Indonesia - Defense Industry

One kind of military enterprise was the service-owned factory, which had as its primary purpose the production of ordnance and equipment for the armed forces. By the mid-1980s, however, the government had taken over and managed as public-sector enterprises such major concerns as the navy’s P.T. PAL shipyard in Surabaya, Jawa Timur Province, and the army’s munitions factories.

Indonesia is far from self-sufficient in the production of weapons and defense-related matériel. Domestic facilities remain inadequate for the repair of certain complex weapons systems, and equipment inventories often represent considerable overstatements of what is actually in functioning order. Moreover, although defense guidelines favor the standardization of weaponry and other defense matériel, such as communications equipment and ground and air transport systems, the armed forces still possess and continue to procure equipment from a variety of sources. This situation has caused serious problems in obtaining and stocking spare parts and training technical maintenance personnel.

Major defense industries were transferred from the armed forces to civilian control in the 1980s. Under a new policy, these plants also served the commercial and civilian sectors. For example, when fully operational in the 1990s, the aircraft industry produced parts and equipment for commercial aviation. Although the aircraft industry was for decades the favorite project of Suharto and his minister for research and technology (and successor as president), B. J. Habibie, it was another money-wasting effort that cost hundreds of billions of dollars. After Suharto’s 1998 resignation, the aircraft industry stagnated; and, by the early 2000s, it was producing very little, not even spare parts. The army’s former munitions plants, by contrast, became very successful, manufacturing commercial explosives for the mining and petroleum industries as well as defense-related products. P.T. Pindad, another former army plant, now produces much of the TNI’s small arms as well as several models of wheeled and armored vehicles. The P.T. PAL shipyard also manufactures commercial ships and maritime equipment, in addition to naval vessels.

Despite being the fourth most populous nation in the world and a major player in Asian diplomacy and politics, Indonesia has historically given a low priority to its defense industry. Now, however, leadership is looking to reverse the trend and seek rapid modernization in just a few years. The upgrades affect all branches of the military; air, land and sea. US firms are very competitive in every realm of the defense industry, and looked to as a best in class provider. Recent changes in embargo regulations and a high level of support by the US Mission in Indonesia mean significant opportunities for US defense companies looking to do business in Indonesia.

Because Indonesia’s aircraft fleet and defense equipment consists largely of U.S. products, the Indonesian aerospace industry offers excellent prospects for U.S. companies. Most desired are leasing services, aircraft spare parts (commercial and military), and maintenance services.

The Presidential Decree No. 70/2012 regulates the procurement process for government agencies, including the state-owned companies, the Indonesian military and the Indonesian Police. Although it may be possible in some cases to sell directly to the Government, there is good reason to use the services of an agent or distributor for the early stages of project development, delivery, installation and service needs. Key factors in purchasing decisions in Indonesia are pricing, financing, technical skills, and after-sales service. Firms should be prepared to invest capital and manpower into making their local representative a first-class service provider.

Indonesia grants special preferences to encourage domestic sourcing and to maximize the use of local content in government procurement. It also instructs government departments, institutes, and corporations to utilize domestic goods and services to the maximum extent feasible. Presidential Regulation 54/2010 requires procuring entities to seek to maximize local content in procurement, use foreign components only when necessary, and designate foreign contractors as sub-contractors to local companies. Presidential Regulation 2/2009 stipulates that all state administrations should “optimize” the use of domestic goods and services and give price preferences for domestic goods and providers. Ministry of Industry Regulation 15/2011 provides for the creation of an Accelerated Use of Local Product National Team to optimize local product use in goods or services procurement.

Indonesia’s 2012 Defense Law, passed in October, mandates priority for local materials and components and requires defense users to use locally produced defense and security tools whenever available. In addition, when procurement from a foreign defense supplier is made due to lack of availability from an Indonesian domestic supplier, there is a requirement for countertrade, local content and/or offset production. Initially this domestic value requirement is 35 percent of the total contract value and will increase by 10 percent every year for the next 5 years, after which 85 percent of the value should be accounted for by countertrade, local content or offset production. It is expected that the local content/domestic offset requirement may be met in several forms such as coproduction, joint venture, buyback, knowledge transfer, and training. U.S. defense firms have already been meeting existing informal Indonesian government policy on the defense industry that 35 percent of the contract value be sourced domestically.