Indonesia — Reform package may improve long term investment climate

A landmark ‘omnibus law’ approved this month aims to remedy longstanding impediments to Indonesia’s investment climate and competitiveness. Broadly, the new law aims to improve the ease of doing business, remove bureaucratic and regulatory obstacles to investment, address labour market rigidities, and use tax reform to incentivise investment.

The new law is unlikely to induce a rapid economic turnaround, but if implemented well, could fundamentally strengthen potential economic growth and external stability. FDI into Indonesia is low compared to peers and has moderated as a share of GDP from its peak in 2016. Indonesia has failed to capitalise on supply chains diversifying out of China. This is despite Indonesia’s substantial competitive advantages including a large domestic market, favourable demographics and natural resource wealth. Low levels of FDI have in turn contributed to lacklustre economic performance since the end of the commodities super cycle. That has, in turn, increased Indonesia’s reliance on volatile portfolio inflows, which puts external stability at risk during global financial market turmoil.

Given strong parliamentary support for the reform, the key challenge for the implementation of the bill is popular backlash and judicial review. Labour unions and environmental groups oppose the law, arguing it weakens protections for workers and the environment. This has resulted in violent protests in recent months. Continued protests could limit the benefits of the law for productivity and the investment climate.

Fig 2 OECD FDI Regulatory Restrictiveness Index