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We’ve long argued that infrastructure investment is an important driver of the Indonesian economy. The government has been trying to jump start the sector this year, but legal issues have stood in the way.

Last week, a major hurdle was removed when Indonesia President Susilo Bambang Yudhoyono signed an implementation directive for a wide-ranging land reform bill. This action should overcome obstacles that have blocked the government’s efforts to acquire land, finally paving the way for major infrastructure development plans that have been stalled.

The implementation directive clearly outlines steps for land acquisition and introduces special tax incentives to encourage landowners to voluntarily participate in the land clearance process.

Indonesia’s infrastructure is one of the worst in Southeast Asia; remedial investment not only helps the economy over the long haul, but also generates substantial construction work for thousands of local workers.

Sticking With Stimulus

Bank Indonesia, the country’s central bank, last week announced a widening of the current account deficit in the second quarter to USD6.9 billion, or 3.1 percent of gross domestic product (GDP). Regardless, this worrisome development did not precipitate any tightening in monetary policy. Bank Indonesia acknowledged that its loose policy has helped widen the deficit, but the weak global economy is compelling the nation’s policymakers to err on the side of stimulus.

For now, the central bank will support the country’s currency and local financial markets by deploying some of its USD107 billion in reserves. The reasoning is that financing the deficit will become easier, as the economy grows.

Meanwhile, the latest government budget recently passed by Indonesia’s Parliament pumps an extra USD2.7 billion in spending for roads, bridges and other fixed capital investments in six provinces in eastern Indonesia, from now into 2013. The Jakarta administration also is in the process of awarding contracts for the construction of the first Mass Rapid Transit line that will be 111 kilometers long and cost USD1.5 billion.

The combination of large public sector funds allocated to infrastructure, combined with government initiatives to stimulate private sector spending, should provide a massive boost that results in a multiyear boom for the domestic construction industry.

Indonesia’s spending on infrastructure still remains below that of its neighbors, providing plenty of room for future spending. Despite the sharp projected increase in infrastructure capex, the government’s spending is only expected to rise to USD18 billion per year, representing a mere 2 percent of Indonesia’s GDP. Malaysia, with an economy one-third the size of Indonesia’s, plans to spend almost an equal amount of money on infrastructure development during the same period.

Indonesia has a huge population of nearly 240 million, with a median age of 28. The country has the largest economy in Southeast Asia and has enjoyed strong economic growth for almost a decade. For the last five years, GDP growth averaged about 6 percent, based mainly on consumption and infrastructure investment. Under Indonesia’s economic plan for 2011-2014, infrastructure has been targeted as requiring up to USD191 billion, for the economy to grow at its full potential.

The government also seeks to attract USD140 billion for infrastructure spending from the private sector. Now that the country’s president has signed the resolution on land acquisition, additional private money should start to flow.

Local as well as foreign investors are eager to get in on this activity; annual returns from investing in such projects as toll roads and power utilities are expected to reach 20 percent.

The government has formed dedicated infrastructure entities (e.g., the Indonesia Infrastructure Fund and the Indonesia Infrastructure Guarantee Fund) to facilitate project funding and undertake due diligence.

The Indonesian stock market has been a relative underperformer this year among its Asian peers. This isn’t surprising, because the market has been a huge outperformer in 8 of the past 10 years and cheaper markets have been trying to catch up.

That said, the view here is that the country’s infrastructure spending will serve as the new growth catalyst for both its economy and stock market.

The best way to play this trend: iShares MSCI Indonesia Investable Market Index Fund (NYSE: EIDO), which offers exposure to banks and key industrial, materials and energy companies. Buy EIDO up to USD35.