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Foreign direct investments on the rise

Total realised investments into Indonesia continued to improve through the pandemic, with the strength in foreign investments helping to balance an early moderation in domestic interests due to Covid-driven curbs and uncertainty. Since last year, domestic investments have also recovered, with foreign flows extending their climb.

Direct investment realisation in 2021 rose 9% yoy, closing in on the targeted IDR900trn, of which FDI jumped 10%, and DDI (domestic direct investment) increased by 8% in IDR terms. Back then, economic recovery on the back of an improving pandemic situation, manufacturing PMI, buoyancy in commodity prices, and overall better sentiments contributed to the pickup, besides ongoing reforms. Encouraged by this strong run, the 2022 target for total investments was set at a higher IDR 1200trn target. Considering past run rates/ CAGR, the nearly ~30% increase expected for 2022 is considered to be an ambitious target. Encouragingly, about 48.7% of the target has been met by the first half of the year.

Quarterly foreign investments rose to a record high in Jun22. The four-quarter rolling sum of realised FDI totalled US$37bn by mid-2022, up from $31bn in late 2021 and $28bn in Dec-19. This year, Singapore remained a key investor, including which the ASEAN region made up nearly a third of total flows, followed by China, Japan, and the US. A gradual but persistent rise in China’s share as an investor has been a significant development in the past decade, which is the case in Indonesia and the broader ASEAN region.

Provinces and sectors

Encouragingly, the spread of targeted provinces by foreign investors (realised) is becoming more broad-based. Even as Java single-handedly accounts for nearly half the flows, its share in the total has moderated in the past few years.

Instead, a bigger share of the investment pie is heading to provinces like Sumatera and Sulawesi, whilst that of Kalimantan eases. Amongst these, Sulawesi has been consistently rising, from ~5% in 2015 to ~16% in the first half of this year, which closely ties in with the growing importance of commodities, especially Nickel which have attracted the interest of offshore investors across the value chain. Sumatera is the other key draw due to the abundance of agricultural commodities including palm oil, rubber, and coffee, amongst others. This shift from highly populated cities was likely hastened by the pandemic, besides also mirroring a sharp rise in activity in the downstream commodity sectors.

With regard to jobs generation, total investments generated a strong ~1.2mn jobs last year but lagged the previous upcycle a decade ago when the run-rate was higher at 1.4-1.6mn annually. 

Incremental increase in foreign inflows has been witnessed in all three industry buckets – primary, secondary, and tertiary. A large quantum of increase, for instance, between Jun22 and Dec20, was in the primary and secondary sectors, into mining, basic metal industry and metal goods, chemicals, besides tertiary (real estate and business activities).

Few drivers have hastened the rise in foreign investments:

a)  concerted shift towards downstream commodities, smelters, and related activities, especially in the Nickel industry (we discuss more below). Export curbs on ores have been intended to improve supplies for domestic industries as well as disincentivise raw material sales; b) reforms under the Omnibus Law which includes the likelihood of dealing with the parts that were rendered ‘conditionally unconstitutional’ last year. The overall push towards deregulation has seen ex-ante licensing (satisfying all requirements in advance) effectively replaced by ex-post licensing (requirements are checked afterward), which will be particularly advantageous for low-medium risk businesses, according to the authorities. A positive list for investments, with a few exceptions of strategic industries, is also a step in the right direction. Export-oriented FDI carries the additional benefits of labour absorption, larger market share and key dollar earnings; c) active engagement and discussion with big-ticket foreign companies (for instance, Tesla, global EV battery manufacturers, etc.), amongst others.

Digging into one such driver is the economy’s widening presence in the base metal industry and downstream industries. Nineteen smelters have been constructed since 2021, with work on 34 more underway. Of these, work on 21 projects is over 90% complete spanning nickel, bauxite, copper, iron, etc. As a policy preference to move away from ore exports and move by the value chain, restrictions on exports of raw nickel ore have led to a sharp increase in the construction of smelters to produce processed ferronickel and nickel pig iron, with the latter a key ingredient for stainless steel production. Domestic nickel reserves are the largest in the work at ~21mn, with a share of 23.7% of global reserves.

As capacity continues to be added, Indonesia has emerged as the largest stainless-steel exporter in the past two years, a big shift from being a net importer of processed metals in the past. Tightening environment standards in other key producing countries, including China, also hastened this shift for alternate production hubs in the region, with Indonesia’s benefiting by being a resource-rich country.

The other industry that has benefited from the economy’s nickel reserves is Electric vehicles (please read Indonesia: Investments and foray into Electric Vehicles), especially as an input for the batteries and battery inputs. Authorities have been keen to promote the downstream metals industry which includes being a global player in midstream and downstream processes in EV battery production/ nickel processing. The nodal investment agency BKPM notes that batteries are the key components to EVs contributing a quarter to 40% of the cost of the vehicle itself, thereby making it cost-effective to be closer to the inputs/resource base.

This has attracted interest from various players, led by China and South Korean business groups. Few pipeline projects (cumulative ~$15.3bn) include

• Chinese battery manufacturer Contemporary Amperex Technology Co., Limited (CATL), along with Indonesia’s Aneka Tambang and PT Industri Baterai Indonesia has invested ~$6bn into battery production in Indonesia, across the value chain and might kickstart production in 2026-27
• South Korea's Hyundai Motor Group and LG Energy Solution began the construction of a battery cell factory in Indonesia, including nickel smelting to assembling finished products[1], which might start operations in the first half of 2024
• In Sep22, Taiwanese tech group Hon Hai Precision Industry, also known as Foxconn, announced a joint venture with domestic coal miner Indika Energy to manufacture batteries and EVs locally[2]. The initial investment is expected to be to the tune of $1.75mn.
• Preliminary discussions are ongoing with the US-based Tesla
• Indonesian unit of Brazilian mining giant Vale is embarking on three nickel processing projects worth a combined $8.6bn with other partners: a) with China’s Zhejiang Huayou Cobalt and potentially U.S. automaker Ford Motor, in Sulawesi; b) the other HPAL plant in Pomalaa, where construction is due to start this year and be completed in 2024-25; c) joint development of an estimated $2.3bn ferronickel facility with Tisco, a subsidiary of state-owned stainless steel giant China Baowu Steel Group, and top Chinese nickel pig iron producer Shandong Xinhai Technology

Considering sufficient pipeline interest in the base metals and processing industry, the momentum for Indonesia’s FDI is likely to remain strong over the next 2-3years. Nonetheless, higher investments into the nickel processing industries, in particular, will have to be balanced with the carbon-intensive nature of the production cycle (high reliance on coal).

Strong FDI flows are also a tailwind for the financial account under the balance of payments when heightened global uncertainty has weighed on portfolio flows. The current account balance is likely to register a second consecutive year of surplus (DBSf: +0.4% of GDP), which along with a firmer net FDI position, will help offset the weakness in volatile portfolio flows and keep the overall balance of payments in green this year.

Updating macro views

Our latest GDP Nowcast model for Indonesia suggests that 3Q22 is likely to register >5.5% growth, quickening from average 5.2% in 1H22.

For 2H, export outperformance is likely to be a key driver, besides higher investment, and consumption growth as a complete resumption in service sector activity provides the lagged lag of boost to incomes and purchasing power.

Rising inflation and a hike in subsidised fuel prices in late 3Q will dampen spending at the margin, besides temporarily weakening sentiments. Part of the impact of higher fuel prices on low-income households’ demand, however, is likely to be offset by fiscal support measures.

In all, a stronger-than-expected boost to growth nudges us to revise the 2022 forecast to 5.4%yoy from 5.2% previously. In light of dampening growth prospects in the US, our outlook on China and Europe, lagged impact of tightening liquidity, a strong rise in rates and risks of a further pullback in commodity prices, besides base effects, we retain our 2023 growth at 4.8%yoy.

On the inflation front, Jan-Sep22 inflation has averaged a modest 3.8%yoy, with price pressures building up since Jun-Jul owing to a rise in food costs which was accompanied by higher transportation and unsubsidised fuel price increases. The hike in subsidised fuel prices (read Indonesia’s fuel price hike, a medium-term positive) in early-Sep is likely to drive inflation up sharply over the next 3-6months, already evident in the jump in Sep’s inflation at 6% from 4.7% in Aug. Even if we assume that inflation is likely to top 7.0% in 4Q22 due to lagged transportation cost adjustments and second-round effects, there are downside risks to our full-year inflation forecast as a) a softer Jan-Sep average and b) and food costs ebbing on easing supply-side constraints, including the volatile segment. We moderate our 2022 inflation forecast to average 4.6% from 5.0% projected earlier whilst maintaining 2023 at 4%. 

These changes don’t alter our policy rate view. BI’s inflation concerns have been overshadowed by rupiah volatility as well as a challenging flows outlook. Armed with a resilient growth backdrop, we expect the central bank to deliver at least three more 25bp hikes each in October, November, and December. Risks are tilted towards frontloaded and more policy tightening especially if global uncertainty triggers further volatility in the rupiah’s movements and/ US Fed signals a more aggressive rate hiking path. Operation twist operations have helped to keep a lid on long-end bond yields, with the authorities allowing the short end of the curve to adjust up and restore rate differentials.

[1] Reuters
[2] Nikkei Asia, Vale,

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