Global Economics

Indonesia: Poised for Rapid Growth?


Democracy plus low labor costs make the world's largest Muslim country a potential economic powerhouse. One problem: a restrictive legal system

Here's a quick quiz: What country produces 60% of Mattel's (MAT) Barbie Dolls, limited edition false eyelashes worn by J.Lo and Madonna, and nearly two thirds of all the world's zippers? No, the correct answer is not China, but Indonesia. The world's largest Muslim country and its third-largest democracy, Indonesia has become a model of religious tolerance that is admired by the Bush Administration. The country has also been able to prevent the escalation of terrorist attacks since the Bali bombings of 2003 and an explosion at the Australian embassy in 2004. After the end of the 30-year authoritarian rule of President Suharto in 1998, Indonesia has established democratic elections. It has even achieved peace in rebel Aceh province, devastated by the tsunami in 2004.

Trade Minister Mari Pangestu is eager to convert that political success into economic growth. "Indonesia is the world's biggest untold story," she boasts. Since taking her post with the election of President Sisilo Bambang Yudhoyono in 2004, Pangestu has been campaigning to boost Indonesian exports beyond traditional resource sectors involving mining, oil and gas, and forest and agricultural products. "We are trying very hard to diversify our product mix, including the services sector," says Pangestu, an ethnic Chinese Christian who holds a PhD in economics from the University of California at Davis.

It won't be easy. Foreign investors enamored of the growth stories in China, India, and Vietnam can easily overlook Indonesia. Foreign direct investment was just $5.9 billion last year, down 33% over 2005. That compares with $69.5 billion for China. The country's economy still relies heavily on its rich hoard of natural resources. Its vast reserves of gold, nickel, bauxite, coal, and timber, not to mention oil and gas, have enabled the country to benefit enormously from strong commodity prices of recent years. Last year exports grew 17.5%, to $100.8 billion. The economy grew 5.6% last year and is on track to expand by 6.3% in 2007, according to a forecast by Bank Indonesia, the central bank. That's respectable by standards of developed countries but not so impressive compared to the double-digit growth rates in China or the 8%-plus growth in India and Vietnam.

Risk of Being Steamrolled by China

And while Indonesian exports have continued to climb, reaching a 15% year on year growth during the first eight months of 2007, Pangestu warns that more than half this growth owes its success to higher prices for palm oil, coal, and minerals such as nickel, and that the country needs to focus aggressively on attracting investment to non-resource-based industries.

Like other low-cost-of-labor countries such as the Philippines and Mexico, Indonesia risks being steamrolled by the Chinese manufacturing juggernaut, as well as the emerging one in Vietnam (BusinessWeek, 12/16/06).

Although Indonesia has benefited to some degree from a trend among garment and shoe customers such as Nike (NKE) to diversify their supply sources to avoid total dependence on China, it faces tough competition from the Vietnamese. Nonetheless, Pangestu bravely insists that there's room for Indonesia to develop. "Countries have to change their strategy to find a niche so as not to compete directly," she says. "Indonesia can develop a niche because of its artistic capability and cultural heritage."

Special-Order Eyelashes for J.Lo and Madonna

That's where faux eyelashes come in. One of the country's leading eyelash manufacturers is Royal Korindah. The company, which is owned by a Korean family, produces about 14 million sets of eyelashes per year for companies such as MAC cosmetics of Toronto and Japan's Shu Uemura, which outfitted singers Jennifer Lopez and Madonna with special-order lashes made of mink and red fox fur. The company's 2500 employees, virtually all women in their twenties, thread each pair of lashes by hand for about $57 per month.

Chief Operating Officer Cheung Shu Fong says Korinda tries to avoid direct competition with Chinese rivals by "emphasizing the highest quality fancy styles" such as special order Shu Uemura Diamond-studded lashes for the Material Girl. Sales have doubled in the past five years, to about $5 million, and the company expects 20% growth in 2008 once a new factory that will increase capacity by 20% comes on stream.

Another area the government is pushing to promote is the animation and film industry. One promising example is Castle Production, a Jakarta-based studio that has been doing animation since 2000. With 100 artists, 20 of whom do 3D computer animation, Castle got its first overseas contract for a 13-part animated series called Carlos Caterpillar commissioned by Dallas-based Sunny-side Entertainment. The show has aired in the U.S. and Spain. Castle is now working on a 26-part series subcontracted by an Indian company on behalf of a French client. "Our business is going really well and growing," says Maria Tjhin, Castle's general manager.

Flexing Its Muscles in Animation

That said, even Tjhin admits that it's tough convincing prospective clients that Indonesia's animation industry is up to global standards. And it doesn't help that Castle is competing with bigger rivals throughout the region. From India to Vietnam to Hong Kong, animation studios across Asia (BusinessWeek, 10/15/07) are trying to produce TV shows and movies for Western audiences.

Not all of Indonesia's problems come from competition. The country's labor codes make it more costly to lay off workers than to keep them. That is a big turn-off for foreign companies. "You can't sack anyone without paying a lot of money and going to court," says a foreign lawyer with a local firm, who requested anonymity." Indonesia's legal framework is also a huge obstacle to foreign companies. The slow pace of reform of the legal system continues to deter investors, large and small, from coming to Indonesia. "It may continue to be the country's Achilles' heel" says Rajiv Louis, head of investment banking for UBS (UBS) in Jakarta.

Another problem for investors comes from the decentralization of government in the past decade. "Everything used to be very top-down, but now with decentralization it is difficult for central government to coordinate with provincial governors and difficult for the governors to coordinate with subprovinces," says Mirza Adityaswara, director of equity research at Credit Suisse in Jakarta. "The situation has become investment-unfriendly, but this is a long-term learning process for Indonesia."


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