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The following provides a summary of chapter 2 of the Economic Assessment of Indonesia published on 24 July 2008.
Sustaining high growth calls for improvements in the business climate
There is near consensual agreement that long term growth is being held back more by supply rather than demand side constraints. The private sector can play a prominent role in the growth process, so long as the business climate can be improved considerably. Economic and regulatory uncertainty, deficiencies in law enforcement and infrastructure bottlenecks are among the main barriers to entrepreneurship. Indonesia’s ranking in international indicators of perceived corruption also suggests that there is significant room for improvement in that area too. The authorities are aware of the need to take decisive action to tackle these deficiencies, and there has been unequivocal progress in some policy domains in recent years. In particular, enactment of the Investment Law in 2007 was a considerable step forward. The Law makes the investment regime more transparent to investors, and ensures equal treatment for domestic and foreign investment. Screening, notification and approval procedures have been simplified, but ownership ceilings remain in many sectors. As a result, Indonesia’s FDI legislation remains more restrictive than those of most OECD countries on the basis of the OECD methodology for assessing and comparing FDI regimes across countries. Further liberalisation of foreign ownership restrictions could therefore be envisaged in support of policy efforts to encourage investment and boost entrepreneurship. Policy effort in this area would therefore be welcome to nurture investor confidence in the new FDI regime.
FDI legislation: Cross country comparisons (1)
Low scores indicate less restriction
1. Refers to the state of legislation in 2007 for Indonesia and in 2006 for all other countries.
More can be done to encourage much needed investment
Indonesia’s ratio of investment to GDP remains below those of regional comparator countries. This has raised concern among policymakers about the country’s ability to lift and maintain potential growth over the longer term and to match the growth rates of the fastest growing economies in the region, including China and India. At the same time, Indonesia has some of the weakest infrastructure development indicators in Southeast Asia, suggesting ample pent up demand for such investment. A strong fiscal position is creating room in the budget for increasing government spending on infrastructure. But greater private sector involvement in infrastructure development and maintenance would be essential. For that, regulatory uncertainty must be reduced, especially with reference to the pricing of water/sanitation services, fuels and electricity. Price subsidisation complicates investment decisions, because it makes it difficult for investors to assess the rates of return of projects. Existing restrictions on foreign ownership in these sectors also constrains private sector involvement. The design of a new, pro investment regulatory framework, including price liberalisation, free entry into network industries and the setting up of independent regulators would obviously be a complex task but could create attractive opportunities for the private sector to participate in infrastructure development.
Investment and FDI: Trends and cross country comparisons
1. Excludes Hungary, Mexico, Poland, Slovak Republic and Turkey.
Source: UNCTAD, World Bank and OECD.
Business regulations by local governments are onerous to the private sector and need to be reduced
The decentralisation programme that was implemented in 2001 granted local governments considerable autonomy to issue business regulations, including licenses, and to levy fees and user charges for the provision of local services. Based on this prerogative, most jurisdictions have introduced several levies, often without the accord of the central government, as a means of raising revenue. Central government efforts to tackle this problem have so far yielded mixed results. Initiatives have nevertheless been put in place, including by independent think tanks, to raise awareness among district level policymakers of the undesirable effects of a proliferation of local regulations on business activity. These efforts seem to be bearing fruit. Several local governments are setting up one stop shops as a means of facilitating business registration and the issuance of licenses. Also, legislation is under consideration by the central government to abolish local levies that are deemed in breach of nation wide regulations. Continued efforts to simplify business regulation procedures further and to make them more business friendly would therefore be welcome. Steadfast progress in this area is crucial for rendering the regulatory framework more transparent and pro investment.
Capacity bottlenecks at the local level will need to be removed to ensure a recovery in public investment
Decentralisation has put the local governments at the forefront of service delivery, including in public investment programmes. But capacity constraints have resulted in a backlog of investment projects. At the same time, delays in approval of local government budgets by the Ministry of Home Affairs, which is required by law, have taken a toll on the implementation of investment projects. In addition, a focus on short term, calendar year budgeting makes it difficult for local governments to carry out and finance multi year investment projects. Anecdotal evidence suggests that deficiencies in public procurement and tighter oversight in the context of the authorities’ ongoing anti corruption initiatives have made local government officials wary of executing budgetary commitments for fear of prosecution. This may be an unavoidable short term cost of anti corruption efforts towards boosting accountability at the all levels of government over time. The stock of unspent budgetary appropriations, especially those financed through revenue sharing with the natural resource rich jurisdictions, has increased over time, taking a toll on the government’s ability to implement investment projects. There is, therefore, considerable scope for reducing capacity constraints at the local level and for making budgetary processes, including central government approval of local government budgets, swifter and better equipped to deal with the multi year nature of investment projects.
How to obtain this publication
The Policy Brief (pdf format) can be downloaded in English. It summarises the OECD assessment. The complete edition of the Economic Assessment of Indonesia 2008 is available from:
For further information please contact the Indonesia Desk at the OECD Economics Department at firstname.lastname@example.org. The OECD Secretariat's report was prepared by Luiz de Mello and Diego Moccero under the supervision of Peter Jarrett. Research assistance was provided by Anne Legendre.