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October 27th 2010
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FROM THE ECONOMIST INTELLIGENCE UNIT
Plans to abolish restrictions on overseas investment in Indonesia’s pharma sector should spark a sharp rise in foreign direct investment.
Indonesia’s government has said that it will eradicate restriction on foreign investment in the domestic drugs sector. Under current laws, foreign companies are barred from owning more than 75% of any firm manufacturing drugs in the country, leaving at least 25% in the hands of a local partner. The move breaks a deadlock over the government’s previous heavy-handed attempts to force pharma companies to produce locally, and could well boost investment in this fast growing market.
The latest initiative comes as the government tries to provide a system of universal healthcare in the country, to increase spending on healthcare, upgrade healthcare facilities, and to improve access to affordable medicines. Healthcare spending is already rising rapidly, albeit from very low levels. The Economist Intelligence Unit estimates that health spending in Indonesia accounted for 2.8% of GDP in 2009, compared with 3.3% in Thailand and 3.9% in the Philippines. We expect this share to remain steady over the next four years, tracking real GDP growth of around 6% a year.
The government’s plan to allow full foreign ownership of drug firms is intended to increase overseas investment in the sector and thereby raise the volume and quality of local production. This will make foreign-made innovative medicines much more accessible to the Indonesian population and more affordable for the government to provide via a new national healthcare system.
The initiative also falls in line with a wider policy of encouraging foreign investment to help support government’s target of raising GDP growth to 7% a year by 2014. Indonesia’s flow FDI fell sharply after the Asian financial crisis of the late 1990s, and took around six years for investment to pick up pace again. By then, the dearth of spending in manufacturing facilities, machinery and product lines had taken its toll on productivity and blunted the country’s competitiveness.
But political stability, growth in export earnings from commodities such as coal, nickel, and rubber and an agenda of economic reform and liberalization have all combined to boost investor confidence. According to the Wall Street Journal, “foreigners accounted for 80% of the $US10bn in private-sector investment in the first half of this year.”
In June this year, ministers announced that the country’s agricultural sector would be opened up to foreigner investors for the first time. They have also raised the maximum level of investment in sectors including healthcare, transport and education. The government hopes that by opening up these key sectors, it can attract overseas investment, advanced technologies and know-how to Indonesia in the face of fierce competition from regional rivals such as Vietnam and China.
Production boost
The move to allow 100% foreign ownership in the pharma sector has certainly been welcomed by foreign pharma companies, after years of heavy-handed pressure from the Indonesian government. It follows an unpopular attempt to force international companies to produce their drugs in Indonesia rather than just operate marketing operations for importing their products into the country. In 2008, the government introduced new rules that stipulated a two-year grace period in which multinationals would have to set up production facilities in Indonesia or risk losing their licences to sell medicines in the country.
Of the 29 multinational pharma companies marketing their drugs in the country in 2008, 13 did not have production facilities. These included several leading global players such as Wyeth (US) Eli Lilly (US), Roche (Switzerland), Novo Nordisk (Denmark), AstraZeneca (UK) and Astellas (Japan). Despite the market’s potential, many of these firms – along with trade bodies such as the US Chamber of Commerce – protested against that decree. They argued that two years was not enough time for them to find local partners, and that few local manufacturers had the capabilities to manufacture their products anyway.
They also argued that if they invested in pharma manufacturing facilities in Indonesia, they would want to distribute the medicines made there regionally in order to maximize returns from their investment, to take full advantage of the country’s low operating costs and to use it as a regional hub. But, they said, although many local companies were interested in producing for the local market, few were looking to expand capacity and diversify product ranges for regional distribution.
Kalbe Farma, Indonesia’s largest native drug manufacturer, is one of the few that has succeeded in asserting itself on the international stage, exporting drugs to Malaysia, the Philippines, Thailand and Sri Lanka, as well as South Africa and Nigeria. But few of the company’s compatriots are ready to broaden their horizons just yet. So finding Indonesian firms with the capacity and vision to become a joint venture partner has been extremely difficult for multinational players.
The decision to open the sector to 100% foreign ownership is intended to overcome these problems. Indonesia’s Health Minister Endang Rahayu Sedyaningsih has said that the government wants to create a more attractive investment climate for foreign investors and that “she expects pharma firms to move their production units to the country”, reports The Indonesia Today. If that is true, then drug firms worldwide are likely to take a closer look at this fast-growing market.
With the economy growing fast and public spending rising, by 2014 Indonesia’s healthcare spending per head is likely to double in US dollar terms, to reach US$125. The pharma market, too, is underdeveloped but growing rapidly. The Economist Intelligene Unit estimates pharma consumption at US$7.60 per head in 2009, compared with US$24 in Thailand or over US$38 in Malaysia. This signals considerable room for growth in a highly populated country. Total spending on pharma amounted to around US$1.8bn in 2009 and that this will grow by nearly 63% in dollar terms to reach nearly US$2.96bn by 2014.
Low-per capita income has thus far meant that demand has been highest for cheap generic and over-the-counter medicines. But rising incomes and changing disease profiles mean that consumption of branded prescription drugs – the target of multinational companies – should increase considerably in the medium-to-long term. Deutsche Bank expects that the number of people in Indonesia that fall into the middle-income bracket will double to 52m people by 2015. At the same time, the population is set to rise from around 240m to around 253m over the next four years.
With restrictions on company ownership soon to be lifted and demand for their products growing, foreign pharma companies will now be keener to invest their money. The government has also promised to push through regulatory, bureaucratic, administrative and tax reforms to improve the operating environment in sectors such as the pharma industry.
First to invest may be those that pharma companies that already hold majority stakes in joint-venture manufacturing facilities, such as Pfizer and GlaxoSmithkline (UK). They may see the changes as an opportunity to increase their stakes, and improve their control over their ventures in order to maximise their returns. Meanwhile, those companies that have so far refrained from investing may see the government’s lifting of foreign ownership restrictions in the sector as a signal that the time is now right for entry.
Over time this could encourage consolidation in what is currently a highly fragmented market. Multinationals will be scanning local firms for potential acquisition targets to increase their market share and, in response to stronger foreign competition on home turf, domestic manufacturers may well engage in a spate of mergers and acquisitions. Either way, a new era has begun.