Indonesia's ties with the world's second-largest economy influence policy

Indonesia is tailoring its exports and foreign direct investment (FDI) growth strategies towards enhancing its relationship with China, where authorities are hoping to transform the economy from an investment- to a consumption-based one. At the same time, falling commodity prices, particularly for coal and crude palm oil, have emphasised the importance of bilateral ties between the two nations.

The government’s move to ban the export of raw minerals, meanwhile, creates significant opportunities in downstream, value-added production, with the country already witnessing an influx of new investment, particularly in smelting, energy and transport infrastructure, demonstrating the importance of trade growth with China. Although investment realisation remains low, and economic stagnation in China could reverse the trend of rising FDI inflows into Indonesia, a recent spate of announcements concerning new Chinese-led projects should keep Chinese investment on a near-term growth path.

Government Agenda 

In January 2016 Bambang Brodjonegoro, the then-minister of finance, told delegates at the Mandiri Investment Forum that Indonesia is losing its competitive export edge to Malaysia and Vietnam, both of which have maintained exports of finished goods to China despite the country’s economic slowdown, which saw GDP growth fluctuate between 9.2% and 14.2% between 2004 and 2011, before falling to 7.75% in 2012, 7.68% in 2013 and 7.35% in 2014, according to World Bank data. GDP growth dropped to 6.9% in 2015, according to the Chinese government, its lowest level in 25 years.

In order to boost value-added exports to meet rising domestic demand in China, Indonesian authorities have sought to increase the levels of Chinese FDI. Although Brodjonegoro noted that the realisation rate for investment commitments for China are around 10%, Chinese investment has risen significantly in recent years. Indeed, recent announcements indicate China may already be one of the largest investors in the Indonesian economy.

Rising Chinese Investment 

In January 2016 the Indonesia Investment Coordinating Board (BKPM) reported that although Singapore was the largest contributor to FDI in Indonesia in 2015, with $5.9bn (20%) of the total, it is likely that China is a more significant investor than official figures suggest.

Chinese outbound investments hit $219.9bn between 2010 and 2015, according to the Financial Times, of which Indonesia receives roughly $23.2bn (11%), putting it in second place behind the US as China’s largest investment destination and ahead of Russia and India. Although BKPM data shows that China was Indonesia’s ninth-largest investor in 2015, authorities also noted that Chinese investors often direct outbound investment through proxy companies that are based in other countries, such as Singapore and Hong Kong, making it likely that China is the largest foreign investor in Indonesia.

Smelting 

A study conducted by consultancy firm Control Risks of 144 cases of Chinese investment in Indonesia between January 2013 and January 2015 revealed that the metal and mining sectors were the most common destinations for investments, accounting for 34.2% of the total, with more than half related to nickel smelting or extraction. China sourced 55% of its total supply of lateritic nickel ore from Indonesia in 2012, with the Chinese Ministry of Commerce reporting that the majority of investment in Indonesian nickel in 2014 had been Chinese, suggesting a heavy reliance on the industry in Indonesia.

Further to this, in June 2014 the Indonesian Chamber of Commerce and Industry announced that Chinese companies will invest $5bn in an industrial plant containing ferronickel and nickel pig iron smelting facilities to be located in Bantaeng, South Sulawesi. According to the chamber, eight Chinese smelters will be located at the facility, which will have a combined production capacity of 9.6m tonnes of nickel per year. Construction is expected to begin in 2016.

Bauxite Development 

Chinese firm Shandong Nanshan Aluminium, the country’s second-largest aluminium producer, is also constructing Indonesia’s first bauxite smelting facility. In December 2015 the company announced it would commence development of a $2bn manufacturing complex located on Bintan on the Riau Islands.

The 2000-ha project includes development of a smelter, dams and a 2800-MW power plant, which will enable production of aluminium ingots, powder, foil and sheet, using bauxite sourced from Kalimantan. The plant is expected to produce around 2.1m tonnes of alumina and 570,000 tonnes of ingots annually, employing up to 9000 locals and 2000 foreign workers, according to media reports.

In May 2015 the Ministry of Energy and Mineral Resources announced that 11 new nickel smelters are slated for construction over the next two years at a cost of over $1.4bn, demonstrating the impact of new regulations banning the export of raw minerals passed in January 2014. These reforms sought to reduce commodity export dependency and improve value-added production in the country by prohibiting the exportation of all raw minerals in the country by 2017, although the government has since announced plans to review the reform.

The first six facilities will be located on Sulawesi and offer capacity for 6000 tonnes of refined nickel, 66,000 tonnes of ferronickel and 50,000 tonnes of nickel pig iron, for a combined investment of $920m. If all smelters are completed by 2018 as planned, Indonesia’s nickel ore production capacity will rise to 30m tonnes, an increase of 50% over 2013 levels, according to the ministry.

Energy & Transportation 

Energy was the second-most-popular sector for Chinese investors, according to the Control Risks study, accounting for 21.4% of investment. This was followed by the construction sector, which comprised 19.6% of the total, while ICT, finance and manufacturing each accounted for less than 10% of investment.

The transport sector has also seen Chinese involvement recently, with Indonesian authorities announcing in September 2015 that they had approved a Chinese bid to build the planned Jakarta-Bandung railway project, a $5bn high-speed railway connecting Halim, Karawang, Walini and Tegallur. More than half of the project budget will be funded by the China Development Bank, with work to be carried out by a joint venture formed between the two countries. Kereta Cepat Indonesia China (KCIC) comprises the China Railway Corporation and a consortium of four Indonesian state-owned companies, including construction firm Wijaya Karya and toll operator Jasa Marga. Since the tender was awarded, however, work has encountered a number of difficulties, with construction halted in January 2016, just five days after ground was broken, due to the fact that KCIC had not obtained the necessary construction permits.

Currency Trading 

While these large-scale projects will most certainly offer significant economic and knock-on benefits to Indonesia’s economy, other moves to further enhance trade with China have stirred controversy. In November 2015 Bank Indonesia (BI), the central bank, announced it would renew a bilateral currency swap arrangement with the People’s Bank of China, the terms of which were agreed at a meeting during the most recent G20 summit. The previous deal had been renewed in 2013 for the second time since it was first reached in 2009.

BI’s deputy governor, Perry Warjiyo, stated that the volume of funds under the renewed pact will change from RM100bn ($7.3m) to RM130bn ($9.5m), noting that the agreement is in line with the government’s commitment to further strengthening its external line of defence. It is argued that the deal will protect the Indonesian financial services sector against external shocks, particularly US dollar appreciation, while also reducing Indonesia’s dependence on the dollar and alleviating pressure on the rupiah after it hit a 17-year low in October 2015.

Conversely, in the same month Statistics Indonesia (BPS) reported that the move could worsen the country’s trade balance, since Chinese goods still account for the largest proportion of imports to Indonesia, at 24.34%. To add to this, imports from China rose by 63.4% between January and October 2015, hitting $23.82bn. “The cheaper goods from China are, the happier we will be. The problem is it will be difficult for us to manage our trade balance with China since its products are cheaper. Moreover, if the rupiah strengthened, Chinese products would become cheaper still,” Sasmito Hadi Wibowo, BPS deputy head of distribution and statistics, said at a press conference. Wibowo also argued that Indonesia needs to further boost non-traditional exports, particularly value-added goods, to China in order to offset these current significant price pressures.

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The Report: Indonesia 2017

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