Weak Diversification Behind Indonesia's Trade & Current Account Deficits
The central bank of Indonesia (Bank Indonesia) said it expects to see another monthly trade deficit - approximately USD $230 million - in February 2018. If so, it would be the third straight monthly trade deficit for Southeast Asia's largest economy after a USD $220 million deficit in December 2017 and a USD $678 million deficit in January 2018 (the latter being the country's highest monthly deficit since April 2014).
Main reasons for another trade deficit in February 2018 is that the nation's export performance continues to be outperformed by its import performance. In the first month of the year Indonesia exported USD $14.46 billion worth of goods, while it imported USD $15.13 billion worth of goods. In the second month of the year a similar situation is expected to occur (albeit the central bank expects a much lower trade deficit) because domestic industries have continued to import a significant amount of capital goods and raw materials (which is actually a good sign as it signals that manufacturers are boosting their production).
Read more: Trade Balance Indonesia: $678 Million Deficit in January 2018
Bank Indonesia Governor Agus Martowardojo said another monthly trade deficit is not something to worry about, especially as a big chunk of the deficit is caused by rising demand for raw materials and capital goods among domestic manufacturers. This points at rising activity and rising confidence in the manufacturing industry, which should impact positively on employment opportunities and future exports. Capital spending by manufacturers is one of the signs that a manufacturer expects growth or at least steady demand for its products.
However, based on data from the Central Statistics Agency (BPS), not only imports of capital goods and raw materials rose by double-digit figures, also imports of consumer goods grew by a double-digit figure in January 2018. On the one hand this can be a good sign because it signals purchasing power and household consumption are strengthening in Indonesia. On the other hand, it puts pressure on both Indonesia's trade balance and the current account balance as well as the rupiah exchange rate.
Another monthly trade deficit will put more pressure on Indonesia's current account deficit (which records all international trades of goods and services, as well as income transfers, debt payments and remittances). Martowardojo said he expects Indonesia's current account deficit to widen to 2.1 percent of gross domestic product (GDP) in full-year 2018 (from a deficit of USD $17.29 billion or 1.7 percent of GDP in the preceding year). This new estimate is in the lower end of Bank Indonesia's earlier current account deficit forecast of 2.0 - 2.5 percent of GDP. Martowardojo added that a 2.1 percent of GDP current account deficit is a "healthy level". Several analysts, however, claim that the rupiah will remain Asia's most vulnerable currency as long as the country has a current account deficit.
A widening current account deficit puts additional pressures on the Indonesian rupiah exchange rate. Earlier this week, Credit Suisse said it believes the rupiah is among the most vulnerable emerging market currencies in Asia (vulnerable to trade fears) as the country has to cope with a current account deficit. The rupiah is typically the first among Asian currencies to be sold when there emerges global economic turmoil.
The key problem why Indonesia has to cope with a current account deficit - and has volatile monthly trade balances - is that the country remains highly dependent on raw commodity export products, hence the nation's export performance heavily depends on commodity prices. Indonesia should therefore encourage a new export model, reducing its traditional reliance on commodities.
In the 1980-2000 period, Indonesia's exports mainly consisted of oil and gas as well as processed wood. In the 2000s (when Indonesia's oil production declined rapidly) clothes, coal, and crude palm oil (CPO) joined Indonesia's key export products club (coal and CPO thrived in the 2000s commodities boom era).
Today, the structure of Indonesian exports has not changed significantly. Therefore, the improvement in Indonesia's export performance over the past two years is mainly attributed to strengthening commodity prices. Contrary to several of its regional peers, Indonesia has not been developing a high-technology manufacturing industry. Only the electronics manufacturing industry of Indonesia is doing reasonably well (this sector actually developed rapidly during the last decade of the Suharto regime but the Asian Financial Crisis undermined its momentum).
It would be great if foreign exchange earnings from Indonesia's two biggest (non-commodity) exports, namely clothes and electronics, can be optimized through diversification, hence boost Indonesia's role on the global trade stage for these two products. The foundations of these two sectors has already been laid in Indonesia (hence no need to develop a new export-oriented sector from scratch), while its export markets already exist (but can be intensified as well as searching for new markets).
However, it is not an easy process to diversify the electronics and clothes industries as there are several bottlenecks that cause the limited competitiveness of Indonesian products compared to foreign counterparts. Firstly, high electricity rates raise production costs for Indonesian companies. The Indonesian government released several economic policy packages, with some particularly aimed at improving the business environment (such as cutting energy tariffs for certain industries). It would be good to see more efforts to boost the manufacturing industry (and more importantly: fully implement the contents of the packages).
A second problem that makes Indonesian products less competitive is that minimum wages are higher in Indonesian than in Vietnam and Bangladesh. There is not much that can be done here except for guarding a not too fast pace in minimum wage growth. A third problem is that Indonesian industries need to import many raw materials from abroad. This adds costs, surely in times of heavy rupiah depreciation (although on the export side a weaker rupiah is an advantage).
The Indonesian government can support the development of the diversification of the electronics and clothes industries by offering more fiscal incentives (for example the scrapping of import duties for capital goods and raw materials) and by signing bilateral trade deals to cut tariffs. Without firm actions, Indonesia will remain dependent on (raw) commodity exports.
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Interesting article. Import replacement is an effective way to improve the trade balance too i.e. increasing domestic production of currently imported goods. The 'low hanging fruit' are products with a low share of raw material import and/or high transport cost. It creates jobs, saves hard currency outlays, stabilises the currency, and is faster/easier to achieve than developing new export markets. An attractive Investment Climate motivates foreign investors/manufacturers to establish Indonesian operations.