IB-ADB-6th Preliminary 240912 (1)

7/29/2019 IB-ADB-6th Preliminary 240912 (1)

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PRELIMINARY REPORT

NCLUSIVE BUSINESS STUDY

FOR INDONESIA

Private Sector Mapping and Financing for Inclusive Business

Prepared by

Indonesia Consultant Team for the Asian Development Bank


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Table of Contents

Executive Summary ...... [pg]

1. Background ........... [pg]

1.1 Inclusive Business (IB) Contributing to Poverty Reduction in Indonesia..... [pg]

1.2 IB and Social Enterprises in Indonesia... [pg]

1.3 Methodology of the Inclusive Business Study for Indonesia....... [pg]

2. Poverty Analysis and Its Relevance for Private Sector Support...... [pg]

2.1 Key Features of Poverty and Implications for Inclusive Growth in Indonesia. [pg]

2.3 Role of Private Sector in Poverty Reduction...... [pg]

2.4 Implications for Inclusive Business Strategy in Indonesia [pg]

3. Macro-economic Analysis for Private Sector Development....... [pg]

3.1 Macro-economic Background [pg]

3.2 Opportunities and Challenges for Private Sector Development in Indonesia [pg]

3.3 Sector Growth Potential for Private Activities in Poverty Reduction Impact.. [pg]


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Abbreviations

ADB - Asian Development Bank

ADF - Asian Development FundAFTA - ASEAN Free Trade Area

ASEAN - Association of Southeast Asian Nations

BAPPEDA - National Development Planning Agency

BKPM - Indonesia Investment Monitoring Coordinating Board

BOP - Base of Pyramid

BPS - Central Statistics Agency (Badan Pusat Statistik)

CEP - Credit Enhancement Products

CGI - Competitive Growth Index

CSR - Corporate Social Responsibility

FDI - Foreign Direct Investment

GDP - Gross Domestic Product

IRB - Internal Ratings Based Approach

MP3EI - Master Plan for Acceleration and Expansion of Economic Development

OPIC - Overseas Private Investment Corporation

SBY - President Susilo Bambang Yudhoyono

SME - Small & Medium Enterprises

PE - Private Equity

PPP - Private-public partnership programs

UNDP - United Nations Development Program

WEF - World Economic Forum

WHO - World Health Organization


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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.

IRB approach An internal estimate used by banks to determine a clients credit

worthiness when assessing risk in their portfolio

Mezzanine finance 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.

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.

Secured versus 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 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. Asubordinated 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 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


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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


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List Table and Figures

Tables

Table 1:

Table 2:

Table 3:

Figures

Figure1:

Figure 2:

Figure 3:


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Asian Development Bank Inclusive Business Market Study for Indonesia IBCSDDraft Report KADIN Indonesia

Assessing the Inclusive Business Marketin 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.


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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 Indonesiasgovernment 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 analyzedfor 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.


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EXECUTIVE SUMMARY

(page intentionally left blank)


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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.

Korea, Rep.

Malaysia

Vietnam

Thailand

India

Philippines

Cambodia

Indonesia

Lao Peoples Dem. Rep.

Table..PUBLIC SOCIAL SECURITY EXPENDITURE (as % of GDP)

0 2 4 6 8

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 economicrowth and overt alleviation. One fundamental remise is


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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

1.1.1 BASE OF PYRAMID (BoP)

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 largecompanies are exploring alternatives for tapping into the

benefits of sharing prosperity with poorer communities in

Indonesia.


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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


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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 incomepyramid.

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.


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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.


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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

1.2 INCLUSIVE BUSINESS AND SOCIAL ENTERPRISES IN INDONESIA

State (Public Sector) The govt. aims to cut thepoverty rate to 1 percent in2012 from 12.36 in2011 byaccelerating government

spending to the measure ofUS$10 billion in 2012 Govt. spending includesloans for the poor intendingto start new smallbusinesses

Private Sector Creating opportunitiesfor IB entrepreneurshipmakes sound businesssense IB Business linkage

initiatives have been thefocus of large firms insupport of micro and smalland medium-sizedenterprises IB models havepotential to leveragethousands of useful

Social Economy Since 2004 the poverty head count inIndonesia has fallen from 16.7% to 12.49% in2011 Over 30 million Indonesian still live belowthe poverty line and around half of allhouseholds remain clustered around therational poverty line

INCLUSIVE BUSINESS MARKET

INDONESIA

GOOD INTENTIONS

Challenge


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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.

BusinessInclusive

business

Below

market

Social

enterprise

Above

market

returns

Low High

Classificationofbusinessmodels

Strategyforsocialenterprises

Addressequityrequirements

beyondthescopeofseedand

socialventurecapital

Addressdebtrequirementsof

equityinvesteessothatequity

goesfurther

Identifyimpedimentstogrowth

andprofitability

- technologygap

- man agementskills- strategicalli ance

Offertechnicalassistance/grant

supporttohelpcompaniesinvestin

areasthataretypicallyunder-

investedduetolong-term,public

goodnatureofreturns (ADB/SNV

assisttodevelopandraisesocial

enterprisestolevelattractivetoPE

funds)

1

Fund Design Recommendation

Helpinghighperformingsocialenterprisesdevelopscaletoachievemarketreturns

1 Improvementinhumandevelopmentindicators

Source;Dalberganalysis

Positiveexternalities1

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?


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- 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


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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 fitinto 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 longer-

term 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. Itcan 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 includedesktop analysis of each company.

Face-to-face interviews with senior company management are reviewed based onquantitative survey questionnaires. These interviews are necessary for the early

scoping of issues based upon past experiences and the associated impacts of both


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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 summaryreport 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 firmii. Goods and services producediii. 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 businesslines where relevant

iv. Percentage of revenues that BOP business accounts for:oAs producers /as consumers /as both.

oAssessment of the impacts on the BOP (on current business operations)v. Percentage of revenues derived from product exports and/or domestic

consumptionvi. Target markets (BOP percentage)vii. Coverage: national or international marketsviii. 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 thecompany (previous experience with private equity, terms andperformance)

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 marketsxvi. 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 theirpolicies (affirmative action policies, etc.)

xvii. Strategies, barriers and opportunities (internal/external to the company)for growth (regulatory, governance, infrastructure, liquidity, supply chainrisks, etc.)

xviii. Access to finance (equity, debt) and related issues/opportunities for thecompany (previous experience with private equity, terms andperformance)

xix. Exit strategy (for private equity investments)

b) General Type of BOP related information of selected / identified firms


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i. Extent to which the firm includes BOP in the production andcommercialization process

ii. Focus on the BOP as target market of the firmiii. Extent to which business model value creation is localized of the firmiv. Strategies used to enable BOP access to products of the firm

v. Extent of awareness/knowledge/commitment to business sustainabilityissues of the firm

vi. Potential for Scaling Up of currently existing / or potential BOP elements ofthe 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 becharacterised?

d) Environmental sustainability of businesses

Do the selected / identified firms address environmental sustainability within theiroverall business strategy? How? What? Where?


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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) PopulationDensity(2007)

SumatraNAD (Aceh) 56.500 5.201.002 92North Sumatra 72.427 12.450.911 171Riau 87.844 4.579.219 52Kepulauan Riau 8.084 1.274.848 157West Sumatra 72.427 4.566.126 108South Sumatra 60.302 6.782.339 112Bangka Belitung 16.424 1.043.456 63Bengkulu 19.795 1.549.273 78Jambi 45.348 2.635.968 58Lampung 37.735 7.116.177 188

JavaWest Java 36.925 38.965.440 1055Central Java 32.799 31.977.968 974Jogjakarta 3.133 31.977.968 1067East Java 46.689 36.294.280 777

KalimantanWest Kalimantan 146,807 4,354,300 27

Central Kalimantan 153,564 2,029,100 12South Kalimantan 43,546 3,174,100 69East Kalimantan 230,227 2,665,800 11

SulawesiNorth Sulawesi 15,273 2,112.400 132Gorontalo 893,100 68Central Sulawesi 63,678 2,338,000 35South Sulawesi 74,580 8,639,800 129South-East Sulawesi 38,140 1,998,600 48

Maluku and PapuaMaluku 43,610 ,261,100 26North Maluku 30,895 798,100 25Irian Jaya / Papua 421,981 2,460,700 6

Source: Indonesia Central Bureau of Statistics, 2007


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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;


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- 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 withdoing business in Indonesia. Among the most glaring shortcomings is poverty. The

World Bank reported that 12.5% of the Indonesian population was living in povertyin 2011, down from 16.6% in 2007. With the consumption-based poverty linemethod, 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 targetinterventions 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.


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1976 1996 1998 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

40.1% 17.7 24.2 19.1 18.4 18.2 17.4 16.7 16.0 17.8 16.6 15.4 14.2 13.3 12.5%

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

52.2ml

34.5

49.5

42.9

60M

50

40

30

20

10

0

42.0 42.1 42.4

38.736.6

39.8

43.6

30.7ml

39.0

34.132.3

TOTAL POPULATION

224,784,200 231, 328,100 245, 452,700238, 453,900 237,694,000 242,968,300206,611,600

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

Table..... POVERTY LINE, NUMBER, AND PERCENTAGE OF POOR PEOPLE,

2000-2011

YearPoverty Line (rupiah) Poor People (million) % Poor People

Urban Rural Urban Rural Urban Rural

2000 91,632 73,648 12,30 26,40 14,60 22,38

2001 100,011 80,382 8,60 29,30 9,76 24,84

2002 130,499 96,512 13,30 25,10 14,46 21,10

2003 138,803 105,888 12,20 25,10 13,57 20,23

2004 143,455 108,725 11,40 24,80 12,13 20,11

2005 150,799 117,259 12,40 22,70 11,68 19,98

2006 174,290 130,584 14,49 24,81 13,47 21,81

2007 187,942 146,837 13,56 23,61 12,52 20,37

2008 204,896 161,831 12,77 22,19 11,65 18,932009 222,123 179,835 11,91 20,62 10,72 17,35

2010 232,989 192,354 11,10 19,93 9,87 16.56

2011 263,594 223,181 10,95 18,94 9,09 15,59

Source: Statistical Yearbook of Indonesia, BPS-Statistics Indonesia

Table..INDONESIAS POOREST PROVINCES


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Province Percent of Poor Number of People

Papua 31.98% 944,790

West Papua 31.92% 249,840

Maluku 23.00% 360,320

East Nusa Tenggara 21.23% 1,013,000

Source: BPS

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 17.14% 5,107,000

East Java 14.23% 5,356,000

West Java 13.32% 4,649,000

Source: BPS

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 toachieving 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


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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, badweather, 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 whomust 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.


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TablePOVERTY AND VULNERABILITY REDUCTION

SLOW RATE OF POVERTY ANDVULNERABILITY REDUCTION

Lack of Productive

Opportunities

Weak Human

Capabilities

Inadequate Social

Protection

Low levels of private

Investment andEntrepreneurship

- 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 PublicService 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.


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Investing in broadened socio-economic opportunity by promoting small business

development and entrepreneurship opens opportunity for commercially viable, action-

based 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 lacksufficient 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,


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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 DEVELOPMENT3.1. 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 TotalGoods Export Value

in 2011 (%)

Coal -29.0 13.4

Palm Oil -11.9 8.5

Rubber -35.2 5.8

Copper -12.4 4.1

Source: BPS, World Bank

Despite the downtown in commodities exports, the Indonesian economy is still

outperforming nearly all of its Asian neighbors this year.


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8.00

6.00

7.80

China Indonesia Philippines Malaysia Vietnam Thailand Singapore

6.40

5.90

5.50

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

Y-on-Y

Table..

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

4.00

2.00

0.00

5.40

India

4.404.20

2.00

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 G20nations 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 successfuleconomic year for Indonesia. Central Statistics Agency data showed that theIndonesian 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


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Source: CEIC

Table..Real GDP Growth Rates (Forecasts)9

8

7

6

5

4

3

2

1

0

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 comingyears, attaining an average growth rate of 6.6 % per year between 2012 and 2016.


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

GPDNominalGrowth(2009 2015)

15.7%

14.5%

12.4%

12.1%

11.7%

10.0%

9.9%

4.1%

4.0%

9.6%

Indonesia

Russia

China

India

Brazil

Turkey

South Korea

Japan

USA

ASEAN (excl.Indonesia)

Indonesia Expects Second Fastest Growth among 18 Largest Economies

2009-2015

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.


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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 resourceextraction 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.


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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 upgradedIndonesias 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 InvestmentCoordinating 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.

3.00

4.00

2.00

1.00

0.00

(1.00)

(2.00)

3.80

Jul-10

Jul-11

Jan-12

Feb-12

Mar-12

Apr-12

May-12

June-12

July-12

(0.10) (0.20)

0.90

EXTERNAL TRADE BALANCE

(1.30)

(0.50)

0.60 0.80

(0.60)

Source: Central Statistics Agency

US$Bl

From a positive perspective, the rise in imports has been driven by business

expansion and new local manufacturing investments predominantly aimed at


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producing goods for the domestic market. Indonesian exports, on the other hand,

remain comprised largely of primary commodities rather than industrial goods.

3.2 INDONESIAS INVESTMENT AND BUSINESS DECISION FACTORS

3.2.1 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 7 th 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 dealingswith 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


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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 oftheir 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 long-

term 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


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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 policy-

making 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


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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% andstable 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 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

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.


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

7.0

6.0

5.0

4.0

3.0

2.0

1.0

0.0

2004 20062005 20082007 201120102009

6.01

4.58

6.10

6.51

2013(F)

2012(F)

6.326.45

Source: BPS, CEIC, Danamon Estimates

A broader portrait of Indonesian GDP growth follows.

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

Year GDPUSD

Exchange(rupiah)

Inflation Index(2007 = 100)

Nominal PerCapita GDP

(as % of USA)

PPP Per CapitaGDP

(as % of USA)

1990 233,013.890 1,842.80 16 3.01 6.63

1995 502,249.558 2,248.60 24 4.11 8.14

2000 1,389,769.700 7,396.33 53 2.32 6.92

2005 2,678,664.096 9,705.16 83 3.10 7.51

2010 6,442,918.230 8,555.00 121 6.38 9.05

Source: Central Statistics Agency, BPS


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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 andSouth 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 18.90% US$1.1Bl

Transport, Storage, Communications 13.40% $0.8Bl

Food Crops, Plantations 9.00% $0.5Bl

Metal, Machinery, Electronics 8.70% $0.5Bl

Motor Vehicles, Transport Equipment 7.80% $0.4Bl

Others 42.20% $2.4Bl


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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 economicsuccess 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


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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 sub-

sector composition of Indonesian manufacturing has been shifting in favor of

productivity. Since the Asian financial 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.

1. Agriculture, Livestock,Forestry, and Fishery

2.Mining andQuarrying

3.Manufacturing

4. Electricity, Gas,and

Water

5. Construction

6. Trade,Hotel, andRestaurant

7. Transportation and

Communications

8. Finance, RealEstate, and Business Services

9. Public Administration,

Social&personal services

Total

Table..

SECTOR SHARE IN EMPLOYMENT (%)

2000 2005 2010 Total Employees 2010 (approx)

44,943,447

1,415,541

15,099,110

235,923

6,134,014

24,536,055

6,134,014

1,887,389

17,340,385

117,725,878

45.3 44.0 38.1

0.5 1.0 1.2

13.0 12.7 12.8

0.1 0.2 0.2

3.9 4.9 5.2

20.6 19.1 20.8

5.1 6.0 5.2

1.0 1.2 1.6

10.7 11.0 14.7

100.0% 100.0% 100.0%

Sector

Source : World Bank Report , 2012


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Agriculture, Livestock, 13.6 39.7 3.7 0.5 0.13

Forestry and Fishery

Mining and Quarrying 8.3 1.1 2.4 2.2 0.94

Manufacturing 26..2 12.2 3.9 3.0 0.77

Electricity, Gas & 0.8 0.2 9.4 -0.5 -0.05

Water Supply

Construction 6.4 5.2 7.8 3.9 0.50

Trade, Hotel & 16.9 20.9 6.3 2.8 0.44

Restaurants

Transport and 8.8 5.8 14.6 2.2 0.15

Communications

Finance, Real state 9.6 1.4 6.7 5.7 0.86

And Business Services

Services 9.4 13.4 6.1 5.9 0.97

All Sectors 100.0 100.0 5.6 2.3 0.40

Sector Share

In GDP

(2009, %)

Sector share

In Employment

(2009, %)

Average

Annual Output

Growth (2004

2009 %)

Average

Annual Employment

Growth (2004

2009 %)

Employment

Elasticity to

Output Growth

(2004-2009)

Source: International Labor Organization 2010

EMPLOYMENT

BREAKDOWN

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


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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+, %)

Unemployment

Male

Female

Under-

Employment (%)

Male

Female

1990 1995 2000 2005 2006 2007 2008 2009

Source: BPS,

1,382,161

798,206

583,955

8.0

7.8

8.2

4,029,506

2,002,841

2,026,665

20.0

16.7

24.9

5,084,279

2,817,529

2,266,750

24.2

23.5

25.3

7,459,636

3,945,857

3,513,779

33.4

30.1

38.2

6,816,216

3,688,505

3,127,711

30.6

27.8

34.7

5,660,036

3,278,337

2,381,099

25.1

23.8

27.3

5,031,017

2,819,259

2,211,758

23.3

21.8

25.5

4,821,769

2,842,611

1,979,158

22.2

21.6

23.0

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

Despite unemployment and underemployment, labor rigidity, including wage demandsand 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


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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 apositive 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 sub-national 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 sub-

districts 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


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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 of2012, 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 otherindustries such as textiles, leather, and footwear collectively dropped to 2.86% from

9.45% growth posted over the same period in 2011.


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

S

ource:

Central Statistics Agency

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 (%)

2007 2008 2009 2010 2007 2008 2009 2010

Table..

GROWTH AND SOURCE OF GROWTH OF GDP BY INDUSTRIAL ORIGIN, 20072010(PERCENT)

Industrial

Origin

(1) (2) (3) (4) (5) (6) (7) (8) (9)

1. Agriculture, Livestock,Forestry, and Fishery

2.MiningandQuarrying

3.Manufacturing

4. Electricity,Gas,and

Water

5. Construction

6. Trade,Hotel,and

Restaurant

7. Transportationand

Communication

8. Finance,RealEstate,

andBusinessServices

9. Services

GROWTH BY INDUSTRY CONTRIBUTION TO GDP GROWTH

3.5 4.8 4.1 2.9 0.5 0.6 0.5 0.4

1.9 0.7 4.4 3.5 0.2 0.1 0.4 0.3

4.7 3.7 2.2 4.5 1.2 0.9 0.6 1.1

10.3 10.9 14.3 5.3 0.1 0.1 0.1 0.0

8.5 7.5 7.1 7.0 0.5 0.4 0.4 0.4

8.9 6.9 1.3 8.7 1.4 1.1 0.2 1.4

14.0 16.6 15.5 13.5 0.9 1.1 1.2 1.1

8.0 8.2 5.1 5.7 0.7 0.7 0.5 0.5

6.4 6.2 6.4 6.0 0.6 0.5 0.6 0.5

Source: Central Statistics Agency

Size of Enterprise Employees Assets Annual Turnover

Micro 1 - 4Small 5 - 19 Up to Rp.200 million

(+/- US$ 22,222)Up to Rp.1 billion(+/- US$ 111,111)

Medium 20 - 99 Rp.200 million to Rp.10billion (+/- US$ 1.1million)

Rp.1 billion to Rp.250billion (+/- US$ 2,75million)

Large > 100 More than Rp.10 billion More than Rp.250 billion


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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 inthe 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 andinvestment 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.


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Table INDONESIA MORE DOMINANT IN ASEAN - WORLD

Source:International Monetary Fund, World Economic Outlook Database, April 2011; Proyeksi Ekonomi Indonesia 2011 2045; Analisa Tim

* CAGR -

Indonesia Economic Growth (nominal)(USD Billion)

Indonesias economy as % of

ASEAN-6

ASEAN(Total 11

Countries)

40% 48% 53%

38% 46% 52%

Spain

Netherlands

50% 91%60%

91% 165%105%

European Countries:

CAGR 14.5%

According to recent Standard Chartere

IB-ADB-6th Preliminary 240912 (1)

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