Jakarta. Aggressive cuts in the benchmark interest rate and a planned reduction in corporate income tax may be just enough to provide a much-needed boost to Indonesia's investment and dilapidated manufacturing sector, bankers said.
Significant improvement in the manufacturing sector – which has been growing slower than the country's gross domestic product over the past decade – will require government commitments and various reforms. These include licensing simplification, legal certainty, bureaucratic reform, infrastructure reform, revised labor regulations, consumer purchasing power boost and incentive packages.
Bank Indonesia cut its benchmark interest rate by 25 basis points last week to its lowest in the past 17 months. It was the fourth rate cut by the central bank in as many months, as it prepares to prop up Southeast Asia's largest economy in anticipation of a global recession next year.
The government plans to submit a bill to the House of Representatives by the end of this year to revise corporate income tax. It is likely that the new income tax law will become effective in 2021, according to the tax office.
"These synergistic policy responses will certainly strengthen positive investor perception of Indonesia's economic prospects," Bank Indonesia Deputy Governor Dody Budi Waluyo said, adding that he hoped for a turnaround in investment next year.
A lower income tax rate – which, at 25 percent, is among the highest in the Asia-Pacific region – will boost company earnings. The government will experience an immediate shortfall following the policy implementation. But companies would have more funds available to reinvest and, in the medium term, have greater economic output, which would boost tax revenue, Dody said.
"What is clear, is that a policy of reducing income tax rates is very good and is more directed at mitigating cyclical risks," he said.
The World Bank and the International Monetary Fund have warned that Indonesia's economic expansion may slow further to just 5 percent this year and 5.1 percent next year. That would be a sluggish pace for a country with ambitions to become a developed, $7 trillion economy within the next quarter century.
"First, to become a rich country by 2045, Indonesia must grow at above 6 percent annually. This can only be achieved if Indonesia's economic growth engine is renewed," said Masyita Crystallin, chief economist at DBS Indonesia.
"At present, the Indonesian economy is still very dependent on the commodity sector and sectors with low added value. The manufacturing sector, which is usually the engine of economic growth for countries that have successfully accelerated economic growth, such as South Korea and China, has grown by around 4 percent over the past few years, below economic growth," she said.
Masyita said manufacturing revitalization must focus on sectors with high added value and those that can create many jobs, "especially because every year, there are 3 million new workers who need jobs."
Herry Sidharta, deputy director of state-controlled Bank Negara Indonesia, said a gradual reduction in the benchmark interest and corporate income tax rates may encourage industrial growth and attract foreign direct investment.
Therefore, in the long run, the two policies will increase jobs and tax revenue.
"The two policies will certainly boost credit growth. Credit will be driven primarily by the industrial sector and exports of industrial goods," Herry said.
With lower interest rates, the banking industry will try to reduce the cost of funds to maintain a net interest margin.
"Banks will carry out a strategy primarily for cost efficiency efforts, by reducing expensive funds and optimizing the composition of earnings assets and other liabilities. This is to offset the reduction in lending rates, so it is expected to maintain banks' net interest margin ratios," Herry said.
More Incentives to Attract Investment
David Sumual, chief economist at Bank Central Asia, said Indonesia may need to do more than just cut corporate income tax rates to attract investment.
"In fact, neighboring countries have not only reduced corporate income tax rates, but Singapore and India have also implemented a zero percent dividend policy to attract investors," David said. In Indonesia, shareholders pay 15 percent tax on dividends they receive.
David said the Ministry of Industry must also move away from preferring import substitution industries to instead focus on integrating Indonesia into the global supply chain.
"We must also look at the value chain as a whole," he said, adding that many intermediate goods have yet to be developed in Indonesia, due to a lack of skills or capital, so the country still needs imported materials to produce finished goods for export.
"This is like playing Dragon," David said, referring to a traditional Indonesian children's game in which they line up and move together to resemble a dragon.
"We need to catch the dragon's head first and then slowly its tail. But if we can't catch the head, it will be difficult to get the tail," he said.