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A Challenge in Doing Business in Indonesia: A Legal Risk Perspective

The Legal Environment

Doing business in Indonesia is no easy task for foreign investors. Indonesia is certainly not in the rank of five-star investment destination. Deploying capital in Indonesia, like many other emerging markets, involves a number of associated inherent risk and uncertainties.

Some of the key risks considered to be significant in determining investor investment decision include potential political instability, corruption, complicated legal environment and legal uncertainties and infrastructure shortfalls.

Particularly for Indonesia, legal and regulatory risk can be perceived as the most significant impediment to a successful investment.

A common issue concerns legal uncertainties related to the lack of a comprehensive legal and regulatory framework. Important rules can be either scattered in diverse regulations or not yet regulated. Further, new laws introduced are most often not being subsequently complemented with the promulgation of detail regulations for implementation in a timely fashion. This creates a constraint in an effective and efficient application of law due to a significant time gap between enactment of the new laws and the implementing rules. The absence of clear rules creates the practice of applying unwritten policies and administrative discretion by the authorities, which in the investors’ view it is difficult to rely fully upon. In addition, potential divergent legal interpretation of ambiguous provisions of the law by the government authorities and legal practitioners is another occurring issue. These issues add up increase the legal uncertainties risk.

Arguably, an unattractive legal environment may affect investment enthusiasm.

The Indonesian government recognizes this and has been taking measures in regulatory reforms to facilitate inward investment towards a more efficient and certain legal environment. Since the issuance of the new investment law of 2007, investments regulations have been continuously improved through a number of revisions to strengthen clarity and comprehensiveness. Also, some of the key unwritten policies have now been expressly regulated in the legislation.

One of the obvious improvements is with regards to the rules regarding capital investment entry. Investment licensing has been substantially simplified and streamlined minimizing bureaucratic high handedness and red tape and reducing the cost of setting up business presence. The effort does not stop here as the system for an integrated on-line licensing application is underway for a hassle-free procedure. Further, delegation in licensing authority has been clearly defined in the investment regulations making BKPM (Badan Koordinasi Penanaman Modal), the central investment body, as a one stop services investment agency.

BKPM has been actively engaging in investment- generating activities and investment-facilitation services. For example, BKPM regularly organizes conferences for socialization and discussion of new regulations. This is an effective platform for obtaining public feedback or simply exchange of practical information with investment practitioners with the objective of enhancing the regulatory framework and understanding how the law should be properly implemented.

Foreign Investment Growth

Despite the concern about an unpredictable regulatory environment, business interest is still rising in the Indonesian market. The figure for foreign investment realization continues to rise in the third quarter this year recording a figure of 69.8 trillion Rupiah, according to the most recent statistics of BKPM.

Regulatory improvements that have been and continue to be applied have been positively acknowledged by the World Bank in its Doing Business Report 2014 publication which was released in late October this year. The Report positioned Indonesia at 120 on the ease of doing business’ list, the highest rank ever recorded.

There are obvious indications that investors keep coming to invest in Indonesia. For instance, we are still seeing a growing number of consumer goods and modern-store related investments. It is easy to notice that foreign brands (e.g., Lotte Mart, Galleries Lafayette, Uniqlo, H&M, etc) are spurring, particularly in the Java area, where consumers, especially those of the middle and upper class, demand and spending power is relatively high. Indonesia, being the fourth most populous nation with a growing middle class of around 74 million, offers a huge consumer market making it an ideal target for the market-seeking type of foreign direct investment.

Legal Risk Mitigation Strategy

With continuous enhancement of the regulatory framework and the fact that foreign investment inflow is still promising, investors should not be overwhelmingly impeded by the legal and regulatory risk in doing business in the Indonesian market.

When investing in Indonesia, investors need to gauge their ability to tolerate the risk because significant short term fluctuation can occur. Unlike foreign bank lending and portfolio investment which are often motivated by a short-term profit, foreign direct investment is motivated largely by profit consideration in production or marketing activities with investors’ direct control which can only be achieved over a long-term period. We can say that foreign investment in Indonesia is a long-term game and those who come to Indonesia with this view will have a much better chance of translating their investment into significant earnings.

The following are the main available practical mitigation strategies investors may consider adopting to reduce exposure from legal and regulatory risk.

  • Understand how the laws operate in Indonesia, particularly in the area of the relevant business activity, by performing a pre-investment investigation on the legal structure. The intention of this exercise is to obtain accurate information about the local legal environment and become acquainted with it so that investors are able to put in place optimal legal structure for investment protection. The best way to do this is by retaining professional support from a consulting firm (i.e., legal firm and accounting firm) with deep local insights and experience.
  • Work closely with reliable local entrepreneur, either having them as a partner in a joint venture vehicle or collaborating in a business arrangement, to understand local needs. Local Indonesian partner can assist in navigating the complicated and tangled bureaucratic web and deal with the Indonesian government directly. They can also provide investor insight into Indonesian business culture.
  • Establish and develop strong relationship with the government authorities. Indonesian government is guided with a long-term foreign direct investment perspective for capturing the positive spill over benefits in terms of technology transfer, employment creation, business opportunity for local industries, and infrastructure development. Inward investment is an important contributor for national economic growth and it is the interest of the government to attract and preserve it. The government can help investor in opening doors to opportunities and resolve problem. The relationship can boost investor’s credibility in carrying out their business.

In conclusion, assessing investment opportunities from the outset, together with correctly understanding the legal and regulatory challenges of doing business in Indonesia and applying the appropriate measure, will enable investor to navigate their investment process and greatly enhance the likelihood of success.

General Disclaimer.

This article contains general information on legal topic. The statements and opinions expressed by the author are those of the author.