Growing by 5.32% in the second quarter of 2026, the non-oil and gas manufacturing sector is now overshadowed by a PMI that has returned to the contraction zone. Capital renewal and production technology are considered key to maintaining competitiveness.
JAKARTA — The non-oil and gas manufacturing sector has reaffirmed its position as a backbone of the national economy. In the second quarter of 2026, this sector grew by 5.32% year-on-year (year-on-year/yoy) and contributed 18.50% to the Gross Domestic Product (GDP), equivalent to approximately Rp1,212 trillion.
With such a contribution, non-oil and gas manufacturing remains a primary driver of national economic growth, accounting for about 0.90% of total GDP growth.
At first glance, this achievement suggests optimism, as non-oil and gas manufacturing growth even exceeded the national economic growth rate of 5.29%. However, behind these solid figures, signs of weakening have emerged that warrant attention.
Indonesia's Manufacturing Purchasing Managers’ Index (PMI) for August 2026 was recorded at 49.8, falling below the 50-point threshold that separates expansion from contraction. This figure dropped from 50.2 in July, indicating a slowdown in production activity and labor absorption in the most recent period.
The Paradox of Growth and Contraction
At first glance, 5.32% manufacturing growth and a PMI in the contraction zone appear contradictory. However, these two indicators measure economic conditions from different perspectives and timeframes.
The 5.32% year-on-year growth is based on Statistics Indonesia (BPS) value-added data, which records real output for the period of April to June 2026. This data is a lagging indicator , reflecting conditions that have already occurred.
Conversely, the S&P Global PMI is a monthly survey of approximately 400 purchasing managers regarding indicators such as new orders, production, inventory, and employment. Therefore, the PMI is often used as a leading indicator , or an early signal to gauge the direction of business activity.
The contraction in August occurred after the second quarter ended, so it does not automatically negate the growth achieved in the previous period.
Nevertheless, PMI fluctuations remain worth monitoring. The index fell to 46.9 in June, rose to 50.2 in July, and then dipped to 49.8 in August. Meanwhile, the Industrial Confidence Index (IKI) for July was recorded at 53.10, remaining in the expansion zone.
Industrial growth has also not been uniform. Manufacturing performance has been supported by domestic demand-based subsectors, among others. The food and beverage industry grew by 6.51%, while the chemical and pharmaceutical industry recorded 4.99% growth.
On the other hand, the decline in production and employment in August was influenced by intensifying competition, weak demand, and rising costs and prices. This condition coincides with a 27.15% growth in consumer goods imports and a negative net export contribution of 0.78%.
Therefore, manufacturing performance should not be read solely through aggregate figures but also needs to be viewed based on the conditions of each subsector.
The Role of Capital in Determining Output
This phenomenon can be explained through the theory regarding the role of capital (capital) in the economy. The Solow-Swan growth model explains that the accumulation of capital stocks—such as machinery, factories, equipment, and technology—can increase productivity and output per worker.
Meanwhile, the Kaldorian approach views manufacturing as an engine of growth because it possesses the characteristic of increasing returns to scale, where increasing the scale of production can drive higher efficiency and productivity.
An empirical study in Ecuador found that a 1% increase in manufacturing production is associated with a 0.483% increase in GDP in the short term and 0.695% in the long term.
In the Indonesian context, the 5.32% manufacturing growth can be read as one of the results of investment accumulation in previous years. Investment in the manufacturing sector increased from Rp186.79 trillion in 2014 to Rp721.3 trillion in 2024, accounting for about 42.1% of total national investment.
A source from a machinery and fabrication company also mentioned that the company's clients continue to invest in machinery and various production equipment.
However, capital accumulation faces the principle of diminishing returns, where additional capital at a certain point yields smaller incremental output. Therefore, technological progress becomes a crucial factor in maintaining productivity growth in the long run.
These limitations are reflected, among other things, in the industrial utilization rate, which stands at around 64.8%. The weakening of the PMI is also considered not solely caused by demand shocks but may be related to suboptimal capital renewal and production technology.
Machinery that is aged, frequently breaks down, and requires high maintenance costs can increase production costs. Consequently, products become less competitive in terms of price and productivity.
At the same time, high interest rates, the weakening of the rupiah, and demand uncertainty may cause businesses to delay investments. This condition has the potential to create a vicious cycle, as delayed investment can hinder technology upgrades and capacity expansion.
Risks to GDP and Employment
If the contraction in manufacturing activity persists, the sector's contribution to GDP in the third quarter of 2026 could potentially slow down.
Overall processing industry growth was recorded to have fallen from 5.04% in the first quarter to 4.52% in the second quarter of 2026. Continued weakening could impact the economy through several channels.
First, through employment and household consumption. Hiring freezes and potential layoffs could pressure public purchasing power. This impact is significant because the manufacturing sector absorbs approximately 19.96 million workers.
Second, pressure could spread to the supply chain. Small businesses, such as fabrication workshops, material suppliers, and various industrial support businesses, are likely to be the first to feel the impact when manufacturing production declines.
Third, there is a fiscal impact. Declining production and corporate profitability can pressure tax revenues. At the same time, the government may face greater spending needs to maintain social protection if the labor market weakens.
In the long term, failure to modernize capital and technology can lower industrial competitiveness, reduce investment interest, and stifle growth in output per capita.
Without continuous innovation, manufacturing also faces the risk of premature deindustrialization, a condition where the role of industry in the economy weakens before a country reaches a high income level. Dependence on imported technology can also be a challenge in achieving higher economic growth targets.
The Way Out: Incentives, Financing, and Innovation
Businesses and policymakers face the challenge of maintaining growth momentum while responding to short-term signals of weakness.
Fiscal incentives such as super tax deduction, accelerated depreciation, tax allowance, tax holiday, and import duty relief can be used to reduce investment costs. Financing support through more competitive credit costs can also help drive capital deepening , or an increase in capital per worker.
Strengthening the domestic machinery industry is equally important. This step could help reduce dependence on imported machinery, which is valued at approximately US$36.6 billion.
On the demand side, the Domestic Component Level (TKDN) policy, downstreaming programs, and various national strategic projects can serve as sources of demand for domestic industry if implemented effectively.
All these policies also need to be supported by strengthening research and technology transfer through the Making Indonesia 4.0 program, improving workforce skills, and enhancing logistics efficiency.
Incentives and easier financing can essentially function as counter-cyclical policies by helping to maintain business margins, preventing credit crunch at the sectoral level, and reducing the tendency of businesses to adopt a wait-and-seeapproach.
However, the effectiveness of these policies remains dependent on targeting accuracy, fiscal credibility, and the coordination of monetary and fiscal policies.
Research and innovation are also essential requirements for strengthening productivity, but they are not the only solution. Research and development spending in Indonesia remains relatively low compared to industrial countries like South Korea. Furthermore, the cost of technology adoption remains high, while collaboration between the private sector, government, and research institutions is not yet fully optimal.
The benefits of research investment will only be felt if technological development can truly be applied to production processes, increasing efficiency and producing higher value-added products.
With about 80% of growth still supported by the domestic market, the non-oil and gas manufacturing industry remains a vital pillar of the Indonesian economy.
However, maintaining its position as a primary contributor requires a growth pattern increasingly driven by productivity, innovation, technology renewal, and efficiency, rather than merely through increasing production capacity.
With this foundation, the national industrial structure is expected to be more competitive and possess stronger resilience in facing changes in demand and global economic shocks.
Data and references: BPS, S&P Global, Ministry of Investment/BKPM, Ministry of Industry, interviews with sources, and literature review.
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