Building up metals processing: New policies help the sector advance

Indonesia has long pushed to move more of its industrial processing onshore to both protect and encourage local manufacturing. At first, efforts to rectify the situation were inconsistent. Regulations were passed but not applied, or loopholes were built in that seemed to water down what at first appeared to be draconian measures. When Indonesia successfully intervened in the markets, as it has done in the textiles sector, it did so carefully. The government made sure it adhered to both the letter and spirit of international obligations. It scrupulously avoided excessive subsidies and promotional efforts that would make the playing field less than level.

Many analysts believed the country would continue on this course, the government would be pragmatic and business would remain largely unchanged. However, in 2013 and early 2014, Indonesia took measures and passed laws that indicated it was serious about developing more industry onshore and that it would go to great lengths to do so. It drew a line in the sand on exports of raw materials and began to put into place the legal infrastructure for a comprehensive industrial policy. It insists it is meeting and will continue to meet the terms of its trade agreements, but at the same time government officials have said the country reserves the right to adjust free trade when it serves the national interest.

Mineral Ban

In this vein, a ban on foreign sales of key mineral ores, including nickel and bauxite, came into effect in early 2014. The 2009 Mining Law, which mandated all mining companies begin processing and refining their output before exporting by January 12, saw some miners who failed to comply with the new rules charged an export duty for processed minerals. Indonesia is a major global supplier of both nickel and bauxite, accounting for 20% of bauxite production in the fourth quarter of 2013. Nickel is used in the manufacturing of steel while bauxite is a component in the production of aluminium. In the months leading up to January 2014, there was some confusion in the marketplace, as the government vacillated on implementing the restrictions. The final regulation, issued by the Ministry of Energy and Mineral Resources, included exemptions for concentrates of copper, zinc, lead, manganese and iron ore, if they meet specified purity levels.

Other Restrictions

The limits on foreign sales of mineral ores came in the wake of major changes to the processed tin market, where Indonesia is also a global leader. In July 2013 the government implemented new rules that raised minimum quality standards for tin smelters, followed by a requirement effective August 30 that year that all tin ingot trades be handled by the Indonesia Commodities and Derivatives Exchange (ICDX).

Sector players’ response to the local trading rule has been mixed. Some smelters reacted poorly, saying it would increase warehousing and trading costs.

But Sukrisno, the president director of Timah, Indonesia’s largest tin exporter, told Bloomberg in October 2013 that the rule’s “objective is how we can create a reasonable price”. Tin prices have been at historically low levels for a few years, leading Indonesia to idle some of its processing facilities in 2012.

Not Without Risks

The recent moves by Indonesia to limit its raw minerals exports could encourage the development of a local processing industry, but the strategy has downside risks as buyers look to alternative sources. The immediate effect of limiting trades to the ICDX was a slump in tin exports, although they recovered in the final two months of 2013 as more traders joined the exchange.

However, major buyers have started to look elsewhere for their tin and other minerals. China is seeking tin suppliers in Bolivia, Japan and Malaysia, and has turned to Africa for its bauxite requirements.

Moreover, the Asian giant has had time to stockpile in preparation for the new regulations. According to international press reports, China has sufficient nickel reserves to last through to the end of 2014.

The effect on Indonesia’s exports is potentially significant, with the changes coming at a time when the country’s trade balance has worsened. In December 2013 Citigroup said the ban on ore exports would cut the current-account position by 0.3% of GDP. The government has also conceded that the law will cost $1bn in export revenues in 2014, in addition to the more than 50,000 mining jobs already shed and potential company losses amounting to $3.7bn, according to KADIN, the national chamber of commerce and industry.

Boosting Processing Capacity

While there could conceivably be short-term costs to Indonesia’s export segment, such as a hit to the trade balance and government revenues, the larger question is whether Indonesia will be able to reap the expected longer-term gains. At present, processing capacity is not sufficient to handle local ore production, and a number of bauxite mines have halted operations since the ban, as they lack access to smelters.

One factor that could slow the development of processing facilities is the significant financial outlay required to build such facilities. Nickel miner Bintang Delapan is currently building a 300,000-tonne-per-year ferronickel smelter in Sulawesi at a cost of $1.2bn. Large-scale industrial projects also require extensive infrastructure and utilities backing, which are costly to the state and require time to put in place.

The government has a role to play in helping make this happen. “Indonesian companies, especially those that are import based, must have a plan to ensure competitiveness in 2015,” Edward Low, the CEO of Arita Prima Indonesia, told OBG. “There needs to be more government support for local manufacturers, and measures including tax deductions on exports would greatly benefit local companies.”

Trade Policy

The move with perhaps the greatest long-term consequences was a trade law passed in early 2014 that allowed the government to put in place both export and import restrictions. Analysts see the law as a culmination of efforts to create an industrial policy piecemeal through the export ban, labelling requirements and import controls on food products. The trade law brings it all together and gives the government a legal framework to engage in large-scale economic coordination.

One clause included in the trade law will give the government the authority to limit and even stop imports of products to protect domestic industries and avoid conflicts that go against Indonesia’s national interest. The law also requires the government to consult the House of Representatives before signing any new international trade agreements, and a new permanent secretariat will be established to review existing agreements and future ones.

The law followed the passing of a new industry law in late 2013. While the new law has extensive implementation requirements – the government has yet to issue 19 government regulations, including presidential and ministerial regulations, to ratify the law – the intent is clear. Indonesia wants to protect industries from competition, create national champions as well as encourage downstream processing. While supporters say that the laws are in accordance with Indonesia’s World Trade Organisation obligations, some elements could face challenges, especially with ASEAN seeking to create a single economic market in 2015.

Some analysts have suggested that the government may try to scale back ore export restrictions at least in the short run, both to boost export revenues and to give investors time to build processing facilities. Election rounds throughout 2014, with legislative polls in April and the presidential vote in July, could also have an impact on foreign investment decisions, but the lack of clarity should dissipate by the third quarter. An improvement in political certainty would go some way toward calming investors’ nerves when it comes to developing the costly downstream processing facilities that Indonesia needs to further realise its local industrialisation goals.

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The Report: Indonesia 2014

Industry Retail chapter from The Report: Indonesia 2014

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