Business in Indonesia: New Challenges, Old Problems

6 RECENT TRENDS IN FOREIGN DIRECT INVESTMENT

The recovery in investment – both domestic and foreign – during the post-crisis period has been sluggish, partly explaining the relatively low economic growth rates in Indonesia since 2001. The consequences of this low-growth period have been slow employment creation in the formal/modern sector and rapid expansion in the informal/traditional sector. Higher rates of investment are required to shift Indonesia to a higher growth path. This chapter reviews recent trends in investment and discusses the factors that explain the sluggish recovery in foreign direct investment (FDI) in particular. The next section reviews recent trends and the changing pattern of FDI. The third section touches briefly on the consequences of the slow recovery in investment , and the fourth discusses the obstacles to a recovery. This is followed by a brief discussion of the government’s investment and employment strategy as outlined in its White Paper. TRENDS IN INVESTMENT DURING THE POST-CRISIS PERIOD As mentioned above, the recovery in both domestic and foreign investment has been sluggish during the post-crisis period. As demonstrated in Figure 6.1, real aggregate investment in the economy collapsed in 1998 and bottomed out in the second quarter of 1999 at half the pre-crisis peak investment levels. There was a sharp rebound in 2000, with investment climbing to 70 per cent of pre-crisis levels, but the recovery stagnated in 2001 and 2002. Investment picked up slightly at the end of 2002 and continued its modest recovery in the first semester of 2003. Consistent with aggregate investment in the economy, new FDI remains at historically low levels. Some foreign firms have closed their subsidiaries in Indonesia during the last few years, especially in footwear and other labour-intensive sectors. 93 6 RECENT TRENDS IN FOREIGN DIRECT INVESTMENT Kelly Bird In addition to low levels of investment, the pattern of FDI during the postcrisis period has changed in three ways compared to pre-crisis patterns: • the average size of new FDI is considerably smaller; • FDI has shifted away from manufacturing and other tradable goods sectors towards trade-related services; and • foreign investment has shifted away from greenfield investment towards the acquisition of domestic firms.1 Figure 6.2 shows that FDI approvals in US dollars declined almost continuously during the post-crisis period, from a peak of $34 billion in 1997 to $14 billion in 1998 and $10 billion in 2002.2 However, the actual number of approved FDI projects continued to hold up during the post-crisis period, indicating that the average dollar value of approved FDI projects has declined considerably. Another notable change in FDI during the post-crisis period is the shift away from investment in the tradable goods sectors, especially manufacturing, towards non-tradable sectors such as wholesale and retail trade. Figure 6.3 shows the change in FDI approvals by major economic sector since 1990. In the early 1990s manufacturing accounted for over 70 per cent of all FDI approvals by both number of projects and value. This percentage declined to under 60 per cent in the mid-1990s as FDI expanded to modern services and other sectors. 94 KELLY BIRD Figure 6.1 Trends in Aggregate Investment,1997–2003 (in 1993 prices, 1997Q1 = 100) Source: National Income Accounts. Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 0 20 40 60 80 100 120 1997 1998 1999 2000 2001 2002 2003 The post-crisis period is strikingly different from the pre-crisis boom years. FDI approvals in manufacturing continued to decline and were overtaken by traderelated services as the preferred sector for intended FDI. Investment in the distribution sector increased, primarily as a result of the government’s removal of restrictions on foreign investment in this sector in early 1998 (see box). While new FDI in the tradable sector, especially manufacturing, has been limited, several foreign firms with operations in Indonesia have expanded either by building new capacity or through friendly acquisitions. Unilever, for example , has expanded its operations by buying brands that are popular in consumer markets. Foreign firms in the manufacturing sector have also seen their market shares expand during the post-crisis period. According to the annual survey of medium and large-scale manufacturing establishments, the share of foreignowned firms in total value added in manufacturing increased from around 22 per cent in 1990...