's public debt to remain broadly stable in the medium-term and

has forecast a value of 23.2% of GDP in 2019. The debt level's sustainability is expected to boost the resilience of

sovereign bonds and would help lower yields, eventually making access to finance easier for Indonesian government and

corporates.

PESTLE Analysis



Figure 3: Comparison of public debt in East Asian economies

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Source: Country Statistics, MarketLine MARKETLINE

Current challenges

Shallow financial sector

Indonesia's financial sector remains shallow, which is reflected from the relatively small size of its banking sector and

financial markets when compared to regional peers. Indonesian firms, to a large extent, depend on retained earnings for

future investments than on bank credit, which could be a big negative for innovative firms short of cash on their balance

sheets. This is well reflected from a low credit-to-GDP ratio of 37.9% and money supply (M2) to GDP ratio of 41.0%

compared to numbers in excess of 100% for Malaysia, Thailand and Philippines for both these indicators. Enterprise

Surveys conducted by the International Finance Corporation and the World Bank cite the lack of access to credit as the

biggest impediment to do business in Indonesia.

The Indonesian stock and bond markets are also underpenetrated. As of September 2014, stock market capitalization of

listed companies on Indonesia stock exchange was equivalent to 50.5% of GDP, much lower than that of Thailand

(118.3%), Malaysia (159.6%), Singapore (263.1%) and even Philippines (91.3%). Outstanding debt securities issued

domestically amounted to 11.9% of GDP, less than half of Philippines (27.7%) and almost one-eighth of Malaysia

(99.2%). It is very important for Indonesia to deepen its banking services and financial markets as they form pillars of

funding necessary for future economic growth and social development.

PESTLE Analysis



Figure 4: Indonesian financial sector, key indicators

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Source: Bank for International Settlements, World Federation of

Exchanges, the World Bank and Country Statistics,

MarketLine

MARKETLINE

Underinvestment in infrastructure

Inadequate infrastructure spending has been one of the major impediments to economic growth in Indonesia. According

to the World Bank, Indonesia has lost more than 1% of additional GDP growth each year due to underinvestment in

infrastructure, mainly transportation. Indonesia has only invested roughly 3-4% of GDP on infrastructure since the Asian

crisis (investment in infrastructure averaged roughly 7% during 1995-97), which is much lesser than peers such as

Thailand and Vietnam, where infrastructure investments have consistently exceeded 7% of GDP. In China, infrastructure

investment averaged even higher at around 10% of GDP during 2001-11.

Road infrastructure, which accounts for most of the inter-urban passenger transport in the country, has not kept pace

with the vehicle and motorcycle fleet on the roads although the government spending on improving road infrastructure

has increased to pre-Asian crisis levels of 1.6% of GDP. Most of the dedicated amount has been spent on

reclassification of main roads, mainly through minor widening of strategically located roads.

Port infrastructure, despite being very important for an archipelago economy, also remains underdeveloped. The

country's largest port, Tanjung Priok, has a capacity of only about 6 million 20-foot equivalent units (TEUs) per annum. In

comparison, Thailand's Laen Chabang Port has a capacity of 10.5 million TEUs per annum, while Singapore has a port

capacity of 30 million TEUs per annum. Apart from port capacity, trade logistics measures such as container charges and

import lead times are also poor compared to other countries in the region.

PESTLE Analysis



Figure 5: Cost and efficiency of Indonesian ports

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Source: The World Bank MARKETLINE

Indonesian businesses also suffer from low power generation capacity and high transmission losses. Indonesia has an

electrification ratio of 74%, much lower than peers such as Malaysia, Thailand and China (which have electrification

ratios of close to 100%). The World Bank estimates that Indonesia needs to generate an additional capacity of 66.8MW

to achieve an electrification ratio of 100%, which would require $200 billion worth of investment.

Overall, high transportation costs, low port capacity and below par power infrastructure undermine firms'

competitiveness, and make it difficult for producers to keep in line with final consumer demand.

Future prospects

Rising investments from American companies

American transnational giants such as General Motors, Cargill, Coca Cola, Chevron, General Electric, General Atlantic,

DuPont, American President Lines, Black & Veatch etc. have been exploring investment possibilities in diverse areas

such as heavy engineering, consumer goods, chemicals, logistics, farming and construction and infrastructure in

Indonesia. For instance, multinational conglomerate, General Electric, plans to spend $300m in a variety of sectors such

as energy, aviation, mining, health, transportation, and oil and gas during 2014-16. Coca Cola, the American

multinational beverage corporation, invested $500m in its American subsidiary to fund accelerated capital expenditure

and for market development in October 2014. Previously, in 2013, General Motors spent $150m to refurbish its

automotive plant outside Jakarta to benefit from the fast-growing automotive industry traditionally dominated by

Japanese and South Korean manufacturers.

The investment prospects of these multinational giants are also reflected in a 2013 study conducted by Ernst & Young

and research centers associated with two leading Indonesian universities. The study, which surveyed the 35 largest US-

based investors in Indonesia, showed that these companies had plans to invest around $61 billion in the next 3-5 years

against a total of $61 billion invested by them during 2004-12. A host of future investments from multinational companies

bodes well for a resource rich country, which is likely to provide a new impetus to its growth.

PESTLE Analysis



Demographic dividends of a vast labor pool

Indonesia, being the fourth most populous country in the world, enjoys a demographic advantage in terms of abundant

labor. The country's working age population (15-64) is expected to increase to more than 176 million in 2019 from 166

million in 2014. Moreover, a stable labor force participation rate (which will remain more or less at 70%) and a relatively

young population (median age of 30 years) will accentuate this advantage. A vast pool of labor is important to contain

wages and improve competitiveness in the international market; especially in light of rising wage costs in China.

Figure 6: Indonesia's demographic advantage, 2014-19

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Future risks

High current account deficit

After registering consecutive surpluses from 1998-2011, the Indonesian current account balance recorded a deficit for

the first time in fifteen years in 2012. The deficit, which amounted to 3.0% of GDP in 2012, was a marked deterioration

form a surplus of 0.2% of GDP in 2011. The deficit deteriorated further to 3.3% of GDP in 2013, and is expected to

remain in excess of 3.0% of GDP in 2014, leaving the country vulnerable to external shocks such as a slowdown in FDI

and portfolio outflows in 2015.

Softer commodity prices of major export items such as rubber, coal and palm oil coupled with strong import demand for

oil due to substantial government subsidies were the major reasons for this widening of current account deficit in 2012-

13. Trade surplus has also suffered since the beginning of 2014 due to imposition of a ban on exports of unprocessed

mineral ores. Other major reason for the widening of current account deficit is slowing Chinese growth. According to the

IMF, a 1% slowdown in Chinese growth could reduce Indonesia's GDP by 0.3-0.5%.

PESTLE Analysis



Figure 7: Indonesia's current account deficit, 1998-2013

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PESTLE Analysis



Social analysis

Overview

Indonesia has implemented cash transfer programs for poor households to mitigate the impact of effect of fuel subsidy

reduction, and to provide them with healthcare and education facilities, effectively raising their standard of living. The

government is also playing its part by aiming to provide social insurance to the entire population by 2029. However, the

country has witnessed many instances of human trafficking since 1991, which is a cause for concern. Rising ethnic

violence and religious intolerance could pose a risk to social harmony of the Indonesian society.

Table 5: Analysis of Indonesia's social system


▪ Cash transfer programs

▪ Human trafficking


▪ Universal social security system

▪ Religious intolerance


Current strengths

Cash transfer programs

Indonesia has implemented both conditional and unconditional cash transfer programs to raise the income of levels of

poor households, consequently reducing the poverty levels in the country. The government runs a conditional cash

transfer scheme, Program Keluarga Harapan (PKH) and an unconditional cash transfer scheme, Bantuan Langsung

Tunai (BLT). The PKH was started as a pilot scheme in 2007 and provides cash transfers to more than 1.5 million very

poor households, mainly covering children and pregnant women (as of 2013). The BLT, started in 2005, mitigates the

effect of fuel subsidy reduction for over 19 million households in poverty. These programs have helped Indonesia in

improving education and healthcare access for the bottom 30% of the Indonesian population. This is well-reflected from

the fact that the proportion of the population living in poverty halved during 1999-2012 (24% to 12%).

Current challenges

Poor social development indicators

Indonesia's performance in terms of social parameters has been poor. Indonesia ranked 108th out of 187 countries in

2014 Human Development Index published by the United Nations, which is lower than many of its neighbors, including

Singapore (ranked 9th), Malaysia (62nd) and Thailand (89th). This indicates that the government has much to do in order

to improve the social landscape.

Human trafficking

The country has reported many instances of human smuggling and trafficking since 1991. There are instances where

PESTLE Analysis



security personnel have been found guilty of smuggling asylum seekers to Australia, although some of the guilty have

been convicted in the recent past. The issue of smuggling has been lingering although many steps to patrol coastal

areas have been undertaken by both Australian and Indonesian authorities. By August 2012, more than 7500 people

were smuggled, up from around 200 in 1991, and most of them seek jobs and asylum in Australia, according to the

Australian department of immigration and citizenship (DIAC). In many cases, boats have sunk, leading to hundreds of

deaths over the past few years. The government has taken steps to counter the smuggling of people by jointly signing an

agreement with Australia and Taiwan; however, the measures have not been that effective as incidents of smuggling and

trafficking have been on the rise.

Future prospects

Universal social security system

In 2004, a new Social Security Law provided for pensions, national health insurance, work injury insurance, death

benefits, and severance payments for laid-off workers. The new system, the implementation of which began in 2014,

intends to cover all Indonesian residents under a universal healthcare system by 2019 and a common employment

benefits system by 2029. Two new non-profit public agencies, which were created in 2011, namely BPJS Health Care

(BPJS Kesehatan) and BPJS Employment (BPJS Ketenagakarjaan) will be responsible for the administration of this

system. While the former will administer health care benefits, the latter will be responsible for employment benefits,

which include old age, pension, workplace injury and death benefits.

The government aims to follow a staircase approach to finance the new schemes. While it will fully pay for the social

protection of the poor, it will employ contributory schemes for the workers in the informal sector, who will pay a fixed

monthly contribution. Workers in the formal sector will pay a statutory contribution of 5% of their wage, which will be

divided between employee and the employer. A strong social protection system will provide the country with immense

social support, contributing towards the development of the nation.

Future risks

Religious intolerance

Although the country's population is moderate, and for the most part avoids combining politics with religion, there is a

radicalized fringe that seems to be endangering the pluralism in the country, which is a dangerous state of affairs for

minorities in the country. In recent years, the Ahmadiya Muslims (Muslims who do not comply with conservative

teachings), Christian congregations and the Shiites have all been targets of hardline Islamist groups who consider most

non-Muslims as "infidels," and Muslims who do not adhere to Sunni orthodoxy as "blasphemers." According to Setara

Institute for Democracy and Peace, an Indonesia-based religious freedom group, Indonesia witnessed 220 cases of

documented violent attacks on religious minorities in 2013, a marked increase from 91 in 2007.

One of the most notable instances of violence on minority groups was witnessed in February 2011, when three Ahmadis

were beaten to death by 1,500 militants, who stormed the Ahmadiya community in Cikeusik village. It is not only the

Ahmadiya Muslims, who have suffered from religious intolerance. Attacks against Christians and Shia Muslim community

also seem to be on the rise; examples include the suicide bombing of a church in Surakata in September 2011 and

attacks by Sunni militants against Indonesia's Sampang regency on Madura Island. According to Communion of

Churches in Indonesia, at least 430 churches have been attacked, closed down or burned during 2000-10.

Successive Indonesian governments, despite highlighting "religious harmony" as a major objective, were unable to

contain these threats, as it required support from Islamist parties to maintain political stability. Not only this, the

government issued decrees and fatwas (religious rulings) against members of religious minorities, effectively violating

PESTLE Analysis



their rights and freedoms. For instance, the government passed a nationwide anti-Ahmadiya decree in 2008, which

banned Ahmadiyas from preaching their faith. Moreover, a 2006 decree requiring religious groups to obtain permission

from a significant number of community members before constructing house of worships was used for closure of around

30 Ahmadiya mosques, more than 500 Christian churches and several Buddhist temples.

PESTLE Analysis



Technological analysis

Overview



rank of 55th. However, low R&D expenditure has taken a toll on the number of patents granted. Indonesia's proportion of

high technology exports in manufactured exports is also way below peers such as Philippines, Malaysia, China and

Thailand. In addition, the country has high levels of software piracy, and while the government has initiated measures to

reduce the problem, there is still much work to be done.

Table 6: Analysis of Indonesia's technology landscape


▪ Improving technological landscape

▪ Declining export share of high-technology products

▪ Poor R&D spending


▪ Fast growing aerospace industry

▪ Increasing software piracy


Current strengths

Improving technological landscape



rank of 55th. The proportion of population using Internet has doubled from 7.9% in 2008 to 16.1% in 2013, while

broadband penetration has almost tripled from 0.4% in 2008 to 1.3% in 2013. Publication performance has improved

four-fold in a decade, growing from 1,000 in 2000 to 4,000 in 2010 with science and technology, engineering and

medicine being the most important disciplines.

In order to improve innovation output, the government has also increased the amount it spends on higher education;

consequently, spending on higher education has increased from 0.14% of GDP in 1990 to 0.27% in 2007. Although

Indonesia lags other ASEAN nations in terms of technological infrastructure, the government is making efforts to improve

innovation performance.

Current challenges

Declining export share of high-technology products

According to the World Bank, Indonesia's high technology exports (as a percentage of manufactured exports) stood at a

dismal 7.3%, way below peers such as Philippines (48.9%), Malaysia (43.7%), China (26.3%) and Thailand (20.5%).

High technology exports are products with high R&D intensity, such as aerospace, computers, pharmaceuticals, scientific

instruments, and electrical machinery. High-end technological innovation would make Indonesia's exports less vulnerable

PESTLE Analysis



to price competition. Moreover, the country's exports are witnessing a declining trend, which could mainly be associated

with windfall gains the country made through its focus on commodity exports until 2011. With the commodity supercycle

ending, the country needs to focus on increasing its share of high-tech exports as low and medium technology exports

are likely to suffer from high competition and price pressures from other emerging markets.

Figure 8: Intensity of high technology exports

0.0

10.0

20.0

30.0

40.0

50.0

60.0

Philippines Malaysia China Thailand Indonesia

Proportion of high-tech exports in manufactured exports in East Asia,

2012

0.0

3.0

6.0

9.0

12.0

15.0

18.0

2005 2006 2007 2008 2009 2010 2011 2012

High-tech exports as a percentage of manufactured exports, 2005-12


Poor R&D spending

Indonesia spends less than half a percentage point of its GDP on R&D; low R&D spending is expected to impede

innovation in the country. Low R&D expenditure indicates that the government has to do a lot more in terms of fostering

innovation. Poor funding of R&D has weighed upon the patents count for the country. According to the USPTO,

Indonesia managed to get only 15 patents in 2013—a very poor performance compared to Malaysia (214) and Thailand

(77).

Table 7: Patents granted by USPTO, 2008-13

Year Indonesia Thailand Malaysia Philippines China

2008 5 22 152 16 1,225

2009 3 23 158 23 1,655

2010 6 46 202 37 2,657

2011 7 53 161 27 3,174

2012 8 36 210 40 4,637

2013 15 77 214 27 5,928

Source: USPTO MARKETLINE

PESTLE Analysis



Future prospects

Fast growing aerospace industry

The Indonesian aviation industry is expected to grow at a robust rate in the coming years. After making parts for civilian

planes like Airbus A380 and military ones like Airbus C295 transporter for almost a decade, the state-owned aerospace

manufacturer, PT Dirgantara Indonesia (PTDI), has won contracts from Airbus to assemble whole planes on a

commercial basis. Airbus has shifted complete production of the Airbus C295 transporter to Bandung in Indonesia from a

factory in Spain. The company has also won contracts from the Philippines Air Force of supplying two smaller military

transporters based on Airbus's C212.

Future risks

Increasing software piracy

Indonesia has high levels of software piracy. According to the 2011 BSA Global Software Piracy Study, piracy was

estimated to be around 86% in 2011, up from 84% in 2007. The study claims that losses due to piracy were around

$1.46 billion in 2011. Although the Information and Communications Technologies Council was established, it is difficult

to predict whether it can crack down on piracy in an effective way. High piracy will deter foreign investment and dampen

investment in innovation.

PESTLE Analysis



Legal analysis

Overview

The country has an effective competition law; besides, the total tax rate is lower than regional average. However, the

country's legal environment remains affected by an inefficient bureaucracy, rigid labor laws and a weak judicial system,

which can easily be influenced and manipulated by the political and business elite. Further, foreign companies face risks

from the arbitrary intervention of the Indonesian government, which has often created problems for foreign entities by

either not honoring deals or imposing new conditions after an agreement has been signed.

Table 8: Analysis of Indonesia's legal landscape


▪ Effective competition law

▪ Low total tax rate

▪ Rigid labor law

▪ Weak judicial system


▪ Better business environment

▪ Economic nationalism


Current strengths

Effective competition law

An effective competition law is a vital tool for attaining and maintaining sound economic performance in any country, and

Indonesia is no exception. The country's first competition law, Concerning Prohibition of Monopolistic Practices and

Unfair Business Competition, was enacted on March 5, 1999, and came into being a year later. The law, which has been

in effect since February 2000, prohibits any single domestic company from controlling more than 50% of the market. The

Commission for the Supervision of Business Competition (Komisi Pengawas Persaingan Usaha [KPPU]) was established

immediately after the passage of the law. Although it has been criticized on various occasions, the KPPU has been

credited with countering a large number of cartels.

Low total tax rate

According to the World Bank's 2015 Doing Business Report , Indonesia's total tax rate (includes profits taxes, labor taxes

and other taxes) of 31.4% is lower than the East Asia & Pacific average of 34.4%. Further, it is lower than that of its

neighbors, Philippines (42.5%) and Malaysia (39.2%). A low total tax rate bodes well for an emerging economy to attract

investments.

PESTLE Analysis



Figure 9: Tax burden comparison for corporates in East Asia, 2014

0% 10% 20% 30% 40% 50% 60% 70%

China

Philippines

Malaysia

Indonesia

Thailand

Prof it tax Labor tax and contributions Other taxes


Current challenges

Rigid labor law

Indonesia's rigid labor law, which restricts hiring and firing, has been a prominent issue for foreign investors. According to

the World Bank, severance costs in Indonesia are as high as 58 weeks of salary. Wage setting has also been a

problematic matter for foreign investors due to significant increases in the past few years. For instance, Jakarta

witnessed an extraordinary 44% increase in minimum wage in 2012. Although labor contracts are relatively

straightforward to negotiate, they are subject to renegotiation despite the existence of written agreements. Even local

courts side with Indonesian citizens mostly in labor disputes, contracts notwithstanding.

Weak judicial system

The Indonesian judicial system is weak and is considered to be easily influenced and manipulated by the political and

business elite. Occasionally, the system is perceived to be discriminating against foreign interests. Since 2011, a number

of judges, prosecutors, lawyers and even public notaries have been implicated in corruption cases, notable the

Constitutional Court Chief Justice, Akil Mochtar and District court judge Syarifuddin Umar. According to the Human

Rights Report 2013, NGOs implicated 84 court judges for engaging in corruption in both civil and criminal cases in 2012.

All this has resulted in a perception among Indonesian citizens that the country's judicial system is the second most

corrupt public institution in the country after the parliament, according to Transparency International's Global Corruption

Barometer 2013.

Another key issue hurting the effectiveness of the Indonesian judicial system is the low qualification criteria required to

become a judge in Indonesia, which is just four years of post-grade school legal education and two years of training in

the Supreme Court judicial candidate program.

PESTLE Analysis



Future prospects

Better business environment

The newly elected Indonesian president has prioritized corruption, inefficient government bureaucracy and inadequate

infrastructure as his main objectives, all of which are considered problematic issues for conducting business in

Indonesia, according to the Global Competitiveness Index 2014-15. The new administration hopes to set up a "one-stop

service for investment" and reduce the time taken to get a business license to a maximum of 15 days from 52.5 days

(according to the World Bank). In 2014, the former Yudhoyono administration made tax payments less expensive for

companies by reducing employers' health insurance contribution rate, which bodes well for job creation in the country.

The previous government also revised its Negative Investment List in April 2014, which loosened restrictions on foreign

ownership in public-private partnership projects in large power plants, electricity transmission and distribution, and

seaport projects. These steps are expected to support Jokowi's vision of improving Indonesia's infrastructure and

improve the country's business environment.

Future risks

Legal uncertainty and economic nationalism

Foreign companies face significant risks due to the arbitrary intervention of the Indonesian government, which has often

created problems by either not honoring deals or imposing new conditions after an agreement has been signed. A few

instances of regulatory hurdles and the government's protectionist policies faced by foreign companies are mentioned

below:

Mexican cement company Cemex bought shares in state-owned cement company PT Semen Gresik in 1998.

The company went on to sue the Indonesian government as the latter failed to honor the deal, under which

Cemex was to become a majority stakeholder. The deal could not go through due to opposition from legislators,

non-governmental organizations, local cement companies, residents, religious groups, and unions. Cemex went

for international arbitration but later settled the issue with the Indonesian government in July 2006. Cemex

subsequently sold all its shares and withdrew from Indonesia.

In 2000, ExxonMobil bought rights to the Cepu oilfield and immediately discovered large reserves that

Pertamina had failed to locate in 30 years of exploration. Indonesia then insisted ExxonMobil share its find with

Pertamina in exchange for a 20-year extension of its contract over the area. The two companies signed a joint

operating deal under government pressure for the field in 2006, which showed the Indonesian government in a

poor light.

Pertamina signed a $130m contract to acquire two new tankers in 2003; however, a management reshuffle in

October 2003 led to a decision to sell them. Goldman Sachs ran into problems when the KPPU began

investigating Pertamina over the sale of the two large crude carriers, with authorities claiming that the tender

may have violated anti-monopoly laws. The KPPU criticized Goldman Sachs for not holding an open auction

and accused it of influencing the results of the tender and charging an unusually high fee. The Indonesian

Supreme Court agreed with the KPPU's criticism, and imposed a hefty fine against Goldman Sachs.

French company Carrefour was ordered to sell its shares in local retailer Alfa Retailindo in late 2009. Carrefour

was accused of monopolistic trading practices by the KPPU.

In 2010, the government revoked four coal mining licenses held by a local subsidiary of Churchill Mining, an

American company. The company filed a $1.3 billion lawsuit against the government in the International Centre

for the Settlement of Investment Disputes in Washington.

PESTLE Analysis



In March 2012, the government brought in regulations in which 51% of foreign operation should be passed to

local companies after a period of 10 years, up from 20% after five years.

In November 2012, the court dissolved the state energy regulator BP Migas on the grounds that it did not have

the power to oversee Indonesian resource reserves and sign exploration and production sharing contracts with

foreign oil companies. In addition, the court stated that some parts of the 2001 oil-and-gas law are not valid.

Further, the court also stated that the Indonesian operations of all foreign petroleum companies should be

passed on to state run oil company Pertamina after their contracts expire.

In July 2013, an Indonesian court sentenced three Indonesian employees of Chevron to two years in prison.

The sentence escalated uncertainties across the already troubled Indonesian oil and gas sector. The

criminalization of civil disputes has made foreign investors wary of investing in the energy sector. This does not

look good for Indonesia, as the energy sector needs foreign capital and technology to boost production, which

has fallen over the last decade.

In 2014, Indonesia imposed a moratorium on exports of all metal ores, mainly to boost domestic smelting and

other mineral processing. Although the parliament saw that there was not enough capacity to process all

minerals, it turned down a government proposal to allow exceptions for mining companies that had already

invested in building smelters.

The country's arbitrary policy reversals along with its protectionist policies are surely going to hurt investor

sentiment.

PESTLE Analysis



Environmental analysis

Overview

Indonesia's biodiversity is one of its greatest assets. The country is among the top five in the world in terms of plant

diversity, with an estimated 38,000 higher plant species. Indonesia leads the world in terms of palm diversity. However,

large tracts of Sumatra's forest have been destroyed to make way for palm oil plantations, with companies clearing trees

and burning the stumps that remain. A 2008 Greenpeace report suggested that around 1.4 million hectares of virgin

forest in Riau have already been converted to plantations to provide cooking oil and a further 3 million hectares are set to

be used for the production of biofuels. Further, the government's heavy energy subsidies have been contrary to its

environmental initiatives.

Table 9: Analysis of Indonesia's environmental landscape


▪ Rich biodiversity

▪ Increasing forest loss


▪ Conservation of wildlife

▪ Distorted pricing


Current strengths

Rich biodiversity

Indonesia has 515 species of mammals (second on the world mammal list behind Brazil), 39% of which are endemic;

511 species of reptiles (which places Indonesia fourth in terms of diversity), 150 of which are endemic; 1,531 species of

birds (fifth), 397 of which are endemic; 270 amphibian species (sixth), 100 of which are endemic; 75 species of psittacine

birds (first), 38 of which are endemic; and 35 species of primates (fourth).

The country is also in the top five on plant diversity, with an estimated 38,000 higher plant species; it leads the world list

in palm diversity with 477 species, 225 of which are endemic; and has over half of the 350 species of dipterocarp trees,

with 155 endemic in Kalimantan. Indonesia ranks behind only Brazil and possibly Columbia in freshwater fish diversity,

with around 1,400 species. This makes Indonesia richly endowed in terms of biodiversity.

Current challenges

Increasing forest loss

The rate of forest loss in Indonesia is increasing. On average, around 1 million hectares per year were cleared in the

1980s, increasing to around 1.7 million hectares per year in the first part of the 1990s. Furthermore, since 1996,

deforestation appears to have increased to an average of 2 million hectares per year. Indonesia's lowland tropical

forests, the richest in timber resources and biodiversity, are most at risk. They have been almost entirely cleared in

Sulawesi and Sumatra, while those on Kalimantan could also be cleared in the next few years. One of the main reasons

for deforestation in Indonesia is the corrupt political and economic system, which regards natural resources—especially

PESTLE Analysis



forests—as a source of revenue to be exploited for political and personal gain. The rising demand for palm oil has

motivated further deforestation.

The drive to increase palm oil cultivation is taking a major toll on the environment, driving forest clearing, polluting rivers,

and introducing more pests. Around 2.1 million hectares of land in Sumatra was taken up by oil palm plantations until

August 2008, compared with only around 400,000 hectares in 1998. Farmers across the region have switched from food

crops to palm oil, as the price of palm oil has increased due to the rise in demand for biofuels. A Greenpeace report in

2008 suggested that around 1.4 million hectares of virgin forest in Riau has already been converted to plantations to

provide cooking oil, and a further 3 million hectares are set to be used for the production of biofuels. Large tracts of

Sumatra's forest have been destroyed to make way for palm oil plantations, with companies clearing the trees and

burning the stumps that remain. In December 2012, the government of Indonesia approved Reducing Emissions from

Deforestation and forest Degradation (REDD), for which Indonesia would get $1 billion from Norway for not cutting down

trees to make way for palm plantations. This should reduce deforestation to some extent.

Future prospects

Conservation of wildlife

Indonesia has initiated a new 10-year action plan to conserve orangutans, which will have important benefits in terms of

reducing climate change. It has been estimated that around 50,000 orangutans died during 1992-2007, as their habitat

shrunk. The orangutan plays a significant role in the fight against climate change and forest regeneration, as it disperses

seeds that help regenerate fruit trees, which in turn help keep the forest healthy and able to reduce greenhouse gases

such as CO2.

However, deforestation for timber, pulp, and palm oil plantations mean that Indonesia is a major carbon emitter; such

actions have also increased the threat to orangutans. Therefore, the Indonesian Ministry of Forestry finalized its plan for

orangutan conservation. As part of this plan, developed in conjunction with non-governmental organizations, Indonesia

will aim to stabilize the orangutan population and habitat and return orangutans housed in rehabilitation centers to the

wild by 2015.

Future risks

Distorted pricing

Energy prices are highly distorted in Indonesia. Subsidies on fossil fuels have resulted in increased utilization, which

ultimately contributes to pollution. The price of scarce energy resources should take into account the environmental and

social costs, and putting a tax on it is an effective way to curb their reckless use. Moreover, the distortive pricing

mechanism is also inhibiting the development of green technology. The government should ensure the market prices for

a resource rather than arbitrarily fixing them. The lack of a market-driven pricing mechanism could become an obstacle

to emission reduction.

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