Indonesia weighs the pros and cons of several big trade deals

Although Indonesia’s history has been marked by periods of protectionism and closed trade, the administration of President Joko Widodo has made major strides in liberalisation since coming to power in late 2014. This is especially apparent with the recent announcement that the country plans to join the Trans-Pacific Partnership (TPP), which will stand as the world’s largest free trade agreement (FTA) should it be ratified, bolstering Pacific Rim trade by billions, if not trillions, of dollars.

The TPP can benefit Indonesia in many ways and is expected to positively impact growth in both trade and investment, while also boosting competitiveness and providing the impetus for important regulatory reforms. At the same time, some fear that the country could lose out due to its comparatively lower purchasing power, and current investment restrictions would need to be relaxed in order to comply with foreign equity regulations enshrined in the TPP. Although doubts remain as to whether the agreement will be ratified, particularly given the current political climate in its largest member, the US, Indonesia’s progress in readying itself for TPP membership will benefit economic growth regardless of whether the agreement is ratified. At the same time, ongoing negotiations with China to join the Regional Comprehensive Economic Partnership (RCEP), a proposed FTA between ASEAN, China, India, Japan, Australia, South Korea and New Zealand, offer an alternate, complementary growth path.

Historic Trade Deal

In October 2015 Widodo declared that Indonesia had an interest in joining the TPP. Five other countries have also expressed interest but have yet to sign on: Colombia, the Philippines, Thailand, Taiwan and South Korea. The TPP’s 12 current members are Australia, Brunei Darussalam, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the US and Vietnam, which together account for 40% of the world economy – $295bn of global income – and could benefit from $1.9trn in trade gains when the agreement is finalised. TPP members met in Auckland in February 2016 to officially sign the agreement. Each member must now ratify the treaty nationally, and although this could pose a problem for the US, Japan and Australia, it is widely expected that a final agreement will come into effect in 2018.

Benefits 

TPP membership offers a host of potential benefits for its participants, the most obvious of which is the reduction or elimination of an estimated 18,000 tariff and non-tariff barriers. For example, Indonesian textiles and apparel manufacturers would benefit greatly from improved access to new markets, with 60% of production already exported and the industry valued by the US at $17bn. Fair trade practices are also encapsulated in the TPP, as well as regulations calling for small and medium-sized enterprise (SME) support systems – a critical consideration for Indonesia, where the IMF reports that SMEs account for 97.2% of total employment and 57.8% of GDP (see Economy chapter).

The TPP also includes foreign equity rules, which stipulate that foreigners will be able to hold a majority stake in businesses within TPP member countries. In Indonesia, which has long limited investment across a host of industries under its negative investment list, TPP membership is likely to prompt further economic liberalisation, particularly since the government moved in February 2016 to strike 35 industries from the list (see analysis).

Additionally, the TPP is expected to increase and improve cooperation between various production and supply chain entities, helping commodity producers and farmers connect with traders and manufacturers, while also reducing poverty via mechanisms for small-scale producers.

Joining an expansive FTA also supports the president’s bid to seize new opportunities in international markets. Trade visits to the US, the UK and Europe in 2016 have been concerted steps towards these goals, as the country is also in the midst of negotiating the Indonesia-EU Comprehensive Economic Partnership Agreement, an FTA with the European bloc (see overview). In late 2015 ratings agency Moody’s stated that TPP membership for Indonesia would be “credit positive” for the country’s sovereign credit rating, and a 2012 study published by US-based think tank the Peterson Institute for International Economics also found that under certain circumstances and in combination with membership of other planned regional trade agreements, Indonesia could realise up to $38bn in income gains at 2007 prices by 2025 if it becomes a TPP signatory.

FOMO 

Indonesia could also risk losing out if it does not join the deal, given that one of its fastest-rising regional competitors, Vietnam, is a member, as well as Malaysia, Brunei Darussalam and Singapore.

A 2013 report by the Asian Development Bank found that non-signatory ASEAN countries would suffer greater losses in the event of TPP expansion if they were non-members under a TPP12 scenario – whereby all 12 original signatories ratify the agreement domestically. This would mean that these nations are likely to insist on strengthening the centrality of the ASEAN Economic Community and the RCEP as major policy options.

Competition and productivity would also likely drop off should Indonesia choose not to sign, according to a January 2016 editorial in The National Interest written by Retno Maruti, an economic analyst at the Ministry of Finance. Indonesia’s regional competitiveness has already been lagging lately, sliding three spots to 37th of 140 economies on the World Economic Forum’s 2015/16 Global Competitiveness Index, below Thailand (32nd), Korea (26th), Malaysia (18th) and Singapore (2nd).

Drawbacks 

The TPP is considerably far reaching, establishing regulations for intellectual property rights, food safety, state-owned enterprise sector reform, environmental protection and financial regulations, as well as trade. Indonesia has not yet developed a comprehensive regulatory framework for many of these areas, and in many cases reforms will be needed to ensure TPP compliance.

However, the country’s purchasing power is also not as strong as many developed TPP members, meaning greater involvement in international trade would be advantageous, particularly given China’s ongoing economic slowdown (see analysis).

Ratification

As it stands, there are two ways in which the TPP can come into force: either the deal is ratified two months after each nation completes its own ratification process, or a minimum of six countries, which represent at least 85% of the total GDP of the original 12 nations, ratify the deal within two years. According to a February 2016 article in The Diplomat, this means the agreement’s success will hinge on domestic ratification in the US and Japan, which together represent just under 80% of the GDP of all signatories. This will prove to be one of the biggest challenge to TPP ratification, as even if the US and all other signatories apart from Japan sign, they will still fall short of the 85% requirement by 2%. Furthermore, the US is currently in the midst of an election year and is unlikely to move forward on the TPP until at least 2017. Both of the country’s presidential hopefuls have publicly opposed the TPP, at least in its current form, putting the future of the deal in serious doubt.

Widodo triggered an intense debate after declaring an interest in the deal, with former president Susilo Bambang Yudhoyono going as far as warning the president on Twitter not to be too ambitious with trade liberalisation. The new administration is facing a unique series of challenges, and with GDP growth dropping to a six-year low of 4.79% in 2015, FTAs are viewed as a means of encouraging competition, efficiency and innovation, while also opening up opportunities to prepare the country for future international competition.

China Effect

Indonesia’s options are not limited to the TPP, however. The country’s growing trade ties with China offer it another, potentially concurrent growth path. Indonesia is a member of the Beijing-led Asian Infrastructure and Investment Bank, and China rose to become Indonesia’s fourth-largest trading partner for the first time in the fourth quarter of 2014, according to the Indonesia Investment Coordinating Agency. Indonesia also awarded the contract to build its $5bn high-speed railway network to China in September 2015, after months of intense negotiating with both China and Japan.

The project was halted just five days after ground broke, however, and remains in limbo as of June 2016. Perhaps most significantly, the country is currently involved in critical negotiations related to the Chinese-led RCEP, which could offer yet another major opportunity for trade growth (see analysis).

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The Report: Indonesia 2017

Trade & Investment chapter from The Report: Indonesia 2017

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