T

he ASEAN-China Free Trade Agreement (ACFTA) has so far had a neutral — if not positive impact for the financial market. However if we look beyond the immediate future, the issue should serve as a reminder of the deep-rooted problems that are engulfing the economy.

As widely reported, starting this year Indonesia along with other ASEAN nations has begun implementing the controversial FTA with China.

This topic has been widely covered by the local media, complete with a variety of doomsday analyses about massive layoffs and scenarios of a rapidly deteriorating external position.

Yet the reaction of the financial markets has been neutral. The equity market has corrected recently but mainly as a result of rising sovereign risk in Europe. Meanwhile the local currency has been fairly stable and is slightly stronger than the dollar compared to the end of 2009.

With two views in sharp contrast with each other, we may think that one must be out of touch with reality. But this may not necessarily be the case. Markets are known to have a short-term memory … and therefore short-term foresight.

Indeed, under a six month, one year or even two year perspective, we find little reason to be worried.

Let’s first start by dissecting trade links. There are mainly three commodity groups that Indonesia imports from China: metals, electronics (especially telecommunications equipment such as mobile phones) and textiles. Conversely, Indonesia exports primary commodities such as oil and gas, coal, palm oil and ore to China.

That the FTA is treated as a non-event should come as no surprise. The top 30 companies in the Jakarta Composite Index — which covers 75 percent of total market capitalization —consist mainly of telecom, banks and natural resource sector companies. One would have a hard time finding listed steel, textile, let alone mobile phone producers with a significant market capitalization.

It’s even easy to argue that the FTA could have a positive impact. If Indonesia is further flooded by cheap mobile phone imports, would not increased phone usage eventually find its way to the profits of listed Indonesian telecom companies? And let’s not forget that China is in the midst of a massive commodity import spree, which could benefit a number of listed Indonesian coal and CPO producers as well.

The short-term macro perspective on the FTA also looks good. China’s commodity import spree has led to a surge in Indonesia’s exports, which have so far managed to outpace the rise in imports and sustain the country’s trade surplus.

So does this mean that everything is all right? Unfortunately not. Only when the analysis goes beyond investment horizons of the typical money manager (where performance is usually assessed every semester or year) does the problem become clearer.

While emerging economies such as China and Vietnam are striving toward becoming a manufacturing hub, Indonesia is drifting further toward becoming a natural resource-based economy.

Note the changing structure of Indonesia’s exports: the proportion of natural resource-related exports (hard and soft commodities) has grown from around 35 percent of total exports in the year 2000 to as high as 50 percent in the present day, by our estimates.

This is a trend that has been going on far before the ACFTA, and one which could continue going forward as manufacture exports (such as textiles, garments and electrical appliances) to the US and European countries stagnate — in the face of a weaker economic recovery on that part of the globe.

The problems associated with this deindustrialization trend have been widely documented, so let’s not go into that here. But basically, natural resource dependence is hardly a good model for sustainable growth. It can only get you so far before the day of reckoning arrives; for example, when production starts to decline, or the ecosystem is severely impaired.

At the end of the day, we don’t want to follow in the footsteps of Saudi Arabia, for example, which in the 1990s saw shrinking GDP per capita in the face of maturing oil fields.

So we have pointed out that unfavorable economic trends can persist although financial markets are doing well. But what should be done about it?

FTA renegotiation is one thing, but it can only go so far if no strategic step is taken to help revive the manufacturing sector.

Indeed the government has started a manufacturing revitalization drive this year, allocating an equivalent of US$60 million in credit subsides to be spread out across various sectors. However, that looks like a baby step compared to the billions of dollars that China has spent over the century subsidizing its steel industry.

And by the way, $60 million is only ten times the amount spent on importing luxury sedans for Cabinet ministers. So we can see how high up the priority list this revitalization issue really is for the government, underneath all the rhetoric.

Nowadays Indonesia is being associated with the second “I” in the BRIIC group of countries, which are touted to become major global powers by the year 2050. Let us just hope we do not run out of natural resources by then; because by the way things are going, it sure looks like we are betting a lot on them.


The writer is an economist for PT Bank Danamon Indonesia