The Indonesian central government took a number of far-reaching decisions concerning Batam last month. First, Jakarta appointed Mr Lukita Dinarsyah Tuwo, formerly the secretary of the coordinating minister for economic affairs, as the chairman of the investment facilitation agency Batam Indonesia Free Zone Authority (BP Batam). The state agency manages the free trade zone.
Second, the agency's entire management team was replaced with a group of Java-based senior civil servants.
Third, the island's decade-old status as a Free Trade Zone (FTZ) is to be rescinded, with Batam instead becoming a Special Economic Zone (SEZ).
The moves are of particular interest to Singapore, given the Republic's close economic ties with Batam. Operating costs are lower there and it is just a 40-minute ferry ride away. Batam, along with parts of neighbouring Bintan and Karimun, are a part of an SEZ with Singapore.
Batam's total export value last year reached US$8.41 billion (S$11.4 billion). Total imports topped US$6.13 billion, with Singapore accounting for US$3.89 billion of exports and US$2.1 billion of imports.
However, last month's centrally-mandated changes imply a serious loss of confidence in BP Batam. Established by presidential decree in the 1970s, the agency has high-quality staff, central government funding and close links to policymakers in Jakarta. Over the past decades, BP Batam has been at the forefront of the island's industrialisation process through liaising with investors and managing land banks and assets, such as the airport and seaports.
These measures come in the wake of declining economic performance in Batam, which had been intended to become one of Indonesia's foremost industrial centres. Over the past two years, economic growth has levelled off, registering a mere 2 per cent growth over the last six months. This is substantially below the national average of 5 per cent.
Foreign direct investment has plummeted to a quarter of the levels seen during the 2000s. According to Batam's Manpower Agency, between 2015 and last year, more than 110 firms closed operations. This trend has continued unabated, with 53 firms closing in the first half of this year.
These worrying indicators have been coupled with widespread dissatisfaction within the business community about limited communication with senior BP Batam officials and scarcity of available land, as well as hikes in lease prices and port fees.
Indeed, with the aim of raising revenue, owners of industrial parks allege that BP Batam has started selling land directly to investors, constituting, in effect, a conflict of interest.
Restoring Batam's industrial competitiveness and growth trajectory will be challenging and require some time. In particular, the transition to an SEZ will be a highly complicated process and require negotiations with many stakeholders.
Consequently, the Coordinating Minister for Economic Affairs Darmin Nasution decided to replace the former chairman, Mr Hatanto Reksodipoetro. Mr Hatanto, a former World Trade Organisation negotiator and ambassador to Norway, had been appointed a mere 18 months ago with a mandate to revitalise the agency and, consequently, Batam's economic fortunes.
The new chairman, Mr Lukita, has substantial experience in government, specifically in the Ministry of National Development Planning during the Susilo Bambang Yudhoyono administration and then the Coordinating Ministry for Economic Affairs under President Joko Widodo.
He will be accompanied by a team of four senior civil servants, who will each head one of BP Batam's departments: finance, planning and development, business facilities, and general affairs and resources.
Mr Lukita faces several daunting tasks: restoring Batam's industrial competitiveness and attaining an annual growth rate of 7 per cent within two years and overseeing the island's transition from an FTZ to a SEZ.
While this transition will entail a period of uncertainty, the SEZ status has a number of positive attributes. New investments in Batam will benefit from a range of fiscal incentives including income tax cuts of 20 per cent to 100 per cent for up to 25 years; exemption from value-added tax ; removal from Indonesia's negative-investment list, which denotes industries from which foreign investors are barred; as well as postponement of import duty on capital goods, equipment and materials for industrial processing.
DOMESTIC MARKET BECKONS
More than the incentives, the new status will enable investors in Batam to sell goods and services on the domestic market, which is penalised under its current FTZ status. This is a really crucial provision as investors have long complained about being unable to cater to Indonesia's increasingly large consumer base.
Indeed, over the last few years, Batam has lost out to more central locations such as Central and East Java for this reason.
However, while this provision has the potential to increase the island's attractiveness for investors, Mr Lukita faces considerable challenges elsewhere.
First, red tape and bureaucratic overlap needs to be reduced. Indonesia's decentralisation reforms have increased the number of agencies and veto-players facing businesses. Specifically, investors in Batam need to deal with two authorities, which compete instead of complementing each other.
BP Batam has the authority to distribute land for industry, issue business licences and develop infrastructure. The municipal administration, for its part, is in charge of public services and administrative affairs.
For instance, to build a factory, an investor must secure a land allotment from BP Batam while, at the same time, apply for a building permit from the municipal government. Investors have bought land with the approval of one agency, only to find out that the other has gazetted it as part of a forestry reserve. These disputes have affected up to 22,000 land titles.
Second, other aspects of the island's competitiveness need to be addressed. Key among them is wage levels, which after Jakarta, are the highest in Indonesia. Crucially for manufacturing, they are substantially higher than those in Central and East Java, which are the new frontiers for industrial investment.
Closely linked to this is the absence of affordable and regular logistics connections from Batam to Java. Until recently, there was but one container ship per week plying between the two islands, and the island does not have a deep-water port.
While domestic connections have improved of late, cost concerns and inefficiencies in the local port sector mean that it is still easier for companies in Batam to first ship to Singapore and then to Jakarta.
Third, relations between Jakarta and the Riau Islands province are complicated. Like this current batch of Java-based civil servants, the previous leadership was appointed by Jakarta.
This decree of central control is unlikely to go down well in the Riau Islands, which is a new province enjoying a period of intense cultural and political self-awareness.
Restoring Batam's industrial competitiveness and growth trajectory will be challenging and require some time. In particular, the transition to an SEZ will be a highly complicated process and require negotiations with many stakeholders. Streamlining regulations and improving the environment for business will also not be straightforward.
And reaching out to an alienated business sector and reconciling central imperatives and local preferences will require well-honed diplomatic skills.
• Siwage Dharma Negara is a fellow and co-coordinator of the Indonesia Studies Programme and Francis E. Hutchinson is a senior fellow and coordinator of the Regional Economics Studies Programme at the ISEAS - Yusof Ishak Institute. S.E.A. View is a weekly column on South-east Asian affairs.
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