The Political And Legal Systems Of Indonesia

1. Country profile:

Indonesia is located in the southeast part of Asia. Indonesia stretches 5120 km along the equator and has 13000 islands between Australia and Asia. Due to this there has been an influence on the social, cultural, economic and political life of the country. Indonesia’s total area is 80% sea mass. Java, Sumatra, Kalimantan, Papua and Sulawesi are the five a largest island of which java is the most populated island, a total population of 125 million (CIA 2010). Jakarta is the capital of Indonesia. Indonesia has a tropical climate which consists of two season’s summer from May to September and the rainy season from October to April. Indonesia experiences rain during both the seasons.

The fourth most populated country in the worlds is Indonesia with a population of 242.96 million (CIA 2010). Indonesia is the largest Muslim country. It is an ethnically diverse country with more than 300 languages.

http://mapoftheunitedstates.files.wordpress.com/2008/03/indonesia_.jpg

Figure 1: Indonesia Map

Sources: CIA Website 2010

2. Political system and Legal systems:

Indonesia today is Southeast Asia’s most vibrant democracy. The Indonesians enjoy a level of political freedom. The present improved political system now encourages freedom and equality for the people of Indonesia.

Figure 2: Political system of Indonesia

Source: Indonesia 2009: An official handbook

The three key branches of the Indonesian government are

The executive branch

The legislative branch

The judicial branch

2.1 Executive branch:

The president is the head of the state and government, in turn is on top of the executive branch. Under him is the vice-president, cabinet ministers and also non-departmental agencies. He is also the commander-in-chief of the armed forces. The main role of the president is to govern his nation, make policies and look in to the foreign affairs. The president has the power to assign and reject the cabinet ministers. One of the main roles of the president is to assign the judge for the Supreme Court.

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2.2 Legislature branch:

This branch consist a representative body which is the people’s consultative assembly or (MPR). The MPR has the right to question the integrity of the president. The MPR has two lower chambers i.e the People’s Representative Council or the (DPR) and the Regional Representatives Council or (DPD).

2.3 Judicial branch:

The Indonesian judicial system has three main courts i.e. the high court, Supreme Court and the district courts. The Supreme Court is the highest level. These courts have the rights to exercise both civil and criminal cases. Indonesia has different courts for different matters, religious courts, military courts and administrative courts. Firstly all the civil disputes are handled in a state court and then forwarded to the high court. A commercial court exists to handle bankruptcy and commercial matters.

The three branches of the legal system in Indonesia are

The notaries

Advocates

Legal consultants.

A notary is appointed by the Department of Justice & Human Rights who is trained legally to notarise deeds. A notary prepares and executes the formal deed called the notarised deed, it is also known as the authentic deed. The legal documents require notarised deeds. The role of the notary is to make sure that the parties have considerable amount of proof for their deeds and the deed is executed properly. The notary should be present when a party plans to start a company.

A notary is appointed by the government and his duty does not include giving legal advice. These parties need to get legal advice before they meet the notary. The main duties of the notary are to prepare and verify the documents. The parties are free to choose any notary they want.

Advocates are lawyers who practice privately and have formal legal training. The main duty of the advocates is to focus on litigation but they can also provide general legal advice. For advice on foreign transaction experienced lawyers are needed.Hiring a good and trust worthy lawyer is essential for doing business in Indonesia. Some of the important laws relevant for businesses in Indonesia are given below:

The Law on Investment

The Labour Law

The bill on Mineral and Coal Mining

The Oil and Gas law

The Shipping Law

Law on Disputes and Conflict resolution

Corporate Law

Land rights

Few tips for the foreign investors

There should not be any restrictions on the type of business the company is planning to start.

A good notary is a must to set up a business.

The employees who have an important position should be paid well.

Build good relations with the company and the society.

3. Economic system

Under the leadership of Suharto who was the president of Indonesia for over three decades the economy had witnessed two major financial crises. This was during 1997- 98 and 2008. Indonesian economy is directly dependent on three main sectors,

Agriculture

Manufacturing

Service.

These crises were direct result of corrupt politicians, natural disasters, disturbances in the society and terrorism. The result was that the economy suffered which in turn caused in drop of employment opportunities and loss of manpower that migrated in search of employment. The graph shows the distribution of workforce among the three key economic sectors.

Indonesia’s Employment

Figure 3: Indonesian Employment

Source: Economy Watch

The three main sectors that constitute the Indonesian Economy are:

Primary Sector:

Agriculture by far is the largest employment sector. Some of the common produce is rice, pork, coffee, tea, cocoa, spices, rubber, eggs, copra, palm oil and peanuts. Indonesia stands 4th in world market for the production of coffee and rice.

Secondary Sector:

Nearly 27.9% of Indonesian’s GDP comes from the manufacturing sector (EIU 2010).

Tertiary Sector:

Service sector has for long has been the pillar of Indonesian economy contributing nearly 38.5% towards the country’s GDP. Global financial crises slowed down the IT sector. However, it has been predicated to contribute up to 15% towards the compound annual growth rate (CAGR) during the period of 2010-2014 (EIU 2010) . Hospitality industry has surprisingly started contributing towards Indonesian economy. The tourism industry flourished with no major impact due to the global recession.

4. Economy:

Indonesia has the largest economy in Southeast Asia. It is a market based economy with a significant involvement of the state. There are a large number of state owned enterprises (SOEs). Indonesia is considered as an emerging economy. In the end of 2009 the GDP was $540.3 billion and the per capita GDP was $2717. The GDP growth in 2010 reached 5.9% and to further accelerates to an average of 6.2 % a year in 2011-2014. In terms of GDP industrial sector is the largest (46.9%), followed by services (37.2%) and agriculture (15.9%) [i] . Indonesia is a major exporter of oil (US Department of State 2010)

Indonesia is market leaders in the production of palm oil and one of the main producers of rubber, coal, liquefied natural gas and cocoa. Some of the prime industries are mining, petroleum and natural gas, cement, textiles and chemical fertilizers.

There is a reduction in the poverty of the population. Indonesian economy has been improving after some major financial crisis in the past, thus investing on Indonesian Economy would be associated with low risk.

Growth in GDP by field of business from 2005 to 2009:

Growth (%)

2007

2008

2009

Agriculture

3,5

4,8

4,13

Mining and Quarrying

2

0,5

4,37

Manufacturing

4,7

3,7

2,11

Electricity, Gas and Water Supply

10,3

10,9

13,78

Construction

8,6

7,3

7,05

Trade, Hotels and Restaurants

8,4

7,2

1,14

Transportation and Communications

14

16,7

15,53

Finance, Rental and Business Service

8

8,2

5,05

Services

6,6

6,4

6,40

GDP

6,3

6,1

4,55

Sources: Bank Indonesia and Asian Development Bank 2010

Distribution of GDP by field of business from 2005 to 2009:

Distribution of GDP (%)

2007

2008

2009 [ii] 

Agriculture

13,8

13,7

15,3

Mining and Quarrying

8,7

8,3

10,5

Manufacturing

27,4

26,8

26,4

Electricity, Gas and Water Supply

0,7

0,7

0,8

Construction

6,2

6,3

1,0

Trade, Hotels and Restaurants

17,3

17,4

13,4

Transportation and Communications

7,3

8

6,2

Finance, Rental and Business Service

9,4

9,5

7,2

Services

9,3

9,3

5,6

Sources: Bank Indonesia and Asian Development Bank 2010

4.1 Inflation Rate:

According to the financial report in April 2011 Indonesian inflation rate stood at 6.16 %. During the period between 1997 to 2010, Indonesian inflation rate averaged between 13.26% and reaching its all time high of 82.4% in the third quarter of 1998 and reached a all time low record of -1.17 % in first quarter of 2000.

4.2 Social Economy:

The population of Indonesia stood at 232.4 million during 2010. It has a healthy percentage of population who are young. The median age is 27.2 years and the population growth is 1.175%. Looking at the age structure, 28.4% of the population is between 0-14 years, 67.5% are between 16-67 and 5.8% over 65 years. Life expectancy is 70.46 years. As of February 2011, labour force was 116.5 million. When dividing the labour force by sector, one finds that agriculture employs the most people (42.1%), closely followed by the services sector (39.3%). 18.6% are employed in the industrial sector.

The table shows the distribution of the employment among the major industries.

Industry

# of employees

%

Agriculture, Livestock, Forestry, Fishery

42,689,635

41.83

Mining and Quarrying

1,062,309

1.04

Manufacturing

12,440,141

12.19

Electricity, Gas, Water

207,909

0.20

Construction

4,733,679

4.64

Trade, Hotels, Restaurants

20,684,041

20.27

Transportation, Storage, Communication

6,013,947

5.89

Finance, Real estate and Business services

1,440,042

1.41

Community, Social and Personal services

12,778,154

12.52

Source: Indonesia 2008: An Official Handbook

Indonesia’s official unemployment level is currently 7.4 %; a decrease from former levels of unemployment between 8 and 9 %.

5. Cultural issues

Indonesias workforce values is as given below:

http://www.geert-hofstede.com/graphs/hofstede_indonesia.gif

Figure 5: Geert Hofstedeâ„¢ Cultural Dimensions

Sources: Geertz Hofstede 2009

The above graph indicates that Indonesian’s are generally inclined towards distribution of power in a pyramid like structure as opposed to individualism which is promoted in western cultures. Culture is a multi layered which incorporates a multitude of aspects which has to be closely understood before any new venture is planned. Below figure outlines a few key determinants which constitutes a culture,

Figure: Cultural Norms

Source: International Business, Asia pacific edition.

The Indonesian culture is quite different from the western culture. Tradition is very important for the Indonesian’s even though they live in a modern society. This does not mean they don’t welcome the western culture. Indonesians are proud of their background and are not very keen on learning about different cultures. They in turn expect the foreigners to invest time and effort in learning their culture. In order to build good relations with the Indonesians it is better to learn their language and culture. This won’t be an obstacle since the Indonesians are friendly and polite people.

To establish itself it is mandatory for business to invest and participate in the development of the social structure and economy of Indonesia. Variables such as gender, age, marital status and education affect the ease with which personal and commercial relationships are formed. In order to penetrate and govern smooth operations it is advised to nominate older and mature executives to be in charge as opposed to young executives. It has been proved that aggressive nature of pursing business has many risks associated as the social structure calls for investing time in nurturing and building relationships adhering to the cultural norms which in turn will lead to successful business operations.

6. Ethical Issues:

The most common ethical issues encountered are employment practices, human rights, environmental regulations, corruptions and the moral obligations. Skilled labour is more of a commodity in Indonesia as the local companies invest minimal time and effort on training their staffs. Investing on training and development is one of the key initiatives that have to be undertaken by any new ventures.

Recent trends show employees value the time and money invested in training and development which in turn leads to increased loyalty and increase production. Drastic changes in management policies have to be subtle and well planned, as this might lead to insecurity and misunderstanding. It is suggested to seek assistance from independent auditors to review any human rights violations that might indirectly affect the business. But recent trends suggest minimal human right violations.

Environmental regulations in Indonesia are still being formalized and this in turn posts a challenging dilemma of adhering to the policies which is far inferior to that of the home nation’s environment policies. Added measures have to be put in place to maintain the delicate balance of the local surroundings and ensuring minimal impact to the environment. Corruption in Indonesia has been a long standing issue. Recent change in the government structure has not been to counter this major concern. This has been a major determinant for foreign investors to shy away from Indonesian markets. To negate this factor the organizations culture and leadership should draft a code of ethics against corruption. And emphasize all business practices to strictly adhere to these ethics.

7. Trade:

Due to the improvement in Indonesia’s trade the economy had seen a lot of positive changes. This change has increased employment opportunities, has reduced poverty and increased the status of the middle class. Indonesia has been able to recover well after the financial crisis when compared to the neighboring countries. Because of this Indonesia can increase its share in the global market and increase the domestic sales. For this to happen successfully Indonesia needs to reform its trade structure and reduce the tariffs and quotas. Even though there has been a drastic growth in the export of the countries resources, it has not made any progress in the exports of manufactured products.

The main concern of the producers in Indonesia is they cannot compete with the producers who manufacture with reduced costs. One of the main reasons for Indonesia’s products to be weak in competition is the low level of connectivity. The high cost of transportation is one of main causes in the declining of trade. Trade between countries might be cheaper than trading among the islands.

Transportation using trucks is inconvenient because of the poor roads in Indonesia. Another main disadvantage that reduces international trade is the low performance of Indonesia’s main ports. Just-in-time production is not possible in Indonesia because of the inefficient and expensive transports. Another issues concerning international trade is licensing and policies imposed by the government. Indonesia does not encourage in improving the logistics which deprives them of new technologies.

8. Investment opportunities by sector:

Indonesian economy has great potential for foreign investments, as it is a large country with ample natural resources, mining and energy, forestry, agriculture, and marine resources, many of which are not exploited yet. The country has a very large and inexpensive workforce as well as a significant market. Indonesia has been experiencing a steady annual economic growth and this growth is continuing for years.

8.1 Energy:

As an emerging economy, Indonesia depends heavily on an increased production domestically of energy resources. Energy is the largest export product and the second largest import product. When considering both the exploited/developed and unexploited/undeveloped energy resources, there is still a great potential for increased trade and investment in the energy sector.

8.2 Oil, gas and coal:

Among the countries in Asia, Indonesia is among the top ranked country as it has proven gas reserves of about 3.18 trillion. It is predicated that the requirement is likely to increase in local power plants.

Due to disappointing exploration by major players, oil production has decreased during the last decade. Its currently consumes nearly 1.2 million bbl/d of oil which makes it a net importer.

The country has invested heavily on the production of natural gas targeting the export market, but declining oil production has forced them to divert most of its gas production into local markets.

8.3 Telecommunications:

Indonesia for several years has been the fastest-growing mobile phone market in the Asia-Pacific region with annual growth rates of up to 60%. Even though Investing on mobile markets has been high its relatively small compared to the cost of establishing a fixed-line network. Millions of Indonesians who otherwise would not have access to telecom services now have a mobile Phone (CIA 2010).

8.4 Infrastructure:

Indonesia has experienced rapid growth in the total number of road vehicles, particularly motorcycles, but also cars and trucks. Inadequate infrastructure is therefore often mentioned as one of the main impediments to investments in Indonesia. The government with the help other financial aids, is trying to improve the infrastructure by introducing new projects (Bloomberg 2010).

9. Foreign exchange:

Exports are an integral part of Indonesian economy as it generates foreign exchange. This in turn allowed it to acquire raw materials and machinery required for the development. The earnings from Export helped Indonesia to borrow from international financial markets and development agencies. This helped government sponsor developmental projects in Indonesia. Because of the increase in borrowing by 1990 Indonesia’s total foreign debt was US $ 54 billion. A committee was established in 1991 named The Foreign Debt Coordinating Committee to check the growing foreign debt. Indonesia was funded by World Bank, Netherlands, Japan, Denmark and Asian Development Bank.

The supply and demand relationship between international and the domestic market is determined by the foreign exchange rates in Indonesia. In an effort to stabilize the exchange rates the Bank of Indonesia regularly sterilizes the exchange rate.

9.1 Currency:

The currency of Indonesia is the Rupiah It is a freely convertible currency. Since the rupiah was subjected to high inflation during the Asian Financial crisis in 1997-98, the rupiah has been considered as risky currency to hold. After the recovery of the economy the currency has been relatively stable. Today, this perception has changed as the solid fundamentals of the economy and sustained high yields underpin the attractiveness of investment.

Historical exchange rates:

Year

IDR/USD

IDR/NOK

2004

8,939

1,335

2005

9,704

1,507

2006

9,159

1,431

2007

9,143

1,559

2008

9,699

1,721

2009

9,754

1,675

2010

9,048

1,525

2011

8,590

1,534

Sources: Norges Bank, CIA

10. Financial management:

Indonesia Financial sector in Indonesia is divided into banks held by local governments, banks held by state, private sector banks, foreign banks and cooperative banks. However three major players in the microfinance industry which govern the Indonesian markets are the state-owned BRIs, BPRs are small financial institutions and pawning company. Since 1986 the BRI unit has been profitable and has operated as an autonomous entity since its 1987.

The Indonesian Movement for Microfinance Development (GEMA PKM) which is an organization comprising representatives of the government, NGOs, financial institutions, the business sector, universities, and research institutes. There primary objective is to partner in the drafting of a Microfinance Act, also formulating some best practices which would aid in poverty reduction and for the growth in economy. One such change was to introduce Tax Laws to fix corporate income tax to 25% from 2010.Description

Description

Final Income

Tax Rate (%)

Rentals of land and buildings

10%

Proceeds from transfers of land and building rights

5%

Interest on time or saving deposits and on Bank of Indonesia Certificates (SBIs) other than that payable to banks operating in Indonesia and to government approved pension funds

20%

Interest on bonds other than that payable to banks operating in Indonesia and to government approved pension funds

15%

Sale of exchange-traded shares on the Indonesian stock exchange

0.1%

Forward contract derivatives

2.5%

T

ax Rate (%)

The primary agenda in front of National Committee is to draft out issues and road blocks that are elevating poverty; It also organizes meeting between business and institutions in order to identify and assess policies that are currently imposed on small businesses and MFIs; They are in the process of accelerating the passage of a new Credit Collateral Law that will simplify distribution of microcredit system.

11. Recommendation:

Indonesia remains as attractive destination to invest, but has been found vulnerable to multiple risks. Therefore is it imperative for Organizations to take a proactive approach while considering investment options. Below are some of the strengths which will aid in decision making and also some of the weaknesses that have to be assessed in order to formulate an effective risk management strategy.

Weakness

Low investment rate

Limited bank intermediation

Infrastructure deficiencies

Persistent corruption and lack of transparency

Interethnic tensions exacerbated by high unemployment and poverty

Strengths

Strengthened banking sector

Diversity of natural resources (agricultural, energy, mining)

High competitiveness underpinned by low labour costs

Consolidation of political stability

Dynamic tourism

12. Conclusion:

The above report provides a high level overview of the feasibility and associated risk involved in investing in Indonesia. The current business environment posts several challenges some of the main issues are bureaucracy which lacks transparency, uncertain legal structure, poor infrastructure and lacks security. But recent trends all point towards organizations exploring developing economics in search of expansion as the market has tremendous opportunities. Decentralization of power is not adding in smooth investment as this structure introduces further levels of bureaucratic process. Adding to the above mentioned problems Indonesia has been prone to natural calamities which add to the existing risks.

13. Executive Summary:

As the fourth most populated country in the world, Indonesia’s large domestic market offers a wide range of investment opportunities for foreign and domestic investors. This report will try to assess some of the key elements such as the political system and legal system asses the favorability and ease of investment in Indonesian markets.

Then the report shifts its focus on the economic system which by far is one of the most important factors that directly influences investment decisions. Economic growth which has been predicated to be in the range of 5% and 7 % for the next five years, which shows proactive approach by the Indonesian government to attract FDI. The projected FDI by 2014 is expected to reach approximately US$222 billion.

The government has made amendments to reduce income tax on cooperates and fixed it to a flat rate of 25%. The licensing process has been made easy to encourage investments in the mining and shipping sectors. Decentralization of government sectors has acted as a major road block in simplifying the licensing process for foreign organizations to invest in Indonesian markets.

Indonesia currently has some of the largest deposits of natural gas and oil resources across Asia. According to the recent trends and investigating the various sectors contributing towards the current situation, Indonesia can be considered as a medium risk investment opportunity. It is recommended to take a cautious approach in investing in Indonesian markets. Foreign investments should consider investing on Indonesian Limited Liability Company to reduce potential risks. Also opening small branch offices and assessing the market condition is the most suitable option of investment.