Global Business Guide Indonesia

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Business Updates | What China’s Slowdown Means for Indonesia: A Trade Perspective

As one of the world’s fastest growing economies for much of the last decade, China has seen its influence on the global stage expand markedly through trade, both as a leading exporter of manufactured goods but also as an active importer of energy resources. The country’s current slowdown has thus had far-reaching implications for a broad swath of economies as well as stoked fears of a new global recession. Whether this pessimistic projection comes to pass is open to speculation, but what is clear is that several countries stand to suffer more than others. Indonesia, as a nation whose balance of trade is heavily dictated by the export of commodities, looks to be among the most vulnerable with institutions such as the IMF predicting a 0.5% decline in GDP growth for every 1% slowdown in China.

In this second instalment of a two-part analysis of Indonesia’s ties to China (See What China’s Slowdown Means for Indonesia: An Investment Perspective), further insights are provided into the nature of trade relations between the nations and what this means for Southeast Asia’s largest economy going forward.

An unsustainable trade structure

The make-up of Indonesia’s trade links to China at its core is typified by the export of commodities and the import of a wide range of goods utilised at both the industry and consumer level. Given each country’s relative positioning – one a resource-hungry market keen to power the world’s largest manufacturing sector, and the other a resource-rich market lacking the local manufacturing capabilities to meet domestic demand – the development of trade relations of this nature is not surprising. The implementation of the ASEAN China Free Trade Agreement (ACFTA) in 2010 further consolidated this dynamic and soon saw an influx of Chinese imports into Indonesia and the ascendency of Indonesia as one of China’s top suppliers for coal and rubber. In 2011, China became the top destination for Indonesian exports of these commodities, accounting for 30% and 25% of total exports, respectively, and consistently placed among the top three recipients in the years that followed.

During China’s extended period of accelerated growth, the problems inherent to this trade structure were allowed to fester. With projections from as recent as 2012 predicting growth above 8% through 2017 for China, there appeared no immediate incentive on Indonesia’s part to take anticipatory action to curb its reliance on China as the primary export market for its commodities. Of course, in hindsight, this course of action – or inaction – left Indonesia’s balance of trade vulnerable to a decline in demand for commodities from China. Its reliance on commodities and energy-related resources as a proportion of total exports to all markets (65% as of January 2014), moreover, left it precariously susceptible to a decline in global commodity prices that could be triggered by a drop in demand from a major importer of natural resources such as China. Unfortunately for Indonesia, the actualisation of a slowdown in China brought this worst-case scenario to reality.

By year-on-year comparison, Indonesia’s total exports to China during the first half of 2015 decreased by 19.32%. As expected, a substantial proportion of this can be attributed to a jarring decline in the shipment of coal to China, which in falling by 49% (Bloomberg) y-o-y saw Indonesia receive the unwanted distinction of being the hardest hit of the five largest coal exporters to China. Relative to other commodity businesses, Indonesian coal producers were especially negatively impacted in recent months due to China’s implementation of policies to exercise tighter quality requirements for imported coal and provide better support to its local mining industry. These government mandates suggest that lower Chinese demand for Indonesian coal may extend beyond the current slowdown.

Indonesia’s crude palm oil exports to China also suffered a significant decline in value in 2015, in that data from Indonesia’s Ministry of Trade shows a 48% decrease between Q1 2014 and Q1 2015, from $613.3 million USD to $318.5 million USD. The implications of this fall are substantial, considering China’s present ranking as the second largest importer of this resource for Indonesia, behind only India.

A similar downwards trend can be found with rubber; the export value of this commodity to China dropped by 48% from $1.55 billion USD in 2013 to $803 million USD in 2014, and from January to March 2015 recorded a further dip of 70% compared to the same period last year.

A one-way street to a growing trade deficit

With Indonesia also experiencing a slowdown in GDP growth characterised by lower household spending and a decrease in imports (down 17.06% y-o-y in July 2015), it follows suit that imports from its main trading partners will have decreased in a manner similar to events that transpired in China. While this was certainly the case for imports from Japan, USA and Singapore; the shipment of Chinese goods into Indonesia in the first half of 2015 fell by only 2.61% y-o-y.

Year-on-Year Change in Exports to Indonesia (First Half of 2015)

Source: Ministry of Trade

The small magnitude of this decline is indicative of China’s success in shaping Indonesian dependence on its cheap manufactured goods. The aforementioned implementation of the ACFTA in 2010, which removed tariffs on more than 54,000 products, served to flood Indonesia with goods from a full spectrum of China-based industries including but not limited to textiles, garments, footwear, electronics, toys, furniture, steel, chemicals and machinery. The influx of cheap Chinese products via the ACFTA therefore served as a key factor in Indonesia’s swelling trade deficit with China which jumped from $2.5 billion USD before the free trade agreement to more than $13 billion USD in 2014.

Indonesia’s Trade Deficit with China (in billion USD)

Source: Ministry of Trade

With this said, the existence of a trade deficit with China is not worrying in and of itself. As indicated in a recent analysis of China’s trade on a bilateral level carried out by Foreign Policy, Indonesia is but one of many nations currently in this position. More concerning is that the unabated inflow of goods from China has led to complacency among the government as well as industry players to strengthen the local manufacturing sector - a misstep that was easy to ignore until the slowdown. The ready availability of imports from China that were in some cases more cost-effective to procure than locally-sourced alternatives – if available at all – stunted the development of a local manufacturing sector that has yet to take full advantage of a domestic market in which 56.6% of GDP comes from private consumption. Such is the gap in the production capabilities of local manufacturers that Indonesia in 2014 needed to import in excess of $136.2 billion USD in intermediate goods – indicative of a specific weakness in upstream manufacturing activities and processing (Indonesia’s Oil and Gas Sector – Upstream Challenges).

The consequences of this reliance on imports are now truly being felt, with a weak rupiah (See The Present Plight of the Indonesian Rupiah) leading to skyrocketing costs for Indonesian manufacturers already contending with a rise in labour and electricity costs (See Indonesia’s Subsidies on Electricity Powered Down).

Remedying unhealthy trade relations

With regards to the commodities downturn, Indonesia must reap what it has sown in accepting that its dependence on natural resources for its export activities left it exposed to volatile global price movements. To avoid a reoccurrence of this going forward, the country must commit to its long-held plans to spur downstream manufacturing activities as a means of capitalizing on periods of low natural resource prices and producing value-added goods that are internationally sought-after. Though some progress has been made in this domain, as evident in the highly controversial ore export ban (See The Question of Indonesia’s Unprocessed Ore Export Ban), incentives also need to be provided to encourage the entry of investors. The realization of a new tax holiday regulation (See Indonesia Introduces New Tax Incentives for Pioneer Industries) stands as an example of the type of initiative needed, in its provision of tax breaks to large-scale projects within fields such as oil refineries, agricultural, forestry and fishery-based processing industries, as well as upstream metal industries that are also in need of greater investment.

Success in advancing its manufacturing industry will serve Indonesia well in addressing a trade imbalance with China as the latter moves towards becoming a consumption-led economy. As the world’s most populous country accounting for one-fifth of total global consumers, China in carrying out this policy shift will open up new opportunities for its trade partners to meet consumer demand. Early signs of progress for Indonesia’s consumer-oriented exports to China, such as an increase in the value of processed food exports from $147 million USD in 2010 to $384 million USD in 2014, hint at prospectively lucrative openings.

In steering clear of an overreliance on Chinese demand for commodities such as coal, Indonesia should also focus on driving domestic demand upwards through the construction of local power plants. As with much that has been speculated about Indonesia’s economic outlook in the medium and long-term, a great deal depends upon the extent to which the government is able to disburse its budget (See Action Needed to Put Indonesia’s Economy Back on Track) and kick-start comprehensive infrastructure development (See High Stakes for Indonesia’s New Infrastructure Push).

Global Business Guide Indonesia - 18th September 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)