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Jakarta Post

When import-substitution makes a comeback

  • Yu Liuqing

    -

Singapore   /   Thu, October 1, 2020   /   08:30 am
When import-substitution makes a comeback Industrial port of Tanjung Priok with stacks of containers. (Shutterstock.com/Creativa Images)

In Indonesia, import substitution policies are showing signs of making a comeback. In recent years the country has appeared committed to outward-looking free-trade agreements. ASEAN countries, through the founding pacts of the ASEAN Economic Community (AEC), have secured significant tariff reductions across member states. Indonesia has also been among the more vocal supporters of the Regional Comprehensive Economic Partnership (RCEP), a mega-regional trade agreement set to harmonize many existing trade agreements.

However, protectionist sentiment has never been far from the surface and it may be that the country sees such trade agreements primarily as ways to promote its exports. President Joko “Jokowi” Widodo has expressed concerns about Indonesia being a destination for exports from other ASEAN members once the AEC is finalized. The Indonesian government has also managed to retain many non-tariff barriers, despite its rhetoric.

According to the World Bank, 69 percent of goods imports to Indonesia are subjected to non-tariff measures, like pre-shipment inspection and traceability requirements, compared with 31.1 percent in Thailand and 38 percent in Vietnam.

Besides insulating parts of the domestic economy, Indonesian policy toward crossborder trade and investment is also influenced by structural factors. A persistent current-account deficit has been a longstanding concern for successive Indonesian governments owing to the volatility it can cause in the rupiah’s value. A weak rupiah increases the cost of external debt repayment for the country.

The COVID-19 pandemic is further encouraging an inwardlooking tendency. In July this year the Industry Ministry outlined a target of reducing import reliance across a range of sectors, including machinery, chemicals, metals and electronics, with a goal of shifting 35 percent of current imports in such areas to domestic sources by 2022.

While the road map is still at the planning stage, it appears to be a more emphatic version of earlier self-sufficiency plans backed by the ministry, such as those targeting a higher share of domestic products in government procurement. The authorities hope that the drive will help increase utilization rates for domestic manufacturing and create more jobs for locals.

While the specifics are still being shaped, direct import limits and prohibition, more pre-shipment inspections and some port restrictions are likely to be imposed. The government is contemplating revamping national standards certification (known as the Indonesian National Standards or SNI) and applying them on more imports; reshaping a program aimed at increasing the use of domestic goods (known as P3DN); and increasing the “most favored nation” tariff on commodities.

The government’s program can be attributed to several concerns. First, the additional safeguarding will help distressed state-owned enterprises (SOEs). Among the more notable of these is PT Krakatau Steel, a steel maker, which is dependent on government support and has been struggling to restructure its debt. The government has requested all import steels to be subjected to SNI starting from September, an initiative pushed by the firm. Alongside this, imports for capital-intensive goods in the electronics, machinery, and pharmaceutical sectors have drained Indonesia’s foreign exchange and widened the trade deficit.

Positive incentives for domestic entities operating in sectors where a large import dependency pertains are also likely. Indonesia’s largest goods imports in 2019 included machinery, electrical machinery, iron and steel, and plastics. Such areas will be an area of policy focus for the authorities as they seek to bolster levels of domestic production.

Prospects for import substitution will differ by sector. Reducing imports of machinery and other capital-intensive goods will be unlikely to succeed. Indonesia does not have a strong industrial foundation and lacks the domestic supply chain through which to produce higher-end capital goods. Insufficient intellectual property protection and weak research and development capacity make the production of indigenous advanced machinery a distant goal.

Consumer-facing industries stand a better chance of success, supported by proximity to a large and growing domestic market. Industries such as food and beverage and consumer goods manufacturing are likely to be recipients of government support, including tariff adjustments and subsidies.

Opportunities could extend to sectors such as automotive and consumer electronics manufacturing if Indonesia is able to make broader progress on improving its business environment and infrastructure.

Metals, plastics and the oil and gas sectors will be other sectoral considerations given the structure of Indonesia’s import demand. Domestic producers of aluminum, iron and steel will benefit from the revamped SNI requirement and a possible tariff hike on foreign metal.

Barring strong investment in exploration, it is difficult to envisage Indonesia arresting the decline in oil production that has led it to becoming a net importer of the fuel, but it will seek to refine a greater quantity of its domestic output within its own borders.

There will also be a desire to protect the trade surplus it maintains for natural gas, which could lead to tie ups with foreign investors.

The government’s strategic work plan and the earlier “Make in Indonesia 4.0” plan outlined some general support measures, including setting up vocational training facilities, improving infrastructure access, and enhancing credit support to priority industries.

However, few tangible support schemes are likely to be introduced, given the limited fiscal space. The policy focus will therefore be on strategic adjustments to the trade regime, including non-tariff barriers, and ongoing protection of SOEs.

Unlike China and India, Indonesia’s inward-looking policies are not guided by specific geopolitical concerns but are more an assessment of domestic economic interests. The country has few trade tensions with the United States or China, for example. The trade deficit with China is substantial, but Indonesian exports to China have increased substantially over the past few years.

While investors may therefore find themselves relatively insulated from geopolitical tensions in Indonesia, navigating domestic political interests remains challenging. As noted, SOEs retain a protected role in key segments of the economy, such as finance, metal processing and construction. Scrutiny will also be applied by the authorities to investments in sensitive primary sectors, such as mining and palm oil plantations.

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Country analyst at The Economist Intelligence Unit. These views are personal.

Disclaimer: The opinions expressed in this article are those of the author and do not reflect the official stance of The Jakarta Post.