Global Business Guide Indonesia

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Business Updates | Indonesia and the EU CEPA – Deal or No Deal?

Overshadowed by the imminence of the ASEAN Economic Community (AEC) and the unexpected announcement of tentative plans to join the Trans-Pacific Partnership (TPP), Indonesia has in recent months taken steps to revive another free trade agreement (FTA) that despite having received less of the media spotlight also has the potential to dictate the country’s future positioning on the global stage. On 24th November 2015, Mr Thomas Lembong in his capacity as Minister of Trade confirmed that Indonesia intends to revive long-dormant negotiations with the European Union (EU) to finalise an agreement on the proposed Comprehensive Economic Partnership Agreement (CEPA) between the two markets. Speaking to local reporters on the topic of the government’s decision to evaluate all ongoing FTA negotiations as a means of spurring a rebound in the country’s export activities, Mr Lembong intimated that implementing the EU CEPA would in fact be a priority given that meeting all of its requirements would simultaneously account for 60-70% of the provisions laid out in the TPP (The Jakarta Post, 25/11/2015).

As with all prospective FTAs, the resumption of CEPA trade talks between Indonesia and the EU calls into question its varying impact on different industries as well as its potential to open up new opportunities for local and foreign investors. Unlike the TPP, which in its sheer size, scale and opacity presents many uncertainties for businesses operating in Indonesia (See Indonesia and the Trans-Pacific Partnership - Worth the Membership?); the EU CEPA and its prospective pros and cons are generally well-understood. As a function of its having been delayed for so long, the EU CEPA is backed by a wealth of research and analysis – compiled by both local and international organisations – which suggest that this FTA will ultimately prove to be mutually beneficial. What remains to be seen, however, is whether the two parties will be able to move beyond hurdles that brought negotiations to a premature halt several years ago.

An agreement six years in the making

The Indonesia-EU CEPA was first proposed following on from the formation of a Vision Group by then-President of Indonesia, Susilo Bambang Yudhoyono, and then-President of the European Commission, Jose Manuel Barroso in 2009. This group, comprised of pre-eminent academics, business leaders and policymakers from the EU and Indonesia, through its examination of existing trade and investment ties came to recommend the creation of ‘an ambitious bilateral agreement’ in the form of a CEPA. This CEPA would mandate the establishment of an FTA as the platform from which Indonesia and the EU would work together towards greater market access, capacity building and the facilitation of trade and investment.

Armed with the Vision Group's recommendations as the targets to strive toward, Indonesia and the EU formally agreed to commence negotiations in mid-2011, only to find that they were unable to move past several irreconcilable differences. By 2013, talks had ceased entirely – bogged down by disagreements on tariff reductions, service liberalisation, and concerns regarding restrictions on foreign ownership and the enforcement of intellectual property rights. Of general concern to the EU was Indonesia’s move towards protectionist policies characterised by a new trade law (See Understanding Indonesia’s New Trade Law) that run counter to the CEPA’s overarching goals. Indonesia, meanwhile, balked at the EU’s approach to negotiations centred around the submission of a scoping paper deemed overly inflexible in laying out the proposed scale and ambition of the CEPA. This system, Indonesia argued, did not provide enough room for future compromise in working towards objectives such as the elimination of tariffs on 95% of total trade in goods between the two economies (CSIS).

A remedy to stagnant trade

Failure to come to an agreement in finalising the Indonesia-EU CEPA has not been without consequences. In the years that followed the negotiation breakdown, trade between the two markets stagnated, dropping from €25.269 billion euros in 2012 to €23.933 billion euros in 2014. Moreover, neither economy is solely to blame for this decline; both markets saw their exports to the other fall over this period.

Indonesia - EU Trade 2010 to 2014 (in billion euros)

Source: European Commission

This pattern is in sharp contrast to trade between the EU and Vietnam – a market oft cited as one of Indonesia’s closest competitors in the ASEAN – which rose from €23.911 billion euros in 2012 to €28.369 billion euros in 2014. Uncoincidentally, these two countries on 2nd December 2015 put the finishing touches on their own FTA, having first begun negotiations in mid-2012.

Though very much a case of missed opportunities for both the EU and Indonesia, the impetus to take action in addressing the trade slowdown should lay with the latter, if only because it has more to lose if a fix is not found soon. The EU stood as Indonesia’s 4th largest trading partner in 2014, accounting for 9.6% of the country’s total exports. By contrast, Indonesia ranked 31st among the EU’s most active trading partners, and received only 0.6% of the region’s total exports. The archipelago nation, more so than its counterpart, can therefore ill afford to suffer a further deterioration in this trade dynamic, particularly given that slowing growth in China has already severely hampered its export activities this year (See What China’s Slowdown Means for Indonesia: A Trade Perspective).

Indonesia’s Top Export Destinations in 2014 (in billion euros)

Source: BKPM, European Commission

The EU CEPA offers Indonesia a means through which it can not only take steps to reverse worrying trade trends, but also benefit from greater direct investment from Europe. In 2013 the EU was the third biggest source of foreign direct investment (FDI) into Indonesia, channeling €1.8 billion euros into the country. This figure, however, amounted to only 6% of all EU investments flowing into the ASEAN (Eurocham) and suggests that there exists a real need for the CEPA’s proposed measures to facilitate greater investment between Indonesia and the EU. By way of comparison, Singapore – an economy that successfully concluded its FTA negotiations with the EU in late 2012 – accounted for 60% of EU-origin FDI in the ASEAN in 2013. A rise in investment from the EU, which in the ASEAN typically focuses on processing, manufacturing and power generation industries, would be in keeping with reforms being carried out by the Indonesian government to streamline licensing processes within these specific areas of business (See Twice as Nice? – Indonesia Unveils Second Economic Policy Package).

Complementary economies

There are clear incentives for Indonesia to finalise its CEPA with the EU that go beyond a general desire to keep pace with regional counterparts. As opposed to being primarily motivated to act by a fear of falling behind fellow ASEAN nations, Indonesia should embrace the EU CEPA for its potential to link two highly complementary economies that are readily positioned to cater to each other’s needs. In stark contrast to Indonesia’s previous FTA experiences through which the country was left exposed to an influx of products from competing overseas industries, the EU CEPA would remove trade barriers between two markets with significantly different strengths and should thus serve to create new export openings without placing undue pressure on local businesses through increased competition.

Indonesia’s access to an abundance of natural resources has seen it serve as an increasingly popular supplier of goods such as vegetable oils (including palm) and fishery products to the EU. Total export value for these two products increased by 22.86% and 28.27%, respectively, between 2011 and 2014, and should be among those most likely to rise again following on from the completion of a CEPA. As described by the Trade Ministry’s Director General for International Trade Cooperation, Mr Bachrul Chairi, the fisheries industry in particular, stands to benefit from the CEPA’s removal of a 22.5% import duty currently levied against its products upon entry into the EU. Also likely to take advantage of a formalized FTA with the EU are Indonesia’s timber and wooden furniture industries, which having introduced a new legality verification system in late 2013 (See Trading Timber: Business Insights into the Indonesia-EU VPA) already saw exports of wood and wood-based articles into the EU jump from €392 million euros in 2013 to €419 million euros in 2014.

EU businesses seeking to further their presence in Indonesia are most likely to find traction in building upon the region’s current advantages as a supplier of machinery and appliances, which together comprised 38.4% of the EU’s total exports to Indonesia in 2014 with a value in excess of €3 billion euros. Success in this regard feeds into the development of a symbiotic relationship between the two economies, in which the EU provides the technology through which Indonesia is able to move up the value added manufacturing chain to produce high quality goods that are sought-after in discerning markets. The textiles industry is but one example of an area of business poised to prosper from this kind of trade dynamic, particularly as Indonesian firms seek to move towards greater automation amidst rising minimum wages (See Indonesia’s Textile Industry - Testing Times Upstream).

The complementary nature of the economies involved in this proposed FTA has most analysts projecting positive outcomes for both parties should the CEPA move forward. The Centre for Strategic and International Studies (CSIS) in its comprehensive study on the impact of the EU CEPA concluded that the EU would likely experience a 14% uptick in exports to Indonesia following on from the implementation of the CEPA, while Indonesian exports to the EU would rise by 5%, or $1.1 billion USD. Moreover, the study posited that without the CEPA, Indonesia runs the risk of having no plan in place for when it graduates from General System of Preferences (GSP) eligibility and therefore no longer qualifies for advantageous tariff and import duty rates granted to developing nations.

Same old problems?

Having previously been criticised for its perceived protectionist leanings, Indonesia’s government under President Joko Widodo seems to have turned a corner in opening up to international markets, perhaps forced into this course of action by the harsh reality of a new economic landscape in which it is no longer tenable for Indonesia to prioritise self-sufficiency in the face of slowing growth. This bodes well for CEPA negotiations; as does Mr Thomas Lembong’s willingness to put a two-year time frame on this FTA’s implementation. Moreover, the Indonesian government appears poised to address EU concerns related to restrictions on foreign ownership through revisions to its Negative Investment List slated for April 2016.

This is not to say that CEPA negotiations are to proceed without any major objections from the Southeast Asian nation. In truth, new challenges have emerged since talks grinded to a halt, such as the EU’s increasingly strict environmental laws that have been fiercely opposed by Indonesia’s agribusiness industry on the basis that they create additional barriers to entry. It seems unlikely that the EU will make concessions in this domain, given the context of Indonesia’s highly publicised ineptitude in countering recent catastrophic forest fires and haze caused in part by rampant industry-led deforestation. To avoid this becoming an insurmountable point of conflict, both parties could choose to view it as an opportunity to demonstrate the potential of the CEPA’s capacity building provision, in which the EU through knowledge sharing and technology transfer could serve to boost Indonesia’s environmental standards.

Global Business Guide Indonesia - 8th December 2015

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Indonesia Snapshot

Capital: Jakarta
Population: 259 million (2016)
Currency: Indonesian Rupiah
Nominal GDP: $936 billion USD (IMF, 2016)
GDP Per Capita: $3,620 USD at Current Prices (IMF, 2016)
GDP Growth: 5.0% (2016)
External Debt: 36.80% of GDP (BI, Q2 2016)
Ease of Doing Business: 91/190 (WB, 2017)
Corruption Index: 90/176 (TI, 2016)