The political risks of doing business in Indonesia

Indonesia’s size, resource wealth and growing number of middle class consumers have made it an attractive market for foreign investment and trade. Net inflows of foreign direct investment (FDI) have seen a steady increase since the doldrums of the Global Financial Crisis in 2009 and continued to increase through the second quarter of 2015.

This remains a policy priority for the current government, which has estimated that infrastructure development through 2019 alone will require an estimated $450bn of investment.

Indonesia’s president, Joko ‘Jokowi’ Widodo, who was elected on an avowedly populist platform in mid-2014, has nonetheless, unabashedly promoted the country as a destination for FDI, going so far as to say at the World Economic Forum held in Jakarta in April, that should investors have any problems, they should just “call me.”

In recent months, however, optimism has faded somewhat as investors have become increasingly aware of the inherent economic and political risks posed in an emerging market like Indonesia.

Confronted by the trifecta of a decline in commodity prices, China’s recent slowdown and the expected Federal Reserve rate increase, Indonesian growth has slowed. In the second quarter of 2015, GDP only grew 4.67%, lower than the roughly 5% expected and significantly behind the 5.8% it has averaged for the previous five years. This slowdown has been further complicated by weakening consumer spending, a major component of the country’s income.

While growth in excess of 4% would still be the envy of much of the rest of the world, it is a level that cannot sustain the employment gains made in the previous years of commodity boom-fueled growth. This does not bode well for the political situation in Indonesia, which is already complicated by significant youth unemployment (20% of young men, aged 15-24 were neither employed nor in school according to a 2014 World Bank report) and growing income disparity, both factors that are correlated with social instability.

Investment in Indonesia has also suffered from a poor regulatory environment. According to the World Bank’s Ease of Doing Business Index, Indonesia ranked 114^th in 2014, well below it’s Southeast Asian peers like Vietnam and the Philippines (78 and 95, respectively), putting it roughly on par with Ecuador, not a good place for a country looking to attract more than $450bn in infrastructure investment.

The Jokowi administration has made an effort to streamline these processes, implementing a ‘one-stop shop’ for investment licensing.

While this has helped on one end, local opposition, land acquisition issues and intra-governmental conflict, continue to be problems and have resulted, in some cases, to massive delays and even project derailment.

According the Berne Union, the international organisation of the world’s export credit and political risk insurers, Indonesia ranked eight in 2014 among the countries for which political risk claims have been paid. It also continues to be a country for which investor’s have demanded political risk mitigation, ranking fifth in the same year.

Like all emerging and frontier markets, political risk in Indonesia should be a key investor concern. Insurance alone, of course, is not a sufficient mitigant. Investors in Indonesia need to keep aware of both the macro-framework of governmental policy as well as the project-specific circumstances underpinning any investment.