Indonesia faces daunting obstacles in value chain; Country needs to do more than export raw natural resources it has in abundance

July 18, 2013 3:15 pm

Indonesia faces daunting obstacles in value chain

By Henny Sender

Country needs to do more than export raw natural resources it has in abundance

Asia desperately wants to believe it is relatively immune to the darker clouds over the world today and nowhere is that hope more passionate than inIndonesia, one of the principal victims of the Asian financial crisis 15 years ago. That hope is grounded partly in the fact that since Indonesia did go through a crisis, today its banks are independently run, better managed and have fewer vulnerabilities than at that time. It is also based on the fact that unlike its neighbours to the north, Indonesia’s demographics are favourable. Analysts love to trumpet a young population whose demand will propel the Indonesian economy.In fact, though, Indonesia’s circumstances are neither that simple nor so rosy.

Indonesia has been among the biggest beneficiaries of what once seemed China’s insatiable appetite for natural resources. But now that demand is tapering off and for Indonesia to thrive it has to move up the value added chain. At the same time, the cost of capital for allemerging markets, especially those that like Indonesia have current account deficits, is going up as capital flows reverse away from emerging markets.

There are several challenges. Most importantly, if Indonesia is to realise its hopes of moving up the economic value chain, it needs to do more than export the raw natural resources that it has in abundance. Instead of exporting unprocessed palm oil, coffee, coal or iron ore, Indonesia has to start processing these commodities before exporting them. And instead of just exporting natural rubber, it needs to turn it into finished products, such as tyres. Today, primary commodities account for more than half of Indonesian exports, while cars and other road vehicles account for just over 3 per cent of total exports, according to Citigroup data.

Indonesia needs to increase its manufacturing prowess to generate jobs for its young people, many of whom are illiterate. It is also hoping to take advantage of rising wage costs in China as companies look for cheaper locations elsewhere. But a visit to a tyre factory underscores just how difficult it will be for the country to tackle the challenges ahead.

It takes almost three hours from Jakarta, the capital of Indonesia, to reach the factory in Cikarang where PT Multistrada Arah Sarana turns out tens of thousands of tyres a day, a total of 6m motorcycle tyres and 10m tyres for cars every year.

Today, Indonesia plans to use the size of its domestic market as leverage to create an automotive industry of scale. The ultimate aim is to take on Thailand, the centre of automotive production for southeast Asia, and other potential rivals in the region, such as Vietnam.

But there are significant obstacles to such ambitions.

Every factory in Indonesia is faced with a daunting lack of infrastructure. When capital was cheap, Indonesia should have done more to get its infrastructure act together – but it hasn’t. Trucks ceaselessly shuttle from Multistrada’s factory in an industrial zone to the port of Jakarta, from which the tyres will be exported to Europe, the US and even Japan, in a journey taking several hours. It would be far more efficient to transport the tyres by train, but Indonesia lacks functioning railways. Even India has a better train network than Java.

The next difficulty is labour. Bulletin boards in the factory feature photos of the workers’ families and messages from their relatives, urging them to be mindful of safety. Many of these messages go unread since some workers at the factory are illiterate. To move materials around and piece them together, they have to use punch cards and match up the holes.

Indonesia must try to remain competitive with Chinese workers whose pay is rising but whose productivity vastly outpaces that of Indonesian workers still. This year, workers were granted a 30 per cent rise in their basic wages on top of an increase of 10 to 15 per cent last year, though productivity gains do not begin to match the speed of the pay rises.

There are also considerable challenges on the financial front, suggesting that some lessons from the financial crisis have faded from the collective memory. Bank credit has risen by an annualised 24 per cent over the past three years, according to data from CLSA while nominal GDP has grown at a 13 per cent rate. The loan to deposit ratio has narrowed. But more worrying is that Indonesian companies (like other companies in southeast Asia) have been borrowing in dollars again – not anticipating the recent dollar strength. Much of that borrowing was not hedged, bankers say, a currency mismatch that was a big part of the problem Indonesia faced last time around. Bond issuance alone was $10bn last year and $6bn so far this year.

It will be interesting to see if memories of creditors prove more long-lasting than those of borrowers.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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