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he government recently planned to restrict imports with the goal of maintaining external stability, including in the exchange rate, and reducing the current account deficit.

In the last few months, external jitters triggered by the interest rate increase in the United States and the latest financial crisis in Turkey have been putting more pressure on the rupiah. The rupiah depreciated to Rp 14,600 per US dollar on Aug. 15, 2018, the lowest level since September 2015.

Internal pressure, meanwhile, is also higher, with the latest data showing that the current account deficit widened to 3.04 percent of gross domestic product (GDP) in the second quarter. It was the biggest current account deficit since 2015.

The reason there was a larger current account deficit in the second quarter of 2018 was higher growth in imports than in exports. In July 2018, exports grew by 19.3 percent year-on-year (yoy), lower than the import growth of 31.6 percent yoy.

For those reasons, the government is trying to reduce the trade balance deficit through an import restriction policy for 500 imported goods. The import restriction policy is expected to be imposed not only on consumer goods, but also on raw materials and capital goods.

An import restriction on consumer goods may not have a big impact on the trade deficit as its share of total imports was only 9.23 percent from January to July 2018, according to available data. Meanwhile, raw materials and capital goods made up the biggest share of imports, which contributed 75 percent and 15.8 percent to total imports, respectively.

We think the import restriction policy should be implemented very carefully because it may potentially create several problems in the economy.

First, an import restriction on raw materials and capital goods may negatively impact the manufacturing industry. The main reason for this is that a lot of manufacturing industries have a high content of imported materials. Data from Central Statistics Agency (BPS) show that on average, large and medium manufacturing industries imported 30.2 percent of their raw materials during 2011-2015.

A restriction on raw material imports could shrink the growth of the manufacturing sector. Economic growth will unquestionably be affected when the manufacturing sector shrinks, because manufacturing is the largest contributor to GDP at 21.2 percent.

Several industries that have high import content are: repair and installation of machinery and equipment industry; other transportation equipment industry; computers, electronic and optical products industry; pharmaceuticals; medicinal chemical and botanical products industry; electrical equipment industry; fabricated metal products except machinery and equipment industry and basic metal industry.

Second, an import restriction could potentially drive higher inflation as a result of a shortage in supply. One of the reasons for growing imports is a lack of supply from domestic producers. If imports are restricted especially to the widely consumed products, such as rice, meat and soybean, it may lead to higher inflation. At the same time, an import restriction on raw materials and capital goods may increase production cost of industries, particularly those with high import content. Therefore, we may create a cost-push inflation.

In our opinion, import restrictions are really unproductive for the economy if they are implemented using additional import tariff or quota. Further, import restrictions may go against the World Trade Organization’s (WTO) rules and invite our trade partners to retaliate by restricting Indonesia’s exports to those countries.

We therefore think that import restrictions are not necessary, but we may need other strategies to reduce imports in a smarter manner and in normal ways.

In the first strategy, Indonesia could increase safeguards to prevent possible dumping products from other countries. The possibility of dumping is higher because the US-China trade war is escalating, creating a higher likelihood that the products charged with a higher import tariff in a particular country will try to find a new market in other countries with lower prices. We see that China’s exports, such as electronics, steel and machinery, are charged with a higher import tariff in the US. Meanwhile, US exports that are charged with a higher import tariff in China, such as soybean, are potentially sold at a lower price.

The second strategy is that Indonesia could apply technical barriers to prevent imports without breaking WTO rules. A good example is halal certification requirement on all consumer goods imported to Indonesia based on the clear reason that Indonesia is a Muslim-majority country.

As for the third strategy, we think that reducing imports could be implemented naturally by reengineering on both the production and consumption sides. An example of reengineering the production side is the biodiesel program. Since it is clear that Indonesia has an abundance of crude palm oil (CPO) for biodiesel production, the country could enforce the use of 20 percent blended biodiesel (B20) to reduce fossil fuel consumption, which is imported either as diesel oil or crude oil.

Our calculation shows that the B20 program can reduce 2.86 million kiloliters of diesel fuel imports. It could also increase CPO demand for 3.25 million tons, which may help to increase the CPO price to around US$650-700 per ton.

An example of reengineering on the consumption side is the extensive use of plastics in our society, with total imports of the product reaching $7 billion in 2017. We could carry out a massive campaign to reduce plastics and encourage people to use eco-friendly products and plastics substitutes.

In conclusion, we believe that import restrictions may backfire on the economy looking at its potential impacts. Instead of reducing imports through tariff and quota, we think the government should think to reengineer production and consumption. This strategy may not always be successful, but the best way to reduce the current account deficit in particular in the long term is to grow exports. It is a great challenge for the government and industry players.
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