The Batam Island Free Trade Zone, formerly a sparsely inhabited fishing village, is now home to nearly 600,000 people and more than 600 foreign companies. It is a prime example of creating something out of nothing.

Houston-based oil-services equipment manufacturer McDermott, one of the first foreign investors to venture onto the island, has seen the changes at first hand. When the company first arrived, Batam was little more than jungle, so it made its site entirely self-contained, pumping in its own water, building its own houses and so forth. As the area developed, McDermott began gradually shedding these once-essential services. The infrastructure has grown up around it.

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Development plan

Indonesia’s founding president Sukarno started the project to develop Batam, and his four consecutive successors have continued with it. Development plans called for the island to be made into a logistics hub, capitalising on its position at the northern tip of Indonesia’s Riau archipelago where the Indian Ocean meets the Pacific.

Designated as a free trade zone in 1971, Batam has attracted foreign investment in technology, medical equipment and electronics, telecoms, agribusiness, textiles, industrial assembly and fabrication, shipbuilding, oil, and energy services. The Batam Industrial Development Authority (BIDA), which was created in the early 1960s to develop and promote the area, is seeking investment in waste-water treatment, medical and educational facilities, and port harbour expansion.

Among the foreign companies with operations in Batam are AT&T, PerkinElmer, Bechtel, Seagate Technology, Babcock & Wilcox, Holiday Inn, Matsushita, Kyocera, Hitachi, Sanyo, Nippon Steel, Hyundai, Sony and Philips.

Batam’s sales pitch is centred on its proximity to Singapore – the city-state’s skyline is just visible from Batam and 120 ferries run between the two every day. All of this was bolstered when Batam was incorporated into the US-Singapore Free Trade Agreement signed in 2003.

Best of both

The Singaporeans are happy with this arrangement. “We see Batam as very complimentary to Singapore. It’s the best of both worlds for the companies because they can carry out high-value-added manufacturing here and more labour-intensive manufacturing there. In fact, we promote that,” says Manohar Khiatani, a director at the Singapore Economic Development Board.

Batam has something valuable that Singapore does not have: space. But it has more to offer than tracts of land: “Here we keep operational costs as low as possible. Electricity, water and other resources are comparatively cheap,” says Ismeth Abdullah, governor of the newly-created Riau Islands province, which includes Batam, Bintan, Karimun, Lingga and Natuna Regency.

Mr Abdullah, who also served as chairman of BIDA until April 2005, seems conscious of the less-than-favourable perception many Western investors have of Indonesia and stresses that Batam is different. “We keep everything smooth and easy here – no red tape. Goods get here no problem.”

The World Bank’s Doing Business 2006 report ranked Indonesia 115th out of 155 countries for ease of doing business and Transparency International has it sharing 133rd place out of 145 with the Democratic Republic of Congo, Côte d’Ivoire, Georgia and Tajikistan in the Corruption Perceptions Index for 2005.

Drive to diversify

Batam wants to diversify its pool of source countries and decrease its dependency on Singaporean companies. Promisingly, Indian investors have taken an interest recently and discussions are under way about an entire industrial park dedicated to them (there is also talk of a Japanese-focused park).

At Batamindo, Batam’s oldest and largest industrial park which accounts for half of the island’s total export value and nearly half its total workforce, there are 37 companies from Japan, 28 from Singapore, five from the US, four from Germany and two from France. The average tenant company size is 1000 employees.

In the past few years, public investment of $3bn in Batam has generated nearly $9bn in private investment, a public/private ratio of three to one. Mr Abdullah points out that the same ratio equated to a lot of FDI success for Shenzhen in China. Batam is a long way from Shenzhen – metaphorically and literally – and Mr Abdullah acknowledges this: “The magnitude is different because Shenzhen is bigger but we are on the same track.”

Local frustration

Whether Batam does go on to become another Shenzhen is in the hands of higher powers – but that seems to give local officials more frustration than confidence. “It now depends on the seriousness of central government and whether there is a strong willingness to make [the area] grow or not,” says Mr Abdullah.

He suggests that Indonesia’s fiscal policy and legal framework are not as conducive to investment promotion as they should be. “Our competitors, like Chennai, Bangkok and Hanoi, are offering more attractive incentives while we are getting tighter here. This will be a problem,” he says. “Luckily, even with some limitations, foreign companies are coming to Batam. But imagine if we could offer incentives – the number would double.”

Having been elected governor in June after serving as acting governor, Mr Abdullah says he will implement some new regional policies with the first priorities being bringing in more investment, building more infrastructure and creating incentives. But he urges the central government: “Let Batam become a model and show that we can compete with similar locations and other free zones.”

In addition to limits on incentives, land titles are another of the top-down legislative constraints that Batam faces: in Indonesia investors are granted rights to use land only up to a maximum of 80 years, compared with 90 years in Shenzen.

The amount of corporate tax generated by Batam for central government coffers is growing, so perhaps that will help to raise its profile in the country. But because Indonesia is so vast and its provinces so widely dispersed, and because the central government has so many other larger issues with which to contend, such matters as land titles are “not a priority”, Mr Abdullah says. “So we have to keep pushing them, keep asking them.”

It would appear that some relief is on the way. The government promises that a new investment law, working its way through parliament, will include fiscal incentives to attract investment and guarantees against the nationalisation of foreign companies.

Trade measures

In July, the finance ministry announced new trade, customs, tax and fiscal facilitation measures for Batam, Bintan and Karimun islands aimed at improving the business environment in these bonded areas. They included simplified business licensing and easier movement of goods to and from bonded zones; simplified customs reporting procedures; reduction and elimination of taxes on several items; and liberalisation of imports of used capital goods, including for factory relocation purposes.

Meanwhile, the shape of Batam’s future development has become somewhat clearer. Rather than the entire island being classed as a free trade zone (FTZ), only a handful of areas maintained bonded status.

After some debate, however, the government announced recently that the whole of Batam Island is to become a single FTZ. This long overdue decision should provide at least some measure of clarity and reassurance to potential investors in Batam. Mr Abdullah will undoubtedly keep pressing the federal government for more.