Master of Strategic Studies (Advanced) student at Australian National University
In August, Indonesia announced that state-owned trading company PT Perusahaan Perdagangan Indonesia and Russia’s state-owned defence holding company Rostec had signed a memorandum of understanding, on a countertrade deal for the procurement of 11 Russian Sukhoi SU-35 Flanker E combat aircraft. While the precise details are yet to be finalized, Trade Minister Enggartiasto Lukita has stated that Indonesia is offering to trade rubber, coffee, palm oil, tea, and other strategic products in exchange for the SU-35 jet fighters.
The countertrade deal is convenient as it allows Indonesia to reach the requirements of the second phase of its modernization doctrine, the minimum essential force (MEF), amidst the limited state budget. Still, the deal will face some challenges in its implementation.
Indonesia has a long history of countertrade arrangements for the procurement of defense platforms from Russia, including the 2003 acquisition of Russian SU-27SK and the SU-30MK combat aircraft.The 2003 deal involved a hard currency down-payment of 13.5 percent of US$192 million contract, with the remaining settled through the countertrade of commodities.
This deal represents the first major defense acquisition project for President Joko “Jokowi” Widodo’s government that falls within the parameters of the 2012 defense law. The law allows the engagement of foreign defense contractors for acquisition unable to be achieved domestically through countertrade, local content, and or technology transfer offset arrangements.
According to Defense Minister Ryamizard Ryacudu, the countertrade deal will involve a local content and offset arrangement of 35 percent, and a countertrade arrangement of Indonesian exports equal to 50 percent of the total US$1.14 billion contract.
Indonesia is struggling to achieve the requirements set out in the second phase (2015-2019) of its MEF modernization doctrine due to a limited budget. The second phase of MEF includes several big-ticket items such as submarines, new and existing upgrades of fighter aircraft, as well as advanced missile and radar systems.
Indonesia’s revised defense budget for 2017 is Rp 109.3 trillion, a 1.2 percent increase of the approved budget, and a 4.6 percent increase overall from the original draft defense budget. However, this funding has already been allocated to finance satellite lease payments and to support Indonesia’s deployment as part of the United Nations peacekeeping operation in the Central African Republic.
It’s estimated that Indonesia requires Rp 150 trillion to achieve the requirements in the second phase of the MEF. There is a defense economic gap between tangible funding in the state budget and what is actually required for the MEF.
Countertrade deals make sense given Indonesia’s fiscal constraints. It will allow acquisition of expensive defense platforms without paying the total price in hard currency. Indonesia’s economy will also benefit, as state funds budgeted for defense acquisition will now be used to purchase commodities from domestic suppliers.
Indonesia has also revealed that the countertrade deal will involve the establishment of maintenance, repair, and overhaul facilities (MRO) as part of the offset arrangements. This will reduce whole-of-life sustainment costs significantly. Currently, Indonesia must send its Sukhoi fighters to Russia, making it practically dependent on Russia for maintenance.
Initial details indicate this offset arrangement will include the maintenance capability for radar targeting, synthetic and enhanced display, integrated logistics management, and facilities to maintain and repair the AL-417-1S and AL-31F engines. This will enable Indonesia to maintain the new SU-35s and its legacy fleet of Sukhoi jet fighters. An MRO facility in Indonesia has the potential to become a regional maintenance hub, providing MRO services to Malaysia’s and Vietnam’s Sukhoi fleets.
Nevertheless, there are still important domestic challenges in implementing this countertrade arrangement. The main challenge will be centered around the procurement of requested commodities. The 2003 deal under former president Megawati Soekarnoputri involved a multi-phase tender process through the State Logistics Agency (Bulog), which awarded tenders based on the cheapest price. However, the current deal is worth substantially more, and the market price of crude palm oil and rubber – the most likely requested commodities – has also increased. This will make it a more contested process prone to corruption.
This risk is amplified by the political and military links to many of the palm oil and rubber conglomerates in Indonesia. These lucrative businesses are known to operate under an organized patronage political network, which involves well connected politicians and former military officers being appointed to director and advisor positions. The military and major political figures at the national and regional level are also known to hold substantial shares in some of these companies.
Furthermore, it is estimated that more than two-thirds of the total production of Indonesia’s palm oil is controlled by Malaysian and Singaporean companies through subsidiaries in Indonesia.
A political scandal involving this countertrade deal such as a corruption involving Indonesia’s palm oil conglomerates with links to the military or serving politicians, or the involvement of foreign-linked companies in the countertrade deal at the expense of Indonesia’s smaller farmers, could make effective political ammunition come campaign time in 2019.
The Jokowi government will have to implement this countertrade deal much more carefully than the former Megawati government. The 2003 countertrade deal became heavily politicized leading to a parliamentary inquiry referred to as the “Sukhoi-gate” affair. President Jokowi will want to avoid such a scenario by demonstrating the successful implementation of the first major defense acquisition project under his government.
If implemented correctly, however, Indonesia may find one answer to its underfunded military modernization plans and domestic defense industry ambitions. But if implemented poorly, the SU-35s may not be worth their weight in commodities, but in political capital for Jokowi’s opposition come 2019.
The writer is a Master of Strategic Studies (Advanced) student at the Australian National University’s Strategic and Defence Studies Centre. He was the 2017 Robert O’Neill scholar at the International Institute for Strategic Studies (IISS-Asia) based in Singapore.
We are looking for information, opinions, and in-depth analysis from experts or scholars in a variety of fields. We choose articles based on facts or opinions about general news, as well as quality analysis and commentary about Indonesia or international events. Send your piece to [email protected]
Disclaimer: The opinions expressed in this article are those of the author and do not reflect the official stance of The Jakarta Post.