Construction sector gearing up for economic recovery

Yenwy Wongso, Research Analyst

Following Indonesia's slow recovery from the financial crisis, growth in the country's construction sector has been lagging. Will things stay this way going forward?

Ten years after the financial crisis, construction activity has not fully recovered. The contribution of construction to GDP has been gradually increasing over the past five years, although it has not reached pre-crisis levels yet. Construction as a share of GDP only amounted to 7.5 percent in 2006, still below the pre-crisis level of 8 percent.

This situation has forced the country's infrastructure sector to re-enter a phase of major growth in the construction of public, as well as private, infrastructure, which will eventually boost and support future demand for construction services.

Going forward, the domestic construction industry looks set to experience robust growth in line with economic expansion.

Development of public and private infrastructure is needed to attract the foreign and private investments that are necessary for supporting GDP growth.

In the 2002-2006 period, the construction industry grew on average by 7.1 percent, while GDP grew concurrently by 5.1 percent. As Indonesian growth is expected to rise towards the six percent level this year (versus 5.5 percent in 2006), construction growth is expected to surge.

As for this year, investment is expected to soar as the macroeconomy stabilizes.

So, what are the factors that help to boost demand for construction services?

Indonesia's benchmark interest rate may further decline toward 8.5 percent by the end of the year from the current level of 9 percent. Oil prices have risen, but on average are lower than last year (US$60/barrel versus US$66/barrel).

These conditions, along with the absence of major administered price adjustments, should encourage both private and public sector construction projects.

Moreover, the government has been striving to improve the statutory framework so as to make the infrastructure projects offered to investors more attractive and bankable. Under Presidential Decree No. 65 of 2006, the government will encourage accelerated infrastructure development in Indonesia through investment cooperation, revolving funds, subsidies (public service obligation), guarantees and tax waivers.

The various new regulations that have been introduced should serve to attract potential local and foreign infrastructure investment inflows, thus benefiting suppliers of construction and civil engineering services.

According to the government, Indonesia's infrastructure needs to expand by over US$150 billion between 2005 and 2010. However, only 17 percent of this can be financed from the government's own resources.

Hence the government is actively encouraging the participation of both local and foreign investors in developing the country's infrastructure.

As for this year, the central government has allocated nearly 20 percent of this year's overall budget spending to public infrastructure development, consisting of both multi-year and single-year projects.

Although delays cannot be ruled out, most of the construction work is expected to start in April and be completed by mid-December (single-year projects). The terms of the tenders will favor those companies requiring the least government support, but which possess the highest levels of expertise and experience.

In addition, 19 infrastructure projects costing Rp 63 trillion (US$6.8 billion) will also be put out to tender in 2007, including thirteen toll roads (worth Rp 43 trillion) and three water supply projects (worth Rp 950 billion), as well as a ferry port, an international airport and the national fiber-optic cable network.

But in spite of all the good news and support from the government, progress in terms of actual construction remains fairly limited, especially in the case of public infrastructure projects.

This is shown by the fact that fewer than ten projects offered at the January 2005 Infrastructure Summit have entered the construction phase, while the majority of the remaining projects are still stuck at the tender and prequalification stages.

None of the projects offered in the 2006 Indonesian Infrastructure Summit (Infrastructure Summit II) have been realized. In fact, the tender processes for these projects have not even been completed.

Among the factors that have made these projects less attractive are regulatory restrictions, high commercial-risk levels, difficulties with land acquisition and the surge in inflation that followed on from the slashing of fuel-subsidy spending (which resulted in the prices submitted during the tenders being rendered outdated).

Therefore, the demand for construction services in Indonesia will depend on the investment climate (though not necessarily FDI), as well as the supporting government regulations.

If one is convinced that substantial improvements are forthcoming, then the outlook for the construction services industry, as well as for other sectors directly related to it, such as cement, heavy equipment and property, should also be robust.

Therefore, investment in construction-related stocks would currently seem to be a notion worth considering.
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