Indonesia Country Illustration - European Commission · Indonesia Country Illustration Yose Rizal...
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1 European Report on Development 2015 Financing and other means of implementation in the post- 2015 context Indonesia Country Illustration Yose Rizal Damuri, Ira Setiati, Raymond Atje § Bagus Santoso ç § Centre for Strategic and International Studies, Jakarta Indonesia ç Definit Indonesia
Transcript of Indonesia Country Illustration - European Commission · Indonesia Country Illustration Yose Rizal...
1
European Report on Development 2015 Financing and other means of implementation in the post-
2015 context
Indonesia Country Illustration
Yose Rizal Damuri, Ira Setiati, Raymond Atje§
Bagus Santosoç
§ Centre for Strategic and International Studies, Jakarta
Indonesia ç Definit Indonesia
2
Section 1: In-country Transformation
Indonesia is known as the largest archipelago in the world that has 17,508 islands, 6,000 of which are
inhabited. Indonesia is also known for its diversity with 300 distinct native ethnic groups and 742
different languages and dialects. Indonesia is rich of natural resource, such as petroleum, natural gas,
coal, gold, and silver. In terms of environmental aspects, Indonesia is home of the world's richest
biological diversity of plant and animal life, the highest marine diversity, and the second largest area
of rainforest (USAID, 2008). Moreover, in terms of population, Indonesia is the fourth most populous
country in the world after China, India, and the United States with estimated population of 242.3
million in 2014.
Indonesia is considered as the third largest democratic country in the world after the United States and
India. The progress of democracy implementation in Indonesia is more rapid than other countries
(Diamond, 2010). Moreover, Indonesia is also an important regional and global player and its location
that seats among key international maritime straits make it as one of the key players of the regional
security.
The current condition in Indonesia is the result of a long transformation that has been taking place
since 1970s. The most significant milestone for Indonesia's transformation is the Asian Financial
Crisis (AFC) in 1997-1998, which had an impact not only on the economy, but also on the area of
politics, social and cultural, and environment.
Before the AFC, Indonesia enjoyed the highest economic growth in Southeast Asia with low inflation,
modest current account deficit, rapid export growth and growing international currency reserves.
Indonesia started as a country with dominant agricultural sector, especially during 1950s and 1960s.
At that era, the Government of Indonesia (GoI) strongly promoted food self-sufficiency programs. In
the period of 1960s and 1980s, industrialization and urbanization were gradually improved. This can
be seen as the sign of shifting from agricultural country to a more industrialized country.
From 1971 to 1981, Indonesia showed sustained economic growth. Real GDP increased at annual
average rate of 7.7% (Hill, 2000). This growth was partly contributed by the increase of international
oil prices which quadrupled and which brought massive revenue gains for Indonesia in the mid of
1970s. Moreover, Indonesia was as one of the fastest growing economies in the world.
When international oil prices fell in 1986, Indonesia started to look for a new engine of growth.
Indonesia transformed itself from an exporting oil country to be a manufacturing goods country. It
also tried to reduce trade barriers and enhance global integration. Indonesia was considered as one of
the East Asia's major success stories on economic structural transformation (Basri, 2013 and Goeltom,
2007)). Together with Thailand and Malaysia, Indonesia was the member of the second tier of Newly
Industrialized Economies (NIEs) (DiCaprio and Gallagher, 2006).
However, behind all the above economic success, Indonesia had macroeconomic imbalances and a
weak macroeconomic foundation. These two factors, combined with regional shocks and turbulence,
contributed to the crisis experienced by Indonesia. The previous achievements as one of the Asian
Tigers were almost vanished when Indonesia was hit by AFC. The crisis has weakened the economic
and political forces that have previously supported rapid economic growth and have enforced social
stability in Indonesia (Malley, 2001). The crisis and its subsequent events have a huge impact on
economic, social, political, and environment transformation that affecting and resulting with the
current condition of Indonesia.
This paper tries to explore on the Indonesian transformation, from economics, social, and
environmental, and the consequences of those transformation on further development of Indonesia,
including the options on how to finance these development processes. The paper is constructed in
five sections. This section will discuss thoroughly on the Indonesian transformations that has been
experienced. Section two will focus on financing options for Indonesia. Section three will discuss on
the financing human capital, physical infrastructure, and environment capacity development. Section
four will be on complementary factors in mobilizing development finance and how to use finance
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more effectively in transformation changes in Indonesia. The last section will be section five as the
conclusion section.
Political and Institutional Transformation
During the New Order Regime under Soeharto era (1966 – 1998), Indonesia was known as an
authoritarian country. The executive power was very powerful and the president held absolute power.
Following the fall of the New Order regime, several changes have been made through a series of
amendments of the constitution. These amendments have shifted Indonesia from an authoritarian
country into a more democratic country.
Regarding the relation between central and local governments, the political and institutional
transformation also included the implementation of decentralization in Indonesia. During this process,
Indonesia transformed from one of the most centralized country in the world into one of the most
decentralized in countries through a process that is known as the “big bang” of decentralization.
Decentralization is defined as the transfer of responsibility for planning, management, and resources
utilization and allocation of certain public functions from central government to local governments
(Rondinelli et al., 1981).
The key objective of the decentralization in Indonesia was to achieve efficient public goods allocation
by bringing decision makings close to people. It is also expected that the decentralization will be able
to help to spread and balance regional economic growth. The decentralization was executed as
consequences of Law No. 22/1999 and Law No. 25/1999 that was implemented in 2001. The
decentralization also involves the division of responsibilities between central government and local
governments. The central government is responsible for foreign policies, national security, defense,
national finance, religion, law, and macroeconomic issues. Meanwhile, the local governments are
responsible for local issues, such as local economy, education, heath, and infrastructure provision.
To finance their new responsibilities, local governments have received central government transfers to
secure the provision of basic public services. These transfers are mainly in the form of General
Allocation Grants (DAU) that are not earmarked and can be freely allocated by the regions, and
Special Allocation Grant (DAK) where the fund is earmarked on specific purposes.
The transition phase from a centralized governmental system to a decentralized one in Indonesia is
one of the most impressive transition phases, far from chaos and potential of splitting-up countries
(Kurlantzick, 2012). However, the decentralization process in Indonesia is not free from negative
impacts. One of the negative impacts is in terms of significant increase in number of provinces and
districts (pemekaran daerah) 292 district local governments in 1999 to497district local governments
in 2013. Nevertheless, the increasing number of new regions is not accompanied by decreasing
disparities among those regions. One of the reasons for this is the lack of human resources and
infrastructure to deliver public services (Decentralization Support Facility, 2007).
Economic Transformation
The Asian Financial Crisis (AFC) started when Thailand was forced to devalue its Bath. In a matter of
days, the depreciation of Bath had caused the significant depreciation of Indonesian Rupiah. A high
depreciation of Rupiah led to several unpleasant consequences such as increasing domestic debt, high
inflation, increasing unemployment, bank rush, increasing poverty, and increasing government debt.
Economic growth decreased by 13.7%. The crisis hit several sectors hard (McKinsey, 2012), such as
construction (-39.8%), finance (-26.7%), and retail trade, hotel, and restaurant industry (-18.9%). The
crisis also resulted in an increasing level of poverty by 24%.
The immediate impact of Asian crisis could be seen on levels of real output and employment
(Krishnamurty, 2009). Apart from huge negative economic growth (-13.4% in 1998 (Figure 1.1)),
Indonesia has also managed to push its economic growth, entering the recovery process and has been
continuously growing steadily. Even during the Global Financial Crisis in 2008-2009, the Indonesian
economy is one of only a few economies that still managed to have a positive growth, reaching 6%
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during 2008-2009. Although many institutions predicted that Indonesia would be experiencing a slow
down, in the first quarter of 2014, Indonesia still managed to grow by 5.21%.
Figure 1.1
Indonesian Economic Growth (%), 1961 - 2012
Source: www.databankworldbank.org
The Indonesian economic transformation can further be analyzed from the shifting of the main sector
in the economy. Indonesia was previously known as an agricultural country. Starting from the early
1980s, the industrial sectors started to become the main sector in Indonesia. However, since 2000 this
sector has been showing a decreasing trend in its contribution to the economy. The service sector has
started to surpass the industrial sector in 2006 (Figure 1.2). This transformation from agricultural, to
industrial sector, and finally to service sector happened in relatively short time, especially the shifting
from industrial sector to service sector. However, although the contribution of industrial sectors is
decreasing, manufacturing as part of the industrial sector is still the main sector in Indonesian
economy in 2012, followed by agriculture and trade.
Figure 1.2
GDP Indonesia by Sectors
Note: The pie chart shows Indonesian GDP by sector in 2012
Source: Asian Development Bank, Key Indicators
-15
-10
-5
0
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15
1961 1964 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012
0%
10%
20%
30%
40%
50%
60%
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Agriculture Industries Services
Manufacture 25.59%
Electricity, gas, and
water, 0.77%
Public administratio
n, 3.80%
Others, 5.54%
Construction, 6.57%
Mining, 7.36%
Finance, 9.66%
Transport and
communctns, 10.14%
Agriculture, 12.51%
Trade, 18.05%
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On the expenditure side, the Indonesian GDP is dominated by private consumption (Figure 1.3).
Although recently showing a decreasing trend, private consumption still contributed more than 50%
of the GDP (57% in 2012). The dominance of private consumption as the main component of
Indonesian GDP occurred even before Indonesia was hit by the Asian Financial Crisis. This structure
of expenditure shows that for Indonesia, the consumers are the engine of growth. Therefore, since it is
highly dependent of the people purchasing power, high inflation would reduce the purchasing power
and slow down the economic expansion.
Figure 1.3
GDP Indonesia by Expenditure
Note: The pie chart shows Indonesian GDP by sector in 2012
Source: Asian Development Bank, Key Indicators
Indonesia needs to try to search other source of growth and not only depend on private
consumption. Another source of growth that has potential as the next engine of growth is
investment. Figure 1.4 shows the development of investment in Indonesia from 1995 to 2012.
During the crisis, all forms of investments (direct, portfolio, and other type of investments) were
experiencing investment outflows. This condition started to change, showing a positive trend after
2004. Currently, the main investment mode in Indonesia is through direct investment. This is a
change from previous period where the main investment mode is through portfolio investment.
This shift happened since 2010 and continued to go on up to 2012.
-10%
0%
10%
20%
30%
40%
50%
60%
70%
80%
1996 1998 2000 2002 2004 2006 2008 2010 2012
Private consumption Government consumption
Gross fixed capital formation Net Exports of goods and services
Private consumption
56.57%Net Exports of goods
and services,
9.45%
Net Exports of goods
and services 9.45%
Government consumption
8.05%
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Figure 1.4
Investment in Indonesia (million US Dollars)
Source: Key Indicators, Asian Development Bank
The role of international investors are significant, especially in the portofolio investment. The main
investors in portfolio investment through Indonesian capital market are foreign investors (Table 1.1).
Foreign investors hold 57.46% effects compared to 42.54% that are owned by the domestic investors.
Foreign investors mostly hold their effects in the form of equity, mutual fund, and warrant, whereas
domestic investors hold their effects in the form of corporate and government bonds, and Islamic
bonds. The increasing present of foreign investors in the capital market can be seen as trust from
foreign investors. However, the negative aspect of this development is that investments that are
conducted through this mode will have a limited impact on economic growth since it is not directly
connected to the real sector. Therefore, the impact of this type of investments are not directly linked to
decreasing unemployment through job creations. Moreover, financial markets with high foreign
investor presence can be prone to capital flight in the presence of shocks since the capital market is an
open market.
Table 1.1
Composition of Effects´ Owner in Indonesian Capital Market
(By 7 February 2014)
Effects Value (in billion rupiah) Percentage of Total Value
Foreign Domestic Foreign Domestic
1. Equity 1,532,329.40 893,553.70 63.17% 36.83%
2. Corporate Bond 13,852.10 197,148.90 6.56% 93.44%
3. Government Bond 434.60 21,674.20 1.97% 98.03%
4. Warrant 1,015.00 1,367.70 42.60% 57.40%
5. Right 0.00 1.60 0.00% 100.00%
6. MTN 4,939.10 17,297.90 22.21% 77.79%
7. Mutual Fund 1,320.70 600.60 68.74% 31.26%
8. SBSN 150.20 9,632.90 1.54% 98.46%
9. Sukuk (Islamic Bond) 141.00 7,119.00 1.94% 98.06%
10. EBA 0.00 2,325.70 0.00% 100.00%
Total 1,554,182.10 1,150,722.20 57.46% 42.54%
Source: Financial Services Authority, weekly capital market statistics (2014, February 1st week)
In order to improve its investment climate and its competitiveness, Indonesia still needs to carry out
-15,000
-10,000
-5,000
0
5,000
10,000
15,000
20,000
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Direct investment Portfolio investment Other investment
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many improvements. Two indicators on investment conditions and competitiveness are Doing
Business (Table 1.2) and World Competitiveness (Table 1.3). The Doing Business report shows that
Indonesia is still categorized as having a low performance. Indonesia's rank is even lower in 2014
(rank of 120) compared to 2013 (rank of 116). Furthermore, from the components of Doing Business
Rankings, Indonesia is considered to have good investor protection and cross border trade (rank 52
and 54 out of 189 countries). On the other hand, Indonesia still needs major improvement in terms of
starting a business, enforcing contracts, paying taxes, and resolving insolvency, where all of these
aspects are having lower rank than the Indonesia's overall rank. In terms of competitiveness,
Indonesia ranks 38 out of 148 countries, where Indonesia is considered as having a good advantage in
terms of market size. Moreover, based on this competitiveness index, Indonesia still needs to improve
significantly especially in the area of labor market efficiency, technological readiness, and health and
primary education.
Table 1.2
Indonesia's Doing Business Rank
Table 1.3
Indonesia's World Competitiveness Ranking
Topics 2014 2013
Starting a Business 175 171
Dealing with Construction
Permits 88 77
Getting Electricity 121 121
Registering Property 101 97
Getting Credit 86 82
Protecting Investors 52 51
Paying Taxes 137 132
Trading Across Borders 54 52
Enforcing Contracts 147 146
Resolving Insolvency 144 142
Rank Overall (out of 189
countries) 120 116
Aspects 2013-2014
Basic Requirements
Institutions 67
Infrastructure 61
Macroeconomic Environment 26
Health and Primary Education 72
Efficiency Enhancers
Higher education and training 64
Goods market efficiency 50
Labor Market Efficiency 103
Financial Market Development 60
Technological Readiness 75
Market Size 15
Innovation and Sophistications Factors
Business Sophistication 37
Innovation 33
Global Competitiveness Index (out of 148
countries) 38
Source: World Bank (2014) Source: Source: World Economic Forum (2013)
SOCIAL AND CULTURAL TRANSFORMATION
The last population survey conducted in 2010 estimates that Indonesian population is reaching 237
million. This number of population has increased significantly from the previous survey in 2000
which estimated Indonesia's population at 206 million. Although Indonesia continues to increase in
term of total population, the Indonesian population growth is showing decreasing trend, from 1.98%
per year for 1980-1990 to 1.49% per year for the period of 1990 to 2010.
It is predicted that Indonesia will have a demographic bonus in 2025-2030. During this period, the
number of people within the productive age bracket is higher than the number of elderly people and
children (Figure 1.5). Therefore, the dependency index will reach its lowest point and more than 60%
of the population is in the working age. This condition will provide a dynamic workforce for
Indonesia and according to Indonesia Investment Coordinating Board will be one of the highest in the
region.
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Figure 1.5
Predicted Demographic Bonus for Indonesia
2010 2025
Source: Ministry of Finance, state budget (2014)
This situation can lead to opportunities as well as challenges for Indonesia. On one side, Indonesia
will have significant resources for the country's economic development. Moreover, with the majority
of the population at productive age, the burden of the state to provide support will be reduced. On the
other hand, if these resources are not equipped with sufficient skills and education, the high number of
productive age in the population will lead to a drastic increase in unemployment and in the end would
be the burden of the state.
Before the Asian Crisis, there were no or relatively only a few policies targeted at the poor. As a result
of this, many of the poor are excluded from the development outcomes. When the Asian financial
crisis hit in 1997, the poor was directly exposed to this shock resulting in the significant increase of
the number of people living below the poverty line. This impact can be shown from Figure 1.6 where
in 1997 and 1998, there was a significant increase in the number of poor. This showed that at that
time, Indonesia did not have or lack of social protection mechanism. Therefore, when a shocks hits
the economy, in this case the Asian Crisis, there are no protection to prevent people to fall below the
poverty line
In 2013, approximately 11.4% people were living below the poverty line in Indonesia. Above this
number, there are also people that are categorized as vulnerable groups which means they are living
above the poverty line, but very prone to move back to below poverty line whenever a shock
occurred. Moreover, from the perspective of regional disparity, it can be seen that provinces in the
eastern part of Indonesia such as Papua, Maluku, Bali, and Nusa Tenggara tend to have higher level of
poverty rate compared to other provinces (Figure 1.7). Despite the success of Indonesia in reducing
national poverty, the disparity among region is still apparent. The provinces in western part of
Indonesia tend to be more successful in reducing their poverty rate, while others find it quite difficult
to reduce their poverty rate.
Man Woman Man Woman
9
Figure 1.6
Total Number of Poor and Near Poor, 1976 - 2013
Source: Statistics Indonesia
Figure 1.7
Poverty Rate based on Regions (September, 2013)
Source: Statistics Indonesia
In terms of income inequality, the indicators show that the gap between the rich and the poor in
Indonesia is getting wider. From 1990 to 2012, Indonesia's Gini coefficient has risen from 0.33 to
0.41, the highest in Indonesian history (Figure 1.8). The increasing trends of the Gini coefficients
occur consistently in both urban and rural area as well as across regions in Indonesia. Moreover, the
Gini coefficient in rural areas is still and always lower than in urban areas.
Moreover, the inequality are continued to increase across income groups. The increasing gap between
the poor and the rich are driven by the differences in growth of per capita income. The poor only
experiences annual per capita income growth of 2 percent, while the rich is enjoying an annual per
capita income growth of 9 percent.
Figure 1.8
0
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p/1
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r/1
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Number Of Poor People(Million)
Percentage of Poor People
Papua and Maluku, 21.40, 28%
Kalimantan, 6.53
Jawa, 10.24, 13%Sumatera, 11.03
Sulawesi, 12.85
Bali and Nusa Tenggara, 13.99
Million People %
10
Gini Coefficient by Urban and Rural Areas of Indonesia, 1990 - 2012
Source: SEADI and CEDS, 2012
There are several statistics that can be used to monitor the achievements in improving education
qualities, improving health conditions, and alleviating poverty. One of the indicators that is widely
used is Human Development Index (HDI). The HDI is a summary of measure for assessing long-term
progress in three basic dimensions of human development, those are; a long and healthy life
(measured by life expectancy at birth), access to knowledge (measured by expected and mean years of
schooling) and a decent standard of living (measured by GNI per capita) (UNDP, 2013). Figure 1.9
shows the development of Indonesia's HDI from 1980 to 2012.
Figure 1.9
Indonesia's Human Development Index
Source: UNDP, Human Development Report Indonesia, 2012
Figure 1.9 shows that Indonesia has managed to improve all HDI components. life expectancy is
reaching 69.8 with expected years of schooling 12.9 years. The GNI per capita has quadrupled since
1980, reaching 4,154 (using 2005 PPP$ in 2012). However, if we compare to other countries
achievements, it shows that Indonesia still needs to improve more and faster (Table 1.4). Indonesia
has higher rank only if it is compared to Cambodia and Lao PDR.
Table 1.4
YearsLife expectancy
at birth
Expected years
of schooling
Mean years of
schooling
GNI per capita
(2005 PPP$)
1980 57.6 8.3 3.1 1,278
1985 60 9.3 3.5 1,478
1990 62.1 9.9 3.3 1,911
1995 64 9.9 4.2 2,630
2000 65.7 10.3 4.8 2,390
2005 67.1 11.2 5.3 2,950
2010 68.9 12.9 5.8 3,775
2011 69.4 12.9 5.8 3,973
2012 69.8 12.9 5.8 4,154
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HDI Comparison with Asian Countries (2012)
No Countries HDI
(Value)
Rank
of HDI
Life
expectancy at
birth (years)
Mean years
of schooling
(years)
Expected
years of
schooling
(years)
Gross national
income per
capita (2005
PPP $)
1 Indonesia 0.629 121 69.8 5.8 12.9 4,154
2 Japan 0.912 10 83.6 11.6 15.3 32,545
3 Singapore 0.895 18 81.2 10.1 14.4 52,613
4 Brunei
Darussalam 0.855 30 78.1 8.6 15.0 45,690
5 Malaysia 0.769 64 74.5 9.5 12.6 13,676
6 China 0.699 101 73.7 7.5 11.7 7,945
7 Thailand 0.690 103 74.3 6.6 12.3 7,722
8 Philippines 0.654 114 69.0 8.9 11.7 3,752
9 Cambodia 0.543 138 63.6 5.8 10.5 2,095
10 Lao PDR 0.543 138 67.8 4.6 10.1 2,435
Source: Human Development Report 2013, UNDP
12
Environmental Transformation
In terms of environmental aspects, Indonesia is faced with several issues that need serious attentions
and rigorous policy formulation from government and other stakeholders. One of the main issues is
regarding energy provision. Although Indonesia is blessed with abundant energy resources, such as
oil, natural gas, and coal, its energy sectors are still heavily dependent on non-renewable fossil fuel
and natural gas. These non renewable fuels are finite, gradually depleting, and also contribute to the
emissions of greenhouse gas. Moreover, the abundant energy resources that are owned by Indonesia
are often not used fully for energy provision in Indonesia. For example, Indonesia is one of the largest
LNG producer, but most is exported to Japan. This is one of the examples where Indonesia is facing a
trade-off between profit from energy resources export activities and for domestic consumption, what
should be used for domestic demand and what should be exported (Figure 1.10) (Ministry of Energy
and Mineral Resources, 2012).
Figure 1.10
Natural Resources Dilemma
Indonesia is also the third largest emitter of greenhouse gases in the world (World Bank, 2010).
Indonesia's CO2 emissions are showing an upward trend since 1998 (Figure 1.11). However, unlike
industrialized countries, Indonesia's greenhouse gases emissions are mostly as the result of forest fires
and environmental degradation. In 1990, Indonesia’s forest covered close to 65% of the total land
area. By 2011, the forests only covered 52% of the total land area (Figure 1.12). Between 2000 and
2003 the rate of deforestation in Indonesia was about one million hectares per year (Redd, 2012). In
2011 and 2012, the rate doubled to about two million hectares per year. Moreover, many plantations
in Indonesia are created in areas of high conservation forest, that led to the loss of forest ecological
resources and socioeconomic benefit for local people.
The main method of forest clearing for plantations is the burning the forest area. This method not only
significantly contributes to the greenhouse gases emission, but also the smog from the fire causing
hazardous pollution for Indonesia, and its neighboring countries, such as Malaysia and Singapore. In
the last 16 years, the smog from forest fire in Indonesia has shrouded neighboring countries and
increased the pollution standard index up to the hazardous level. Not only impacting the health, the
smog could also hurt the economic sectors in Indonesia and neighboring countries.
Natural resources
Domestic Needs
Energy for Export
Fuel
Electricity
Foreign Exchange
Social Function
Commercial Function
Export
13
Figure 1.11
Indonesia’s CO2 Emissions (Millions of Metric Tons) from 1980 - 2009
Source: Various Source of World Bank Publication and World Development Indicators
Figure 1.12
Forest Area (% of land area)
Source: World Development Indicators, World Bank
The issue of climate change is also another important issues related to environment in Indonesia. It is
widely believed that global climate change will be felt by all countries. Moreover, poor countries will
receive the greatest impact of global climate change despite their contribution to greenhouse gases
emission is least compared to rich countries. The greatest impacts of climate change will be
experienced by the poorest people in the country, especially those who live in areas vulnerable to
flooding, landslides, and drought. The poor lack the assets and flexibility to handle the impacts that
climate change have on productivity. With their limited sources, developing countries will not be able
to mitigate and adapt to the climate change. It is believed that if climate change is not adequately
addressed it will have severe consequences on economic development and the reduction of poverty
(ADB, 2009). It needs global policy and commitment to reduce the impact of climate change to
overcome the problems of climate change.
Indonesia has been identified as one of the most vulnerable Asian countries in the face of climate
change. Indonesia climate change not only has implications for the Indonesia’s environment, it also
affects its economy, development, poor population, and health. It is predicted that climate change will
cost Indonesia approximately between 2.5% to 7% of GDP by the end of this century (World Bank,
0
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0.4
0.6
0.8
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1.2
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1.6
1.8
2
1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010
45.0
50.0
55.0
60.0
65.0
70.0
14
2009). The sectors in the Indonesian economy that will significantly affected by climate change are
agricultural and fisheries (ADB, 2009).
Yet with all programs and mainstreaming the principles into the National Plan, Indonesia has not been
too successful in harmonizing its short-term goals with the long-term development objectives. It
happened particularly when crisis struck (the Asian Financial Crisis 1998 and the Global Financial
Crisis 2008) and the urgency to push for economic recovery was high (See Table 1.5 below, in 2000
and 2008 total natural resource rent as percentage of GDP in Indonesia was increased significantly).
Another problem for implementation came from decentralization and regional autonomy. Central
government must work together with local regions in order to conduct programs at grass-root level.
Table 1.5
Towards Sustainable Development, Indonesia 1990-2012
Electricity prod. fr
renewable sources,
excl hydroelectric
(% of total)
GDP per unit of
energy use (PPP
$ per kg of oil
equivalent)
CO2
emissions
(metric tons
per capita)
Forest area
(% of land
area)
Total natural
resources
rents
(% of GDP)
Fossil fuel
subsidy
(% of
GDP)
1990 3.44 2.73 0.84 65.44 13.52 n/a
1995 3.74 3.39 1.16 60.16 8.63 n/a
2000 5.22 3.22 1.26 54.87 14.62 n/a
2005 5.20 3.93 1.52 54.02 15.37 n/a
2007 4.96 4.58 1.63 53.26 13.87 2.10
2008 5.59 4.85 1.76 52.88 15.91 3.00
2009 6.01 4.78 1.91 52.51 8.38 0.80
2010 5.60 4.85 1.80 52.13 8.45 1.30
2011 5.25 5.33
51.75 8.90 2.20
2012 n/a n/a n/a n/a 7.13 1.60
Source: World Bank Database, 2013
To overcome the above environmental problems, there are several key strategic elements that are
important to be addressed (Jupesta, 2011), those are reducing oil subsidies, improving green
technologies, supporting a sustainability transition through improving skills and capabilities of
workers, improving the international cooperation, and transparent and responsible accounting
framework involving social, economic and environment indicators. Moreover, to achieve green
economy, there are four energy policies that are planned to be implemented (Sitompul, 2013)
1. Energy conservation, intended to increase energy efficiency on supply and demand side, e.g.
industrial, transportation, household, and commercial sector
2. Energy diversification, intended to increase the share of new and renewable energy use in
national primary energy mix consisting of new energy (liquefied coal, nuclear, and
hydrogen) and renewable energy (geothermal, hydro, solar, wind, and ocean wave)
3. Energy price, in this case the administered oil price where the government tries to reduce the
oil subsidy by various policies, where increasing oil price is one of the options.
4. Environmental degradation which currently continued in an alarming rate
The current condition in Indonesia is the result of a long transformation. However, as already
discussed above, Indonesia as one of emerging developing countries, still have lots of homework to be
solved. One of the most significant issues is how to have and maintain the financing for a stable and
sustainable economic development. The next section (Section 2) will discuss the various financing
options in Indonesia and their current conditions.
15
Section 2: Financing Options for Indonesia
The financing options in Indonesia is growing as the financial sector in Indonesia develops. Until the
early 1980s, Indonesia’s financial system was heavily controlled by the government. The role of the
government was quite broad, from establishing the interest rate to setting strict geographic restriction
on private banks’ branching. Moreover, under this mechanism, the saving rate and aggregate
investment level were quite low. The government realized this condition would not be conducive to
support the economic growth.
During those period, the main goal of Government of Indonesia (GoI) budget policy was to maintain a
balanced budget (Anggaran Berimbang). Balanced budget means keeping government revenue and
expenditure in balance, including revenue sources from foreign aid and borrowing (Asher and Booth,
1990). When the budget was not in balance, the GoI will counterbalanced it with increasing foreign
aid and borrowing in order to maintain a balanced budget. In this case, balanced budget policies tried
to avoid financing the deficit through money creation.
Moreover, GoI also played an important role in the financial system. Official Development Assistance
(ODA) and private capital (Foreign Direct Investment/FDI, portfolio investment, and Debt) was under
GoI supervision. There were no incentive mechanism for the public to put their money in the banking
sector and the rate of saving were low .
There is public and private finance. Private finance includes credit from private sector/commercial
bank lending, Foreign Direct Investment (FDI), and Portfolio Investment. Meanwhile the main source
of public finance is domestic revenue, such as tax, non-tax, and government bond, and foreign
revenue.
Domestic private financing
The national private financing for Indonesia can be divided into domestic savings and domestic loans.
Domestic savings can play a key role in development financing since the domestic saving can provide
resources to finance the investment, increase financial (or capital) market development, stimulate
economic growth, and maintain the living standards. Countries with higher economic growth usually
have high savings ratios (Rodrik, 1998; and Hammouda and Osakwe, 2006). However, the domestic
savings in Indonesia are considered as inadequate to meet Indonesia investment needs. Therefore,
other sources of financing are needed to close this financing gap.
Another source of financing for development in Indonesia is loan in capital markets. Capital markets
have important and strategic roles in providing sources of funds for economic development. Efficient
capital markets would lower the cost of mobilizing savings and facilitating investments to the
productive sector (Greenwood and Smith, 1996). The international risk sharing through
internationally integrated stock markets improves resource allocation and accelerates growth
(Obstfeld, 1994). Moreover, capital market development will contribute to economic growth both
directly, for example through market liquidity or turnover ratio, and indirectly, such as through market
size or capitalization ratio
The development of Indonesian capital market can be seen in Figure 2.1. The market capitalization
has significantly increased since 2004, although it experienced a drop during the Global Crisis in
2008. Indonesian state-owned enterprises (SOEs) also play a major part in the Indonesian capital
market. In 2010, listed SOE contributed 29.5% of the total market capitalization on Indonesia Stock
Exchange. Among ten biggest market capitalization in Indonesian Stock Exchange, five come from
SOEs (MoF, 2011).
16
Figure 2.1
Market Capitalization and Total Value of Stocks Traded in Indonesian Capital Market, 1990 -
2012
Source: www.databankworldbank.org
Note: - Market capitalization of listed companies as % of GDP (left axis)
- Value of stock traded (left axis)
- Market capitalization of listed companies (right axis)
Despite positive progress, capital market share still shallow. Deepening them would help maintain
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23
-
50.00
100.00
150.00
200.00
250.00
300.00
350.00
400.00
450.00
0.00
10.00
20.00
30.00
40.00
50.00
60.00
Market capitalization of listed companies (current billion US$)
Market capitalization of listed companies (% of GDP)
Stocks traded, total value (% of GDP)
Billion US$ %
Box 1. Banking Deregulation to Mobilize Private Financing
Before 1983, banking sector in Indonesia was relatively small, consisting of Bank of Indonesia as
Central Bank and regulator with several state-owned bank. Some private banks did exist, but very
limited in terms of permitted activities and capitalization. The financial system was able to utilize
the abundant funds from foreign aid and the soaring revenue of the 1970s’ oil boom.
The decline of oil price pushed the government to radically alter the previous banking structure. In
order to facilitate private financing needed for private sector activities, the government of
Indonesia introduce several deregulation reform in promoting banking industry. The financial
reform in 1983 and the second reform of 1988 transferred Indonesia’s fund allocation principle,
with deregulation and liberalization at the core, from the government to the market. The third
reform in 1991 turned the attention to prudential regulation and the government started to pay
close attention to soundness in banking practice.
The deregulatory package in 1983 included the abolishment of credit ceiling, the ability for banks
to determine their own interest rate, and the removal of 20% tax on interest earned by foreign-
currency- denomination deposits. The Bank of Indonesia also introduced several inter-banking
credit facilities to help liquidity problems of banks. These were followed by 1988’s policy
package which lift up the restriction to establish new private banks (previously set in 1968), as
well as reduce the capital requirement of new banks, while at the same time allow private banks to
open branches nationwide. Foreign banks were also admitted into Indonesia’s banking system.
The result was that the number of banks increased tremendously from 111 in 1998 to 240 in 1994.
The third reform in 1991 was intended to tighten the prudential regulations. However, poor
implementation of those regulations lead to the weakening control to banking system and
increased their vurnerability, which would be the major source of banking crisis in Indonesia
during the (AFC).
17
financial stability in the medium term and ease access to finance, especially for small firms. A wider
range of instruments has been provided, and banking sector has been encouraged to carry out more
transactions in the wholesale markets. However, there are segments on the financial markets, such as
venture capital and micro-finance that remain insufficiently developed.
Moreover, the level of participation in the Indonesian capital market is particularly low compared to
several advanced and emerging countries in Asia (Table 2.1). The number of investors in the capital
market in Singapore and Hongkong is 60% and 17.5% of their total population, respectively.
Meanwhile, in the case of Indonesia, the number of investors is only around 0.14% of the total
population.
Table 2.1
The Number of Investors and Population in Several Asian Countries
Country Population
(Million)
Number of Investors in
Capital Market
(Million)
Number of Investors in
Capital Market (% of
Population)
Singapore 5.08 3.05 60.00
Hongkong 7 1.23 17.50
Malaysia 28.9 3.61 12.50
South Korea 49.1 4.17 8.50
Japan 127.53 10.2 8.00
Indonesia 238 0.33 0.14
Source: Indonesian Ministry of Finance (2011)
International private finance
Another alternative for development financing is through international private financing options. One
of the main sources of this type of financing is through Foreign Direct Investment (FDI). FDI is
considered an important source of financing for developing countries, since FDI is more stable and
has less risk than other international financing options, such as portfolio investment or foreign debt. In
addition, FDI is not easily influenced by the fluctuation of exchange rate.
Various studies have discussed the effects of FDI in an economy. FDI is believed to be a source of
economic growth (Balasubramanyan et al., 1996 and Borenszteinet al., 1998). FDI will promote
economic growth through strengthening human capital (Romer, 1990). The role of FDI in the
economy occurs through direct and indirect effects (Piyaareekul, 2008). The direct effects of FDI
consist of increasing capital formations, employment or job creations, and increasing trade volume
(Figure 2.2). Meanwhile, the indirect effects of FDI consist of increasing local productivity, transfer
of knowledge, technology, and management skills for the host country. Several studies have been
discussing the role of FDI in the Indonesian economy and conclude that FDI have positive effects on
Indonesian economic growth (Khaliq and Noy, 2007). It can also be seen that high level of FDI can
generate high level of economic growth, and vice versa, a high level of economic growth can generate
high level of FDI (Pradhan, 2009).
18
Figure 2.2
Foreign Direct Investment Flow
FDI in Indonesia is intertwined with Indonesian financial deregulation policies. By adopting a fixed
foreign exchange rate system in 1970 and followed by further liberalization of the financial sector in
1980s, Indonesia has become an attractive destination for foreign investment. Indonesia changed the
system from fixed exchange rate that is pegged to US Dollars to managed floating exchange rate since
the Asian Crisis 1997. As the result, Indonesian FDI has increased steadily since the early 1990s. It
increased significantly in 1995 to 1997 (Figure 2.3). After the Asian Financial Crisis, Indonesia was
experiencing FDI outflows from 1998 to 2001, where the highest outflow occurred in 2000. In 2002,
Indonesia managed to have a substantial FDI inflow, and, afterwards in 2003, Indonesia experienced
another net FDI outflow. Indonesia started to have net FDI inflow since 2004, and until 2012 the total
amount of net inflow FDI continues to increase.
Figure 2.3
Foreign Direct Investment in Indonesia
Source: World Development Indicator, World Bank
Note: - FDI in million USD (left axis)
- FDI as % of GDP (right axis)
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
-4.0
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
-25,000.0
-20,000.0
-15,000.0
-10,000.0
-5,000.0
0.0
5,000.0
10,000.0
15,000.0
20,000.0
25,000.0
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
FDI (million US$) FDI (% of GDP)
19
Table 2.2 shows the development of net FDI inflow among Asian countries. In 1982, the Indonesia’s
net FDI inflow was lower than that of Singapore, Malaysia, Japan, and China. However, by 2012, the
Indonesian net FDI inflow had significantly increased. Only China and Singapore that have higher net
FDI inflow than that of Indonesia.
Table 2.2
Comparison of Net FDI Inflow in Various Asia Countries
In million USD
Country Name 1982 1990 2012
China 430.00 3,487.00 253,474.94
Singapore 1,601.85 5,574.74 56,651.07
Indonesia 225.00 1,093.00 19,618.05
Thailand 190.87 2,443.55 10,689.32
Malaysia 1,397.20 2,332.46 9,733.62
Vietnam 13.05 180.00 8,368.00
Korea, Rep. 69.00 788.50 4,999.00
Philippines 16.00 530.00 2,797.00
Japan 440.00 1,777.36 2,525.41
Source: www.databankworldbank.org
Domestic public finance
The Government of Indonesia also plays a significant role in financing for development. The
government policies to achieve the national development goals are conducted through implementing
policies related to government revenue, government expenditure, and government financing. The
government revenue policies are focused on optimizing the revenue from tax and non-tax sectors that
include continuing basic taxation policies, intensifying tax potential exploration, and improving
supervision and services in customs sector. Table 2.3 shows the State Budget on tax and non-tax
revenue both from domestic and grants. The figure shows that the domestic revenue continues to
increase in an upward trend. Figure 2.4 also shows that the revenue from Grants on the other hand
shows a downward trend since 2012. This is due to the GoI policy to reduce dependency on foreign
sources while at the same time strengthening domestic capital market.
20
Figure 2.4
Actual Revenue (trillion rupiah)
Source: Ministry of Finance
Notes: ** shows estimated values
The main revenue of government financing comes from domestic tax and natural resources (Table
2.3). The natural resources revenue is the revenue from the usage of natural resource, which one of its
form is royalty that is paid to the government from fisheries, forestry, and mining sector. Table 2.3
shows that the domestic tax revenue in 2009 was Rp 619.92 trillion, and continued to increase to
Rp1,192.99 trillion in 2013 or 74.2% of the total government revenue. The main tax revenue comes
from Income Tax and Value Added Tax. Table 2.3 also shows a significant role of revenue from
natural resources, although it is showing a decreasing trend.
Table 2.3
Indonesia’s Government Revenue 2009 - 2013 (In trillion rupiah)
Item 2009 2010 2011 2012 2013
Value* % Value* % Value* % Value* % Value* %
I. Domestic Revenues 847.10
992.25
1,205.35
1,357.38
1,525.19
1. TAX REVENUES 619.92
723.31
873.87
1,016.24
1,192.99
a. Domestic Tax
Revenues 601.25 70.8% 694.39 69.8% 819.75 67.7% 968.29 71.3% 1,134.29 74.2%
b. International trade tax 18.67 2.2% 28.91 2.9% 54.12 4.5% 47.94 3.5% 58.70 3.8%
2. NON-TAX REVENUES 227.17
268.94
331.47
341.14
332.20
a. Natural Resources 138.96 16.4% 168.83 17.0% 213.82 17.7% 217.16 16.0% 197.20 12.9%
b. Profit transfer from SOE's
26.05 3.1% 30.10 3.0% 28.18 2.3% 30.78 2.3% 33.50 2.2%
c. Other non-tax revenues 53.80 6.3% 59.43 6.0% 69.36 5.7% 72.80 5.4% 77.99 5.1%
d. Revenue from BLU 8.37 1.0% 10.59 1.1% 20.10 1.7% 20.41 1.5% 23.50 1.5%
II. Grants 1.67 0.2% 3.02 0.3% 5.25 0.4% 0.83 0.1% 4.48 0.3%
Revenues and Grants 848.76 100.0% 995.27 100.0% 1,210.60 100.0% 1,358.21 100.0% 1,529.67 100.0%
Source: Ministry of Finance (2014)
During the oil boom in 1980s, Indonesia enjoyed a significant improvement in revenue mainly from
oil. When the oil market collapsed in the middle of 1980s, the government started to look for other
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
(1)
-
1
2
3
4
5
6
7
-
200
400
600
800
1,000
1,200
1,400
1,600
1,800
Domestic Revenues Grants
21
sources of funds. To overcome the decrease in revenue, government started tax reform with the
purpose of generating more revenue from taxes as substitution for oil revenues. The two big steps in
the 1985 tax reform were the introduction of value added tax and self assessment system in income
tax. This has improved the economy’s performance by increasing the funds available for urgently
needed public expenditure items and by easing the burden on tax payers.
Figure 2.5 shows that tax revenue in Indonesia is higher than the non-tax revenue. Moreover, the
difference between these revenues is getting wider. Currently, GoI have a wide variety of taxes with
varying impacts on income distribution, such as income tax, Value Added Tax (VAT), property tax,
acquisition duty of right on land and building (Bea Perolehan Hak atas Tanah dan Bangunan-
BPHTB), excise tax (cukai), and other tax. As shown by Figure 2.6, income tax was the main source
of Indonesian government revenue compared to the others tax.
Figure 2.5
Comparison Tax and Non-Tax Revenue,
1996-2012 (% of GDP)
Figure 2.6
Indonesian Tax Revenue, 1991 - 2013
(in trillion rupiah)
Source: Key Indicators, Asian Development Bank Source: Indonesian Financial Statistics, Bank of Indonesia
Figure 2.7
Realization Government Non-Tax Revenue, 1991 - 2013
(in trillion rupiah)
Source: Indonesian Financial Statistics, Bank of Indonesia
*) Based on state budget
0%
5%
10%
15%
20%
25%
30%
35%
40%
Tax revenue Non-tax revenue
-100
0
100
200
300
400
500
600
700
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013*
Income Tax Value Added Tax Property Tax
BPHTB Excise Tax Other Tax
Import Tax Export Tax
-50
0
50
100
150
200
250
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012*
2013*
Natural Resource
Profit Transfers fromStated OwnerEnterprises (SOE's)
Surplus form BankIndonesia
Revenue from PublicService Institution
Other Non-taxRevenues
22
Government revenues from non-tax revenue are dominated by revenue from natural resources
compared to others, such as profit transfers from Stated Owned Enterprises (SOE's), surplus form
Bank Indonesia, revenue from public service institution, and other non tax revenues. Natural
resources revenues are revenues from oil, gas, and other natural resources including mining, forestry,
fishery, and geothermal. Oil is the main source of revenues collected from natural resources sector
with contribution of 72.58% on average during 1991 - 2013 (see Figure 2.8). Despite of dominance of
oil revenues on government revenue from natural resources, but the trend shows decreasingly (see
Figure 2.9). Oil revenue in 2013 amounted to 61.3% of total revenue from natural resource, decreased
significantly from early 1990s when oil revenue contribution to the total revenue from natural
resource reaching 93.70%. The second main source of natural resources is from natural gas. This is
consistently increasing both in terms of value and contribution to total revenue from natural resources
(see Figure 2.8 and 2.9). Gas revenue is significantly increasing from 6.30% in early 1990s to 27.36%
of total revenue from natural resource in 2013.
Figure 2.8
Comparison Oil, Gas, and Other Natural
Resources Revenue, 1991 - 2013
(in trillion rupiah)
Figure 2.9
Comparison Oil, Gas, and Other Natural Resources
Revenue, 1991 - 2013
(% of total revenue from natural resources)
Source: Indonesian Financial Statistics, Bank of Indonesia
*) Based on state budget
This option to increase revenue from tax is still feasible since Indonesia still has low tax-to-GDP ratio,
narrow tax base, and low tax ratio. Although it has increased over the years, the Indonesia tax-to-GDP
ratio is less than 12%, which is quite low by international standards (Figure 2.10). To a large extent,
this reflects widespread informality and tax evasion. Moreover, in 2013, the Indonesian tax ratio is
12.2%. This ratio has been steadily improving since 2009 (Figure 2.10).
-20
0
20
40
60
80
100
120
140
160
180
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013*
Oil Revenue Natural Gas Revenue
Other Natural Resource Revenue
-10%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013*
Oil Revenue Natural Gas Revenue
Other Natural Resource Revenue
23
Figure 2.10
Indonesia’s Tax Revenue and Tax Ratio, 2008 - 2013
Source: Ministry of Finance, State budget (2014)
Moreover, Indonesia’s tax rate is still low compared to both regional and OECD countries. The ratio
of general government tax revenues to GDP was 12.6% in 2011, slightly lower than in 2008, and one
of the lowest in the G20 countries. For comparison, several of the more developed ASEAN countries
collected more than 15% of GDP in tax revenues in 2009, and the OECD’s countries average was at
33.8% of GDP (exc. non-tax revenues). The IMF estimate of the maximum tax revenue that Indonesia
could achieve by broadening the tax base and enhancing compliance at current rates is 21.5% of GDP
(IMF, 2011).
The challenges for increasing the tax ratio in Indonesia come from many aspects: governance,
monitoring illicit work, tax evasion, efficiency, tax collection, tax payer identification, and corruption.
If these issues are not addressed properly, the government will find it difficult to increase the tax to
GDP ratio.
Another alternative to increasing tax rates and increasing tax revenues is through broadening the tax
base. The rise of the middle class and the high number of informal sectors in Indonesia offer an
opportunity for the government to broaden the tax base. According to the Statistics Indonesia (Badan
Pusat Statistik/BPS) 68% of Indonesian was employed in informal sector in 2009. Currently,
Indonesia is experiencing a rapid expansion ofitsmiddle class, which has helped to transform the
country's consumer market. The population of middle-class Indonesian reaches 74 million. It is
estimated that by 2020, that number will increase by two-fold, reaching 141 million people.
Businesses can expect to capitalize on both the strong purchasing power and the high labor skills of
the middle class.
The expenditure side of the State Budget is shown in Figure 2.12. The expenditure in Figure 2.11 is
divided between the central government expenditure and local government expenditure. Figure 2.11
shows that the actual expenditure both for central and local governments has increased steadily.
Moreover, it can also be seen that after the implementation of decentralization, there is a gap that
becomes wider between the expenditure of central government and local governments. It means that
the growth of central government expenditure is faster thanthat of the local governments.
1 2 3 4 5 6
10.0
10.5
11.0
11.5
12.0
12.5
13.0
13.5
0
200
400
600
800
1,000
1,200
1,400
2008 2009 2010 2011 2012 2013
In trillion rupiah %
24
Figure 2.11
Actual Expenditure (trillion rupiah)
Source: Ministry of Finance
Notes: ** shows estimated values Table 2.4
Central Government Expenditure, 2011 - 2013
Item
2011 2012 2013
Rp
(billions) %
Rp
(billions) %
Rp
(billions) %
1. Personnel Expenditure 175,738 19.89 212,255 19.85 241,606 20.93
2. Material Expenditure 124,640 14.1 162,012 15.15 200,735 17.39
3. Capital Expenditure 117,855 13.34 176,051 16.46 184,364 15.97
4. Interest Payment 93,262 10.55 117,785 11.01 113,244 9.81
a. Interest of Domestic Debt 66,825 7.56 84,749 7.92 80,703 6.99
b. Interest of Foreign Debt 26,437 2.99 33,036 3.09 32,541 2.82
5. Subsidy 295,358 33.42 245,076 22.91 317,219 27.48
a. Energy 255,609 28.92 202,353 18.92 274,743 23.8
b. Non Energy 39,749 4.5 42,723 3.99 42,476 3.68
6. Grant Expenditure 300 0.03 1,791 0.17 3,621 0.31
7. Social Assistance 71,104 8.05 86,028 8.04 73,609 6.38
a. Natural Disaster Rescue 3,978 0.45 4,000 0.37 4,000 0.35
b. Ministry/institution
Assistance 67,126 7.6 82,028 7.67 69,609 6.03
8. Other Expenditure 5,465 0.62 68,535 6.41 19,983 1.73
T o t a l 883,722 1,069,534 1,154,381
Source: Ministry of Finance, State Budget (2013)
-
200
400
600
800
1,000
1,200
1,400
1,600
1,800
2,000
Central Governement Expenditures Regional Budget Expenditures
25
Figure 2.12
Government Subsidy and Capital Expenditure (2007 - 2013)
Source: Ministry of Finance (2013)
In Indonesia, government expenditures are dominated by personnel expenditure (civil service
expenditure) and subsidies. In 2013, these two components cover 48.41% of total government
expenditure. Total personnel expenditure in 2013 is Rp241 trillion, and total subsidies expenditure is
Rp317 trillion. This means that the Indonesian budget are mainly used for operational and subsidies,
while the allocation for development itself (through capital and goods and services expenditure) is
lower compared to the expenditure for personnel and subsidy. (Table 2.4 and Figure 2.12).
Figure 2.13
Budget Allocation of Local Government (2013)
Source: Ministry of Finance (2013)
From the figure above, it can be seen that government revenue is generally lower compared to its
expenditure. This difference means that the government needs additional financing to close the gap
and finance its activities. The type of financing can be divided into two categories based on the origin,
1 2 3 4 5 6 7 8
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
0
50
100
150
200
250
300
350
400
2007 2008 2009 2010 2011 2012 2013 (StateBudget)
2013(Revised
StateBudget)
Subsidy (Billion rupiah) Capital expenditures (Billion rupiah)
Subsidy (% of State Budget) Capital expenditures (% of State Budget)
Personnel Exp. 49%
Transfers 1%Grants
3%
Others 3%
Good and
Services Exp. 20%
Capital Exp.26%
26
that is domestic financing and foreign financing. The actual financing of the State Budget can be seen
in Figure 2.14. The figure shows a decreasing trend of Indonesia’s foreign financing. From 2000, the
government has started to repay its foreign debt, which is the source of foreign financing. On the other
hand, the domestic financing is experiencing a significant increase which shows that the government
prefers to use the domestic market as its financing source.
Figure 2.14
Actual Financing (trillion rupiah), 1990 - 2014
Source: Ministry of Finance
Note:
- The figure represents the value in the state budget, not the realization
- Negative numbers indicate that the loan repayment greater than the withdrawal
The use of foreign financing in the form of foreign debt by Indonesians (especially GoI) to finance
development started in 1966 due to lack of domestic resources. In the mid of 1960s, Indonesia’s
foreign debt reached $2,015 million (Cholifihani, 2008). Along with the implementation of
deregulation in financial sector that allows the private sector to borrow from external sources,
Indonesia’s debt (both government and private sector) started to increase. Indonesia’s Debt to GDP
ratio reached almost 100% in 1998 as the impact of Asia’s crisis. However, the government has been
able to lower its debt to GDP ratio, reaching 22.9% in 2012 (Figure 2.15). At the moment, the ratio of
Indonesia government debt to GDP is relatively low and experiencing the fastest reductions compared
to other countries, including developed countries (Figure 2.16).
(300)
(200)
(100)
-
100
200
300
400
500
600
700
199
0
199
1
199
2
199
3
199
4
199
5
199
6
199
7
199
8
199
9
200
0
200
1
200
2
200
3
200
4
200
5
200
6
200
7
200
8
200
9
201
0
201
1
201
2
201
3*
201
4**
Domestic Financing Foreign Financing
27
Figure 2.15
Indonesia’s Government Debt to GDP Ratio, 1972 -
2011
Figure 2.16
Debt to GDP Ratio (2013 )
Source: Ministry of Finance Source: Ministry of Finance (2014)
The underlying motivations to reduce Indonesia’s foreign debt include:
1. Increasing pressure of debt repayment due to foreign exchange fluctuation;
2. Decreasing ability to pay due the increase of Debt Service Ratio (DSR);
3. Increasing ability to foster foreign debt that will decrease the ability to foster domestic
capacity; and
4. Large foreign debt that could affect public expectations through an assessment of the
economic outlook.
5. Large foreign debt will bring a negative impact on the business sector and the national
economy.
Learning from previous experience in managing external debt and in order to improve the debt
structure, the government has tried to alterits debt composition to be more dominated by domestic
debt. This policy is in line with empirical studies ofReinhart, Rogoff and Savastano (2003), and
Santoso (2004) that stated the ideal foreign debt to GDP ratio to prevent sovereign debt crisis is 15-
20%. The switching process from foreign debt to domestic debt can be seen in Figure 2.15.
Financing the deficit using domestic debt is conducted by the additional issuance of Surat Berharga
Negara (SBN) and withdrawal of loan programs. At the end of 2013, there was a significant increase
in government debt outstanding of 20% from 2012. The increase in outstanding government bonds
due to the SBN issuance both in the global and domestic markets, meanwhile the increase of
outstanding loans is caused by the depreciation of the rupiah against the foreign currency since more
than 99% of outstanding loans denominated in foreign currency.
Therefore, by the end of 2013, there is a change in the composition of government debt, the portion of
SBN instruments increased to 70.0% while the share of loan instruments decrease to 30.0% (Table
2.5).This is due to the government's debt financing strategy that prioritised debt financing through the
issuance of government securities compared with loan withdrawal.
% Debt/GDP,
2012, 22.90
0
20
40
60
80
100
120
1972 1977 1982 1987 1992 1997 2002 2007 2012
1972 1973 19741975 1976 1977
Debt/GDP threshold based on law No. 17/2003
28
Table 2.5
The Development of Government Debt
2009 2010 2011 2012 2013
SBN 62% 63% 66% 69% 70%
Loan 38% 37% 34% 31% 30%
Total Debt (Rp) 100% 100% 100% 100% 100%
Source: DMO Ministry of Finance, 2014
Indonesia Government Securities (Surat Berharga Negara/SBN) consists of Government Bonds
(SUN) and Sharia Government Bonds (SBSN). Government Bonds (SUN) are securities in the
form of acknowledgement of indebtedness in rupiah and foreign currency secured by the
payments of interest and principal amount by the State of the Republic of Indonesia, according to
their validity period, as referred to in the applicable laws.
Indonesia has also tried to implement other alternative methods to finance its development. One of the
options is through Public Private Partnerships (PPP) and Municipal/Local Government Bond. There
are several PPP opportunities in infrastructure in Indonesia are potential to develop in the nearest
future, such as (Strategic Asia and UK Foreign Commonwealth Office, 2012):
1. The drinking water sector (facility for raw water extraction, transmission network,
distribution network, drinking water management installation);
2. The transportation sector (port, airport, railway and train station);
3. The road sector (toll roads and toll bridges);
4. The electricity sector (power plant, transmission and electricity power distribution);
5. The oil and natural gas sector (processing, storing, carrying, transmission or distribution);
6. The waste management sector (wastewater management installation, carrier and disposal
sites);
7. The irrigation sector (pipeline for raw water);
8. The telecommunication sector (telecommunication network).
Although potential to be develop in the future, some of the PPP schemes are still constrained by the
difficulty of land acquisition, regulatory uncertainties, and lack of funding. There are numerous
attempts by the government to attract private sector involvement into the schemes. However, the
number of projects funded to date is close to nothing (CEDS, 2012). For example, none of 99 projects
offered to the private sector in 2005’s Indonesia Infrastructure Summit were executed. This is similar
tothe case of 200 projects offered during 2008’s Indonesian Regional Investment Forum..
Securing contracts from the private sector to commit securing long term investment is not easy. There
are several barriers and challenges in implementing PPP projects in Indonesia, such as:
1. Land acquisition problems;
2. Lack of local government capacity on PPP mechanism and implement procedures;
3. Unclear procedures or mechanism for private sector to enter the PPP market;
4. Contradicting and overlapping regulations among government regulations;
5. Poor governance coordination among government institutions; and
6. In conducive business environment that causes inadequate business environment for GoI to
promote PPP.
29
The PPP mechanism has been implemented by local governments. However, without proper
monitoring mechanism and adequate capacity building from local governments, this will bring a more
complicated problem in setting infrastructure PPP scheme to work. Low capacity building of local
government civil service will hamper the continuation of the PPP coordination. Moreover, it also
needs good coordination and robust policies to manage PPP schemes.
The current conditions and the development of financing options in Indonesia has been discussed in
this section. However, there are several aspects of developments that need a deeper discussions
regarding the financing options for those aspects. Those aspects are, among others, human capital,
physical infrastructure, and environment capacity. The detail on financing human capital, physical
infrastructures and environment capacity developments in Indonesia, especially regarding their past
and current conditions will be discuss thoroughly in the next section (Section 3).
30
Section 3: Financing Human Capital, Physical Infrastructures and
Environment Capacity Developments
In this Chapter, it would be discussed how Indonesia improve its human capital formation and
physical infrastructure over the years as they are the key enablers to stellar performance of the
Indonesian economy. In addition to human capital and physical infrastructures, there have been lots of
programmes and policies designed to support sustainable development by enhancing environmental
carrying capacity. Along with those, there have been lots of resources and financing options dedicated
to those plans. It would be interesting to see the impacts of such programs to the achievements of
MDGs in 2015 for Indonesia.
Human Capital Formation
Sustained economic growth is always associated with high labour productivity growth. Labour has
been the main driver of economic growth anywhere, both in terms of quantity and quality. Since the
start of the New Order Government in 1967, development of human capital has always been
mentioned to be top priority in its long-term development plans.
Since 1984, the Government of Indonesia had implemented 6-year compulsory education. At the 10th
anniversary of the program, in 1994, the Government extended the coverage to students aged 12-15
years old. Another milestone in education policy was set in 2002 when the amendment of 1945
Constitution mandated the government to allocate 20% of annual government budget to education
spending. Followed by Act no 20/2003, the 20% allocation to education sector has been fully
achieved since 2009.
Table 3.1
Selected Indonesian Education Indicators, 1990-2011
Year School enrollment rate,
primary (net)
Persistence to last grade of Primary
School (% of cohort)
1990 97.86 79.71
1991 96.93 79.80
1992 96.05 79.91
1993 94.81 84.55
1994 95.32 87.00
1995 95.11 89.23
1996 93.96 89.32
1997 93.87 87.05
2001 93.19 85.89
2002 92.71 86.37
2003 92.09 85.10
2004 91.21 83.45
2005 90.41 N/A
2006 93.37 N/A
2007 95.38 79.98
2008 94.57 87.87
2009 94.92 91.80
2010 94.90 88.00
2011 93.67 N/A
Sumber: World Development Indicators (World Bank)
31
Table 3.2.
Literacy Rate Among Youth (Age 15-24)
Year Literacy rate youth male (age 15-24) Literacy rate youth female (age 15-24)
1990 95.07 97.40
2004 98.54 98.87
2006 96.27 97.03
2008 99.38 99.54
2009 99.40 99.55
2011 98.75 98.80
Sumber: World Development Indicators (World Bank)
In terms of access to school, net enrollment rate for Primary School has reached 95.55% in 2011,
improved from 88.7% in 1992. While improving so much, this indicator only described easy access to
school but needs to be complemented with another indicator that reflects school retained rate.
Similarly high school retained rate indicates minimum drop-out rate which also means school system
has improved its internal efficiency to retain students until primary school graduation. In 1990, the
proportion of grade 1 students who graduated from primary school was only 62%, and in 2011the
proportion reached 96.6%1. On the other hand, literacy rate progressed from 96.6% in 1990 to 98.8%
in 2011 with female and male literacy rate reached 98.8% and 98.8% respectively.
The successful achievement in education has been largely supported by provision of education
facilities at primary level through BantuanOperasionalSekolah (BOS)/School Operational Assistance
funding. This programme began in 2005 and was also designed to subsidize school tuition for students
from low-income families. Up to 2011, BOS funding has covered more than 42.1 million students. In
addition to BOS funding, the Government disbursed Dana Alokasi Khusus (DAK)/Special Allocation
Fund for primary and secondary school since 2003. DAK was used to rehabilitate damaged
classrooms and school buildings, and to build other school facilities such as libraries and school labs.
The Government also conducted teachers’ trainings and accelerated certification program. In 2011,
there was a special allowance budget to support teachers’ welfare (TunjanganProfesi Guru/Teacher
Professional Allowance).
Table 3.3
Government Spending on Education, 2006-2012
Year
Government spending on
education (in IDR billion)
Public spending on education
(% of government expenditure)
Public spending on
education (% of GDP)
2006 45,303.9
2007 50,843.4 14.98 3.04
2008 55,298.0 13.63 2.90
2009 84,919.5 19.31 3.53
2010 90,818.3 16.42 2.99
2011 91,001.3 14.99 2.77
2012 95,599.6
Sumber: Ministry of Finance and World Bank
In terms of health financing, recent data showed that the government budget for healthcare has
increased overtime. However, its proportion in total government budget is relatively low compared to
other items in the budget such as energy subsidy and education budget (which is mandated by Law to
obtain 20% of government budget annually). In 2006, government budget on healthcare was only
5.3% of total budget. Despite all the programmes and spending on human capital formation,
Indonesia’s labour productivity is lagging behind that of its neighboring countries.
Table 3.4
1Laporan Pencapaian Tujuan Pembangunan Milenium di Indonesia 2011, Bappenas 2011 p. 31
32
Health Spending, Private and Public, 1995-2012
Year Health Expenditure,
Private (% of GDP)
Health Expenditure, Public
(% of GDP)
Health Expenditure, Public
(% of govt expenditure)
1995 1.26 0.70 4.75
1996 1.27 0.73 4.71
1997 1.26 0.68 3.89
1998 1.37 0.71 3.93
1999 1.49 0.79 3.74
2000 1.25 0.71 4.47
2001 1.27 0.96 4.65
2002 1.38 0.85 4.73
2003 1.52 1.02 5.43
2004 1.43 0.93 5.02
2005 1.99 0.80 4.37
2006 1.99 0.91 4.57
2007 1.97 1.13 5.87
2008 1.80 1.01 5.05
2009 1.81 1.02 6.10
2010 1.82 1.10 6.80
2011 1.78 1.09 6.22
2012 1.83 1.20 6.87
Source: World Development Indicators (World Bank)
There are a number of factors that may explain why Indonesia’s labor productivity is low.
Firstly, the level of education of Indonesia’s workers is low and most workers are unskilled. In the
agriculture sector, for instance, around 90% of the workers have attained only basic education. It is
one reason why productivity in this sector is very low. Agriculture employs almost 40% of the total
employment but produces only around 14% of the country’s GDP. Other sectors such as, construction,
mining, manufacturing, trade, hotel and transportation, also have a high share (over 60%) of workers
with only basic education.
On one hand, the underdevelopment of the country’s agriculture is, arguably, partly a result of a
virtual neglect of the sector’s productivity. There has not been a sufficient attempt directed toward
improving productivity through innovation. This is unfortunate since, according a report by McKinsey
Global Institute (MGI, 2012), agriculture together with fishery sectors could play a pivotal role in
transforming Indonesia’s economy into a modern one. In addition, boosting the sector’s productivity
will also serve other purposes. A higher productivity in the sector will help alleviating rural poverty.
The sector’s low productivity is a main reason why many of the workers remain poor.
On the other hand, the government has been pursuing a policy to achieve self-sufficiency in a number
of agriculture products. Given the low productivity in the sector, the government aims at achieving
this goal through trade restrictions in the form of tariff and s non-tariff measures on the products in
question. Additionally, the government also provides farmers with fertilizer and seed subsidies as well
as other measures.
Furthermore, a higher productivity in the agriculture sector will also help slowing down the
urbanization process. A rapid urbanization process has helped sustaining a huge informal economic
sector in urban areas. In a way, the process has been, and still is, facilitating, if inadvertently, the
transferring of poverty from rural to urban areas.
One may argue that one reason for the country’s sizable informal sector in rural and urban areas has
something to do with the country’s labor low productivity, as well. For instance, workers who are
rendered unqualified to work in the formal sector have no alternative but to work in the informal
sector. Another reason is the formal sector has not been growing fast enough to absorb the country’s
fast-growing labor force.
33
Data about the exact size of the country’s informal economy are hard to find. According to OECD
(2012), informal employment is around 62.2% of the total employment in 2011.2 Meanwhile, a survey
conducted by the Asian Development Bank and CBS Indonesia (2011) in two provinces, Yogyakarta
and Banten, shows that while the informal sector contributes a significantly to employment in both
provinces, i.e., 89% in Yogyakarta and 76% in Banten, yet its contribution to regional GDP is rather
low, i.e., 37% and 27%, respectively, in Yogyakarta and Bantan. OECD claims that the large informal
sector distorts the country’s labor market, arguing that there have not been enough opportunities for
poor workers to move to the non-agriculture formal sectors.
With regard to education, two recent developments are likely to have significant impacts on human
development in the country. The first is the introduction of universal education. Under this policy, the
government offers Indonesian children free education for up to 9 years. The second one is a provision
that is enshrined in the country’s constitution which requires the government to allocate 20% of the
national budget to education.
Figure 3.1
Sectoral Labor Force Level of Education
Source: Bappenas (2013)
Properly implemented, these two policies could improve the level and the quality of education. There
has not been any comprehensive assessment, at least not to the authors’ knowledge, concerning the
likely implications of the policies on the education sector in particular, an on the country’s economy
in general. However, according to the MGI study cited above, Indonesia will need around 113 million
skilled workers in 2030, more than twice as many as the current level of 55 million. The study also
points out that there will be a huge discrepancy between the supply of and demand for college-
educated skilled workers in 2030. The shortfall is estimated to be around two million.
A study by the World Bank (2010) corroborates the above claim about the importance of skills to the
future of Indonesia’s economy. In particular the World Bank’s study points to the existing skill gap in
Indonesia, i.e., the discrepancy between the available (supply of) skills than that demanded by the
economy. A survey of firms operating in Indonesia conducted as a part of the study found the
following:
The gap exists in the quantity, relevance and quality of the available skills.
The gap is more pronounced in larger, export-oriented firms than in smaller, domestic-oriented
firms.
2OECD Economic Surveys: Indonesia, September 2012
Agriculture Construction Mining ManufacturingTrade, Hotel,Restaurant
Transportation,Storage,
Communication
Social,PersonalServices
Electricity, Gas,Water
Financing,Insurance,BusinessServices
-20%
0%
20%
40%
60%
80%
100%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Agriculture Construction Mining Manufacturing Trade, Hotel,Restaurant
Transportation,Storage,
Communication
Social,PersonalServices
Electricity, Gas,Water
Financing,Insurance,BusinessServices
34
In general, the gaps are in English, computer, thinking and behavioral (intrapersonal) skills.
Among younger workers, the largest gap is in English but there are also important gaps in
creativity, computing and some other technical skills.3
It is also important to note that the constitutional requirement to allocate 20% of the government
budget to education has a number of downsides. Firstly, it deprives the government a discretionary
power, or least limits its flexibility, to allocate the budget according to an emerging priorities.
Accordingly, the allocation of the budget may not be as optimal as it should absent the requirement.
Secondly, and as corollary of the former, it crowds out, or at least limits the resources available for
other government programs, some of them such as healthcare, are also important ingredients for
human development. From the Table below, in 2009, there was the increase in education expenditure
from 7.98% in 2008 to 13.50% in 2009. However, there was a significant drop in public service
expenditure of central government budget from 77.1% to 66.4% during the same period. For
healthcare sector, the proportion fell from 2.5% in 2009 (the year when the Government fully
implemented the amendment of Constitution that requires the Government to allocate 20% of its
annual budget to education sector) to 1.11% in 2011 and 2012.
Table 3.5
Indonesia: Sectoral Proportion of Central Government Budget (%), 2006-2012
2006 2007 2008 2009 2010 2011 2012
Public Service 64.39 62.65 77.10 66.44 67.62 63.89 63.89
Defence 5.55 6.08 1.32 2.09 2.45 6.75 6.75
Domestic Security 5.40 5.61 1.01 1.23 1.98 2.73 2.73
Economics 8.70 8.37 7.28 9.36 7.48 10.22 10.22
Environment 0.61 0.98 0.77 1.70 0.94 1.11 1.11
Housing and Public
Facilities 1.24 1.81 1.80 2.33 2.88 2.72 2.72
Healthcare 2.77 3.17 2.02 2.50 2.69 1.54 1.54
Tourism and Culture 0.21 0.37 0.19 0.22 0.20 0.26 0.26
Religion 0.32 0.37 0.11 0.12 0.13 0.20 0.20
Education 10.30 10.08 7.98 13.50 13.02 10.02 10.02
Social Protection 0.52 0.53 0.43 0.49 0.48 0.55 0.55
100.00 100.00 100.00 100.00 100.00 100.00 100.00
Source: Ministry of Finance (2012)
Thirdly, it may also lead to wasteful use of education budget on other purposes that have less to do
with education.
Figure 3.2
Productivity by Sector: Comparing Indonesia with East Asian Neighbours, 2010
3World Bank , 2010, “Indonesia Skills Report: Trends in Skills Demand, Gaps, and Supply in Indonesia”, available at http://siteresources.worldbank.org/EASTASIAPACIFICEXT/Resources/226300-1279680449418/HigherEd_IndonesiaSkillReport.pdf
35
Source: Bappenas (2013)
Physical Infrastructure
During the last decade, Indonesia has lagged its regional neighbors in infrastructure development. The
only significant improvement of infrastructure in the country occurred in telecommunication sector—
enjoying early reform in the sector after the Asian Financial Crisis 1998. In the second administration
of President Yudhoyono, the Government has pledged to invest IDR 1.429 trillion rupian (USD 157
billion) in 2010-2014 with approximately 65% of it comes from private sector funds.
In addition to minimum investment of infrastructure, the situation is worsened by the quality of
maintenance that also requires finance. The number of roads and railways is limited, electricity supply
is inadequate, seaports and airports are congested and therefore, created many stumbling blocks to
economic activities. Logistic costs in 2012 reached 26.4% of Indonesia’s GDP, or IDR 1820 trillion,
consisting of IDR 546 trillion for storage cost, IDR 1092 trillion for transportation cost and IDR 182
trillion for administration cost.
There were lots of programs to improve investments in infrastructures. In its Rencana Pembangunan
Jangka Menengah (RPJM)/National Medium-term Development Plan (2010-2014), the Government
acknowledged lack of financing infrastructure projects and invited private sector participation. At
about the same time, it established PT PenjaminanInfastruktur Indonesia/the Indonesia Infrastructure
Guarantee Fund (IIGF). This institution gives certain guarantees against infrastructure risks for
projects under the Public Private Partnership scheme. In another attempt to further infrastructure
development, the Government issued the Masterplan for the Accelaration and Expansion of
Indonesia’s Economic Development Plan (MP3EI 2011-2015) in 2011. The MP3EI targeted USD 468
billions infrastructure projects in which 70% of it would be financed by private sector.
0
5,000
10,000
15,000
20,000
25,000
30,000
Agriculture,hunting, forestry,
fishing
Manufacturing Construction Wholesale andretail trade,
restaurants andhotels
Transport,storage and
communications
Other Activities Total
Valu
e A
dd
ed
pe
r W
ork
er
(2005 U
SD
)
Indonesia Malaysia Philippines Thailand Vietnam (2009)
36
Table 3.6
Indicators of Indonesian Infrastructure 1995-2008 1995 2000 2008
Water and Sanitation
Improved sanitation facilities (% of population with access) 51 52 52
Improved water source (% of population with access) 74 77 80
Energy and Transport
Electric power consumption (kWh per capita) 271.6 402.3 566.0
Electric power transmission and distribution losses (% of output) 11.7 10.9 10.6
Roads, paved (% of total roads) 52.4 57.1 55.4
Information and communication technologies
Fixed broadband subscribers (per 100 people) 0.002 0.176
International Internet bandwidth (bits per person) 1.2 34.9
Internet users (per 100 people) 0.03 0.93 7.9
Personal computers (per 100 people) 0.5 1.0 2.0
Mobile and fixed-line telephone subscribers (per 100 people) 1.8 5.0 74.9
Mobile cellular subscriptions (per 100 people) 0.1 1.8 61.6
Source: Pisu (2010) based on World Development Indicators (World Bank)
However, private sector involvement requires good and supporting investment climate, particularly in
dealing with law enforcement. One primary concern was difficulties in land acquisition needed for
infrastructure projects. Because of land disputes, several infrastructure projects came to halt since
2005. In 2012, the Government issued Law no. 2/2012 on Land Acquisition. The introduction of the
Law aimed at speeding up land acquisition process by stipulating procedures and time limit on each
procedure. Although the issuance of the Law was early in 2012, its implementing regulations4were
only ready in 2013.
Infrastructure maintenance is another problem in Indonesia. Damaged roads, crowded ports (seaports
and airports), collapsed bridges are common in many parts of Indonesia, both in cities and remote
areas. Corruption and incompetence are rampant, causing low quality of infrastructures.
4Presidential Regulation no. 71/2012, Head of Land National Agency (BPN) Regulation no 5/2012, Ministry of
Interior Regulation no. 72/2012 and Ministry of Finance Regulation no. 12/PMK.02/2013
Box 2. Masterplan for Acceleration and Expansion of Indonesian Economic Development
Masterplan for Acceleration and Expansion of Indonesian Economic Development (Masterplan untuk
Percepatan dan Perluasan Pembangunan Ekonomi Indonesia, MP3EI) 2011-2025 is implemented to
accelerate and strengthen economic development in accordance with excellence and strategic potential
of the regions within six geographical corridors across the archipelago of Indonesia. The acceleration
is conducted through the implementation of eight main programs, which consist of 22 major economic
activities. Most of the action plan under the MP3EI is intended to improve infrastructure development
by facilitating broader financial strategy including greater development financing and wider public
private partnership.
MP3EI implementation strategy follows three main elements, namely (1) to develop the economic
potential of the region in six economic corridors (ECs), namely Sumatra EC, Java EC, Kalimantan
EC, Sulawesi EC, Bali and Nusa Tenggara EC, and Papua EC; (2) strengthen and integrate national
connectivity locally and globally ; (3) strengthen the capacity of human resources and national science
and technology to support the development of a major program in each corridor economy. The
implementation so far is still below expectation, although according to the President, more than 382
projects — comprising 208 infrastructure projects and 174 real sector projects — with a value of no
less than Rp 854 trillion (US$73.13 billion) having been implemented since the government launched
the MP3EI in 2011. The challenges remained, especially in infrastructure projects due to political,
bureaucratic, social, financial or logistical reasons.
37
Infrastructure spending shrank due to Asian Financial Crisis 1998. Although it had increased in the
last ten years, it has not reached pre-crisis level. Before 1998, infrastructure investment averaged
approximately 8% of the country’s GDP per year but it slowed down to 3% per year due to the crisis.
Recently, the number hovers around 4% in 2010-20135. Out of total spending on infrastructure, in
2013, around 46.5% was financed through central government budget (APBN) with the rest was
funded by either private sector (13.7%) or local government and state-owned enterprises (39.7%).
Table 3.7
Contributions by Related Parties in Financing Investment for the Physical Infrastructure
Year % of Central
Government Budget
% of Local Government
Budget
% of State-Owned
Enterprises % of Private Sector
2010 37.67 28.37 18.13 15.84
2011 40.97 25.95 18.13 14.93
2012 45.40 23.03 17.76 13.81
2013 46.54 22.04 17.67 13.74 Source: Ministry of National Development Planning/Bappenas
Environmental Carrying Capacity
Eventhough the Ministry of Environment had been set up since 1980s, environmentally-sound policy
in Indonesia only began a decade later6. Environmental damage due to heavy industrialization has
caused increased pollution, deforestation and loss of natural biodiversity. It creates concerns on how
environmental carrying capacity would be able to support development in the long-term period.
Sustainable development principles had been mainstreamed into Rencana Pembangunan
JangkaPanjangNasional (RPJP)/Long-Term National Development Plan 2005-2025and Rencana
Pembangunan JangkaMenengah (RPJM)/Medium-Term National Development Plan 2004-2009 and
2010-2014. Included in the Plan was Education for Sustainable Development aiming to educate the
youth on environment and sustainable growth. It is deemed important to raise awareness among the
youth and the public in general to balance out economic growth and environmental protection. Other
programs implemented to suit sustainable development principles7 include forest rehabilitation,
sustainable fishing, and climate change mitigation plan8.
5Menteri PPN/Bappenas, presentasi “Alternatif Pembiayaan Infrastruktur”, Bappenas, 2013 6 The Gold for Green: How the Gold PROPER Award Drives Five Major Companies Achieve Innovation, Value
Creation and Environmental Excellence, Kementerian Lingkungan Hidup 2012 7http://www.menlh.go.id/tentang-kami/sejarah-klh/#sthash.TlZQiuF1.dpuf 8The Government issued Presidential Regulation (Perpres) no 61/2011 on Rencana Aksi Nasional Penurunan
Emisi Gas Rumah Kaca (RAN-GRK)/National Action Plan to Reduce Greenhouse Gas Emission.
38
Section 4: Complementary Factors in Mobilizing Development Financing
and Using Finance More Effectively for Transformation Changes in
Indonesia
In the first half of the New Order Regime, development financing in Indonesia relied heavily on
oil/gas revenue and foreign assistance in the forms of grants and/or debt financing. However, in the
mid-1980s when oil prices dropped to USD 9/barrel, the Government of Indonesia took the
momentum to do some reforms to reduce its dependency on oil revenue to finance development in the
country.
Tax Reform 1983, 1997 and 2000 (domestic public finance mobilization)
Tax reform in Indonesia started in 1983. It began by introducing a self-assessment approach where
taxpayers would calculate, pay and report the amount of money they need to pay as indebted taxes to
replace official assessment. Reforms in 1983 also issued Law no 6/1983 on General Guidelines on
Tax Administration, UU no.7/1983 on Income Tax, UU no.8/1983 on Value-added Tax and Luxury
Good Sales Tax. The GoI also issued Law on Land and Building and Law of duty stamps. With the
reform in 1983, the Government sought to improve the tax structure, widen tax basis and enhance tax
administration. The next reform of tax system in Indonesia came in 1994. This time, the reform was
said to adjust the tax system to respond globalization and its impacts on the domestic economy. The
Government issued four new Laws: Law no 9/1994 to amend Law no. 6/1983, Law no.10/1994 to
amend Law no. 7/1983 on income tax, Law no.11/1994 to amend Law no.8/1983 on VAT and luxury
goods sales tax, and lastly, Law no.12/1994 to amend Law no. 12/1985 on Land and Building Tax.
The reform in 1994 was criticized due to restoring tax facilities which had been eliminated previously
by the reform in 1983. However, the GoI declared that the reform was needed to support export
promotion strategy.
After the crisis in 1998, tax reform was again conducted in 2000 with the establishment of Tax
Service Office for Large Taxpayers. The reform in 2000 also replaced tax dispute settlement board
with Tax Court, which is an independent judiciary under the Supreme Court—tax dispute settlement
board was under Directorate General of Taxation. Another reform in 2005 was due to modernize the
tax administration system, resulting in a more integrated and more professional approach in handling
tax information and complaints. It also utilizes information technology for e-filling, e-SPT, e-
registration etc. This reform phase concluded with the Sunset Policy, enabling taxpayers to abolish
administration sanctions due to previous obligations.
The result of tax reform in Indonesia has brought positive progress to Indonesia. In addition to more
tax revenues collected, there has been a shift from indirect tax revenue to direct tax revenue since
1996/1997. The shift clearly reflected a more equitable tax system because direct tax was collected
directly from taxpayers.
Figure 4.1
39
Tax Ratio, Amount of Direct and Indirect Taxes, 1970-2004
Source: Setiyaji and Amir (2005)
Table 4.1
Tax Revenue as proportion in GDP and Government Revenue, 1990-2011
1990 1995 2000 2007 2008 2010 2011
Tax Revenue
(% of GDP) n/a 14.0 n/a 12.4 13.0 11.3 12.3
Tax Revenue
(% of Gov't Budget) 52.0 66.9 58.5 69.4 67.1 74.9 80.5
Source: IMF
However, the use of revenue has not been returned to taxpayers in the form of development financing.
Some of the revenue was used for energy subsidy (part of government consumption in the annual
budget APBN). Energy subsidy continues to occupy large space in Indonesia’s state expenditure. By
2013, energy subsidy occupies around 19% of Indonesia expenditure realization, of which 13% went
to fuel subsidy. The absolute amount has tripled from around US$10 billion in 2005 to almost US$30
billion in 2013. While in the past, most of the subsidy can be covered from oil export revenue, since
2004 after oil consumption exceeded the production, the subsidy has to be financed from other
revenue sources, including tax revenue.
This big portion of state expenditure is intended to keep production cost low and increase Indonesian
industrial sector competitiveness, while at the same time help less fortunate population. However,
according to World Bank estimation, in 2008 only 54% of the subsidy went to production sector while
the rest is used for consumption purposes. Moreover, the study also estimates that around 40% of the
subsidy went to 10% richest population. It transferred around US$14 per month to richest households,
while only provide US$2 per month to poorer households (World Bank 2011).
International Trade as Engine of Growth (Shift From Import Substitution to Export Promotion
Strategy In 1986)— and International Private Finance Mobilization
40
Foreign aspects have been an integral part of Indonesia’s economic development, including as
provider of capital, destinations for sale of natural resources, and market for Indonesian exported
products.
At the beginning of the New Order regime in late 1960s, forced by the need for fresh funds to restore
the economy from bankruptcy, President Soeharto decided to open up to foreign direct investment
(FDIs). As the legal basis investment in Indonesia, Law No. 1 of 1967 on Foreign Investment was
issued. Based on Law No. 1 of 1967, foreign investment can go into full operation of all sectors
except the sectors that are important to the State and lives of many people such as ports, electricity
and telecommunications. To complement the Law, in 1968, the government also issued Law No.
6/1968 which regulates domestic investment.
The policy has brought significant effects on Indonesia’s economic development. At the earlier stage
of economic development, FDI fed the needs for capital. In the early 1970s, foreign investment
contributed up to 3% of the GDP, taking account of up to 20% of the total gross fixed capital
formation (GFCF). Figure 4.2 shows the development of foreign investment in Indonesia. Most of the
investment went to primary sectors of extraction, taking advantage of Indonesia’s abundance of
natural resources, and to various industries intended to substitute imports and reduce dependence over
foreign products.
Figure 4.2
FDI in Indonesian Economy
Source: UNCTAD FDI Database
In the period 1970-1985, the economic development of Indonesia was dominated by the oil and gas
sector that allowed the government to proceed with more inward-looking, import substitution strategy.
Revenue related to oil and gas contributed up to more than 80% of government revenue in mid 1970s.
However, following a drastic drop in oil prices at the end of the 1970s, which continued until the early
1980s, the government's budget came under pressure enormous. Mega projects that relied on windfall
profits from oil and gas, as well as import substitution industries, could no longer be maintained. This
forced the government to launch various deregulation packages, including on international trade
regime.
International trade deregulation package was taken in March 1985 by reducing import duties,
followed by reform on custom procedures, which allow better procedures for import clearance, more
transparent procedure in calculating import duty, and easier payment of custom duties. In addition, the
government also freed the use of transport vessels. Foreign investors responded to this economic
-10000
-5000
0
5000
10000
15000
20000
25000
-20
-15
-10
-5
0
5
10
15
20
25
FDI (% of GDP) FDI (% of GFCF) FDI (Million US$)
41
reform by investing in the Indonesian economy. FDIs grew steadily during the period of 1985-1997,
reaching the peak in 1996 with the value of investment inflow almost 30 times bigger than the value
in 1984. Most of the FDIs financed the development of manufacturing, in particular export-oriented,
labor-intensive industries, such as textiles and garments, footwear, and furniture, in addition to natural
resource intensive such as wood products. . This reform supported the development of labor-intensive
manufacturing industries that encourage better export performance.
Between 1970 to 1985, for example, the dollar value of Indonesia’s total non-oil exports grew by an
average of 15% per annum. But the growth was accelerating during the period of 1985-1996, reaching
around 18% per annum, while exports of manufactured goods grew by around 20%, giving
manufacturing a share in total exports of more than 50%. This remarkable export performance was
interrupted when Asian Financial Crisis (AFC) crisis broke in mid-1997. Total export growth plunged
to 6% per annum in 1997, and manufactured goods exports grew by only 12% due to the crisis. After
the crisis, exports of non-oil products grew in much slower rate than the previous period. After the
crisis, Indonesia failed to restore its pre-crisis export performance which resulted in slower growth
rate of exports, despite a global economic improvement in the 2000s.
Between 1998 to 2008, Indonesia’s exports only grew by around 10% per annum, while
manufacturing recorded slower growth than average of 9%. Indonesia’s exports began to recover only
in 2003, thanks to high commodity prices in international markets. The period after the AFC reflected
a slowdown in the manufacturing sectors. The export growth of labor-intensive manufactured goods
declined significantly, from 24% in 1990–96 to only 4% a year in the period of 1998-2010. The share
of manufacture in exports also declined to 45% in 2012, whereas in 1990s the share reached 60%.
During the first decade of 2000s, Indonesia’s commodities exports rose by tremendous rate of around
20%, driven mainly by rising international commodity prices. The Global Economic Crisis in 2008,
put a halt on Indonesia’s export growth, especially on commodities. Weaker global demand of
commodities reduce Indonesia’s export performance significantly: during the last two years,
Indonesia’s non-oil exports declined by around 6% due to the fall of world commodity prices,
including crude palm oil (CPO), which account for 15% of Indonesia’s non-oil exports.
The Asian Financial Crisis in 1997-1998, which reduced the value of the rupiah nominal exchange
rate into a-fifth of pre-crisis value, has changed Indonesia’s economic structure significantly as
previously discussed in Section 1. It also reduced Indonesia’s attractiveness to foreign investors:
during the period of 1998-2001, Indonesia recorded negative inflow of FDIs indicating massive
reallocation and withdrawal of investments. Only after 2002, foreign investments started to pick up
again, although with slower rate of growth and fluctuated a lot. In order to improve investment
climate, the government of Indonesia launch several policy and institutional initiatives.
Major improvement was taken when the government finally presented new Law on Investment in
2007 to replace the then two 30 years old laws on foreign and domestic investment. This Law No. 25
of 2007 removes the dichotomy of investment rules and treatments applied to foreign investment and
domestic investment. In addition, the Law also improves treatment and protection to investors,
including the possibility of collateral disputes through international arbitration, guarantees against
nationalization, transparency in terms of capital for foreign investors and granting land use rights for
longer investors with the extension of the use of land given upfront. Some institutional improvement
was also conducted including simplifying investment procedures and cut short the time required for
licensing, followed by assurance to complete the licensing process within certain amount of time. The
reform has resulted to a significant improvement in Indonesia’s FDI performance. Even during the
global crisis in 2009, Indonesia still received a lot of foreign investment, which continue to grow until
now.
One can also observe the change in composition of FDI to Indonesia. In the pre-AFC, manufacturing
and processing industries were the main destinations of foreign investments, counting on average of
70% in the period of 1990-1996. In the period of 2002-2010, investment in manufacturing and
processing industries only contribute in average of around 38%. During the same period, foreign
investment in mining and quarying increase significantly, counting in average of more than 20% of
total FDI. Investment in mining reached the peak just right before the global crisis in 2008, surpassing
investment in manufacture. FDIs also mostly come to several services sector, such as financial and
42
telecommunication, which are badly needed to support the economy. The share of FDI in
manufacture, on the other hand was declining until 2009, where there have been a revival of
manufacturing sector along with significant increase of FDIs.
The combination of global commodity boom and massive flow of investment, both foreign and
domestic, in extraction sectors including mining and plantation has increased the importance of
commodities production. During the period of 2004-2012, the non-oil mining sector grew on average
by 6.5% per annum, higher than 5.8% average growth of the economy. At the same time the
manufacturing sector has grown lower than the economic growth.
In short, trade and FDI has influenced structural transformation of Indonesian economy quite
significantly. Liberalization of capital flow, followed by export oriented policy regime in the past has
moved the economy into manufacturing-dominated economy until the AFC took place in 1997-1998.
The decline of industrial sector in Indonesia has also been influenced by growing global demand of
commodities at the first decade of the 2000s. As a relatively open market economy, international
economic aspect has contributed greatly to development and transformation.
Banking and Capital Market Reform 1988 (domestic private finance mobilization)
Starting in 1983, the Government of Indonesia introduced a series of banking reform programme.
Internal liberalization of banking system began with abolishing all kinds of government intervention
into the banking sector such as credit ceiling, interest rate ceiling, selective credit to certain economic
sectors and portfolio requirement. Further in 1988, the Government opened access to domestic
banking system by lowering minimum capital start-up for banks and allowing foreign banks to open
branches.
At the same time, the Government also introduced several regulations to rejuvenate capital market
development. Since 1977-1988, the Indonesian capital market did not develop well as it competed
with banking sector—private sector preferred placing their money in banks because there was no tax
applied to deposit interests while there was 15% tax applied to dividend from capital market.
Domestic credit provided by financial sector (including banking, and other financial institutions non-
banking) has increased from 46.7% in 1990 to about 60% in 2000. However, due to the Asian
Financial Crisis in 1997-98, the Government reconsidered alternative development financing
approach--the Government finally shifted from external debt to domestic debt financing9. The
Government issued bonds for the first time in 2003 to finance budget deficits. Domestic credit by
financial sectors lingered around 40% of GDP for the past five years as equity and bond markets
slowly strived with government bonds as the engine of growth. Equity and capital market
capitalization reached 46% and 13% of GDP respectively.
Table 4.2
Domestic Credit by Financial Sector, Market Capitalization in Stock and Bond Market, and
Other Indicators, 1990-2011
1990 1995 2000 2007 2008 2010 2011
Domestic credit provided by
financial sector (% of GDP) 46.7 51.8 60.7 40.0 36.8 36.4 38.6
Market capitalization of listed
companies (% of GDP) 7.1 32.9 16.0 49.0 19.0 51.0 46.0
Bond Market capitalization (% of
GDP) n/a n/a 37.0 20.0 16.0 15.0 13.0
Annual new capital raised
(% of GDP) 2.67 2.03 1.41 2.49 3.97 3.52 2.23
9Hendar, Fiscal Policy, Public Debt Management and Government Bond Markets in Indonesia, BIS Paper no.67/2012, http://www.bis.org/publ/bppdf/bispap67n.pdf
43
Corporate bonds issued
(% of GDP) n/a 0.44 0.40 1.59 0.68 1.72 1.86
Source: CEIC, Asianbonds Online, World Bank
Asian Financial Crisis 1998 (Using Domestic public Finance Effectively)
Prior to 1998, there was no specific social assistance policy. The strategy was to have a broad-based
economic growth, coupled with rural development. When the crisis struck in 1998, the number of
poverty incidents in Indonesia expanded swiftly. Surely, the lack of social safety net and protection
exposed the poor adversely to economic shock. As mentioned, no specific social protection means
that poverty reduction efforts took the form of more general price subsidies. Lots of subsidies for
consumption of energy, electricity, food (including rice, corn, sugar and flour) must be given up cut
due to worsening fiscal deficits in 1998 (all food subsidies were abolished in 199810). Rural
development program such as BIMAS, KUK (credit facility for SMEs) etc. underwent massive
reduction.
In the middle of the crisis in 1998, the Government launched JaringPengamanSosial (JPS)/Social
safety net program. The program was a response measure to control negative impacts of the prolonged
crisis. Nevertheless, the program was different from before because it started to be specifically-
targeted. Some programs included under JPS umbrella was rice for the poor (sale of subsidized rice to
poor people), cash for work, block grant for schools and health centers’ operational/running costs,
scholarships for primary and secondary students from low-income families, nutritional assistance for
babies and children. These programs would be the seeds for more permanent programs starting in
2005 since these programs are funded by government budget every year.
Besides more permanent and target-specific, social assistance policy in Indonesia has changed due to
more involvement of regional government. These programs must now be coordinated with local
government. Social assistance programs that have continued to obtain budget support are energy and
electricity subsidy and the sale of subsidized rice to the poor. Then, in 2005, energy prices soared in
international market and created major concerns within domestic and foreign investors in Indonesia
due to large amount of subsidy in 2005 government budget. The fiscal deficits worsened and the
Government was forced to increase domestic fuel prices by 144%. At the same time, the Government
launched compensation programs for the poor in lieu of reduced energy subsidy. The Fuel subsidy
compensation programs were Unconditional Cash Transfer, Education and Basic healthcare
assistance, rural infrastructure development and community-based development/Program
Pemberdayaan Masyarakat Nasional (PNPM)/National Program for Community Empowerment). In
2007, the Government introduced two types of conditional cash transfers: Program Keluarga Harapan
(PKH)/Hope Families Program and PNPM Generasi Sehat dan Cerdas (block grant for communities,
conditional on certain education and healthcare indicators in the communities).
Section 5: Conclusion and Looking Ahead
The Indonesian economy has experience significant transformation since the country began its
economic development programme in 1967. During the early stage of the development, most of the
activities were concentrated in primary sectors, in particular agriculture-related activities. After more
than 40 years of development, the economy is dominated by industrial and manufacturing activities,
in addition to services sector. Financial aspect of this development process has also been transformed
significantly in accordance to the economic situation. While the first decade of economic
development pretty much relied upon government financing, mostly came from natural resources
10 Following IMF Letter of Intent, January 15, 1998, the GoI issued Presidential Decision (Keppres) no. 19/1998) limiting BULOG (National Food Logistic Agency)’s function to control rice prices. Prior to 1998, BULOG was the state agency responsible to control basic food prices (rice, sugar, soybeans, and corn).
44
revenue, the economy developed further counting on the participation of private activities and
financing.
While Indonesia’s financial development has served the transformation process quite adequately,
there are still several related issues to handle properly. The first issue is related to optimization of
public revenue and increase effectiveness of public spending. Currently part of the public revenue
comes from corporate taxes, while at the same time most of government budget has been allocated to
routine spending, leaving limited fiscal space for development. Indonesia is in need to diversify the
sources of public revenue and reduce the fiscal burden. Second is to increase the role of financial
institutions for the transformation process. Currently, most of the financing comes from the banking
sector, while the cost of financing is still relatively high, making it difficult to get access to finance,
especially for the poor and small-scale economic activities. Third is to strengthen mechanism and
institutional requirement for private participation in public goods provision, especially in
infrastructure, to complement government spending.
Optimizing Public Revenue
As mentioned in Section 2, while government expenditure is increasing in absolute term, the role in
the economy has been declining quite sharply from around 50% in the early 1980s to only 18%
currently. However, the budget still serves various important functions, from the provision of public
goods to macroeconomic stabilization. One of the problems in Indonesia’s government budget is
relatively low revenue. The Law on Government Budget states that the government should maintain
budget deficits of less than 3% of the GDP. Although the government has successfully maintained the
deficits below the threshold, the combination of low revenue and low deficits has limited the
government’s ability to boost economic performance and to provide necessary public goods such as
infrastructure and social protection.
As mentioned in Section 2, the biggest portion of government revenue comes from tax collection,
which contributes to around 75% of total central government revenue. However, the tax ratio remains
relatively low, at 12.2% of GDP, compare to other countries in the region, which can reach 17% in
Thailand or 16% in Malaysia. Although tax revenue is increasing quite substantially in the recent
time, the tax ratio has remained almost the same. This indicates that various actions are needed to
increase the tax revenue that in the end provide greater capacity for the Indonesian government to
carry out its functions.
One way to increase tax revenue is by revising tax schedules and increases in tax rate. The Indonesian
government has modified the tax structure several times, partly to become more in line with economic
conditions, e.g. adjusting tax-free income, and partly to raise tax revenue. While this may raise tax
revenue in the short time, it brings consequences of distorting the economy and providing
disincentives to economic activities. Moreover, without having better collection system and
monitoring, increasing tax rate might increase motivation for tax fraud, both from tax payers and tax
collectors.
An alternative to increase tax revenue is by broadening the tax bases. One feature of Indonesia’s tax
composition is a strong reliance on corporate and consumption taxes, which contribute around 45%
and 40% respectively. Tax on personal income only accounts for around 10% of the total tax revenue.
This is quite difference from the tax revenue structure of many developed countries, which rely more
on personal income tax. One possible explanation for this is that much of the revenue comes from
taxes on natural resources wealth. For example, almost 20% of corporate tax revenue comes from
taxes of oil and gas sector. However, personal income tax revenue are indeed still very low even
compare to other countries in South East Asia: personal income tax revenue in Indonesia is only 1.4%
of GDP, compare to around 4% on average in other middle income ASEAN countries. This indicates
there is a big potential to increase tax revenues by intensifying personal income tax alone.
In order to increase tax bases, especially for personal income tax, Indonesia needs to improve its tax
administration. The main challenge is to increase compliance of tax payers, while at the same time
increase the number of registered payers. According to Directorate General of Taxes (Ministry of
Finance) data, out of the current 23 million personal registered tax payers, only around 8 million
actually submitted annual income tax return form--a little more than 35%. There is no data available
45
for what proportion that files the required documents properly and provides sufficient information.
The compliance can be increased through simplifying the procedure and increasing monitoring and
enforcement system.
Simplification is necessary because the largest portion of registered tax payers filling their annual tax
return are employees with single sources of income. Their tax is withheld by employers every month
at salary payment day. Tax administration could be simplified by lifting the requirement to file an
annual tax return for employees with a single source of income and relying solely on the withholding
system to assess their tax liabilities. This would reduce both the compliance burden for such
employees and the workload of the tax administration to allow them improving tax monitoring for
non-employee tax payers.
The informal business sector and the self-employed are among those that should be targeted to
increase the tax bases since most of them still pay little or no taxes. Realizing the big potential of this
group, the government has done various attempts to improve tax collection. A tax census completed in
2012 was intended to provide better information on the magnitude of the problem and to come up
with proper strategy. One of the strategies is to target relatively small informal business activities with
the sales of less than Rp 4.8 billion (around US$400 thousand). The tax schedule for this group is
designed to be very simple: it is calculated based on sales, rather than income, with only a single
applied rate of 1%, making it less complicated for the business. This is expected to increase tax
compliance of the non-formal sector. However, many of those informal business are not voluntary.
They are forced to start non-formal activities because the opportunities to work in the formal sector
are limited. Tackling the problem of inflexible labour mobility as well as improving investment
climate is among those needed to improve the situation of informal sector, which eventually would
increase tax bases and revenue.
Another source of government revenue that need more attention is revenue from the profits state
owned enterprises (SOEs). Currently SOEs only provides 2.2% of government revenue; a decline
from more than 3% in the late 2000s. That is mostly because the profits from SOEs, which only
comes from a handful of them, have remained stagnant. Many of state owned companies are in a loss
position, even depending on subsidies and support from the budget. While some of the companies are
needed to deliver social services, the government of Indonesia need to be more selective in which
types of SOEs to maintain. Deregulation of several sectors that are currently in the monopoly of SOE
such as electricity, ports and airports management, as well as basic telecommunication need to be
carried out, followed by sufficient privatization initiative. That would not only improve the sector
performance, but also increase tax revenue from privatized companies.
Optimizing Government Expenditure
The biggest problem with government of Indonesia’s expenditure is that most of the money available
is already allocated even before the budget is arranged. The constitution, for example, requires that at
least 20% of the budget should be allocated for education purposes. Several other laws also demand
the government to spend a certain percentage of the budget for specific purposes. As discussed in
Section 2, the biggest spending of central government takes place in energy subsidy, which absorbs
around 24% of budget in 2013, and keep increasing. This is followed by personnel expenditure, as
well as material expenditure, which in total constitutes of 38% of the total spending.
Improvements need to be done at various fronts. However, the most crucial aspect is to reduce the
burden of energy subsidy in the budget. As a result of growing economic development, energy
consumption has been increasing tremendously at an average rate of 8.5% per annum. Together with
increasing trend of world oil price and depreciation of the rupiah, energy subsidy has been burdening
the budget. The government needs to revise an ongoing budget on the ground that energy
consumption and oil price increases faster than the budget assumption. Reducing energy subsidy
would allow more spending on other areas, including infrastructure and social assistance.
Two elements are worth considering. First, subsidy reduction should be done sequentially at a regular
basis. Cutting back subsidy would increase the domestic selling price of fuel and consumer prices of
electric power. Increasing the price at a regular basis would make the price increase affect the
economy and the poor less substantially. This would also reduce the psychological effect of price
46
increase that normally foster inflation. Price increases as little as 10% annually should be enough to
reduce the subsidy substantially within a five year period. Similar scheme should also be done in the
case of electric power. It is important, however, that the policy has a definitive target to be achieved at
specific period.
Second, the initiative to reduce energy subsidies need to be complemented by other reforms. The
government should explain where the money previously disbursed as energy subsidy would be
allocated. One of the important complementary programmes is to provide social assistance to mitigate
adverse effect of a fuel price hike. Another possible complementary program is to improve energy
mix of Indonesia by supporting the use of alternative energy.
Another potential issue that can create challenges in public finance if not being handled properly is
the new social security system that has begun since 2014. This is part of the initiatives from the
government to support the poor as amended by Law No. 40/2004 on Social Security System. The Law
stipulates that the government would arrange social protection for all citizens, including pensions and
savings for the elderly, national health insurance, work injury insurance and death benefits for
survivors of deceased workers. In January 2014, the government launched the Universal Health
Coverage (UHC) as a part of the system. The aim is to have every Indonesian covered by health
insurance by 2019 under a new scheme called JaminanKesehatanNasional (JKN, National Health
Insurance).
There are several foreseeable problems with the UHC system. First is inadequate supply of health
infrastructure and personnel. The ratio of health workers to population in Indonesia currently meets
the WHO standard – 25 health worker per 10,000 people, but mostly concentrated in urban and
populated areas. There are 1,700 state and private hospitals are participating in the JKN, with over
9,000 state-funded community clinics, serving as the backbone of primary care. The government
plans to build 150 new public hospitals in 2014, and says all hospitals will be required to serve UHC
patients by 2019. Indonesia also still needs to increase number of health workers, including increasing
number of doctors to meet its goal to have a ratio of 40 doctor per 100,000. This will require larger
expenditure for development of health infrastructure as well as training and recruitment of health
workers.
Second is the problem of financing the UHC. Expected cost of the UHC is not widely known,
although World Bank puts figures between 6.66 percent of total public expenditures (1.17 percent of
GDP) to 11.58 percent (or 2.03 percent of GDP) just to provide enough financing for health services
expenditure, not for infrastructure development. However, in 2014 the government only allocated
around 1% of total public expenditure to support the program. It is complemented by a premium paid
monthly by citizens ranging from 25,500 rupiah ($2) per month to 59,000 rupiah ($5). There will be
inevitable problems with regard to this relatively low premium: health workers will not be paid
adequately and health services would function poorly. The government has realized this problem and
plans to increase its expenditure, while at the same time increase contributions from participating
citizens. This problem needs to be handled carefully as it would be likely to create additional fiscal
burden and jeopardize the objective of the UHC.
Third is to coordinate the current existing public health insurance and programs at national and local
level. After the decentralization of public authorities was introduced in 2001, health is one the
functions decentralized and become the domain of local governments. Many local governments have
introduced local health coverage schemes using the funds available under allocated accounts from the
central government. Successful coordination between the JKN and other programs may increase the
effectiveness of the program and reduce fiscal burden of the central government.
Development of Financial Institutions
There are three major areas of improvement to develop Indonesia’s financial sector and to contribute
more effectively to the economic development and transformation. First is diversification of financial
sources for economic activities. Indonesian economic activities rely intensively on financing from the
banking sector. Around 79% of Indonesian financial assets are controlled by the banking sector. The
current situation reveals the need to further develop non-banking financial institutions (NBFIs),
47
including capital market, pension funds, insurance and consumer financing, to mobilize domestic
financial resources necessary for economic development.
Strong non-banking financial institutions provide greater options for businesses, households and the
public sector to meet their financial needs accordingly. While the banking sector is quite suitable for
financing short-term financing needs, longer-term financing and investment on the other hand might
be best approached by other instruments such as raising funds through capital market. Many NBFIs
provide more specific financing options and instruments that may allow for better risk management
for certain individuals and business activities. In addition, these financial institutions create greater
competition to banking sector that may eventually increase its competitiveness in channeling
resources.
Second is to increase banking sector competitiveness. The Indonesia banking industry experienced
structural change in the 1990s where the number of banks increased significantly reaching up to 200
at one point in time. After a restructuring and consolidation process following the Asian Financial
Crisis, there are around 120 commercial banks operating in the country. Despite a large number of
banks, the industry is dominated by only several players. The top-four banks, three of them are state-
owned, control around 42% of the banking assets, which is around 35% of total financial assets in
Indonesia. Those four banks principally determined market behaviour and the development of
financial institutions in the country, leading to lower competition in the industry
One main problem related to banking performance is relatively high net interest margin (NIM), the
difference between lending rate and deposit rate. Average NIM in Indonesian banking sector is in the
range of 3% for foreign banks to 6% for state-owned banks. The figure is higher than NIM of banking
in Singapore (2.2%), Vietnam (3%) or Malaysia (2.7%). This brings adverse effect to the intermediary
function of banking in mobilizing financial resources, while at the same time reduce the sector’s
competitiveness and efficiency. This partly comes from low competition and oligopolistic
environment in the banking sector. More consolidation and merger, especially among small and
medium banks, would likely to improve the distribution of market share and reduce market
concentration. That would eventually reduce the cost of financing and support development process.
48
Third is improving access to finance. While Indonesian banking and financial sector have been
developed significantly in the last three decades, access to financial institutions is still problematical.
Only 20% of adult population has a lending account at a bank, while less than half of households
maintain any kind of financial accounts. In addition, access to risk management such as insurance and
pension funds is still very low. Moreover, the financial sector is highly concentrated geographically
where some areas, e.g. Java and Bali is rather overbanked compare to the economic needs, while other
areas tends to require more banking facilities. Greater access to financial resources is necessary to
develop the economy and reduce inequality.
The Government of Indonesia launched a program to increase financial access, especially to the poor.
One of the strategies is to increase financial institutions’ involvement in micro financing initiatives by
giving incentives for commercial and public institutions to extend their operations and reduce
transaction costs. This is also complemented by programs to increase financial literacy and enhance
quality of bankable assets of the micro and small business sector. The challenge lies on regulatory
framework and high transaction costs at the supply side, as well as lack of financial endowment and
absence of appropriate individual’s financial history at the demand side.
A new independent financial authority known as OJK has just started fully this year taking over
several regulatory and supervisory authorities previously held separately by Bank Indonesia for
banking sector and the Capital Market and Financial Institution Supervisory Body (Bapepam-LK) for
NBFIs. This new institution is expected to bring more coherence approach toward the development of
financial industry in the country that would lead to increasing competitiveness of banking and non-
banking institution as well as improving access to finance.
Box 3. Non-Banking Financial Institutions and Long Term Financing
Non-banking financial institutions (NBFIs) in Indonesia consist of various financial institutions
with specific means to obtain financing or particular purposes in serving financial needs of
customers and business sectors. Among others are capital and bonds markets, insurance, pension
funds as well as multifinance industries, e.g. leasing and factoring services. Some Indonesia’s
NBFIs are expected to be able to mobilize long term domestic financial objectives. As discussed
in previous section, the capital and bond markets, although growing significantly, are still
relatively small. With the current market capitalization of around 50% of GDP, the capital and
bonds markets, however, have served quite well to the need of long term financing and borrowing.
The development of mutual fund industry since early 2000s has enabled individual and small
investors to take part and brings together domestic resources for further capital market
development.
With assets of around 7% of GDP, insurance industry would offer a pool of assets that have not
yet been tapped optimally for long-term investment needs. A significant portion of the assets is
still invested in short term bank deposits instead of capital market to reduce companies’ risks over
the claim. This is especially more prevalent among smaller insurance companies with lower
capitalization. Strengthening insurance companies by allowing them to consolidate, while at the
same time improving regulatory framework for insurance companies’ investment in equity and
bond markets would allow greater participation for long term financing in Indonesia.
Another potential comes from pension funds. Total assets of Indonesia’s pension funds is still
very small of only around 1.8% of GDP, but it has potential to grow significantly as the
government is planning to launch obligatory pension scheme for the whole population. One
potential use of the funds is for infrastructure development which has to be put in a long
investment horizon. However, there is a need for greater protection for infrastructure financing
before it would become a main destination for pension funds’ investments.
In short, Indonesia NBFIs can serve as an alternative toward long term financing, either through
the development of equity and bond markets, or through infrastructure development financing.
Regulatory frameworks that are not only supportive to the development of the industries, but also
to provide greater certainty over their investment would release the potential.
49
Public-Private Partnership in Infrastructure Development
One particular issue related to the role of financing in Indonesia’s economic development can be
observed in the case of infrastructure development. As discussed in Section 3, Indonesia has been
having problem to catch up with ever increasing needs of physical infrastructure, partly due to low
government spending on infrastructure development. In order to address the financing issue, the
Government of Indonesia has attempted to increase private sector participation and stimulate private
investment through Public-Private Partnerships (PPP) by establishing necessary regulatory
framework, including amending and modifying laws and regulations related to private investment in
Indonesia.
In the 2011’s Master plan for Acceleration and Expansion of Indonesia Economic Development,
Indonesia’s government expected to raise 42% of its US$ 240 billion infrastructure financing need
from private sector participation. But the realization of infrastructure projects through this scheme is
yet to bear fruit. Up to now, only one project has started under the PPP, which is Central Java Power
Plant, a 2000 megawatt coal-fired power plant in the District of Batang, Central Java. Infrastructure
projects in Indonesia are still constrained by the difficulty of land acquisition, regulatory uncertainties
and lack of funding. More specifically, these investment projects are not popular with private
investors because they usually involve expensive and risky investments with a long return horizon.
In order to make the PPP scheme successful, the government needs to provide more commitment to
assure private investors that those projects would be financially sustainable and expose to little risks,
especially from future political risks of regime change, i.e. expropriation and nationalization. The
government also needs to pay more attention in dealing with problems of land acquisition and local
government authority in infrastructure development. These problems can be more easily solved if
there is an independent functioning PPP institution at the national level that is in charge to coordinate
projects offered in the program, and maintain closed relations with similar units at sub-national level.
At the same time, the government should also implement the new Law on Land Acquisition (UU No.
2/2012) fully by unleashing all necessary implementing regulations.
By Way of Conclusion: What we can learn from Indonesian case
The case of Indonesia’s economic development is a rich source of lesson on how different financing
strategies affect the outcome of economic transformation. Indonesia is a country rich in natural
resources with a large population and abundant pool of labor force. During its earlier period of
economic transformation, Indonesia relied on revenue from exploitation of natural resources,
particularly oil and gas production. The government played a very important role in determining the
direction of economic development by channeling the revenue to finance state-led big projects with
heavy import-substitution characteristics. Heavy government involvement in the development process
had restrained the transformation to take place fully, although it laid some foundations necessary for
further process, such as infrastructure, education and health.
The end of 1970s oil crisis, followed by the fall of world oil price, ended Indonesia’s big government
strategies towards development. Economic deregulation and reforms took place several times during
the period of 1980s, encouraging greater private participation and transform the economy from
primary-base to more modern economic sectors. During this period, the economy was dominated by
the development of labor-intensive manufacturing industry, taking advantage of large number and
relatively cheap labor force and export oriented strategy, while the Government focused on financing
public goods, including social infrastructure such as education and health. Boosted with greater
private participation and economic openness, Indonesian economy managed to perform quite well, not
only achieving remarkable growth of 7% during the period of 1980s and 1990s, but also improved the
livelihoods of its population.
The Asian Financial Crisis has changed the country’s economic structure as well as its social and
political situation. Two forces drove the economy away from labor-intensive manufacturing
previously dominated the economy, namely global boom of commodities, such as palm oil and
mineral products, and substantial increase of labor cost. Most FDIs to Indonesia in the first decade of
21st century went to extractive industries, services that cater domestic consumption and capital
intensive manufacturing. This is also the period where the Government found that fuel subsidy
50
became a hindrance to its budget as world oil price soared up to very high level, while at the same
time revenue from oil has been declining sharply. Lack of fiscal space of the budget has reduced the
Government’s capacity to finance many other important public goods, including infrastructure
development and social security system.
Four lessons can be learned from Indonesia’s experience. First is that it is important to share
development financing between government and private sector. While it is tempting for government
to finance productive sectors through public spending, especially for resource-rich countries such as
Indonesia, the experience shows that such strategy might crowd-out private sector ability to finance
their business operation, increasing costs of production and reduce competitiveness. At the same time,
governments also tend to choose productive sectors that may not be suitable with the country’s
comparative advantages and characteristics. Governments should focus on the development of public
goods, including physical and social infrastructure such as education and public health.of the
development and financing productive sectors should become the domain of private sector, with the
assistance of government policy and regulations
Second is the importance of the development of financial institutions to support private sector
activities. Indonesia managed to introduce banking and other financial institutions in the early 1980s
when private sector started to contribute more significantly in the economy. However, the country
failed to create strong and resilient financial institutions due to some practices against prudential
principles, e.g. excessive lending to the same business groups, financing domestic projects with
foreign-currencies-denomination loans, and low capital adequacy requirements. That had led to
massive financial sector collapse during the Asian Financial Crisis. Currently Indonesia is still
struggling to have a policy framework that puts a right balance between prudential action and
financial expansion.
Third is the importance to diversify away from natural resource dependency, both in government’s
revenue and economic activities. The decline of oil price in early 1980s prompted Indonesian
government to take necessary measures to increase other sources of revenue and encourage other
economic activities. This requires long term and consistent reforms and transformation. In the first
decade of 21st century Indonesia was again trapped to commodities boom that failed to stimulate other
sectors growth, except for non-tradable consumption-related sectors, such as property and low
productivity services. Indonesian government also still has difficulties in increasing and diversify its
revenue as now it depends on large tax payers, especially from corporate taxes.
Fourth is the importance of economic openness. As Indonesia moved toward greater participation of
business sector, the country also shifted to more open and outward oriented policy. It provides
financial means for economic activities in terms of FDIs, it opens the possibility of having bigger
market for Indonesia’s products, it supplies intermediate inputs for domestic production, and chance
to learn and progress through technological transfer and competition. The need to be more integrated
toward global economy has currently been deteriorating with the introduction of various inward-
looking policies. This has resulted to low participation of Indonesian industry in the global value
chain and international production network compare to other countries in the region.
Those factors have been contributing to a great deal to the development and transformation of
Indonesian economy. Indonesia is still lack behind in various other important factors and fails to
address them properly in the past. These include bureaucratic reform, development of economic
institution and implementation of rule of law. These holdback transformation process and increase
uncertainty to the economy, which eventually reduce the economic capacity to supply necessary
opportunities and job creation and affect the government’s ability to provide necessary public goods
for the better livelihood of the whole population.
51
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