BATAM - A DEVELOPMENT MODEL FOR INDONESIA?

UNCLAS SECTION 01 OF 03 JAKARTA 008800 SIPDIS SIPDIS SENSITIVE DEPT FOR EAP/MTS AND EB/IFD/OIA USDOC FOR WGOLIKE/4430 AND JBENDER DEPT PASS TO USTR DKATZ AND WEISEL TREASURY FOR OASIA E.O. 12598: N/A TAGS: ETRD EINV ECON EFIN ELAB ID SUBJECT: BATAM - A DEVELOPMENT MODEL FOR INDONESIA? ¶1. (SBU) Summary: The July 25 Indonesia-Singapore "Framework Agreement on Economic Cooperation" aims to create an ambitious Special Economic Zone (SEZ) in Batam and adjacent islands, already the site of one of Indonesia's most noteworthy manufacturing success stories. Batam's local economy continues to perform strongly based on solid manufacturing growth, property development, and a boom in oil and gas support services. Underpinning the island's economic success is an attractive investment climate based on a combination of good local governance, proximity to Singapore, good infrastructure, and labor discipline. Amidst rising growth, however, growing pains are emerging with the large-scale influxes of people and foreign businesses. Businesses and local government officials in Batam believe Indonesia's plan to replicate the Batam model in SEZs across Indonesia will depend heavily on the legal certainty the new zones offer investors. The GOI hopes to begin drafting a SEZ law in July, but the timetable for passage is uncertain. Another big hurdle for new SEZs will be clearly delineating the roles and responsibilities of various levels of government and zone managers. End Summary. Good Investment Climate Leads to a Vibrant Economy -------------- -------------- ¶2. (U) We made a July 6-7 visit to Batam Island to evaluate the recent Indonesia-Singapore framework agreement on SEZs and assess the suitability of the Batam model for other potential SEZs in Indonesia. Our meetings with Mustofa Widjaja, Chairman of the Batam Industrial Development Authority (BIDA),Ismeth Abdullah, Governor of Riau Islands Province, Batam Mayor H. Ahmed Dahlan, and the head of customs for the island underscored Batam's economic prosperity and advantages for attracting investment. Batam operates under a "bonded zone plus" status that provides duty free treatment and income tax exemptions for imported capital goods and raw materials coming into bonded zones and then going out for re-export. The island also assesses no value added tax (VAT) for all processing industries for export purposes. Batam's bonded zones consist of 23 large industrial parks and more than 100 single-company facilities. ¶3. (SBU) Batam's location 12 miles south of Singapore allows companies to set up manufacturing operations in low-wage Batam while leaving back office functions in Singapore, in many cases reducing costs. The island offers a more flexible and cost-efficient business climate for foreign investors compared to Singapore's expensive labor, tougher environmental regulations, and sparse land. After 30 years of development, Batam now boasts strong cargo support facilities, reliable electricity supply, and enough water for one million people and industrial use. Business representatives in Batam told us these resources, together with strong infrastructure and a relatively disciplined labor force, offer better investment opportunities than other parts of Indonesia. A recent USAID-sponsored survey measuring social and political factors, local economic factors, infrastructure, and labor quality and cost found Batam's investment climate to be among the top ten for Indonesian cities. ¶4. (SBU) According to BIDA statistics, Batam attracted nearly USD 700 million annually from 2001-05 in foreign and domestic investment. Approximately 850 foreign companies are operating in Batam, including 4 wholly owned U.S companies and 17 U.S. joint ventures. The largest U.S. company is PT McDermott Indonesia, which manufactures oil and gas drilling platforms at a very large facility employing over 5,000 Indonesian workers. A number of other U.S. firms have impressive, medium-technology manufacturing or assembly operations in Batam, including Vetco, PerkinElmer, and CibaVision. The island has averaged 7.4 percent GDP growth since 2001, well above Indonesia's overall growth during that period. Population growth also shows upward trends, with a 52 percent increase in just six years. Batam's current property development boom reflects this growth, and also may indicates the island's ongoing shift from an industrial zone where workers come to work temporarily to a more permanent city. JAKARTA 00008800 002 OF 003 Challenges Posed by Economic Prosperity -------------- ¶5. (SBU) Population growth has forced BIDA and the Batam city government to grapple with rising social and development needs of a larger and more complex community. Transportation has emerged as a major issue as fuel price hikes in 2005 doubled transportation costs for workers. Development disparities between Batam and the less-developed outer islands have increased, with local government facing challenges in delivering services to hard-to-reach communities. One manager at a U.S.-owned manufacturing plant told us Batam's lack of quality continuing education programs is one of the biggest challenges facing the local government. Increased training and educational opportunities would help meet the needs of upwardly mobile skilled workers and strengthen the unskilled labor force as well. ¶6. (SBU) The Batam city government has authority over health, education, welfare, and tourist-related enterprises. However, the central government chartered BIDA more ten years before it established the city of Batam in 1983 and 30 years before Parliament created Riau Island Province in ¶2004. As a result, BIDA long delivered a wide variety of services that local governments provide in other Indonesian cities. With decentralization, however, certain BIDA functions are devolving to the Batam city government. BIDA's primary responsibility remains the planning and managing of infrastructure development, providing trading licenses and permits, and processing international and domestic investment applications. ¶7. (SBU) Prior to the 2005 local elections that brought to office a new Mayor of Batam and Riau Island Governor, as well as the 2006 appointment of Widjaja as BIDA chief, there were frequent turf fights between BIDA and the local overnment. All sides now profess a strong determiation to work together to improve the island's atractiveness as an investment destination. Busiess representatives we spoke with agree such cooeration will be crucial in addressing new challenes posed by economic prosperity and competition frj t er SEZs in Vietnam, China, and Subic Bay. Indonesia - Singapna FQa mework Agreement -------------- ( -------------- ¶8. (SBU) Riau Islands Governor Abudulaah told us that after years of waning GOI attento*n to Batam, the June 25 agreement signifies theffull support of the Indonesian and Singaporean governments to boost growth, reduce development disa rities in outer islands, and increase foreign ivvestment in the islands of Batam, Bintan, and Kariu n. According to a Singapore Embassy officer in aakarta, growing concerns among Singaporean investors in Batam over manpower, customs, and tax issus" are the driving force behind the agreement on hhe Singapore side. Singapore businesses worry ta t growing business climate problems in Batam simiaar to those found in other areas of Indonesia, such as lengthy business visa procedures, burdensom labor regulations, and customs corruption, are iignificantly reducing Batam's competitiveness. ¶9. (SBU) The Singaporean role in the Agreement cnnsists of investment promotion, training of administrators in charge of running industrial zones, and vocational training. In August 2006, the GOI plans to release authority to issue all business-related licenses to Batam. This authority includes FDI approvals, approvals for foreign workers, and trade and tax permits. An Indonesia-Singapore ministerial-level joint steering committee will meet a second time in mid-July to discuss concrete steps to implement the Agreement. Will the Batam Model Work in Other Regions? -------------- ¶10. (SBU) The Singapore-Indonesia framework agreement dovetails closely with an emerging GOI plan to set up a number of SEZs across Indonesia in order to lure more JAKARTA 00008800 003 OF 003 foreign investment. The logic behind the GOI's SEZ plan is that improving Indonesia's overall investment climate will be a long term process, but that establishing a small number of discrete zones with high-quality services for investors could proceed quickly. As Indonesia's only successful economic zone, the GOI naturally looks toward Batam as a possible model for the rest of the country. Officials in Jakarta and Batam have mentioned a number of possible locations for SEZs, including Bitung in North Sulawesi, Makassar, Bali, Bekasi/Cikarang in the Jakarta area, and Bojonegara in Banten province. Zones in Bitung and Bojonegara would be adjacent to major new port development projects underway in those areas. ¶11. (SBU) The likely success of the GOI's plan to use Batam as a development model for other SEZs will depend on several factors. According to our interlocutors, by far the most important factor will be guaranteeing investors legal certainly via a clear and competitive Special Economic Zone Law. Batam is established pursuant to a 1973 Presidential Decree, since that date, the GOI has made at least five revisions to the island's bonded zone status via Presidential Decree. Since 2001, the island's status has shifted from a bonded zone to a Free Trade Zone to the current "bonded zone plus" format, increasing administrative and compliance costs for businesses. BIDA officials added that a special SEZ law would also perform the important function of de-conflicting Indonesia's existing customs, immigration, taxation, decentralization, and labor laws as they apply to potential SEZs. ¶12. (SBU) Passing a SEZ law potentially could also resolve a second major obstacle to SEZ development in Indonesia: the relationship between SEZ authorities and revenue-hungry local governments. BIDA came into existence more than a decade before Jakarta established the city of Batam, but in other areas of Indonesia the SEZ authorities would be the newcomers and likely in a weaker position. Our business contacts noted that establishing clear lines of authority over key issues like permitting authority and infrastructure provision would be important for reducing conflict over potential zones. Although initially resistant to the idea of asking Parliament to pass a stand-alone SEZ law, Coordinating Minister Boediono has reportedly accepted the idea and formed a special team to produce a draft law. However, although the GOI would not be starting from scratch (Parliament passed a Law on Batam in 2003 that former President Megawati never signed),the timetable for passage remains uncertain. ¶13. (U) TDY Economic Officer Shamila Chaudhary drafted this report. PASCOE