BMI View: Indonesia's domestic defence sector is large but needs the current modernization and reorganization efforts underway to realize its potential. The defence industry is largely state-owned, stifling innovation and preventing independent expansion. Current President Jokowi is not likely to prioritize the defence industry as much as previous President Yudhoyono, but as the government is already taking steps to improve procurement procedures and boost local industry by modernizing and re-structuring, the industry is nevertheless likely to slowly improve over the next few years. Efforts are especially being made in the Navy and Air force, and with foreign partnerships coming into place, the industry will likely have a boost regardless of the realization of the ambitious budget increase to 1.5% of GDP before 2020.
The economy is still under pressure, with a slower growth than President Jokowi had been expecting at 7%. The currency is still weak, and will hinder Indonesia's ability to procure foreign weaponry. Defence spending at 0.8% of GDP is still far below the target of 1.5% in addition to a weakened rupiah driving up the cost of imports. The domestic defence industry is still too immature to fulfil its demand, but the reorganization and the increasing transparency of the Department of Defence's processes will encourage both private sector interest and foreign investors to invest in Indonesia's local defence industries.
Domestically, Indonesia has some security concerns likely to spur spending over the next few years. The continued threat of terrorist activities and insurgencies mean Indonesia will have to continue its efforts of increasing the defence budget, as well as for funding in counter-terrorism. Concerns pertaining to growing Islamic militancy with the emergence of Islamic State (IS) will likely increase, making Indonesia reliant on foreign partnerships and with a need to develop the appropriate technology to counter the threats.
However, with increased pressure, Indonesia will prioritize addressing the defence forces readiness to deal with immediate and medium-term challenges, such as protecting the nation's borders, dealing with major disaster relief operations and being prepared for any escalation of conflict in the China Sea. For the mentioned threats, the Navy and Air force are likely to be upgraded and prioritized for investment more urgently than the Army.
Jakarta will also likely focus more on building up its local defence industry by procuring equipment from Indonesian companies wherever possible. In anticipation of this, two of Indonesia's state-run defence firms have already announced major recruitment drives and will continue to do so. In order to develop the domestic industry, however, Indonesia will still be reliant on international partnerships, leaving open opportunities for foreign players.
An upcoming long-range joint production program with China and closer military ties with Russia, Turkey and South Korea will lead to opportunities for increased transfers of technology. Advanced equipment for research and development is still sorely needed and must be imported, again with opportunities for foreign players. Japan has emerged as a potential partner in the future.
Concerns about Indonesia's human rights records, budget constraints, and domestic insecurity relating to terrorist activities and insurgencies could reduce foreign direct investment and deter some countries from partnering with Jakarta. Nevertheless, domestically developed platforms, such as the C-295 transport aircraft and naval frigates are becoming increasingly effective thanks to collaboration with developed producers, and the modernization and reorganization of the armed forces will continue to boost demand and provide supply opportunities for local defence industries.
Key BMI Forecasts
Defence expenditure to reach USD8.2bn in 2015.
Imports to exceed USD300mn in 2015.
Defence trade deficit to deepen, reaching almost USD390mn by 2019, with little export growth expected.
President Jokowis has said that if the economy grows by 7% the budget of Indonesia's military (TNI) will more than double to 210 trillion rupiah (USD16bn) in 2016.
The deadly crash of an Indonesian air force transport plane in 2015 has highlighted the country's ageing military equipment and provided new momentum for a 'fundamental overhaul' of management and procurement of defence equipment.
Modernisation and diversification of the navy and air force continue to progress, although Jokowi's election raises much doubt about the long-term direction of this programme.