Policy Uncertainties in Indonesia: Trends and Policy Responses

Mohamad IkhsanAdvisor to Coordinating Minister for Economic Affairs Republic of Indonesia and

Senior Research Associate at the Institute for Economic and Social Research University of Indonesia

Presented at Regional Conference on Investment Climate and Competitiveness in East Asia: From Diagnostics to ActionsKuala Lumpur 21-23 November 2005Organized by Bank Negara Malaysia

Outlines• Overview on the state of Economy since the crisis time• Policy Uncertainty Issues in Indonesia

– Macro Uncertainties– Micro Uncertainties

• The Impact of Policy Uncertainties on Performances– TFP– Investment– Employment

• Major Causes for Uncertainties• Policy Responses

Overview of State of Economy• Indonesia’s economy has

steadily improved since the crisis time.

• Per capita income has been backed to pre crisis level since 2004 and growth rate now accelerating to a 6 % p.a

• More balance and sustainable sources of growth indicated by picking up on investment and export.

• Macroeconomic risks improved significantly indicated by a sharp reduction in public and external debt ratio and short term debt over international reserve

Grafik 2: GDP/Kapita

0

200

400

600

800

1000

1200

1400

2001 2002 2003 2004 2005 E)

Debt GDP Ratio for Several Emerging Countries

0

20

40

60

80

100

120

Korea China India Taiwan Malaysia Thailand P hilippines Indonesia

Perc

ent

2000 2004(Est) 2005(proj)

But many (economic) problems remain

• Our productivity remains lagging behind pre crisis period or other regional competitors.

• Unemployment both open and under employment are still higher than pre crisis.

• Poverty trends are moving away of the paths.

Table 2.1: Growth accounting Contribution to growth of:

Growth in output per

worker Physical capital

Human capital TFP

Indonesia 1961-03 2.9 1.7 0.5 0.6 1967-80 5.0 2.0 0.5 2.4 1981-97 3.8 2.5 0.5 0.8 1998-99 -8.8 0.9 0.5 -10.0 2000-03 2.1 0.4 0.4 1.2 Comparator economies 1961-03* East Asia (5) 3.6 1.9 0.5 1.2 Korea 4.7 2.7 0.7 1.3 Malaysia 3.6 2.2 0.6 0.8 Philippines 1.0 0.8 0.4 -0.2 Thailand 4.1 2.3 0.4 1.4 OECD 2.4 1.0 0.4 1.0 All developing 1.4 0.8 0.3 0.3 Source: Bosworth and Collins (2003) and World Bank staff estimates. * Simple averages for comparator groups. OECD and All Developing are 1961-00.

Firm and industry level data amplify those fundamental problems

In short, mostly caused by policy uncertainties

0 10 20 30 40 50 60 70 80

TelecomAccess to Land

Customs & trade localCustoms & trade national

TransportBusiness permits national

AnticompAccess to Finance

Skills and educationBusiness permits local

CrimeElectricity

Lab reg localTax admin

Lab reg nationalLegal system

Costs of FinanceTax rates

Corruption nationalCorruption local

Pol & Reg UncertaintyMacro Uncertainty

Percentage of firms reporting constraint to be severe or very severe

Policy Uncertainties, Government Effectiveness, Investment Climate and Firm Performances

• From a firm’s perspective, three aspects of government effectiveness are particularly relevant:

– the capacity of government to manage its resources and provide public services efficiently;

– the quality of its policies and regulations; and – its ability to implement these policies in a

credible and consistent manner.

• In contrast to new order regime, almost all areas Indonesia falls short.

• Both in term the quality of its policies and regulations—in terms of their complexity, which imposes a heavy administrative burden on firms—and in the extent of policy and regulatory predictability.

• As shown by a quantitative analysis, Pol

Table 5.10. Impact of investment climate on firms’ performance (all variables combined)

TFP Employment

Probability of Investing

Investment climate element

Coefficient Elasticity Coefficient Elasticity Logit coefficient

Government effectiveness a) Quality of regulations measured by: Regulatory burden Entry, exit and competition b) Lack of policy predictability Governance a) Poor functioning of legal and judiciary b) Lack of Security/ Law and order

-0.0044 0.074

-0.667

-0.009

-0.0119

-5.6** 21.9*

-21.5*

-3.4

-1.6

0.0007 -0.007

-0.002

-0.194

0.0007

1.0 -2.1

-0.7

-7.3**

1.0

-0.001 0.052

0.051

-0.109*

-0.053*

Labor Markets Disruptions (incl. absenteeism, strikes and civil unrest)

-0.2078

-20.8*

-0.073

-7.3**

0.804**

Financial Markets Cost and lack of access

-0.0022

-1.65

-0.001

-0.8**

-0.011**

Infrastructure Power outages Low road density

-0.007

-0.0939

-3.0*

-9.4**

-0.001

-0.020

-0.7*

-2.0

0.001

0.020

Control variables (including) Manager’s education Percentage of foreign ownership

** Significant at 5%,* significant at 10%,

Implications of unfavorable investment climate

0 10 20 30 40

Food processing

Textiles and leather

Wood

Paper & printing

Chemicals

Pottery

Basic metal

Machinery

Percentage of output exported

1993-961999-2001

Decline in export ratio

10 12 14 16 18 20

Food processing

Textiles and leather

Wood

Paper & printing

Chemicals

Pottery

Basic metal

Machinery

Average profit margins

percent

1993-961999-2001

Drop in profit Margin

Sources of Uncertainties• Political transition to democratic

regime– No clear majority and expected to

continue up to the next 10 year• Bigbang decentralization.

– Authority vis a vis responsibility• Financial crisis has limited the

central government power.– Crisis increases government debt

services cost and limit the power of central government

• Most of regions rely on central government transfers.

– Inducing regional government to take progressive and in many cases unnecessary new tax and retribution.

• High debt also rises the country’s risks and degree of vulnerability.

– Debt intolerance in Indonesia is about 35% of GDP. It implies focusing on reducing debt burden still the agenda over 1-2 years ahead.

– Vulnerability in financial sector have forced the government to take another burden on contingent liability.

• The crisis also reduced the ability of the state to up grade infrastructures.

– Government spending on infrastructures reduced to only 3-4 % of GDP compared to 7% during the pre crisis time

Trend on Policy Uncertainty:Monitoring Results from LPEM-WB Survey

• Number of days for setting up a business in Indonesia is about 80 days not 151 days as reported in Doing Business Survey 2006.

• But that survey found a huge variation faced the companies when dealing with BKPM.

Table 5 Average Days* to Establish a PT. Company

No Activities Notary Survey LPEM

(2005)

Law Firms I nterview

(World Bank 2005)

I nstitution/ Entity

1 Obtain clearance for the company name from the Ministry of Law (MoL); obtain the standard form of the company deed from MoL

2 7 Ministry of Law

2 Founders draw up the deed of establishment (articles of association) and sign it in front of a notary. 2 7 Notary

3 Obtain a certificate of domicile from the local municipality 4 10

Local sub-municipality office (kelurahan)

4 Obtain a taxpayer registration number (NPWP) and taxable entrepreneur identification number (NPPKP)

6 14 Local Tax Office

5 Open a bank account and deposit the initial issued capital in the name of the proposed company 4 4 Bank

6 Pay to the State Treasury the non-tax state revenue (PNBP) fees for legal services pursuant to the Decree of the Minister of Law No. M.OI -UM.01.06/1993

1 1 Ministry of Law

7 Arrange for the notary to apply for the publication of the articles of association of the company in the supplement to the State Gazette from the State Printing Press, get payment receipt

1 2 Notary office

8 Submit physical documents to the Ministry of Law 1 Ministry of Law

9 I ssuance of the SK approving the deed of establishment by the Minister of Law 14

75 Ministry of Law

10 Register with the Company Register at the Local Trade Office and obtain the Company Registration Certificate (TDP)

9 15 Local Trade Office (Dinas Perdagangan)

11 Apply for the business trading license (Surat I zin Usaha Perdagangan or SIUP) 11 14

Local Trade Office (Dinas Perdagangan)

12 Register with Ministry of Manpower 1 1 Ministry of Manpower

13 Apply for workers social security (Jamsostek) program 1 1 PT. J amsostek Total Time in Working Days 57 Total Time in Calendar Days 80 151

*Notes: The notaries are answering in terms of working days, whereas the law firms are answering to in terms of calendar days

…but 80 days to start a business is still too long

Table 4 BKPM Approval Process: Time Required (Working Days) and Frequency of Not

Acceptance Application (Times)

No BKPM Approval Process Average Min Max Median

1 How much time to collect all of the information and documents required for first submission of an application to BKPM? 24 days 1 day 120 days 5 days

2 I f first application is not accepted, how much time to gather any additional information or documents to satisfy BKPM? 12 days 1 day 60 days 5 days

3 How many times was the application not accepted by BKPM on the grounds that it was not complete and correct? 3 times 1 time 10 times 2 times

4

How much time to collect all of the information and documents required for final submission of an application to BKPM (documents accepted as complete and correct by BKPM) 24 days 2 days 60 days 16 days

5 How much time to issue the approval letter (SP) after documents accepted as complete and correct by BKPM 34 days 1 day 120 days 20 days

Total Time required to have SP (Approval Letter of BKPM) = row 4+ row 5 58 days 3 days 180 days 36 days

Note: 1 week = 5 working days, 1 month = 20 working days

Days to Establish and Register a Limited Liability Company

2

8

30

33

41

50

56

151

0 25 50 75 100 125 150 175

Australia

Singapore

Malaysia

Thailand

China

Philippines

Vietnam

Indonesia

CALENDAR DAYS

… new investment law is not enough

• to a certain sector, other regulations are required.

• Regulatory reforms can be done and needed in both central and local governments

Need to focus on micro sector reforms

Regional Regulations are still problems and sources of policy uncertainties and distortions

Tax administration problems: new draft of tax packages are far from satisfactory and tend to be counterproductive.

Infrastructure: lack of supply and quality Time to start a business is very long and variance is large.

Small and medium businesses are the losers Tax refund still takes long time and in practices require “informal

payment” to disburse it. Labor regulations become less flexible make entry and exit cost

increased significantly. No clear vision over the future state owned enterprises SME Development action plan need to be elaborated further .

… survey results also reveal a lot of effort are needed to improve investment climate in all fronts

Port Clearance Times for Import Containers (days)JICA August 2004 survey

7.0

3.1

2.0

2.0

1.0

5.5

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0

Tanjung Priok

Japan

Germany

USA

Singapore

DAYS

Days from vessel berthing to release by customs

Days from vessel berthing to container exit from terminal

Table 16 Average Time to Obtain Utility Connection (in days)

Types of Utilities 2005 LPEM/ WB Survey 2003 I CA Survey (WB/ ADB) Electricity (PLN) 24 15 Telephone (Telkom) 16 27 Water (PDAM) 17 13

76

68

55

9

0.0 2.0 4.0 6.0 8.0 10.0

PPh article 21/26

PPh article 23/26

PPh article 4 clause 2

PPh article 22 (prepaid)

PPh article 22

PPh article 25

PPN: Added Value Tax for consumers

Average Days Needed to Fill in Monthly Tax Document

Total time: 45 man-days

Table 11 Respondents Reporting VAT Return Negotiation and Extra Payments

According to Firm Size Firm Size (workers) Yes No N

<100 6 50.0% 6 50.0% 6 100 to <500 58 55.8% 46 44.2% 104 500 to 1000 23 60.5% 15 39.5% 38 >1000 30 57.7% 22 42.3% 52 All Firms 114 57.0% 86 43.0% 200

Improving investment climate

Macro adjustment

Quality of public spending

Lower taxes and cost of

capital

Structural and institutional

reforms

Low costs

Better risk x return

Greater demand

and output

More investment

Increase competition

Raise efficiencyLower risk

Policy Responses: Focusing more on executable actions while handling regulatory

issues• Political constraints hinder the ability for GOI to eliminate political uncertainties except

for the areas where all parties and/or interest groups relative have common ground.– Improving one areas may open the other Pandora.

• Lack of trusts and lack of responsibility– Regional government regulation– Tax Reform initiatives– Central Bank Independence

• Some dilemmas:– Need to focus on the process rather than outcomes (but at the cost of relative slow of

implementing and results)– High expectation ( partly due to the past memories) also increases the demand for quick

outcomes. – Inherent dilemmas: look example in fiscal trilemmas.

• PR Problem– “Take it for granted” behavior on the government side.– Intermediary problem– Asymmetric problems of reform: cost of reform always up front while benefit usually appear

in the medium term. Benefit per capita in many cases always less than cost per capita.

A reform agenda

• Macro reform:

– Fiscal Policy trilemma

– Stabilization policy

• Micro Reform:

– Financial Sector

– Trade Liberalization

– Tax Reform including regional tax

– Reform in business regulation

– Combating corruption

Fiscal policy trilema

Reduce public debt/GDP

Lower taxes

Increase public investment

Fiscal reform• Reduce public debt / GDP ratio:

– Sustain a high primary surplus– Lower the cost of debt

• Restructure public spending to accommodate rise in public sector investment

• Reduce tax burden • Develop a medium-term fiscal framework that lowers political

risk.• Gradually reduce contingent liability

– Abolish the financial sector blanket system while introducing new deposit insurance companies

– State Owned Companies Restructuring including initiating new law on Regional State Owned Companies

• Diversifying financial sector and including giving more access to SMEs

• Most of them have been achieved and further reforms are underway.

Action Program Solving regional regulation problems Central government exercises the power to abolish contra

productive local government regulation: From 2001-Oct 05 : 469 Perdas have been cancelled and

about 170 of them abolished between Okt 04-05 Amendment Law No.34/2000:

Changing the concept from open list to closed list Exercise General Allocation Fund as tool to impose

discipline to regional government if : They do not report new Perda to Central Government Still exercise a Perda that has been cancelled by central

government. Implement a perda without central government approval.

Improving Perda Monitoring System by Ministry of Finance and Ministry of Home Affair

This can be done because we have some fiscal space.

Progress on Anti Corruption Effort

Two indicators of corruption dropped sharply.

Bribes to government officials as share of production costs fell from 10.8% in 2001 to just 1.8% in the current survey (3.4% in the 2003 ICA).

At the same time, percent of senior management time spent dealing with government officials dropped from 12.8% in the 2001 survey to just 4.9%.

Pungutan Tidak Resmi (% thdp Biaya Produksi)

10.8

3.40

1.8

0

2

4

6

8

10

12

2001 2003 2005

Two possible explainations :

1. Improvement in anti-corruption efforts including establishing new and powerful anti corruption agency

2. A more competitive environment among regions to provide a better environment and efficient in public sector

Launching a new packages of investment law and regulation

• Investment Law Objectives:1. Increasing the quality and number of Investment2. Reducing cost of doing business in Indonesia.Several Highlights of the Investment Law Draft:– Equal treatment for Domestic and Foreign Investors.– Simplifying Procedure for Registration & Licensing– Repositioning the role of Investment Board (BKPM) as an investment

promotion and facilitation agency.– Clear and Transparent Negative List.

• Target of 30 days for setting up business in Indonesia can be achieved through other improvement in government regulation.

• As part investment packages, GOI also will prepare a serial package of deregulation.

• We try to use all opportunities to lunch new package of deregulation– The 1st October 2005 packet was initiated along with domestic fuel price

adjustments.

Fiscal Incentives: Tax and Custom• Tax Reduction:

• Company tax rate reduction from 30% to 28% in 2007. Beyond 2007 there would be a reduction of 1 % annually to achieve the new tax rate of 25% in 2010.

• Individual tax rate reduction from the maximum of 35% to 33 % in 2007 and achieved a new maximum tax rate of 30% in 2010.

– Simplifying Procedures of Tax & Custom, and also Tax refund

– Equal Treatment for tax payer and officer– Government will discuss further improvements on tax law

draft with the parliament to meet business sector demand

Non-Fiscal Incentives

• Improving Coordination Mechanism for Export and Investment by empowering National Committee on Export Promotion and Investment (PEPI)– President SBY will chair PEPI.

• Empowering Domestic Industries and SMEs.– Action plan for SMEs Development is on the final

stages

Improving Communication

• President try to use a more inclusive approach.– But it may cost the delay of reform.

• Use the good and bad guy tactics when launching unpopular policies.– This is also used to test the water.

Conclusion

• Surveys shows some improvements in policy uncertainties during the SBY-JK administration.

• But there are gaps between political will (for improvement in investment gap) and implementation.

• Need “hands in” policy to improve investment climate in both central government and local government.