• Indonesia, ASEAN's largest economy and the world's fourth most populated country, has shown signs of robust growth in the past two years. FDI was up 73.2% in 2007 year-on-year, and Hong Kong exports to Indonesia rose by 27.3% in the same period. Together with a stabilising political outlook and progress in pro-investment legislative development, Indonesia is positive both as a market for Hong Kong products and an alternative production base.

• Competitiveness as an alternative production base: With the cost of labour nearly half that of Shenzhen, together with a young and large population (225 million people with a median age of 26.9), Indonesia is an attractive destination to consider relocating labour-intensive processes to. Not advanced, but adequate infrastructure, coupled with progressive improvement in customs and government efficiencies, helps create a favourable investment environment.

• Labour-intensive industries will benefit: Low labour costs will benefit labour-intensive industries like garment manufacturing. Labour costs are expected to be even lower in the new textile and garment production base in Majalengka, where production facilities are anticipated to improve after its completion in 2009.

• Potential for Hong Kong products: With a rising middle class and modern shopping malls springing up in major cities, a much bigger market and far better channels exist for Hong Kong products to enter the Indonesian consumer market. The size of the middle class is estimated to be 9.4% as of 2005, with organised retail taking a 35% slice of the consumer market as of 2007. Both figures are set to rise further as the economy steams ahead. In the midst of a possible slowdown in the US economy, Indonesia is a market worthy of further exploration.

Indonesia as an alternative production base

Young and large labour market: Indonesia has a young and large population, which gives it an advantage as a base for labour-intensive production. For example, the average cost of hiring a worker in Jakarta is about US$110-135 per month, compared to over US$200 on average in Guangdong. Indonesia's rigid labour law, which is under reform, has led to widespread employment of contract workers. The preference of workers to work in factories has also resulted in a lower turnover rate.

Other factors of production are generally favourable: Supplies of electricity and water are stable, roads and ports facilities are improving, and customs operations are being reformed to shorten the time needed to process imports and exports, and to provide convenience to users. For example, customs clearance through the “green” channel takes only 30 minutes, compared with four hours previously.

Choosing the location: Indonesia has several free trade zones (FTZs). In choosing a site for relocation, whether inside or out of an FTZ, the decision should lie more with local industry support than on the site's legal status as an FTZ, since there are “bonded zones” in many places of the country, which generally can offer similar benefits as an FTZ. Batam, an island south of Singapore, received FTZ status in 2007. Besides the exemption of import and export duties, other investment incentives are being planned, pending approval from the central government. As an FTZ, the local authority may enjoy greater autonomy in deciding the offer of incentives to enhance industry development.

Indonesia or inner cities in China? Indonesia and some inner cities in China possess different competitive advantages as an alternative production base. Generally, inner cities have a closer connection with Hong Kong and a cheaper cost for land use, whereas Indonesia has lower labour costs, and abundant availability of workers. As a result, the benefits vary from each company's operation model. Labour-intensive industries such as garment manufacturing are likely to benefit more from relocating to Indonesia.

Indonesia as a market for Hong Kong products

A large consumer market: Indonesia's recovery from its financial crisis 10 years ago has given rise to a sizeable and fast expanding middle class. The size of the middle class is estimated to be 9.4% of the population as of 2005, translating into nearly 21 million people, a size comparable to the whole of Australia or the Scandinavian market.

More channels for distribution: Consumer tastes are surprisingly similar to that of Hong Kong. Along with more upscale retail channels (“Grade A” or above retail space accounted for about 24.3% of total in Jakarta as of 2007), Hong Kong products can access the consumer market more easily than before.

Risks and challenges: This promising market is not without its challenges, however. High-end retail stores demand a high commission, and the government imposes a tax on luxury goods. Less well-known brands also face longer tenancy terms when setting up outlets. Red tape and corruption may also add extra costs to businesses.

Hong Kong SMEs should consider entering the market through a local agent first, and building their brand name in the market before directly establishing a presence.

This new report is available at TDC's Retail Outlets. It can also be purchased through the TDC Bookshop section in the TDC's trade portal: info.hktdc.com.