PRELIMINARY REPORT

ININCLUSIVE BUSINESS STUDY FOR INDONESIA

Private Sector Mapping and Financing for Inclusive Business

Draft: 21 August 2012

Prepared by

Indonesia Consultant Team for the Asian Development Bank

Table of Contents
Executive Summary ......
1. [pg] [pg] [pg] [pg] [pg]

Background ...........
1.1 1.2 1.3 Inclusive Business (IB) Contributing to Poverty Reduction in Indonesia..... IB and Social Enterprises in Indonesia ... Methodology of the Inclusive Business Study for Indonesia .......

2.

Poverty Analysis and Its Relevance for Private Sector Support ...... 2.1 2.3 2.4 Key Features of Poverty and Implications for Inclusive Growth in Indonesia. Role of Private Sector in Poverty Reduction ...... Implications for Inclusive Business Strategy in Indonesia

[pg] [pg] [pg] [pg]

3.

Macro-economic Analysis for Private Sector Development ....... 3.1 3.2 3.3 Macro-economic Background Opportunities and Challenges for Private Sector Development in Indonesia Sector Growth Potential for Private Activities in Poverty Reduction Impact ..

[pg] [pg] [pg] [pg]

Abbreviations
ADB ADF AFTA ASEAN BAPPEDA BKPM BOP BPS CEP CGI CSR FDI GDP IRB MP3EI OPIC SBY SME PE PPP UNDP WEF WHO Asian Development Bank Asian Development Fund ASEAN Free Trade Area Association of Southeast Asian Nations National Development Planning Agency Indonesia Investment Monitoring Coordinating Board Base of Pyramid Central Statistics Agency (Badan Pusat Statistik) Credit Enhancement Products Competitive Growth Index Corporate Social Responsibility Foreign Direct Investment Gross Domestic Product Internal Ratings Based Approach Master Plan for Acceleration and Expansion of Economic Development Overseas Private Investment Corporation President Susilo Bambang Yudhoyono Small & Medium Enterprises Private Equity Private-public partnership programs United Nations Development Program World Economic Forum World Health Organization

Glossary
Angel Investor An angel investor is an individual or organization that invests capital into a firm or going concern in return of preference shares and/ or operations of the company. This type of equity injection is mostly used to replace an existing debt of a company or to develop a specific project of the firm and is based on equity returns. An internal estimate used by banks to determine a clients credit worthiness when assessing risk in their portfolio Mezzanine finance can be unsecured debt, or preference shares. This type of funding offers a higher return than debt due to higher levels of risks. However, returns are less than equity where returns are treated as residual payments. Mezzanine finance tends to be used when bank borrowing limits are reached and the firm cannot or will not issue more equity.

IRB approach

Mezzanine finance

Partial risk guarantees The partial risk guarantee covers part of a lenders outstanding debt service against specific political risks. This is usually used by financial institutions and lender if the organizations charter or policy does not authorize coverage of equity risks. Risks potentially can cover issues such as breach of contract and currency inconvertibility. Risk exposure Risk exposure equals the probability of risk occurring times the total loss if risk occurs. The two main types of loans are secured loans and unsecured loans. For secured loans, the borrower pledges some sort of collateral. The bank may repossess the collateral if the loan is not repaid according to the terms agreed to when the loan was taken out. Unsecured loans do not require any collateral. Money is borrowed on the strength of the borrowers credit standing and ability to repay the loan using cash flows from the project or form an independent source. Subordinated debt is a term used to describe debt that is unsecured or has a lesser priority than other debt claims on the same asset. If the party that issued the debt defaults on repayments, people holding subordinated debts get paid after the holders of the senior debt. A subordinated debt carries more risk than a normal debt, and earns a higher expected rate of return than senior debt due to the greater inherent risk. Syndication is the private placement of debt (or equity) securities to third parties. By employing debt syndication, several banks, investment firms, or other companies share the profits and diversify the risk of
4

Secured versus

Subordinated debt

Syndication

making a large loan. Syndications are used to transfer some or all of the risk associated with its loans and guarantees to its co-financing partners, and include fronting (CFS), non-funded risk participations, and sell-down arrangements.

Private Equity Fund

List Table and Figures

Tables Table 1: Table 2: Table 3:

Figures Figure1: Figure 2: Figure 3:

Asian Development Bank Inclusive Business Market Study for Indonesia Draft Report

IBCSD KADIN Indonesia

Assessing the Inclusive Business Market in Indonesia

INTRODUCTION:
The Base of Pyramid (BoP) concept and Internal Business (IB) endeavors are not new in Indonesia. Several initiatives have commenced for studying and clarifying the constraints and opportunities involved with increasing the scale and success of BoP/IB efforts. Although the present momentum is very positive, in Indonesia there is still a steep trek ahead in moving up the learning curve toward further change and improvement. Professor Tulus Tambunan from the Center for Industry, SMEs and Business Competition Studies at the prestigious Trisakti University in Jakarta, stated concisely: Though limitations may vary by region, sector, or even by enterprise within a sector, there are certain constraints that are common to all [micro and small business initiatives], including lack of capital, difficulties in procuring raw materials, lack of access to relevant business information, difficulties in marketing and distribution, low technological capabilities, and policies and regulations that generate market distortions. There is significant room for progress and profit in Indonesias Base of the Pyramid. The importance of micro, small and medium-sized enterprises cannot be underscored due to the millions of underprivileged Indonesians reliant on low-paying labor-intensive agricultural activities across the country. It is a huge market with often overlooked opportunities to promote encouraging prospects through sharper entrepreneurial and managerial mindsets. Key Objectives: 1. Forecast the pace and stability of the Indonesian macroeconomic environment and prospects for future industrial growth; 2. Identify business activities in sectors with the greatest potential to profitably work with lower-income segment of society as employees, suppliers, distributors and consumers; 3. Contextualize strengths and weaknesses, opportunities and threats through comprehensive desk research and face-to-face interviews with key business leaders; 4. Analyze synthesized desk research of each company and summaries of all company manager interviews; 5. Map the potential for BoP enterprises in order to pinpoint the best opportunities for establishing possible Inclusive Business enterprises in Indonesia; 6. Finalize a summary report of key findings from the mapping exercise giving priority consideration to recommendations for next steps.
7

Without refined knowledge and appropriate support in place, mixed messages and misperceptions can easily confuse otherwise positive intentions. Therefore, the initial study is undertaken to ensure a broader understanding of the concerns and priorities of key stakeholders in each sector and consider actions to help support positive momentum. Support of a multi-faceted BoP/IB endeavor should be broad-based across Indonesias government and business sectors, relevant international parties and the communities involved. With presidential elections two years away, the timing is ideal. Delays could risk postponing or foregoing the economic and social rewards inherent in the BoP/IB progression. Indonesia is ready for BoP/IB right now. Expanding knowledge is the key. Information and assistance is available, but without concentrated oversight it is too often overlooked or dismissed. Therefore, this preliminary research is intended to assist future BoP/IB implementation efforts by providing: 1. Introduction 2. Background: including social enterprise overview, imperative for support and description of IB methodology; 3. Poverty Analysis: key features and implications for inclusive growth and the role of the private sector; 4. Macro-economic Analysis: background, present status of opportunities, challenges, and forward outlook; 5. Inclusive Business Market Overview: by sector, describing general characteristics and key impediments and opportunities for business development; 6. Financing Inclusive Business: including state, private and other financing options and development organizations along with their experiences and suggestions; 7. Assessment of Private Sector Interest: through desk research, survey research and the mapping end-product interests and concerns can be captured and analyzed for exploring assistance in an investment fund and/or other means of cooperation; 8. Summary: Conclusions and recommendations. This information will assist in identifying inclusive business activities with the greatest potential to profitably work with low-income people by incorporating them within the value chain. The report intends to help form the basis for ongoing dialogue and engagement between relevant stakeholders intent on advancing the BoP/IB agenda and the betterment of underprivileged Indonesians.

EXECUTIVE SUMMARY

(page intentionally left blank)

1.1 INCLUSIVE BUSINESS (IB) INITIATIVE IN INDONESIA

Considerable discourse among politicians, economists, academics and businesspeople domestically and internationally has been focused on the number of Indonesians growing out of poverty and into the ranks of the nations middle class. Stylish shopping malls, fashionable cafes and expensive cars in cities across Indonesia, however, are misleadingly perceived as signs of cosmopolitan lifestyles, while only a small percentage of Indonesians enjoy such amenities. Although progress in efforts to assist the poor has been achieved, a great number of Indonesian citizens still live in poverty or on the fringes of poverty. Millions of of Indonesians continue to live under vulnerable economic circumstances without job security or reliable social assurances. In terms of social assurance, Indonesia ranks behind many of its Asian neighbors, meaning they endure constant economic insecurity.
Table..PUBLIC SOCIAL SECURITY EXPENDITURE (as % of GDP)

Korea, Rep.
Malaysia Vietnam

Thailand
India Philippines Cambodia Indonesia

Lao Peoples Dem. Rep.

Source: ,ILO World Social Security Report 2010/11

Recognizing this, the United Nations Development Program (UNDP), the World Bank (WB), the World Business Council for Sustainable Development (WBCSD) and the Asian Development Bank, among others, are gravitating toward evolving Inclusive Business models built upon the underlying Base of Pyramid concept. Also in support are large businesses operating in foreign environments that are aware that participatory contributions to poverty alleviation foster cooperative and more profitable operating environments. Host country governments normally support and appreciate this kind of cooperation.
Box _ .WHAT IS IB? Expanding business options and raising productivity through the Inclusive Business (IB) approach is important to economic growth and poverty alleviation. One fundamental premise is
10

There are development approaches, if properly designed and managed, which provide room for stakeholders to assist in mutually beneficial endeavors to assist poverty alleviation in responsible, inclusive and profitable ways. Although there is not one uniform Inclusive Business model that can be applied to upgrading or integrating any given situation, there is room for the government, the private sector, lending institutions and civil society advocate organizations to assist in mutually beneficial endeavors with stakeholders to work together in more responsive and comprehensive manners. The resultant benefits affect a wide array of productive constituencies, regardless of their divergent interests.
Box CORPORATE SOCIAL RESPONSIBILITY

Although different from Inclusive Business models, over the past decade many more private firms have addressed their commitments to the communities impacted by their presence through efforts now classified as corporate social responsibility. However, the private sector is increasingly aware of the reality that many Corporate Social Responsibility (CSR) budgets and commitments pursued in the past, although necessary, were not always as effective or sustainable as initially expected. Many managers and advisors now view CSR budgets as counterproductive essentially throwing money over the fence to keep locals from disrupting operations. More large companies are exploring alternatives for tapping into the benefits of sharing prosperity with poorer communities in Indonesia.

1.1.1 BASE OF PYRAMID (BoP)

11

Underlying the Inclusive Business ambitions is the Base of the Pyramid (BoP) concept. In the broader sense, the term Base of the Pyramid implies that the poor not only lack work, but also require better access to basic goods, services, and income generation opportunities. They make up the base of a theoretical pyramid, while wealthier people live at the higher gradients and the very peak levels of the pyramid. Many donors and private firms are strengthening their focus on the BoP, not only in Indonesia, but also in middle-income and even wealthy countries. There is growing recognition that engaging and empowering small-and-medium scale enterprises (SMEs), or micro businesses, provides opportunities for larger firms to contribute to developing local businesses and creating jobs. This in turn normally generates goodwill and supports a firms local license to operate. Not only is this a form of informal insurance and security, but private firms are also able to benefit from shortened and more efficient supply chains and reduced costs for locally sourced goods and services. The BoP concept focuses on companies or individuals at the top of the income pyramid who are reaching out to work with lower income communities in ways that are both profitable and growth-oriented. At this time there are still a great number of large firms that have not fully addressed opportunities in working with Indonesias poorer demographic segment The primary intent of BoP-based business is to build links between BoP communities and broader markets, thereby lowering various supply and distribution costs for companies while increasing opportunities for individuals to earn their way out of poverty. This involves developing methodologies focused on principles of interdependence and mutually profitable commercial cooperation. The World Resources Institute (WRI) and the International Finance Corporation (IFC) use the purchasing power parity (PPP) methodology to account for differences in costs of living and inflation between countries. Using a PPP cutoff of $1,500 per person per year, estimates indicate that there are around 4 billion people worldwide within this classification with a collective purchasing power of around US$5 trillion per year. There are many observers who estimate the number of people living at the BoP is much higher than the 4 billion people categorized by the fluctuating income threshold. Concentration on the BoP is focused on increasing the number of financially sustainable businesses capable of generating profit while supporting efforts to address issues of improving livelihoods for low-income people. Without such forward-looking approaches to building capacity and fostering ingenuity, Indonesia could continue to face excessive poverty and deficits in the quality of human capital relative to many neighbors throughout the Asian region. Such
12

circumstances not only handicap community potential, but also constrain prospective investment opportunities that could strengthen and broaden the Indonesian economy.

Exhibit.. BASE OF THE PYRAMID INTER-RELATED CONCEPTS

1. BoP is a socio-economic designation for around 4 billion individuals who primarily live in developing countries where annual per capita income averages below US$1,500 (in PPP terms); and, 2. BoP is an emerging field of business strategy that focuses on products, services, and enterprises to serve people throughout the base of the worlds income pyramid. Both concepts are referred to as the Base of the Pyramid the BoP.

1.1.2 INCLUSIVE BUSINESS MODELS

Investors interested in Indonesia continue to face dilemmas concerning the quality of human capital relative to neighbors in the Asian region and across the world, which is a serious competitive concern given the capabilities of neighboring economies in the immediate region. Inclusive Business models enhance the capacity of donors and companies to stimulate direct and indirect social-economic development benefits as a part of their investment priorities. Business linkages between government, large corporations, donors and micro, small and medium-sized enterprises can play a vital role not only in generating job opportunities, but creating avenues for expertise, enhanced managerial skill, and technology transfer, all of which most often lead to a more conducive investment environment.
13

Despite varying and sometimes competing interests, IB endeavors normally generate trust and support among associated parties. However, an IB initiative might be a dynamic endeavor. A company, its partners, clients, stakeholders and other interest groups might change perspectives over time. This is where determining the priorities and lines between those who are directly affected and those who lurk harboring opportunistic objectives can become complicated. Understanding different perceptions and different power circles is very important. Just as important as identifying local champions who might support a project or business, people who perceive that they have been arbitrarily excluded from project benefits are capable of wiping out the good intentions of otherwise positive efforts. The following chart demonstrates why understanding the lay of the land is so important.

Source: Sustainability Marketing

Fortunately, efforts directed toward positive intentions usually outweigh negative sentiments if the message is effectively socialized, understood and shared hence, the term inclusive is key. Unfortunately, many companies seem to know where they intend to be going without understanding where they stand within their own operating environment. Often their immediate stakeholders are even less informed. In the worst circumstances, some firms fail to recognize the power people have when they feel their interests have been discounted until it is too late.

14

Given market development initiatives, business opportunity, risk management and reputation drivers, more major corporations are taking innovative, proactive approaches to strategic business partnerships with local communities affected by their operations. IB models provide these opportunties, while at the same time opening possibilities to make contributions to poverty alleviation in Indonesia. This is another reason why BoP/IB initiatives are an ideal way of better understanding where a firm or a donor stands and who they should be communicating with in a more familiar and mutually beneficial manner. Mapping methodology is one approach to helping firms understand the big picture in a broader and clearer light.

Figure ...........The Inclusive Business Market in Indonesia

GOOD INTENTIONS

INCLUSIVE BUSINESS MARKET INDONESIA

State (Public Sector) The govt. aims to cut the poverty rate to 1 percent in 2012 from 12.36 in2011 by accelerating government spending to the measure of US$10 billion in 2012 Govt. spending includes loans for the poor intending to start new small businesses

Private Sector Creating opportunities for IB entrepreneurship makes sound business sense IB Business linkage initiatives have been the focus of large firms in support of micro and small and medium-sized enterprises IB models have potential to leverage thousands of useful networks

Social Economy Since 2004 the poverty head count in Indonesia has fallen from 16.7% to 12.49% in 2011 Over 30 million Indonesian still live below the poverty line and around half of all households remain clustered around the rational poverty line

Challenge 1.2 INCLUSIVE BUSINESS AND SOCIAL ENTERPRISES IN INDONESIA

15

Inclusive Business models and social enterprises in Indonesia are unique. They are not seen as Corporate Social Responsibilty, but have been better described as Corporate Social Investment. IB is not philanthropy, but is a social investment in capacity building for both the community and the private sector alike.

Fund Design Recommendation Helping high performing social enterprises develop scale to achieve market returns
1
Strategy for social enterprises Address equity requirements beyond the scope of seed and social venture capital Address debt requirements of equity investees so that equity goes further Identify impediments to growth and profitability - technology gap - management skills - strategic alliance Offer technical assistance /grant support to help companies invest in areas that are typically under- invested due to long-term, public good nature of returns (ADB/ SNV assist to develop and raise social enterprises to level attractive to PE funds)

Classification of business models

Above market returns

Business

Inclusive business

1
Social enterprise
Below market
1

Low

High

Positive externalities

Improvement in human development indicators Source; Dalberg analysis

1

The evolution of Inclusive Business is a shift from short-term means of meeting regulatory requirements to a strategic longer-term channel for relationship-building and risk mitigation. As noted by the United Nations Development Program (UNDP), doing business with the poor brings them into the marketplace. For entrepreneurs and large firms, IB drives innovation, builds markets and creates new room for growth for micro and mid-sized businesses. IB empowers people so that they are capable of supporting themselves in a rewarding and profitable manner without being overly dependent on government assistance or corporate handouts.

Exhibit.. QUESTIONS ON ENTREPRENEURIAL ASPECTS OF IB ENTERPRISE:

- What are the objectives?
16

- - - - - -

What product or service will be supported? What is the market potential? What is the budget? Can the efforts generate profit? How are cash flow projections formulated? What is the time frame?

These operational realities are important aspects of Inclusive Business models, because IB is also intended to benefit the affiliated companies. Therefore, engagement strategies should be designed in line with the profit-driven requirements of the private sector. This requires more collaborative approaches among all stakeholders. However challenging, finding answers to these questions should inspire a collective sense of productive ownership among all stakeholders. Although not the only objective of IB, a collective sense of ownership is lucrative. Private sector investors understand that the risks associated with closer stakeholder engagement are offset by the opportunities provided by constructive business relationships built upon effective and profitable partnerships capable of delivering returns, even during challenging times.

1.3

METHODOLOGY OF THE INCLUSIVE BUSINESS STUDY

Efforts to more accurately measure the impacts of poverty on private enterprise in Indonesia have been hindered by inconsistent data of questionable quality. To improve the likelihood of sustainable success, baseline research is necessary. The Inclusive Business study project is aimed at exploring how the IB concept might be best structured and implemented through better understanding of potential pitfalls and lucrative opportunities through the private sector mapping methodology. Mapping captures the size, geographic scale, scope and characteristics of the socio-economy where an IB project might be pursued.

Mapping The mapping concept is a structured methodology to brainstorm, organize and prioritize various concepts and ideas. Mapping can help capture the characteristics of the social economy that are often quantitatively invisible, but are of crucial importance to achieving durable results that could lead to the new development
17

Mapping is useful for community interaction, as it raises awareness of sensitive issues and builds consensus on how to best proceed. The mapping exercise can also lead to even more refined questions to be asked to better assure results where business opportunities are collectively shared. The process should address other fundamental questions such as: What are the dimensions of the specific business climate, and how does that fit into the broader social economy? What is the bulk of the work to be undertaken within an IB project?

Organizing initial thoughts around such basic questions through a mapping exercise provides a base from which to better design implementation work. Mapping and subsequent analysis can help clarify the motivations of many actors, their experiences, their influence and their potential to contribute to the success of longerterm goals. Mapping is important to collect accurate baseline data before initiation and implementation so that changes cannot only be properly attributed, but also distinguished from changes that otherwise might have otherwise occurred naturally. It can also help to better determine necessary team resources, pinpoint strategic budgets and improve high-impact schedules. To delegate resources effectively, a credible methodology for mapping stakeholders who could act as productive development partners is key.Another underlying objective of the mapping methodology is to identify firms in Indonesia with potential to demonstrate the utility of a possible pipeline for a private equity fund to support the IB concept. A list of companies has been identified based on ADB/SNV selection criteria. Individual summaries (survey tools, qualitative forms and questionnaires to be provided by SNV/ADB) of 100 company interviews and surveys of companies would also include desktop analysis of each company. Face-to-face interviews with senior company management are reviewed based on quantitative survey questionnaires. These interviews are necessary for the early scoping of issues based upon past experiences and the associated impacts of both
18

setbacks and successes. The interviews would also assist in clarifying the optimal sequence of a particular engagement. At least 15 case studies of the most promising firms would be included in a summary report of the key findings of the mapping exercise. The following is a base summary of the IB initiative methodology:

a) General information to be collected from the mapping exercise would include: i. Name and type of firm ii. Goods and services produced iii. Sales in local currency / Euro / USD and market share over the last three years (both in general and for the Base of the Pyramid-focused business lines where relevant iv. Percentage of revenues that BOP business accounts for: o As producers /as consumers /as both. o Assessment of the impacts on the BOP (on current business operations) v. Percentage of revenues derived from product exports and/or domestic consumption vi. Target markets (BOP percentage) vii. Coverage: national or international markets viii. CSR Policies and CSR Activities of the firm (current or in the process) ix. Does the firm have elements of social inclusion and gender issues as part of their policies (affirmative action policies etc) x. Strategies, barriers and opportunities (internal/external to the company) for growth (including regulatory, governance, infrastructure, liquidity, supply chain risks, etc) xi. Access to finance (equity, debt) and related issues/opportunities for the company (previous experience with private equity, terms and performance) xii. Exit strategy (for private equity investments) xiii. Percentage of revenues derived from product exports and/or domestic consumption xiv. Target markets (BOP percentage) xv. Coverage: national or international markets xvi. CSR Policies and CSR Activities of firm (current or in process). Does the firm have elements of social inclusion and gender issues as part of their policies (affirmative action policies, etc.) xvii. Strategies, barriers and opportunities (internal/external to the company) for growth (regulatory, governance, infrastructure, liquidity, supply chain risks, etc.) xviii. Access to finance (equity, debt) and related issues/opportunities for the company (previous experience with private equity, terms and performance) xix. Exit strategy (for private equity investments) b) General Type of BOP related information of selected / identified firms
19

i. ii. iii. iv. v. vi.

Extent to which the firm includes BOP in the production and commercialization process Focus on the BOP as target market of the firm Extent to which business model value creation is localized of the firm Strategies used to enable BOP access to products of the firm Extent of awareness/knowledge/commitment to business sustainability issues of the firm Potential for Scaling Up of currently existing / or potential BOP elements of the firm

c) Partnership/alliances Do the selected / identified firms have alliances with other firms, NGOs, public institutions etc. to develop products for BOP markets and can they be characterised? d) Environmental sustainability of businesses Do the selected / identified firms address environmental sustainability within their overall business strategy? How? What? Where?

20

2.

ANALYSIS AND RELEVANCE FOR PRIVATE SECTOR SUPPORT

2.1 KEY POVERTY FEATURES AND IMPLICATIONS FOR INCLUSIVE GROWTH
Undermining a range of quality human attributes, poverty affects Indonesians in terms of personal and environmental health risks, including malnutrition and inability to access health care. The risk of illness and disability reduces household savings, lowers learning ability, reduces productivity, and results in a diminished quality of life. The problems of combating poverty in Indonesia must be understood in light of the countrys size and diversity. Indonesia comprises approximately 17,508 islands. The nation has 33 provinces with over 244 million people, land mass of 1,910,931.32 square kilometers, territorial sea of 284,210.09 square kilometers and an exclusive economic maritime zone spanning 2,981,211.00 square kilometers. The country has 33 provinces, 399 regencies, 98 municipalities, 6,773 sub-districts and 78,558 villages.

TABLE....... INDONESIAS MAJOR ISLAND AREAS AND POPULATION

Sub region Land Area (in sq. kms.) Population (as of 2007) Population Density (2007) 92 171 52 157 108 112 63 78 58 188 1055 974 1067 777 27 12 69 11 132 68 35 129 48 26 25 6

Sumatra NAD (Aceh) 56.500 North Sumatra 72.427 Riau 87.844 Kepulauan Riau 8.084 West Sumatra 72.427 South Sumatra 60.302 Bangka Belitung 16.424 Bengkulu 19.795 Jambi 45.348 Lampung 37.735 Java West Java 36.925 Central Java 32.799 Jogjakarta 3.133 East Java 46.689 Kalimantan West Kalimantan 146,807 Central Kalimantan 153,564 South Kalimantan 43,546 East Kalimantan 230,227 Sulawesi North Sulawesi 15,273 Gorontalo Central Sulawesi 63,678 South Sulawesi 74,580 South-East Sulawesi 38,140 Maluku and Papua Maluku 43,610 North Maluku 30,895 Irian Jaya / Papua 421,981 Source: Indonesia Central Bureau of Statistics, 2007

5.201.002 12.450.911 4.579.219 1.274.848 4.566.126 6.782.339 1.043.456 1.549.273 2.635.968 7.116.177 38.965.440 31.977.968 31.977.968 36.294.280 4,354,300 2,029,100 3,174,100 2,665,800 2,112.400 893,100 2,338,000 8,639,800 1,998,600 ,261,100 798,100 2,460,700

21

Indonesia, as the largest economy in Southeast Asia and a member of the G-20 major economies, has made progress in reducing poverty. With sustained economic growth, more Indonesians have escaped poverty due to job creation and increasing public expenditures for health, education and infrastructure. Since 2004, the poverty headcount has fallen from 16.7 percent of the population to 12.49 percent in 2011. Data from the last six years shows a decline in the number of low income people from 17.75 percent in 2006, 16.58 percent in 2007, 15.42 percent in 2008, 14.15 percent in 2009, 13.3 percent in 2010 and 12.50 percent in 2011. Despite these gains, over 30 million Indonesians still live below the poverty line and approximately half of all households remain clustered around the national poverty line (IDR 243,729 per month/US$26.80). The gap between the poor and non-poor is also widening. Regional disparities persist, as much of eastern Indonesia lags behind other parts of the country. The picture of Indonesian development reveals many families are still not benefiting from economic growth. The Center for Welfare Studies reported that the number of poor people in Indonesia increased by 6.7 percent over the last three years to 43.1 million. The study showed the number of Indonesians living in extreme poverty was 40.36 million in 2008, 44.83 million in 2009, and 43.01 million in 2010. Various regions have different poverty percentages. Maluku and Papua had the largest percentage of people living in poverty, at between 23 and 32 percent, while Kalimantan had the lowest at 7 percent. Java is home to the highest number of poor Indonesians, at 16.74 million people, while Kalimantan reported only 97,000 impoverished residents.

2.2.

DIMENSIONS OF POVERTY
According to the UN, poverty is a condition resulting from deprivation of basic human needs such as food, shelter, safe drinking water, sanitation, healthcare, education and information. The World Bank defines the poverty line at US$1.25 per day. Some 100 million Indonesian live on less than US$2 a day. The Indonesian governments definition of poverty is less money than needed to afford a diet of 2,100 calories a day. Other factors important to sector dimensions of poverty include: Population numbers;
22

Demographic characteristics of locals; Status of women; Economic livelihoods (permanent, seasonal, migrant, unemployment); Land tenure; Natural resource control; Social organization and power dynamics; Literacy levels; Health care; Ability to access technical information; Cultural values and perceptions.

POVERTY: There are a number of commonly cited challenges associated with doing business in Indonesia. Among the most glaring shortcomings is poverty. The World Bank reported that 12.5% of the Indonesian population was living in poverty in 2011, down from 16.6% in 2007. With the consumption-based poverty line method, poverty is defined as individuals ability to fulfill their minimum basic need of 2100 kilo calorie per capita per day and other basic needs such as clothes, shelter, and access to education, health, drinking water, and sanitation. The number and percentage of poor in Indonesia declined during the 19982011 period. Poverty stood at 24.23% representing 49.5 million poor people in 1998 due to the late 1990s economic crisis that resulted in skyrocketing prices which had a severe impact on the poor. Reliable measurement of poverty is an important instrument for policy makers in improving the condition of the poor across time and regions to determine target interventions aimed at improving quality of life. The poverty rate in Indonesia declined to 12.5 % in 2011 and is expected to drop to 12% in 2012.

23

Table..POVERTY RATES (%), NUMBER OF POOR (ml)

1976 40.1% 1996 17.7 1998 24.2 2000 19.1 2001 18.4 2002 18.2 2003 17.4 2004 16.7 2005 16.0 2006 17.8 2007 16.6 2008 15.4 2009 14.2 2010 13.3 2011 12.5%

60M
52.2ml 50 49.5 42.9 40 34.5 30 20 10 0 42.0 42.1 42.4 39.8 38.7 43.6 39.0 36.6 34.1 32.3 30.7ml

TOTAL POPULATION
206,611,600

224,784,200

231, 328,100

238, 453,900

245, 452,700

237,694,000

242,968,300

Source: BPS, The National Labor Force Survey (SAKEMAS)

Table..... POVERTY LINE, NUMBER, AND PERCENTAGE OF POOR PEOPLE, 2000-2011

Year 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Poverty Line (rupiah) Urban Rural 91,632 73,648 100,011 80,382 130,499 96,512 138,803 105,888 143,455 108,725 150,799 117,259 174,290 130,584 187,942 146,837 204,896 161,831 222,123 179,835 232,989 192,354 263,594 223,181 Poor People (million) Urban Rural 12,30 26,40 8,60 29,30 13,30 25,10 12,20 25,10 11,40 24,80 12,40 22,70 14,49 24,81 13,56 23,61 12,77 22,19 11,91 20,62 11,10 19,93 10,95 18,94 % Poor People Urban Rural 14,60 22,38 9,76 24,84 14,46 21,10 13,57 20,23 12,13 20,11 11,68 19,98 13,47 21,81 12,52 20,37 11,65 18,93 10,72 17,35 9,87 16.56 9,09 15,59

Source: Statistical Yearbook of Indonesia, BPS-Statistics Indonesia

Table..INDONESIAS POOREST PROVINCES

24

Province

Percent of Poor

Number of People

Papua West Papua Maluku East Nusa Tenggara

Source: BPS

31.98% 31.92% 23.00% 21.23%

944,790 249,840 360,320 1,013,000

The data on poverty in Indonesia can also be looked at from a different perspective. TABLE..PROVINCES WITH THE MOST POVERTY
Province Percent of Population Number of People

Central Java East Java West Java

Source: BPS

17.14% 14.23% 13.32%

5,107,000 5,356,000 4,649,000

This shows that Java is still home to the largest population of poor people in Indonesia. This is a reality that is often underestimated. Unfortunately there is poverty throughout Indonesia, yet Java West, Central and East is home to most of Indonesias poorest citizens. The poor in Java are often overlooked, due to false impressions that people on Java live better lives, which is not necessarily true. Difficult impoverished circumstances remain thoughout Java. VULNERABILITY: Although the poverty rate has decreased from 24.2% at the height of the Asian economic crisis in 1998 to 12.5% in 2011, the number of poor Indonesians, however, is more than double the official poverty headcount if the people who are still vulnerable to falling into poverty are accounted for. Vulnerability has been defined as the risk of being impoverished or falling deeper into poverty in the future. As insecurity is an important component of welfare, vulnerability is an important aspect of poverty and is a major obstacle to social and economic development. Acknowledgement and understanding of vulnerability is essential to achieving sustainable poverty reduction. The near-poor are only slightly above the poverty line and can easily fall into poverty if negative shocks occur. While some 12.5% of the population lived in poverty in 2011, approximately 40% of the population, about 110 million Indonesians or more than triple the official poverty headcount, lived below the international poverty line of PPP US$2 per capita per day. There are other figures that bring the actual poverty
25

account into question, such as less than half of rural poor have access to clean water and only 55% of poor Indonesian children complete junior high school. The near poor have few buffers or resources to cope with shocks, while at the same time they are more likely to be affected by old age, disability, illness, lost jobs, prolonged unemployment, unexpected expenses, macroeconomic downturns, bad weather, bad harvests, famine or conflict. Some estimates gauge the number of Indonesians vulnerable to poverty to be somewhere between 30 and 50% of the population. Millions could easily slip into the depths of poverty. This underscores the premise that poverty can only be measured at a particular point in time. According to the World Bank, typically only a small proportion of the population is chronically poor; while many more are not always poor but are vulnerable to episodes or seasons of poverty. The poor at any point in time are only a fraction of those who must worry about and struggle to avoid falling into poverty levels of vulnerability to poverty are much higher than poverty rates themselves. This underscores the premise that poverty can only be measured at a particular point in time. By one World Bank working paper estimate, the percentage headcount of the Indonesian population vulnerable to poverty is approximately 47.11% for men and 50.97% for women, 29.10% of the urban population, 58.87% rural, 65.79% employed in agriculture, industry 39.77% in industry and 30.50% in services. Pervasive poverty can be effectively reduced by the effects of strategic exposure to economic globalization. This suggests that "the poor" from time to time are not a fixed but fluid group of households At this stage in its development path, vulnerability remains a looming threat to the Indonesian nation.

26

TablePOVERTY AND VULNERABILITY REDUCTION

SLOW RATE OF POVERTY AND VULNERABILITY REDUCTION

Lack of Productive Opportunities

Weak Human Capabilities

Inadequate Social Protection

Low levels of private Investment and Entrepreneurship

- Unequal access to education - Unequal access to healthcare - Unequal access to other social services

- Uneven playing field - Unequal access to infrastructure and productive assets (credit, land)

Exclusion - Geographic exclusion - Economic exclusion -Social exclusion

Market Failures

Inadequate Public Service Delivery - Limited Resources - Poor Targeting - Poor Governance

2.3

ROLE OF PRIVATE SECTOR IN POVERTY REDUCTION IN INDONESIA

Creating opportunities for entrepreneurship and employment through the Inclusive Business approach can be complex, but if successfully implemented, monitored and utilized, can be rewarding investments for private firms, government, and the communities around business operations. The IB focus in nations such as Indonesia has gained momentum in recent years. The United Nations Development Program and the World Business Council for Sustainable Development, among others, are increasingly using Inclusive Businesses as approaches that integrate low-income people into corporate value chains by recruitment and capacity building processes. Ideally, firms intend to source from, distribute through, and sell to small and micro-enterprises, farmers and merchants. Business linkages between large corporations and micro, small and medium-sized enterprises in Indonesia can play a vital role in creating jobs, improving livelihoods, transferring skills, technology and quality management based on sound business standards. Inclusive business endeavors have potential to expand employment and business opportunities for the poor so their bargaining power and participation in development increases.
27

Investing in broadened socio-economic opportunity by promoting small business development and entrepreneurship opens opportunity for commercially viable, actionbased learning. It is important for the private sector to not only contribute to identifying mutually beneficial ventures, but also to clarify the types of people living nearby or otherwise associated with their operations who have the potential to learn a business, manage a business, grow a business, employ others, raise productivity and increase incomes on a sustained basis. Some of the more ideal opportunities for Inclusive Business include endeavors focused on education, technical and managerial training, research and development, market research, HR systems, finance and accounting systems, distribution channels and job creation.

2.4

IMPLICATIONS FOR INCLUSIVE BUSINESS STRATEGY IN INDONESIA

Development is a complex progression that at its most fundemental levels implies a positive change in the lives of all people. Through Inclusive Business models there is potential to leverage networks of thousands of small enterprises that are located in low-income communities to achieve broader goals for better lives. It is vitally important for vested business interests to understand their stakeholders and grow relationships with them in order to best target efforts while at the same time giving consideration to managing expectations. To delegate resources effectively, a credible methodology for mapping the key stakeholders who could act as productive partners in development is necessary. These steps require time and planning, but there is also the neccesity for establishing a framework for consistently measuring the broader long-term impacts of intentions and initiatives in the future. The Inclusive Business model is not a panacea, either as a business solution or a development driver. Like any other business function, an Inclusive Business model needs to be managed. Many Indonesian start-ups, microenterprises and small and medium-sized firms that would be the target of Inclusive Business initiatives often lack sufficient business development services, technical assistance, and capital necessary to grow into long-term, sustainable enterprises. However, IB/BoP models aim to offer core business-led approaches that can be reviewed, revised and adjusted on an ongoing basis. This responsibility should not entirely be the duty of the private sector. Investment in in-house training and corporate managerial skill upgrades are not the sole solution,
28

nor is the direct provision of financial support. Success would also involve appointing trainees at the village level, assisting micro-entrepreneurs and partnering with local schools, NGOs and microfinance institutions to act as intermediaries in providing access to better contacts and better information.

3. MACRO-ECONOMIC ANALYSIS FOR PRIVATE SECTOR DEVELOPMENT 3.1. MACRO-ECONOMIC BACKGROUND

Economically strong, politically stable and with growing reform momentum, Indonesia is not only the worlds largest democratic Muslim nation, it has evolved into an emerging powerhouse in Asia only 14 years after the country was on the brink of economic collapse and social chaos. With GDP expected to approach US$1 trillion this year, Indonesia is by far the largest economy in Southeast Asia. Indonesias commodity exports have endured significant pressure due to slowing external demand. Non-oil commodity prices have seen sizeable drops in recent months, including the prices of some of Indonesias key commodity exports such as coal, rubber, palm oil and copper.

Exhibit.CHANGE IN INTERNATIONAL COMMODITY PRICES Year to June 2012 Share of Indonesias Total Goods Export Value in 2011 (%) 13.4 8.5 5.8 4.1

Coal Palm Oil Rubber Copper

-29.0 -11.9 -35.2 -12.4

Source: BPS, World Bank

Despite the downtown in commodities exports, the Indonesian economy is still outperforming nearly all of its Asian neighbors this year.

29

Y-on-Y 8.00

Table.. Selected 2Q/12 GDP growths in Asia-Pacific (y-on-y %)

7.80 6.40

6.00

5.90

5.50

5.40 4.40 4.20

4.00

2.00
2.00

0.00
China Indonesia Philippines India Malaysia Vietnam Thailand Singapore

Source: BPS Berita Resmi Statistik No. 57/09/Th. XV, 3 September 2012

The year 2012 is not the beginning of Indonesias successful growth surge. After traumatic political and economic shocks in the late 1990s, Indonesia has enjoyed a resurgence to become one of Asias leading economies in terms of GDP growth. Indonesia grew by 6.5% in 2011, providing a case for the countrys inclusion among the so-called BRIC (Brazil, Russia, India, China) economies nations that are presently at similar stages of economic development. In terms of nominal GDP growth, Indonesia has posted results among the best performers in the world. Indonesia was the third fastest growing economy among G20 nations in 2010. After the positive macro-economic performance posted in 2011 in the midst of the global economic slowdown, 2012 is shaping up to be aanother successful economic year for Indonesia. Central Statistics Agency data showed that the Indonesian economy remained on an impressive trajectory as year-on-year growth closed at 6.3% percent expansion as of June 30th.

Table.Real GDP Growth

30

Source: CEIC

9 8

Table..Real GDP Growth Rates (Forecasts)

4 3

Indonesia

Malaysia

Philippines

Singapore

Thailand

Vietnam

Average 2003 07

Average 2012 - 16

By IMF accounts Indonesia is the worlds 18th largest economy and the sixth largest economy among developing countries. As global capital changes destinations, the mid-term future looks promising for Indonesia. According to a recent forecast by the Organization for Economic Cooperation and Development (OECD), Indonesias economic growth will accelerate in the coming years, attaining an average growth rate of 6.6 % per year between 2012 and 2016.

31

Indonesia Expects Second Fastest Growth among 18 Largest Economies 2009-2015

GPD Nominal Growth (2009 2015)

Russia Indonesia China India Brazil
South Korea Turkey USA Japan
4.1% 4.0% 10.0% 9.9% 12.4% 12.1% 11.7% 15.7% 14.5%

ASEAN
Indonesia)

(excl.

9.6%

Source : International Monetary Fund, World Economic Outlook Database, April 2011

Understanding the economic difficulties across Europe and the US, as well as continued doldrums in Japan, monetary woes in China and inflation in India, Indonesia has become one of the most attractive investment destinations in the world. Unusually, one reason underscoring Indonesias positive macroeconomic performance is that its export sector accounts for only 28 percent of GDP. Various nations, such as China and India, depend much more heavily on exports, which have been hit hard by the global economic slowdown. Indonesia presently ranks very well relative to nations at similar stages of their own respective development paths, as demonstrated by the following chart.

32

Table..

* BICRA: Banking Industry Country Risk Assessment

3.1.1

THREE FUNDAMENTAL FACTORS:

The following are the three fundamental economic factors that distinguish the Indonesian economy from others. First, Indonesias huge population of at least 238 million people. The fourth largest population in the world results in massive domestic consumer demand which has driven economic growth. The growing middle class and healthy domestic demand has insulated Indonesia from much of the economic trials presently troubling other large economies around the world. Second, Indonesia is home to immense natural resources that collectively serve as key drivers of the nations economy. Indonesias resource extraction industries could improve efficiency, thereby raising production and boosting value-added input for domestic and international markets. Third, Indonesias democracy is in itself a key economic driver. Democracy in Indonesia is relatively new after decades of authoritarian rule, but has liberalized economic policy, leading to a vast array of options for new and diversified economic opportunities that have resulted in greater prosperity among the general public.
33

Given the above three factors, there is considerable optimism that domestic consumption will continue driving the Indonesian economy. Domestic consumption will likely grow even further than the 63% contribution to GDP recorded in 2011. Given the sound macro-economic backdrop, the outlook for foreign direct investment (FDI) is bullish, as reflected by international rating agency assessments. Fitch has upgraded Indonesias rating from BB+ to BBB-, Moodys has improved its rating from ba1 to Baa3 and S&P is expected to improve its assessment from BB+ to BBB- in 2012.This optimism has been partly driven by a record-low 5.75 % benchmark interest rate, which in turn has helped keep inflationary pressures in check at 4.56 % year-on-year.

3.1.2

TRADE

The outlook for Indonesias exports has been better in the past. Indonesia booked a trade deficit for a fourth consecutive month in July on higher demand for imported capital goods, raw materials and intermediary goods. According to the Indonesian Investment Coordinating Board (BKPM), Indonesias trade deficit hit a five-year high in June as exports dropped by 16.4% to US$15.36 billion while imports surged 10.71% to US$16.69 billion.

Exports are presently expected to contribute approximately 10 percent to GDP in 2012, a figure not dissimilar from that recorded in 2011.

US$Bl 4.00 3.00 2.00 3.80

EXTERNAL TRADE BALANCE

0.90 1.00 0.00 (0.10) (1.00)

0.60

0.80

(0.20)

(0.60)

(0.50) (1.30)

(2.00) Jul10 Jul11 Jan12 Feb12 Mar12 Apr12 May12

June12

July12

Source: Central Statistics Agency

From a positive perspective, the rise in imports has been driven by business expansion and new local manufacturing investments predominantly aimed at
34

producing goods for the domestic market. Indonesian exports, on the other hand, remain comprised largely of primary commodities rather than industrial goods.

3.2 3.2.1

INDONESIAS INVESTMENT AND BUSINESS DECISION FACTORS RULE OF LAW

Existing and potential investors closely watch Indonesias legal system as a prerequisite to investment stability. The Political and Economic Risk Consultancy has consistently published stern reviews of Indonesias efforts to combat corruption. The need for persistent commitment to battling corruption is important for continued economic dynamism, a sustainable democracy, and poverty alleviation. To a significant degree, further growth in investor confidence in large project, including infrastructure, depends upon substantive legal and judicial reform. A competent and trustworthy apparatus for resolving commercial disputes is critical for assuring investors that their rights will be upheld and implemented according to law. Unfortunately, the judiciary has been the subject of criticism for failure to assure a sense of impartiality with regard to dispute resolution. A few noteworthy prosecutions have recently resulted in convictions and jail sentences, but to date, most have been viewed as merely cosmetic measures driven more by political motives than actual efforts focused on sustained legal reform. Many critics claim the Indonesian legal system is in itself steadfast in resisting change, and is thereby one of the most serious impediments to more robust growth. One of the more contentious issues regarding rule of law and investment in Indonesia has been land acquisition. The situation remains in flux as the Land Administration Agency (BPN), the Finance Ministry, the Home Ministry and the Coordinating Ministry for the Economy and regional governments debate their respective implementing terms following a Presidential Regulation that was signed this past August 7th as the legal basis for the Land Acquisition Law passed by lawmakers in December 2011. In the past it had taken years to acquire land because the process required dealings with central, provincial and district governments which did not always share the same positions and were thereby unable to provide any guarantee for the acquisition process. Private businesses have expressed disappointment with the recently passed Presidential Regulation No.71/2012 requiring intricate consultations with governors, mayors, regents and local and national legislators for spatial planning and acquisition procedures. The Indonesian Chamber of Commerce (Kadin) and the Indonesian
35

Employers Association (Apindo) have expressed disappointment with the bill, claiming that the protracted process is counter-productive to broader development objectives. Eradicating structural corruption in Indonesia is a difficult endeavor. Businessmen looking at long-term horizons in Indonesia recognize this reality. Issues to be addressed include scarcity of commodities and services; general public ignorance of their entitlement to government services; insufficient civil servant salaries; poor examples set by powerful public and private sector figures; uncertain law enforcement; acceptance of corruption as a fact of life and the unwillingness of the general public to come forward with complaints.

3.2.2.

INFRASTRUCTURE

Insufficient infrastructure, such as roads, railways, ports and airports place downward pressure on FDI profit margins. The lack of reliable power supply outside Java and Bali and certain major cities remains a major problem. In many cases, outdated or deficient technology is another major infrastructure problem. The administration of President Susilo Bambang Yudhoyono has consistently expressed its recognition of infrastructure as an essential pillar of sustained economic growth. Infrastructure has been a top priority within the governments Master Plan for the Acceleration and Expansion of Indonesias Economic Development (MP3EI), established in 2011. Under the MP3EI endeavour, the administration has announced intentions to allocate some US$20 billion to infrastructure projects in 2013 to improve connectivity throughout the archipelago. Overall, the government has identified 774 infrastructure projects under the MP3EI, estimated to cost around US$240 billion. Government spending alone is insufficient for fulfilling all of Indonesias infrastructural needs. However, foreign investors are hesitant to invest huge sums of money in fixed assets given bureaucratic and regulatory bottlenecks. Past precedents of breach of contract have hurt perceptions of the governments commitment to protecting longterm foreign investments.

3.2.3.

THE BUREAUCRACY

The overall institutional framework, namely an inefficient bureaucracy, needs concentrated effort focused on improvement rather than maintenance of the status quo. Inefficient management and civil servant indifference are among the serious problems facing bureaucratic reform in Indonesia. According to the Ministry of Administrative Reform, government institutions receiving the most consistent stream
36

of public complaints are the tax office, customs, the National Land Agency, the police, the judiciary, and the legislative branch of government.

3.2.4.

THE LEGISLATIVE BRANCH

Most Indonesians are disappointed by the pace of the reform impetus within the legislative branch of government, both at the national and regional levels. The national House of Representatives is often described as sluggish and weary of change. Coalition and interest group maneuvering has impeded progress toward national interest goals. Focus on substantive legislative matters is distracted by political rivalry. Beyond preoccupation with factionalism, nearly all political parties suffer internal rifts and disputes. Individual ambitions and genuine discontent with party positions has led to diversion from stated agendas. Political maneuvering for electoral advantage will almost certainly escalate ahead of the 2014 elections. The legislative branch of government is extremely important because it holds the primary responsibility for drafting and reviewing new items of legislation and passing them into law. Greater transparency and predictability are needed in the policymaking process, as in, for example, instances of tax policy inconsistency. Various trading curbs and non-tariff measures have complicated the outlook, while so-called policy slippages have constrained Indonesias overall potential, including broader development objectives, such as job creation and poverty reduction.

3.3. OPPORTUNITIES AND CHALLENGES FOR PRIVATE SECTOR DEVELOPMENT

Indonesias economy has shown resilience despite dramatic shifts in the global economy. Strong balance sheets for the government and the private sector, as well as relatively low dependence on external demand have supported the economy through the global financial crisis beginning in 2008. If the government is able to realize its potential through regulatory stability and decreased restrictions, direct investment in 2012 is expected to contribute as much as 25 to 30 percent of overall GDP. Domestic industry is stronger as the government is moving in a positive direction after implementing various tax holidays and allowances which went into effect earlier this year. The government under President Susilo Bambang Yudhoyono has introduced successful reforms in the financial sector, including various tax and customs reforms
37

as well as improved capital market supervision. Banking supervision has been enhanced significantly over the past decade, although there is still scope for further improvements, particularly in dealing with problem banks. The government has promoted fiscally conservative policies, resulting in declining public debt, a small current account surplus, a healthy fiscal deficit below 2% and stable inflation rates. Although the governments fiscal outlook in 2012 is also supportive of economic stability and is consistent with plans to further reduce public debt, it has been argued that emphasis on fiscal policy over the medium-term should be on structural reforms, such as improving budget execution, broadening the tax base, and further reducing subsidies combined with higher transfers to the poor. This would provide additional room for infrastructure spending and better social services to support sustained growth and poverty alleviation efforts.

Table.KEY BASE INDICATORS

The exchange rate has been variable, but relatively stable moving between Rp. 8,800 to Rp.9,600 to the US dollar. Interest rates are predicted to decline by 50 basis points to 5.5 percent. Inflation is expected to jump 1.21 percent from 2011 to approximately 5 percent. The Indonesian trade surplus reached US$35.3 billion in 2011. Indonesias per capita GDP grew to US$4,700 in 2011, up from US$4,300 in 2009, thereby fueling the domestic consumer economy.

The Finance Ministry expects overall year-on-year GDP growth in Indonesia to reach 6.5 percent expansion in 2012, and grow further to between 6.8 and 7.2 percent in 2013.

Table ....... PAST AND FORECAST REAL GDP GROWTH

38

REAL INDONESIA GDP GROWTH (% Y-o-Y) 7.0

6.0 5.0 4.0
6.01 6.10

6.51
6.32

6.45

4.58

3.0 2.0
1.0 0.0

2004

2005

2006

2007

2008

2009

2010

2011

Source: BPS, CEIC, Danamon Estimates

2012 (F)

2013 (F)

A broader portrait of Indonesian GDP growth follows.

Table ...........Trend of Indonesia Gross Domestic Product at Market Prices

USD Exchange (rupiah) 1,842.80 2,248.60 7,396.33 9,705.16 8,555.00 Inflation Index (2007 = 100) 16 24 53 83 121 Nominal Per Capita GDP (as % of USA) 3.01 4.11 2.32 3.10 6.38 PPP Per Capita GDP (as % of USA) 6.63 8.14 6.92 7.51 9.05

Year

GDP

1990 1995 2000 2005 2010

233,013.890 502,249.558 1,389,769.700 2,678,664.096 6,442,918.230

Source: Central Statistics Agency, BPS

39

3.3.1

FOREIGN DIRECT INVESTMENT (FDI)

According to the Indonesian Investment Coordinating Board (BKPM) Indonesias foreign direct investment hit a record US$19.3 billion in 2011, an 18.4 percent increase over 2010. Singapore led the list of foreign investors in Indonesia with US$5.1 billion in 2011, followed by Japan and the United States with around US$1.5 billion each. The Netherlands and South Korea invested US$1.4 billion and US$1.2 billion respectively. Indonesia attracted around the same amount of foreign direct investment as India, which was still only under one-fifth of FDI that went into China. According to the BKPM, Indonesia's total investment in 2011, from both domestic and foreign sources, was 251.3 trillion rupiah (US$27.6 billion), surpassing the government's 240 trillion rupiah target. Foreign investment accounted for about 70 percent of the total. In the first quarter of 2012, FDI rose 30.3 percent from a year earlier to 51.5 trillion rupiah, led by mining. In the first half, FDI was up 28.1 percent year-on-year to 107.6 trillion rupiah. Table .. REALIZED FOREIGN DIRECT INVESTMENT

Source : BKPM

The Indonesian Investment Coordinating Board (BKPM) is predicting investment of Rp 290 trillion in 2012 before a jump to over 390 trillion in 2013. Foreign direct investment in 2011 was centered on the following sectors:
Figure..FOREIGN DIRECT INVESTMENT BY SECTOR
Mining Transport, Storage, Communications Food Crops, Plantations Metal, Machinery, Electronics Motor Vehicles, Transport Equipment Others 18.90% 13.40% 9.00% 8.70% 7.80% 42.20% US$1.1Bl $0.8Bl $0.5Bl $0.5Bl $0.4Bl $2.4Bl 40

3.3.2

DEBT-TO-GDP

Unlike the US, Japan and several nations in Europe, Indonesias debt-to-GDP ratio has been in steady decline over the past decade. A large part of Indonesias economic success has been the result of prudent fiscal stewardship that focused on reducing the sovereign debt burden. Indonesias debt-to-GDP ratio has steadily declined from 95.1% in 2000 to 25% by the end of 2011, the lowest among ASEAN countries, aside from Singapore. The low and stable debt-to-GDP ratio is an indicator of Indonesias strong global financial leverage. As the nation has demonstrated fiscal responsibility on the government side, it has also reinforced indications that there is little risk of another credit bubble in the private sector.
Table.. TOTAL DEBT TO GDP RATIO

Source: IMF

3.3.3

CHALLENGES

BUREACRACY: The World Economic Forums (WEF) 2012-2013 Global Economic Competitiveness (GCI) report cited inefficient bureaucracy and corruption as reasons why Indonesia ranked 50th of 144 countries surveyed. There are other issues, such as
41

poor health care, an unpredictable legal environment, and an education system that continues to lag behind much of the Asian region. LABOR: The CIA World Fact Book states that Indonesias labor force was estimated to be 117.4 million people in 2011 the fifth largest labor force in the world. This figure is contested by different sources, such as the Indonesian Central Statistics Board, which reported that as of February 2011 the economically active labor force reached 119.4 million people, an increase of about 3.4 million people compared to February 2010. The Indonesian labor market has been undergoing a structural shift in employment in terms of sector absorption of workers, mirroring economic structural changes. Employment in Indonesia has been shifting from agriculture to services. The subsector composition of Indonesian manufacturing has been shifting in favor of productivity. Since the Asian nancial crisis, labor-intensive sectors (e.g. textile, leather products and footwear) have declined while other capital intensive sub-sectors (e.g. transportation equipment and machinery) have grown.
Table..

SECTOR SHA RE IN EMPLOYMENT (%)

Sector
1. Agriculture, Livestock, Forestry, and Fishery 2. Mining and Quarrying 3. Manufac turing 4. Elec tric ity, Gas, a nd Water 5. Construc tion 6. Trade, H otel, and Restaurant 7. Transportation and Communic ations 8. Financ e, Real Estate, and Business Servic es 9. Public Administration, Soc ial & personal servic es Total
Source : World Bank Report , 2012

2000 45.3 0.5 13.0

2005 44.0 1.0 12.7

2010 38.1 1.2 12.8

Total Employees 2010 (approx) 44,943,447

1,415,541
15,099,110 235,923

0.1
3.9

0.2
4.9

0.2
5.2

6,134,014

20.6 5.1

19.1 6.0

20.8 5.2

24,536,055 6,134,014

1.0
10.7

1.2
11.0

1.6
14.7

1,887,389 17,340,385

100.0%

100.0%

100.0%

117,725,878

42

EMPLOYMENT BREAKDOWN

Sector Share In GDP (2009, %)

13.6

Sector share In Employment (2009, %)

39.7

Average Annual Output Growth (2004 2009 %)

3.7

Average Annual Employment Growth (2004 2009 %)

0.5

Employment Elasticity to Output Growth (2004-2009)

0.13

Agriculture, Livestock, Forestry and Fishery Mining and Quarrying Manufacturing Electricity, Gas & Water Supply

8.3 26..2 0.8

1.1 12.2 0.2

2.4 3.9 9.4

2.2 3.0 -0.5

0.94 0.77 -0.05

Construction
Trade, Hotel & Restaurants Transport and Communications Finance, Real state And Business Services Services All Sectors

6.4
16.9 8.8 9.6 9.4 100.0

5.2
20.9 5.8 1.4 13.4 100.0

7.8
6.3 14.6 6.7 6.1 5.6

3.9
2.8 2.2 5.7 5.9 2.3

0.50
0.44 0.15 0.86 0.97 0.40

Source: International Labor Organization 2010

Sustained economic expansion over the past decade has brought about a modest decline in informal employment.
Table..INFORMAL EMPLOYMENT BY REGION (AGES 15+, %)

90 80 70 60 50

40 30
20 10 0

2001

2010

Source: BPS Quarterly Wage Statistics

UNEMPLOYMENT: According to the CIA World Fact Book, the recorded unemployment rank in Indonesia was 73rd among 199 countries surveyed. The 6.6% unemployment
43

rate recorded in 2011 was higher than China (6.5%), on par with Russia, but was lower than developed nations such as Canada (7.5), Sweden (7.5), Italy (8.4) the United States (9.0) and India (9.8).

Table.UNEMPLOYMENT (age 15+, %)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

15.0

8.0

10.8

8.7

9.2

11.8

12.5

9.1

8.4

8.1

7.1

6.6

1990

1995

2000

2005

2006

2007

2008

2009

Unemployment

1,382,161 4,029,506 798,206 2,002,841

5,084,279 7,459,636 6,816,216 5,660,036

5,031,017
2,819,259

4,821,769
2,842,611

Male Female
UnderEmployment (%)

2,817,529 3,945,857 3,688,505 3,278,337

2,266,750 3,513,779 3,127,711 2,381,099

583,955

2,026,665

2,211,758

1,979,158

8.0

20.0

24.2

33.4

30.6

25.1

23.3

22.2

Male Female
Source: BPS,

7.8

16.7

23.5

30.1

27.8

23.8

21.8

21.6

8.2

24.9

25.3

38.2

34.7

27.3

25.5

23.0

Despite unemployment and underemployment, labor rigidity, including wage demands and strikes are still cause for concern. Labor-driven economic nationalism and protectionist predilections can also be a problem for foreign investors, underscoring the importance of developing relationships with local colleagues and partners who understand and communicate well with government, the community and other project stakeholders. The obvious reality is that associating with the wrong parties can be very expensive, while finding the right people and cultivating constructive relationships with them can be very lucrative.

DECENTRALIZATION: Indonesias decentralization transition, a colossal undertaking also known as regional autonomy, was first implemented in 2001. The decentralization process has created both opportunities and challenges for better implementation of poverty reduction. There has been strong political will to shift the development paradigm from a top-down supply-driven process to a bottom-up, local demand-driven approach. There is a pro-poor focus in the planning and budgeting processes at the sub-national level and regional governments have prepared regional
44

poverty reduction strategies in efforts to develop pro-poor budgets and programs. Provincial, regency, district and municipal governments have made formal commitments to poverty reduction by means of local regulation and MoUs with central government. Community driven development programs encouraged by regional autonomy tell a positive story about the pro-poor focus of decentralized spending decisions at the community level. Evidence from community driven development projects and other participatory planning experiences suggests facilitated process encouraging non-elites to participate in improving the lives of themselves and their families. Decentralization has at times resulted in seams in vertical reporting lines within government during a period when the need for disaggregated regional data has increased significantly. The disempowerment of concentrated central government agencies at the provincial and the district/municipal levels has led to a decline in the quantity and quality of administrative reporting and routine program data at the subnational level. The governments vertical coordination and communication capacities has frequently resulted in a counterproductive tendency to broadcast mixed signals rather than implementing clear and consistent policies based on empirical evidence. As a result, so-called redundancy costs in Indonesia have continued to be the highest in the region. There is significant room for institutionalizing and strengthening efforts, particularly with regard to using empirical evidence from monitoring and evaluation to drive program design and expenditure allocations. There is a need for a major push to strengthen data monitoring systems, both through the Central Statistic Agency and through cabinet ministries. Better articulation of poverty reduction results the government aims to achieve through decentralization policies and programs is fundamental. The focus of spending at the local level could be improved by providing support to villages and/or subdistricts to directly address poverty and implement well-designed and transparent community-based development activities. Defining and publicizing intended outcomes can help focus those responsible for more effective implementation and overall results. This should increase public sector accountability and enhance consistency of implementation.

3.3

PRIVATE SECTOR GROWTH POTENTIAL ACTIVITIES WITH POVERTY REDUCTION IMPACT

45

The Institute for the Development of Economics and Finance (Indef) said that industry in Indonesia continued to grow at an encouraging pace because it was primarily focused on robust domestic demand. According to the Central Statistics Agency, year-on-year output from Indonesias medium and large manufacturers expanded by 2.55 percent in the second quarter of 2012, while output of micro and small manufacturers grew by 2.11 percent. The rise in micro and small manufacturing output was boosted by expansion in the non-car vehicle sector, which accounted for 11.44 percent of production, leather and footwear at 9.35 percent, and printing and recording media at 6.50 percent.

Table ...... INDONESIAS INDUSTRIAL PRODUCTION

The Industry Ministry recently reported that Indonesias non-oil and gas manufacturing industries would continue to post robust growth of around 7.05 percent in the second half of 2012, driven largely by domestic consumer demand for food, beverages and tobacco; basic metals, iron and cement and transportation and machinery. Transportation and machinery recorded the highest growth during the first half of 2012, posting year-on-year expansion of 8.98%, followed by food, beverage and tobacco growth of 7.03% and cement at 6.92%. Contribution from other industries such as textiles, leather, and footwear collectively dropped to 2.86% from 9.45% growth posted over the same period in 2011.

46

Table ...... INDUSTRY BREAKDOWN BY SCALE IN INDONESIA

Size of Enterprise Micro Small Medium
S Large ource: Central Statistics Agency

Employees 1-4 5 - 19 20 - 99 > 100

Assets Up to Rp.200 million (+/- US$ 22,222) Rp.200 million to Rp.10 billion (+/- US$ 1.1 million) More than Rp.10 billion

Annual Turnover Up to Rp.1 billion (+/- US$ 111,111) Rp.1 billion to Rp.250 billion (+/- US$ 2,75 million) More than Rp.250 billion

There are a number of sectors that play a larger role in employment and in reducing poverty across the archipelago. These sectors have long been the core of the Indonesian economy and are central to job creation and poverty reduction. The following table shows the percentage contribution of each to GDP.

Table ........ CONTRIBUTION OF EACH INDUSTRY TO GDP (%)

Table.. GROWTH AND SOURCE OF GROWTH OF GDP BY INDUSTRIAL ORIGIN, 20072010 (PERCENT)
GROWTH BY INDUSTRY Industrial Origin (1)
1. Agriculture, Livestock, Forestry, and Fishery 2. Mining and Quarrying 3. Manufacturing 4. Electricity, Gas, and

CONTRIBUTION TO GDP GROWTH 2007 (6) 0.5 2008 (7) 0.6 2009 (8) 0.5 2010 (9) 0.4

2007 (2) 3.5

2008 (3) 4.8

2009 (4) 4.1

2010 (5) 2.9

1.9
4.7 10.3

0.7
3.7 10.9

4.4
2.2 14.3

3.5
4.5 5.3

0.2
1.2 0.1

0.1
0.9 0.1

0.4
0.6 0.1

0.3
1.1 0.0

Water

5. Construction 6. Trade, Hotel, and

8.5 8.9 14.0 8.0 6.4

7.5 6.9 16.6 8.2 6.2

7.1 1.3 15.5 5.1 6.4

7.0 8.7 13.5 5.7 6.0

0.5 1.4 0.9 0.7 0.6

0.4 1.1 1.1 0.7 0.5

0.4 0.2 1.2 0.5 0.6

0.4 1.4 1.1 0.5 0.5

Restaurant

7. Transportation and

Communication

8. Finance, Real Estate,

and Business Services

9. Services

Source: Central Statistics Agency

47

3.4

OUTLOOK

For Indonesia to achieve ambitions of above 6 percent growth in the coming years, stable macroeconomic conditions will require support from robust sectoral policies, such as improvement in the investment climate, including expanded infrastructure, an enhanced education system, greater competitiveness and productivity and growth in the overall quality of human resources. These conditions are key to overcoming prevailing supply and demand-side limitations and further stimulating the domestic economy and FDI inflows. The mid-term economic outlook can be characterized as optimistic with expectations of improved policy synergy between the central government and the regional governments, along with willingness to incorporate constructive inputs from the private sector. With steady investment, the Indonesian economy is expected to chart better quality growth alongside stable inflation and improvements in real public purchasing power driving continued robust growth in domestic consumption. Looking forward, a noteworthy development at the regional level is movement toward the establishment of the ASEAN Economic Community (AEC) as early as 2015, with the objective of creating a stable, prosperous and highly competitive zone with balanced economic growth and reduction of poverty and socioeconomic disparities. Of even greater significance for the nation and its economy will be the presidential elections in 2014. Given term limitations, a new president is assured, and as Indonesia clings to a highly presidential system of government, there will undoubtedly be various policy changes that could affect the nations macroeconomic and investment profile. Although the majority of estimates forecast real GDP growth will closely match the 2011 performance of around 6.5%, although there are other forecasts speculating GDP growth will slow to around 5.9% in 2012 due to lack of confidence in the President. Many of the same critics, however, expect growth to accelerate again to 6.6% between 2013 - 2016 pending smooth and safe elections and consistent growth in private consumption and fixed investment. Indonesia ranked 44th out of 139 countries surveyed within the World Economic Global Forums Global Competitiveness Index, making it the most improved country among G20 countries over the 2005-2010 period. Indonesias presence within ASEAN is expected to increase further.

48

Table INDONESIA MORE DOMINANT IN ASEAN - WORLD

Indonesia Economic Growt h (nominal) (USD Billion)

CAGR 14. 5%

Indonesias economy as % of ASEAN-6 40% 38% 48% 46% 53% 52%

ASEAN
(Total 11 Countries)

European Countries: Spain 50% 60% 91%

Net herlands

91%

105%

165%

Source:International Monetary Fund, World Econom Outlook Database, April 2011; Proyeksi Ekonom Indonesia 2011 2045; Analisa Tim ic i * CAGR -

According to recent Standard Chartered commentary, despite significant concern over weakening commodity prices brought on by the global economic slowdown, future economic expansion is expected to boost inclusive growth. Nominal per-capita GDP is expected to quadruple by 2020. Indonesias economy is projected to grow 5-fold by 2025, thereby making Indonesia a serious global economic power. Continued economic growth will not necessarily make these challenges disappear, and in certain cases could actually exacerbate some of them. The impetus is there. It has been growing for nearly 15 years. The will to reform, however, must remain steadfast, as there is a great deal of work ahead before Indonesia achieves its aspirations of becoming a global leader. Indonesias economy is maturing along with its democracy, leading to strengthened institutions and more balanced markets. Robust growth will be driven by increased demographic integration, a strong consumer sector and rich natural resources. Improvments in the efficiency of domestic production and distribution chains are increasing. In this regard, Indonesia is moving forward to address challenges in expanding its tax base and improving infrastructure, technological capacity, bureaucracy, the education system, and the general pool of skilled human resources.

49