The deal calls for the elimination of tariffs on some 90% of Indonesian exports to Japan. Meanwhile, 93% of the tariffs imposed by Indonesia upon Japanese goods are to be eliminated.
According to the terms of the agreement, each country will introduce reduced tariffs in phases. Japan will eliminate 80% of its tariffs, while Indonesia will remove 58% of its tariffs in the first phase. Within the next ten years, the two countries will make further reductions of 10% and 35%, respectively.
Katsunori Tsunoda, press attaché for the Japanese Embassy in Jakarta told OBG the agreement is expected to "liberalise investment".
With an accumulated investment of $39.4bn in Indonesia, Japan is Indonesia's biggest investor and its largest trading partner. This represents 13% of the total foreign direct investment in Indonesia.
Japanese investment is also a stimulus for job creation in Indonesia with around 1000 Japanese companies operating in Indonesia and more than 200,000 Indonesian workers employed by Japanese companies.
Trade liberalisation between the two countries is expected to increase Japanese steel exports, which are currently subject to a 15% tariff, as well as cars, automotive components and electronic goods.
For its part, Japan has committed to reducing tariffs on many Indonesian agricultural products and to completely remove them from the majority of clothing, footwear and timber products.
Indonesian leaders are confident the agreement will increase export revenues to Japan.
"The export market to Japan will certainly increase, because the tariffs on many commodities will be cut to zero," said Mari Elka Pengestu, Indonesia's trade minister.
Japan accounted for 22% of Indonesia's export revenue in 2006.
Japan has come under scrutiny due to lengthy exclusions for items that fall under Japanese special interest. There are 938 pages of rules and exemptions that detail what falls under Japanese exemption including vegetables, sugar, various dairy products, fruits, tobacco and rice.
The Japanese view this agreement as a way to secure energy resources from Indonesian producers. The resource-rich country is already Japan's biggest liquefied natural gas (LNG) supplier, which it is contracted to do through 2010.
Given the strategic significance of energy and mineral resources for sustainable economic growth for the region, both sides have agreed to work to ensure close coordination to promote and facilitate investment in this sector.
"In the energy sector, Japan has always bought from us. However, they have never invested. We need them to invest, to ensure security of supply," said Mari.
Capitalising on the momentum created by signing the agreement, Japan's Mitsubishi bought a strategic position in the Indonesian firm Encore Energy, which holds a 50.7% majority share in Indonesian oil and gas producer Medco Energi Internasional, for a total investment of $353m.
Indonesia's state-owned Pertamina, in joint venture partnership with Medco Energi, signed a $1.1bn deal with Mitsubishi for the construction of an LNG refinery in Central Sulawesi province. The plant will supply fuel exclusively for Japan.
Japanese conglomerate Marubeni Corporation signed a contract with Perusahaan Listrik Negara (Persero) to supply electricity in western Java, including Jakarta, for 30 years. The consortium will build a coal-fired power station, which will be based in Cirebon. Plans are set to begin selling electricity to Persero by August 2011. The project is expected to cost $750m.
In addition, Japan indicated its support for Indonesia's Sarulla geothermal project. Indonesia's new energy bill calls for an increase from current usage of renewable energy presently at 5% to 17% by 2015. The Sarulla geothermal project is one of the biggest ventures in geothermal energy ever planned. Japanese support for the project comes via the Japan Bank for International Co-operation, which is expected to provide the bulk of the $800m necessary to complete the three-stage construction and supply venture.
The signing of this agreement has already ushered in major deals between Japan and Indonesia. Clearly this marks the beginning of much closer integration of the two economies.
Time will tell the true effects of this economic partnership and how it will benefit the respective countries. Certainly, the agreement focuses on "improving the energy relationship, natural resources and human resources development," Tsunoda told OBG.