CNBC Asia Mobile

Indonesia plays hardball with smartphone manufacturers

A chip factory in Indonesia
Getty Images

When Polytron became the first Indonesian company to produce 4G-capable smartphones last year, it changed the 'Manufactured in China' inscription on its handsets to 'Made in Kudus,' a town in Central Java.

Polytron relocated production from China to comply with 'local-content' rules introduced in 2012. The regulations have raised concerns about higher manufacturing costs and hung question marks over an industry championed by the Indonesian government.

The United States has pressed Indonesia to relax the rules, which it says will hamper efforts of tech giants such as Apple to expand into one of the world's last big markets where use of smartphones has yet to truly take off.

Assembling far from China's electronics supply chain means it costs up to 50 percent more to manufacture a mobile phone in Indonesia, according to Polytron, a smaller player among local phone brands.

Why Indonesia is concerned about a weak rupiah
Why Indonesia is concerned about a weak rupiah

"Honestly, we are doing it because of the regulation, to be in compliance," Polytron spokesman Santo Kadarusman told Reuters.

The government ramped up enforcement of the rules last year. The regulations are part of a push under President Joko Widodo to transform Indonesia from an economy that consumes products into one that produces them, in his attempt to boost economic growth and eliminate the country's trade deficit.

Most mobile phones sold in Indonesia are made in China. There was no phone manufacturing industry in Indonesia until last year when 15 companies submitted plans to the Industry Ministry to start production. Among them was Samsung Electronics, which opened a factory near Jakarta.

Read MoreStability, growthkey for Indonesia: Fin Min

The regulations require importers of smartphones to manufacture in Indonesia or have their import licenses revoked by 2016 or 2017, depending on when they received their license.

The ministry is working on a new regulation targeting 4G smartphones. It is expected to be completed in June and come into force on Jan. 1, 2017. The rule will require all companies that sell 4G-capable devices, including Apple and Samsung, to produce a certain percentage of 'local content' in Indonesia.

Apple did not immediately respond to requests to comment on the local content rule. Samsung declined to comment.

It is unclear as to whether this regulation will replace existing requirements or how local content will be measured.

Indonesia needs a bigger share of the $3 billion in annual phone imports to reduce its trade deficit, said Minister for Communications Rudiantara, who like many Indonesians goes by one name. "This phone is $600-$700, so we want $250-$300 of that to go to Indonesia," he said, pointing to his iPhone.

Local content

Local content could include design through intellectual property fees in addition to manufacturing of handsets, Rudiantara said. He declined to give further details on the way the percentage of local content would be calculated.

Around a fifth of local content would have to be research and development, meaning companies would need to have a design development center in addition to manufacturing, said Industry Minister Saleh Husin.

Read MoreWhy Indonesia strugglesto attract investors

Critics of the 'Made in Indonesia' rule, including the American Chamber of Commerce, say the requirement is confusing and could increase costs, restrict access to technology and violate World Trade Organization (WTO) obligations.

The U.S. Trade Representative is raising these concerns with the Indonesian government and the WTO.

But Polytron is optimistic about the move, and expects its mobile division to make its first profit since it started in 2011 by the end of the year.

"Our support from the government is the promise that other 4G brands cannot sell in Indonesia if local content is not 30 percent. Polytron is already at 35 percent. If Polytron gets to 40 percent local content, [the government told us] there is a possibility the local content requirement will go to 40 percent," Polytron spokesman Kadarusman said.

He declined to comment on how the local content percentage was calculated.

Rudiantara said that after hearing of complaints, he was "undecided" on whether the required local content would be 40 percent, which he previously told companies. He planned to release a draft of the regulation in mid-April to give companies time to raise concerns.

He said higher costs would make it difficult for Indonesia to compete purely on manufacturing, but hoped his switch to include research and development would help.

"I'm not crazy. Ministers should have nationalism, but not chauvinistic nationalism," Rudiantara said. "If Indonesia competes only on producing hardware, it's going to be difficult."