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Cablegate: Batam - a Development Model for Indonesia?

DE RUEHJA #8800/01 1950601
R 140601Z JUL 06





E.O. 12598: N/A

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.

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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

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

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

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


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