Indonesia’s trade ties with Japan have expanded in recent years

Indonesia’s trade ties with Japan have shown tremendous growth in recent years, with Japan now its second-largest source of investment and second-largest trade partner, despite a decline in investment in 2014. Bilateral ties are expected to grow on the back of new opportunities in manufacturing, defence and energy, although a persistent trade imbalance between the two has led Indonesia to begin reconfiguring its relations with Japan in a bid to reduce its trade deficit.

While renegotiating the terms of its free trade agreement (FTA) could prove challenging, particularly given ongoing issues facing Japanese investors, Indonesia’s vast domestic consumer base and strong track record of economic growth represent a good value prospect for Japan, and should give Indonesia bargaining power to further expand trade ties in a more equitable fashion. Japanese corporations view Indonesia as vital to their supply chain development and are planning to continue rapidly building up their local capacity in the years ahead. Investors from the country are also beginning to make deeper commitments to Indonesia, while smaller Japanese manufacturers, and not just auto sector subcontractors, are looking to set up there.

Growing Trade Ties

Japan and Indonesia began modern diplomatic and economic relations in 1958, and have since seen trade ties expand enormously, particularly in the last decade. In July 2008 the two signed an FTA, the Indonesia-Japan Economic Partnership (IJEP), which eliminates tariffs on around 92% of trade between the two and allows Indonesian nurses to work full-time in Japan. During the first phase of the agreement, Tokyo removed 80% of tariffs imposed on Indonesian goods and services, while Jakarta removed 58% in turn. By 2018 Japan and Indonesia are set to make further reductions of 10% and 35%, respectively.

The FTA was expected to boost Japanese exports of steel, cars, automotive components and electrical goods to Indonesia, while Indonesia would benefit from a sizeable market for its agricultural products, clothing, footwear and timber. Most significantly, the agreement opened Japan’s market to imports of crude oil and natural gas; at the time of signing, Indonesia accounted for a third of Japan’s natural gas supply and was its sixth-largest crude oil supplier, with crude oil and coal accounting for half of Japanese imports from Indonesia.

Trade ties between the two nations have expanded considerably since, with consultancy Kroll reporting in October 2014 that Indonesia overtook Thailand to become the second-highest recipient of Japanese foreign direct investment (FDI) in 2013. Japan has been among the top four investors in Indonesia every year since 2006. Total investments from Japan reached $2bn during the first nine months of 2013, according to Kroll, while the European Commission reports that total trade between the two nations hit €35.6bn in 2013.

Drop in 2014

The Indonesia Investment Coordinating Board (BKPM) reported that Japanese investment in Indonesia fell by 43% in 2014, owing in part to the fact that the country held a presidential election that year. According to comments made in the press by Himawan Hariyoga, the deputy chairman of BKPM, investors from Japan stayed away because they saw 2014 as a “political year” as the race between Joko Widodo and challenger Prabowo Subianto became heated. At $2.7bn, however, Japan remains Indonesia’s second-largest investor, after Singapore, with $5.8bn in FDI, and ahead of Malaysia at $1.8bn.

Despite the off year for Japanese participation in the market, the outlook is good and the secular trend appears to be strong. In some respects, the fall is just a function of the solid performance in 2013. While 2014 investment was down from the previous year, it was up considerably from earlier periods. It is worth noting that by some calculations, Japanese investment did not fall in 2014. According to Japan External Trade Organisation statistics, Japan invested $4.54bn in Indonesia in 2014, compared with $3.9bn in 2013 and $3.81bn in 2012. The apparent pullback may have been just the result of a quirk of accounting, as different authorities have different standards for booking FDI.

Future Growth

Japanese FDI is expected to continue in 2015, with Prime Minister Shinzo Abe’s fiscal policy, “Abenomics”, emphasising expansion of Japan’s manufacturing base to regional markets, while an ongoing recession in the country is expected to see investors flock to Indonesia, where annual GDP growth has averaged more than 5% over the past decade.

As a result of political and economic concerns in neighbouring China, Japanese manufacturers have moved quickly to expand into South-east Asia, and while Thailand had long been considered Japan’s top investment destination, recent floods and political instability have made Indonesia an attractive option to diversify supply-chain risk. The 2010 protests, the 2011 floods and the 2014 coup in Thailand convinced Japanese investors that they had to diversify their holdings in the region and end their over-dependence on a single country. While they did not abandon Thailand, they saw many advantages to shifting some manufacturing elsewhere. The 2011 Fukushima earthquake and the strengthening of the yen further motivated them to move manufacturing capacity.

Indonesia has been a prime beneficiary of these trends as Japan has long been doing business in the country – it has manufactured cars there since the late 1960s – and has developed a high level of trust and strong relationships. According to a 2014 survey, Indonesia was the fourth-most-popular destination for Japanese investors, after Cambodia, India and Bangladesh.

In addition to being a site for manufacturing, Indonesia’s economic performance has created a burgeoning middle class, attracting investors hoping to capitalise on a growing consumer base and rising domestic consumption (see Economy chapter). Much has changed in Indonesia in recent years, and the Japanese are now viewing the country in a very different way than they did before. In July 2010, the Japan Credit Rating Agency raised Indonesia to investment grade, signalling to Japanese corporations that they could make more significant and longer-term commitments to the country.

The Widodo Effect

The new president has been working to improve relations with Japan. While he has been focused on learning from China, Widodo has also been lobbying Japan to maintain current investments and raise its commitment to Indonesia. In September 2014, he met with the head of the Japan-Indonesia Association, former Prime Minister Yasuo Fukuda.

The rise of Widodo seems to have had an effect on the Japanese. In the 10 weeks from the time of the inauguration to early January 2015, corporations from that country committed $1.32bn to Indonesia, according to BKPM. What is notable about the recent investments is their diversity. Less than half of the total is slated for the automotive sector. The rest is going towards a healthy mix of projects: cattle breeding, an amusement park and a factory for making surfactants. Other projects under discussion cover a wide range of sectors and include a power plant in North Sumatra, a purified terephthalic acid factory, a fishery processing facility and a waste management facility. Then in late March 2015, Widodo made his first visit to Japan as president, and according to press reports brought back business-to-business commitments from Japan totalling $5.9bn.

High-Potential Sectors

Manufacturing in particular is expected to benefit, following Widodo’s call for more foreign investment in that segment, made at the Asia-Pacific Economic Cooperation summit in Beijing in November 2014. In January 2015 BKPM reported that 73 Japanese projects had been approved since Widodo took office, of which 31 were in the manufacturing sector. This built on earlier successes, including the September 2014 announcement that Mitsubishi Motors, a subsidiary of Japanese giant Mitsubishi Corporation, plans to invest $600m to build a multipurpose vehicle factory in Bekasi, West Java, a decision driven in large part by growing domestic demand for automobiles (see Industry chapter). The proposed vehicle will be able to seat up to eight passengers, and some of the production is slated for export.

The Japan International Cooperation Agency and a consortium of Japanese contractors are successfully working with the Indonesian authorities to build the long-delayed Jakarta Mass Rapid Transit system, which broke ground at the end of 2013 and is scheduled for completion in 2017. Defence is another area in which the two nations have expanded ties, as evidenced by the March 2015 announcement that they had signed a cooperation agreement that will facilitate defence trade and industrial collaboration. Widodo and Abe said following a bilateral summit meeting that the two countries would collaborate on maritime security and boost trade. The respective defence ministers also signed a memorandum of understanding agreeing on ministerial meetings and cooperation in the areas of capacity building, defence equipment and technology. Defence publication IHS Jane’s has previously reported Indonesia’s interest in acquiring US-2 amphibious, fixed-wing aircraft from Japan’s ShinMaywa Industries, which would be used for search and rescue operations.

With annual electricity demand expanding at a rate of around 7%, the Indonesian government has also expressed its intention to include Japanese companies in its five-year plan to add an additional 35,000 MW of power to the national grid through construction of multiple power plants (see Infrastructure chapter).

Trade Imbalance

Despite steady growth in trade with Japan, challenges remain, most notably Indonesia’s trade deficit with Japan, which has lingered since the FTA was signed in 2008. According to the Ministry of Trade, Indonesia’s exports to Japan have been outpaced by imports since 2009, with Indonesian exports only increasing by 9.5% to reach $27.09bn between 2009 and 2013. Imports from Japan, meanwhile, expanded by 17.8% to reach $19.28bn in 2013. According to BKPM, Indonesia’s non-oil-and-gas trade deficit with Japan reached $2.4bn between January and November 2014, a sizeable increase over the $627m deficit in 2008, while Indonesia’s trade surplus with Japan averaged $3.6bn annually between 2001 and 2008.

Other provisions of the FTA have failed to benefit Indonesians as intended. For example, despite the opening of Japan’s labour market to Indonesian nurses, strict language requirements have kept most Indonesians out of these positions, with the World Bank reporting that only 29 applicants out of 280 passed a Japanese language test that is mandatory for a job in nursing during the first four months of 2014.

In January 2015, Agus Tjahajana Wirakusumah, director-general of international industrial partnerships at the Ministry of Industry, announced that Indonesia is considering halting the IJEP, following repeated calls for more trade equality between the two nations. Cancelling the agreement is one of three strategies suggested to renegotiate trade relations between the two. Indonesia has committed to the ASEAN-Japan FTA, meaning that ending the IJEP would likely have a minimal impact on exports and tariffs, but the announcement highlights the negative perception of trade inequity between the two nations among Indonesian stakeholders. The Widodo administration has already indicated it will continue to emphasise reciprocity and protection of national interests, and trade ties between the two countries could suffer if they are unable to reach an agreement to stabilise their trade balance.


At the same time, Japanese investors have faced challenges in establishing operations in Indonesia, including excessive bureaucracy, legal uncertainty and corruption, according to Kroll’s 2014 report. Legislative changes, the country’s negative investment list and central government control were highlighted as key concerns, and at a February 2015 meeting between the Japanese Chamber of Commerce and Industry and Indonesian government officials, Japan cited the planned 2000-MW Batang coal-fired steam power plant in Central Java, which was halted as a consequence of land acquisition issues, as a prime example of the barriers to increasing Japanese investment in the country.

Easing Entry

The Indonesian government is working to reduce barriers to market entry, with BKPM launching an online investment licensing platform in December 2014, and a one-stop shop for potential foreign investors the following month (see analysis), which is expected to dramatically improve its licensing procedures. The government has also moved to eliminate fuel subsidies that had cost it more than $20bn annually in recent years, announcing plans to double capital expenditure in the revised 2015 federal budget, with most of this allocated to infrastructure investments (see Economy chapter). These measures should improve Indonesia’s attractiveness to foreign investors, underpinning growth in Japanese investment and supporting Indonesia’s FDI and industrialisation targets.