Protectionism in Indonesia: Falling Role of Commodities in the Economy
An interesting story was released on Bloomberg Markets Asia on Wednesday (29/03) about the sliding role of commodities in the Indonesian economy and the need for Southeast Asia's largest economy to find a new growth engine (or better: several new growth engines) that will take the country to economic growth levels of +7 percent year-on-year (y/y) as once pledged by Indonesian President Joko Widodo during his presidential campaign in 2014.
Based on research conducted by Morgan Stanley and BMI Research, the protectionist policies that were implemented by the Indonesian government through Law No. 4/2009 on Mineral and Coal Mining (New Mining Law) - in addition to low commodity prices - led to the sliding role of commodities in the Indonesian economy. Whereas five years ago, commodities accounted for 60 percent of Indonesia's total exports, this figure has now fallen to 40 percent as it has become much tougher to export unprocessed minerals. Meanwhile, Morgan Stanley also notes that commodities now only contribute 6 percent to Indonesia's gross domestic product (GDP), down from about 12 percent five years ago.
Besides Indonesia's protectionist steps in the mineral and mining sectors, the role of commodities in the economy has also been on the decline due to Indonesia's weakening crude oil and natural gas output. The sliding role of oil in the Indonesian economy has actually been ongoing for several decades and is primarily caused by the lack of investment in exploration, implying existing operators are largely dependent on output from maturing oil fields.
With regard to coal, Indonesia remains among the world's leaders with coal production, export and earnings expected to rise in 2017, supported by the higher coal price (that experienced a big recovery in the second half of 2016). However, production and exports of key mineral exports of Indonesia, which include bauxite, tin and nickel, are estimated to be well behind the commodity cycle's peak.
But is the declining role of commodities in the Indonesian economy actually bad? Or can the decline encourage the nation to find a lucrative replacement, hence reducing its dependency on commodities?
The New Mining Law, revealed in 2009 under the Susilo Bambang Yudhoyono administration, was in fact already part of the government's efforts to reduce Indonesia's reliance on raw commodity exports. When the 2000s commodities ended, and especially after the big drop in commodity prices after 2011, the economy of Indonesia experienced a prolonged economic slowdown during 2011-2015 (and it was not a coincidence that this slowdown ended after commodity prices somewhat recovered in 2016). Through the New Mining Law the government wants Indonesia to become an exporter of mining output that has added value, hence becoming less vulnerable to volatile (raw) commodity price swings. However, encouraging existing miners - especially foreign ones - to comply with all requirements of the New Mining Law has been difficult (which include a ban on exports of mineral ores, the need to establish costly onshore processing facilities, and sell a majority stake to an Indonesian party the latest ten years after the start of operations).
Read more: Mining Dispute Indonesia: Arbitration for Freeport & Government?
Apart from the commodity sector, Indonesian authorities also encourage the development of the manufacturing industry. In the mid-1990s Indonesia was well on its way to become a key manufactured products exporter. After the Asian Financial Crisis, however, the role of the manufacturing industry in Indonesia cooled significantly. Despite incentives, it remains difficult to attract investment, especially foreign direct investment (FDI), in the manufacturing sector due to infrastructure bottlenecks.
Therefore, it is important first for Indonesia to focus on infrastructure development (the Widodo administration is well aware of this and has already been eager to boost infrastructure development through raising its infrastructure budget and implementing policies that aim to improve the country's investment climate). With good connectivity there will occur the so-called multiplier effect and this will automatically trigger new growth drivers, including the manufacturing sector. Without a new growth engine the economic growth pace of Indonesia is likely to remain between 5 - 6 percent (y/y). This is a solid growth figure but with nearly 11 percent of the Indonesian population (or roughly 28 million people in absolute terms) living below the poverty line, while around a quarter of Indonesians (or roughly 65 million people) being near poor, a higher growth pace would be better to push people out of (near) poverty.
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Many countries freely use protectionism, but do not want other countries to use protectionism.
Many countries want foreign investment but after major investments and a few year require more than 50% of the investments to be owned by the host country with the government being give first opportunity to own. Unfortunately investors learn the trick and investment drops. Once a reputation is established it takes decades to establish a new reputation.