By Neil Chatterjee

JAKARTA, Aug 15 (Reuters) - Foxconn Technology Group's investment of up to $10 billion in Indonesia will allow the main supplier of Apple Inc to tap one of the cheapest labour forces in Asia and a duty-free zone of some 600 million consumers.

Such cost savings could be vital for the mass producer, which relies on economies of scale to survive. Foxconn has seen rising wages and labour unrest at its main factories in China and has declared a strategy to diversify its production into other Asian markets.

Illustrating the cost pressures, Foxconn subsidiary Hon Hai Precision Industry, which makes Apple products such as iPads and iPhones, posted a profit margin of just 0.9 percent for January-March compared with the American firm's 39 percent.

"Foxconn already has factories in China and Brazil, and not yet one in Southeast Asia. I think Indonesia is a right decision from a market perspective," said Ali Soebroto Oentayo, chairman of Indonesia's electronics association, forecasting 20 percent growth in the country's electronics sales this year.

Taiwan-based Foxconn plans to start building a plant in October in an industrial zone near Jakarta to assemble 3 million handsets a year and then to increase output and products later, Indonesia's Trade Minister Gita Wirjawan said on Tuesday. The investment would be between $5 billion and $10 billion, he said.

"The fact they are going ahead with Indonesia is a testament to what Indonesia has achieved from a macro sense," he told Reuters on Wednesday.

The investment, courted by an Indonesian government seeking to upgrade its raw commodity-based economy into higher value manufacturing, will also give Foxconn access to a planned Southeast Asian duty-free zone with twice the number of consumers as the United States.

Foxconn has not separately confirmed the investment and the company was not available for comment. Chairman Terry Gou said earlier this year that it would expand operations in Brazil, invest in Japan and Germany, and that the next stops would be Indonesia and Myanmar.

Foreign investment alongside domestic consumption have driven faster-than-expected economic growth in Indonesia this year. Consumer firms are eyeing the rising wealth of a middle class that is expected to reach 150 million people by 2014.


Goods with a substantial component made in Indonesia will qualify for free trade by 2015 within Southeast Asia, a region whose resilient growth is making it a relative safe haven during the global economic slowdown.

"I think Hon Hai is eyeing the local and nearby market, such as TVs and desktops, to lower taxes and transportation costs," said Vincent Chen, an analyst at Yuanta Securities in Taipei.

A pull factor for Foxconn includes monthly manufacturing wage costs in Indonesia, which the Japan External Trade Organization says are 60 percent of China's.

Foxconn came under fire in recent years for producing high-end iPads and iPhones in factory conditions in China criticised as sweatshops. After worker deaths and suicides, Foxconn and Apple have pledged to improve conditions for its 1.2 million workers in the country and raise wages by 16 percent to 25 percent.

"A push factor for Foxconn is labour costs in China. There may be some incentive for companies to diversify their production plants," said Barclays Capital economist Prakriti Sofat. "In the region, when you start looking around, Indonesia remains attractive."

Some studies have found Indonesia's wage costs to be the lowest in Asia, a factor that has attracted footwear and textile firms in recent years to relocate to Indonesia from China and Vietnam in recent years.

Monthly wages in Indonesia average $113, less than half the level in Thailand and a third of China's, Asian Development Bank data shows.

Still, a series of surprise strikes last year suggested labour costs are likely to start rising in Indonesia too.


SUITORS

A team of Indonesian officials from the industry ministry and investment board went to Taiwan in July to convince Foxconn to invest, trade officials said. It is unclear what incentives they offered, though these were likely to include tax breaks.

Indonesia last year offered tax breaks of up to 10 years to draw investors in sectors including machinery and telecoms.

The breaks and increase in Indonesia's sovereign credit rating to investment grade have helped pull in record levels of foreign direct investment in the past year, including from South Korea's LG Electronics.

Still, manufacturers only produce 30 percent of the G20 member's exports. And electronics make up about 5 percent of exports, Barclays Sofat said.

It recently passed rules curbing raw mineral exports to force investment in metals processing, and a law to speed land acquisition for infrastructure, part of efforts to become a top 10 global economy.

Foxconn executives also visited Indonesia recently to assess the country and potential industrial sites.

"I think they left with a pretty good impression, not just on the scale of the market that's here today and in the coming years. I think they will actually create a sizeable operation here with all the strengths and weaknesses that this country has to offer," trade minister Wirjawan told Reuters in July.

Those weaknesses still include congested ports and roads in the crowded main island of Java, where the plant will be located, a n d inadequate transport links in the archipelago of 17,000 islands. Institutional corruption is rampant and red tape rife.

Oentayo said transport infrastructure would not be a major problem for Foxconn as it made small gadgets, though it would need government support to get land for its plants.

Poor infrastructure adds to inflation, which adds to currency risks. Indonesia does not have the financial firepower to control the rupiah exchange rate to the extent that China is able to control the yuan.

Economists worry that a deteriorating trade balance in Indonesia will add pressure on the rupiah, which has already fallen 4.5 percent this year against the dollar.

"The largest deterrent at the moment is our currency volatility because the rupiah has been the worst performer in the region so far...it could hurt investment," said Harry Su, head of research at Jakarta-based broker Bahana Securities.