Posted on 13 Aug 2008
This comparison indicates the tremendous improvement in the
construction sector over the past year and a half.
However, the sector faces many challenges in 2008.
The increase in interest rates to 9.0 percent means
consumers are reluctant to expose themselves to property.
On top of the expected weak demand, skyrocketing costs of
raw materials, including steel and cement, which account for approximately 20
percent of an average project's cost structure, will squeeze margins of ongoing
projects.
So, how will the outcome of these unfavorable conditions
affect the companies in the sector? Is there any chance of a bright next-year
given the gloomy conditions?
Obstacles are lurking in the sector, mainly as a result of
high raw material prices.
Steel has increased 40 percent year-on-year, while cement
prices have increased by between 10 to 15 percent on average.
These higher costs have encouraged construction companies to
be more selective in carrying out their cost of contracts as hedging raw
materials prices is by no means a sure way to counteract the impacts of high
building material prices.
A rejection of escalation clauses may in fact have darkened
the future of the sector. The National Planning and Development Agency
(Bappenas) has rejected a project value escalation proposal by contractors
associations, electric and mechanical associations and other
construction-related associations.
Bappenas argued that a project value escalation was only
applicable to projects affected by natural disasters and not sudden increases
in building materials caused by macro conditions.
However, the Public Works Ministry will continue to fight
for the inclusion of escalation clauses in government related project
contracts.
The sector is also likely to suffer from postponed
infrastructure projects in 2009 as the Public Works Ministry is likely to see
its original expenditure plan slashed to Rp 35.6 trillion from Rp 58.7 trillion
due to budget constraints amid higher oil-related subsidies.
Land clearance issues have also continued to plague
construction companies with increased costs and delays.
The Directorate General for Tax and Excise Office passed a
law on the taxation of construction companies in July 2008.
The new tax law states that construction companies must pay
tax of 2 to 6 percent (3 percent on average) on revenues rather than a
30-percent tax on pre-tax profits.
The new tax law only applies to contracts paid after
December 2008. Our calculation suggests this new tax might not benefit
companies with pre-tax margins below 10 percent.
With so many obstacles facing construction companies, one
might wonder whether there is any light at the end of the tunnel.
To ensure the sector benefits from a bright future, the
government should be more lenient with construction companies engaged in government-related
projects so as to protect their profit margins from rising material prices.
However, we expect commodity prices to ease in the upcoming
year; breathing fresh life into the construction sector. Diversification into
other businesses may help construction firms reduce risks.
Some companies have already begun engaging in the LPG-tank
business or have acquired stakes in toll road or power plant companies to
ensure continued growth and reduced risk.
Next year's elections may also bring with them the promise
of new infrastructure projects as the current administration looks to improve
public facilities to win voters.
Therefore, budgets for infrastructure projects may increase.
Either way, improvements are urgently needed in this sector to help boost the
economy.
