Executive Summary
Indonesia, the world’s third-largest democracy and a self-confident regional power, tries to maintain positive relations with both the United States and China despite simmering geopolitical tensions in Southeast Asia.
Rich in critical resources and aiming to become a developed economy by 2045, the country has placed a bet on the green transition by focusing on industrial downstreaming, the electric vehicle (EV) sector, and digital services.
Newly elected president Prabowo Subianto is expected to maintain national development plans, though democratic standards are set to continue to suffer.
Implications for International Business
Indonesia aims to become an investment hub and manufacturing base, especially in the EV ecosystem. As a fast-growing digital economy, the country boasts firms in e-commerce, food delivery, digital payments, and ride-hailing services.
Despite its openness to investment, the country’s restrictive technical regulations, policy inconsistency, bureaucratic inefficiency, lack of infrastructure, sanctity of contract issues, and widespread corruption continue to hamper businesses.
State of Play
Indonesia at a Crossroads
Despite a fickle global economy, Indonesia has performed rather strongly. Outgoing president Joko Widodo, called Jokowi, imposed an ambitious economic agenda while largely neglecting his promises to strengthen democratic institutions. His pragmatic foreign policy focused on domestic politics and attracting foreign investors but did little to further elevate the country’s regional position. Although repeatedly criticizing the Western-dominated international economic order, he showed little commitment to launch global initiatives that led to tangible changes.
Indonesia’s recent presidential and parliamentary election will keep the country on course. Even before the ballot closed on February 14, frontrunner Prabowo Subianto, a former rival of Jokowi and current defense minister, declared victory. He pledged to continue his predecessor’s policies and regulatory reforms, for which he teamed up the incumbent’s son, Gibran Rakabuming Raka, as running mate. The duo promises an ambitious eight percent annual growth target to hasten Indonesia’s development path till 2045. However, their plan will heavily rely on the digital economy and downstreaming with continuing high reliance on coal as a downside. Also, the Nusantara capital city development, despite its green and smart city blueprint design, poses environmental and ecological risks. Being built on carbon-dense peatlands, it threatens the existing wildlife and the surrounding rainforests. The next president will need a new strategy to counterbalance these climate risks and reach the country’s net zero goal by 2060.
Key Issues A “Free and Active” Foreign Policy Open to All
Indonesia has long upheld a foreign policy emphasizing sovereignty, non-alignment, and non-interference into the internal affairs of others while prioritizing its national interests and maintaining its strategic autonomy. This approach has increasingly been used to counterbalance both the West’s and the East's polarizing forces, as perceived by Jakarta. This chimes well with neighboring countries’ stance, in particular among the ASEAN group, which generally tries to uphold good relations with both the US and China to benefit from investments by either side.
Ties with the United States date back to 1945 and have been cemented over decades through successive defense cooperation agreements. The two sides also cooperate on border security, cybersecurity, counterterrorism, and disaster response through joint training and capacity-building programs. In 2023 they upgraded ties with a comprehensive strategic partnership, which entails not only enhanced military cooperation but also initiatives to reduce supply chain dependencies regarding China, such as a critical minerals action plan. However, under its “open for all” foreign policy, Jakarta also purchases arms from countries like France (Rafale fighter jets) and Turkey (drones).
When it comes to the Indo-Pacific, Indonesia’s strategic outlook clearly differs from the American one. Its tilt towards China includes military exercises as well as intensified economic relations, in particular regarding infrastructure development, such as a $7.3 billion high-speed rail link between the capital and the city of Bandung in West Java. Under Jokowi, Indonesia joined the Beijing-led Asian Infrastructure Investment Bank and its Belt and Road Initiative (BRI). Exports to China account for a quarter of its foreign trade balance, almost twice as much as to the United States. That said, a troubled past marked by violence against minorities and, more recently, territorial disputes in the South China Sea and over the Natuna Islands at times creates tensions with Beijing.
It is not yet clear how Prabowo will seek to maintain this delicate geopolitical balance. At 72, the general-turned-millionaire-businessman is expected to see matters through a military lens, whether on national sovereignty or domestic security.
Balancing Global Trade and Domestic Growth
To bolster its global standing and mitigate geopolitical risks, Indonesia actively seeks new trade partners. Specifically, it wants to secure a limited deal with Washington to leverage the US Inflation Reduction Act's subsidies. However, US lawmakers worry about Chinese influence in Indonesia’s nickel smelter along with the country’s lower environmental and labor standards. As a way out of this impasse, Washington has pledged to help enhance Indonesia's critical mineral sector in an isolated investment zone. Moreover, the United States channeled $20 billion to Indonesia through the Just Energy Transition Partnership (JETP) and committed to enhancing cyber and digital cooperation through IPEF, though this forum lacks market access provisions.
In turn, Indonesia’s trade gains from its comprehensive economic partnership with China are much higher. Notably, Chinese investors are actively involved in developing the new capital city of Nusantara, and Beijing promised a 700 kilometer extension of the Jakarta-Bandung railway. Also, many projects focusing on soft infrastructure like health and digital services are aligned with China’s BRI. Negotiations with the EU for a comprehensive trade and investment deal are underway, even though key trade indicators have remained stagnant, given President Jokowi's reservations about what he perceives as EU protectionism, especially on palm oil imports from Indonesia. Moreover, high tariffs coupled with existing free trade agreements with Asian partners like China contribute to trade diversion effects to the EU’s disadvantage.
Furthermore, Indonesia's status as the world’s biggest nickel producer as well as its renewable energy and carbon storage potential could bolster its position in the EV sector. To boost domestic refinement capacities and attract investment in battery manufacturing, Jakarta issued a series of export bans on critical minerals. It also invests in the semiconductor manufacturing capacity crucial for modern EVs.
In the digital sphere, Indonesia is home to over 2,000 startups, including unicorns and decacorns, leading to rapid growth in fintech, e-commerce, and ride-hailing services. While US tech giants such as Google and Meta have a solid presence, China's TikTok Shop recently disrupted the country's digital market through a $1.5 billion partnership with the GoTo Group, Indonesia’s largest tech company. The latter was born from the merger of a ride-hailing and food delivery startup, Gojek, and Tokopedia, an e-commerce start-up.
Indonesia's enhanced digital capabilities could shift market access and user preferences from the United States, China and even the EU, which is keen on promoting stringent data governance standards. However, as the country prepares to become an investment destination for digital trade and global EV supply chain, it needs to find a solution to its shortage of human capital, weak infrastructure, and often poor regulation. Only through reforms can Indonesia attract enough foreign investment to create a weighty presence in both traditional and digital supply chains.