RECENT ECONOMIC REPORTS

IMI: CAN EXPORTS SAVE INDONESIA, February 19, 1999

1. Summary: economic observers generally believe that economic recovery for Indonesia will be a slow, painful process. many argue that prospects for recovery of domestic demand are dim and that Indonesia will need to look to its export sector to jump start its economy. Many economists, however, are predicting continued economic weakness in many of Indonesia's key markets. If these predictions are correct, prospects are poor for strong export growth in the coming year. Even if these predictions prove overly pessimistic and demand for Indonesia’s exports grows faster than anticipated, the increase in export demand may not fuel a strong, broadbased recovery.

2. Indonesia's resource-based exporters--including the oil sector and agriculture--are those most likely to benefit if export demand increases. The Oil sector has relatively few links with the rest of the economy, however, and recovery there is unlikely to spur a strong broad-based recovery. An Upsurge in agriculture-based exports would provide more widespread benefits to the economy. Recovery of the agriculture sector, however, would still tend to bypass the worst hit parts of the Indonesian economy, the large urban areas of Java which depend on manufacturing.

3. Manufacturers, with constricted cash flows and limited access to new borrowing, probably would have greater difficulty expanding their production to meet increased export demand. Thus, urban areas of Java, where most manufacturing is located, may benefit less than other areas of the country if there is an increase in export demand. End summary.

4. A number of press articles have correctly pointed out that the prevalence of intra-regional trade is one of the reasons the economic contraction in Indonesia and other countries in East Asia has been so severe. With the magnitude of the currency depreciation Indonesia suffered, it should have experienced a strong surge in exports. Many of Indonesia's important export markets, however, were also experiencing economic difficulties. That, combined with difficulties exporters face in the domestic economy, resulted in a 6-percent decline in Indonesia's exports for January-September 1998, compared with the same period in 1997. (see table 1 at the end of this message.)

5. Indonesia is facing several obstacles to economic recovery. Among the most often mentioned are:

6. These are structural and political factors the resolution of which, alone, do not guarantee a return to growth. at the most basic level, demand for Indonesian products must be restored. The Source of that demand can be either domestic or foreign. The Severity of the economic contraction and continuing structural problems make it unlikely that soon there will be a spontaneous recovery in domestic demand that can act as a stimulus for economic recovery. A Keynesian-Style government spending program to stimulate the economy is also unlikely, given the GOI's budget difficulties.

7. This leaves exports as the most likely potential source of economic stimulus. Whether export-led growth can provide the stimulus needed to get economic activity going again depends on both demand--will Indonesia be able to find external markets for its goods? and supply--will Indonesian firms be able to exploit the opportunity if export demand increases?

Who Will Buy Indonesia's Goods?

8. The World Bank, in its recently released global economic prospects, forecasts continued stagnation in Japan and the East Asian Countries most severely affected by the economic crisis. Table 1 illustrates the problem Indonesia currently faces trying to expand exports. Roughly half its exports go to other east Asian Countries, many of them with stagnant or contracting economies. Aside from limiting the potential for export growth, the weak demand in these markets has contributed to the decline in world commodity prices. Such commodities, especially oil and LNG, are a significant part of Indonesia's total exports.

9. Indonesia's trade with Japan exemplifies the problem facing Indonesia in trying to increase its exports. The Dollar value of Indonesian exports to Japan fell 30 percent in the first 9 months of 1998, compared with the same period in 1997. The Sharp fall in petroleum prices accounts for part of this decline. Indonesia suffered a 30-percent decline in revenues from the export of oil, LNG, and other petroleum products despite relatively small declines in export volumes (see table 2). These products, almost entirely crude oil and LNG, account for roughly 45 percent of Japan's purchases from Indonesia.

10. The decline in the value of Indonesian exports to Japan cannot be attributed entirely to the decline in oil prices. Non-oil merchandise exports to japan also declined sharply, falling more than 25 percent in the first nine months of 1998, compared with the same period of 1997 (see table 3).

11. According to the World Bank's global economic prospects, the outlook for Indonesia's other important markets, the U.S. and Western Europe, are better. Nonetheless, export performance to these markets has been weak. Despite strong growth in the u.s., non-oil exports to the U.S. increased only 1.7 percent in the first nine months of 1998. Indonesian exports to western europe grew a scant 0.9 percent in the same period. The World Bank believes there is a significant risk that U.S. growth could slip in 1999. The Possibility of more sluggish growth in this key export market--now Indonesia's largest single market for non- oil exports--suggests that Indonesia could be faced with increased difficulty maintaining even modest growth in non-oil exports.

12. Hence, from the demand side, the prospects for a strong surge in Indonesian exports looks limited. Continued economic weakness in key Asian markets and the possibility of a slow-down in the U.S. market do not bode well for strong growth in exports in the coming year. The Economics profession, however, is littered with examples of forecasts and predictions that prove to be incorrect. The Question arises, what if export markets are, in fact, stronger in the coming year than expected? how will the Indonesian economy respond? the remainder of this cable takes an initial look at these issues.

If Export Demand Picks Up, Can Indonesia Meet the Challenge?

13. Unexpectedly strong economic performance in East Asia, especially in Japan, could provide a significant boost in demand for Indonesian exports. The Question remains whether Indonesia could take advantage of the increase in demand or whether it would lose out to its competitors in the region. Our examination of the structure of Indonesia's exports and the current state of play in the rest of the economy suggests that some sectors could respond quickly to an increase in foreign demand. Others would struggle to take advantage of the increased opportunities.

Oil, Gas, and Minerals:

14. Oil, Natural Gas (primarily in the form of LNG), and minerals account for roughly 20 percent of Indonesia's exports (see table 4). The Decline in the value of exports from this sector in the past year largely reflects the decline in world commodity prices. Export volumes have declined only slightly. Unexpectedly strong world demand for these commodities would likely boost world prices and thus export revenues.

15. Most of the output in this sector is produced by multinational companies based outside Indonesia. They have not faced the same problems that domestic Indonesian companies--even financially sound companies-- have faced accessing working capital and financing their operations. Therefore, most producers should have little trouble, in the absence of political instability, maintaining their current production levels.

16. Opportunities to increase output in response to higher prices are more limited in the short run. Most oil and LNG exports are sold through long-term contracts, providing little scope for short-term increases. Nonetheless, oil industry contacts believe that there would be an increase in activity in Indonesia if oil prices rose above $16 per barrel.

17. Similarly, the scale of most mining operations is determined by contracts of work agreed to with the Indonesian government. These contracts would need to be renegotiated to increase output.

18. The Oil and minerals sectors are largely independent of the rest of the economy. Even if output were to rise significantly, the sectors are not labor intensive, except during the construction phase, so few additional people would be hired. Moreover, there are relatively few linkages with other sectors in the Indonesian economy. The Oil, gas, and mining industry purchase most of their equipment overseas. So an Increase in activity in this sector is unlikely to act as a strong stimulus to other sectors in the Indonesian economy. The Government would enjoy increased revenues, however, which would take pressure off its budget or could be used to fund social safety net programs.

Agriculture-Based Exports:

19. Raw agricultural products and agriculture-based manufactures, including plywood and paper, account for roughly 35 percent of Indonesia's exports. This sector received a substantial boost when the rupiah depreciated. With most costs paid in Rupiah and earnings received in Dollars, producers enjoyed large increases in their Rupiah-denominated earnings. Although the peak has passed, producers in some sectors continue to enjoy higher levels of profits than they did prior to the crisis.

20. As with the petroleum and minerals sector, many of Indonesia's agriculture-based exporters have faced falling international prices for their goods. A Recovery in world demand could reverse this trend, provide another surge in profits, and encourage an expansion in output.

21. The Problems that Indonesia's Agriculture-based exporters face in trying to expand production are in some ways a mirror image to oil and mineral exporters. Given political stability, the oil and mineral exporters could probably find the financing to exploit profitable opportunities. But the long lead times involved in expanding capacity and the need to adjust contracts would probably preclude any substantial expansion in the near term.

22. Agriculture-based exporters, in contrast, face relatively few constraints in expanding capacity in the near term, but would have to find the financing to expand operations. These largely domestic-based companies, like other Indonesian companies, are finding it difficult or impossible to obtain new working capital or trade financing. However, this has proven a smaller obstacle for producers in this sector than for manufacturers. Agriculture-based producers require fewer imported inputs than manufacturers, substantially reducing their need for financing to obtain imported inputs. Moreover, the rise in net incomes they experienced when the rupiah depreciated allows them to finance more of their operations out of current income and reduces their reliance on loans.

23. Beyond their greater ability to self-finance business expansion, many exporters of agriculture-based products have access to government-sponsored subsidized financing targeted at small and medium enterprises. Although some of these subsidized credit programs are open to all small and medium enterprises, many are targeted at exporters, and are designed specifically for the agricultural sector.

24. In addition to possible financing limitations, some policies actively discourage production for export. The Government, for example, imposes a 40-percent tax on exports of Crude Palm Oil (CPO) in an effort to assure steady supplies to the domestic market. This substantially reduces exports from Indonesia, which is the world's second largest producer and exporter of CPO.

25. Therefore, an increase in the demand for Indonesia's agriculture-based exports, like an increase in demand for oil and mineral exports, would probably produce an increase in export revenues because of a recovery in world prices. Beyond the price recovery, Indonesia's agriculture-based exporters are in a better position to increase output to take advantage of an increase in foreign demand.

26. An Export-led expansion in the agriculture sector would provide more wide-spread benefits to the economy than the oil and mining industries. This sector is the largest employer in the Indonesian economy. Expansion would bring an increase in jobs, although most of those created would be low wage. There are also more linkages to the rest of the economy than for the oil and minerals sector, so an export-led expansion in agriculture would provide a greater stimulus to the economy as a whole. An Agricultural expansion, however, would tend to bypass the hardest-hit part of the economy, the large urban areas on Java where manufacturing is concentrated.

Manufactured Exports:

27. Producers of manufactured goods are the most likely to face difficulty in taking advantage of increased export demand. Most Indonesian manufacturers rely heavily on imported components. For this reason, few manufactures exporters experienced the sharp rise in Rupiah earnings that agriculture-based exporters enjoyed when the Rupiah depreciated. The increased cost of imported inputs absorbed most of the higher rupiah earnings they received for the sale of their exported products. This eliminates one potential source of financing that agricultural producers have, that is, profits from foreign exchange gains to finance business expansion.

28. Prices for manufactured goods--generally less volatile than prices of resource-based products--are unlikely to increase substantially in response to an increase in world demand. Therefore, unlike other sectors, producers of manufactured goods are unlikely to get a cash injection from higher world prices to help them expand production.

29. Instead, exporters of manufactured goods are more likely than resource-based exporters to have to rely on bank financing to expand their operations, especially to finance the required imported components. However, manufactures exporters, like most Indonesian firms, are finding it difficult or impossible to obtain working capital or trade financing. Compounding the problem is the fact that many such firms have unresolved existing domestic and foreign debts, and progress on debt restructuring is glacial.

30. This is not to say they won't be able to respond at all to increased export opportunities, only that they will find it more difficult to respond and may find that they can't expand production as much as they otherwise would. Many businesses have found ways to survive in the absence of a functioning financial system. Many of these coping strategies--such as financing necessary imported inputs out of cash flow--allow for only limited expansion. A Second possibility, especially if the political situation remains stable, is that an upturn in demand for Indonesian exports would encourage investors to begin taking a more serious look at investing again in Indonesia. Thus, even in the absence of a recapitalized banking system, Indonesian exporters might be able to attract necessary financing.

31. An Export-led growth in manufacturing output would most directly assist Indonesia's economy, boosting employment and incomes in the sectors hardest hit by the economic downturn. Manufacturing, however, is also the sector most likely to have difficulties meeting sudden increases in export demand. The Same structural problems that caused manufacturing to be among the worst-affected sectors during the economic meltdown would hinder manufacturers from taking full advantage of an upturn in demand for exports.

Comment

32. In the years immediately preceding the crisis, Indonesian export growth was fueled largely by strong growth in manufactured exports. Indonesia was perceived as a low-cost production site and the long-term political stability under former President Soeharto was seen as a strong selling point to potential investors.

33. Indonesia remains a low-cost producer, and its greater currency depreciation relative to competitors in the region should have allowed Indonesia to expand its exports even more rapidly. Unfortunately, like others in the region, Indonesia has found demand for its exports declining at a time when it is even more reliant on external sources of demand to stimulate its economy.

34. Beyond the weak demand for exports and potential supply constraints, perceptions of political risk and security issues will have a bearing on the course of Indonesia's economy for the foreseeable future. The Indonesian Chamber of Commerce and Industry has highlighted the resolution of security concerns as a key to restoring Indonesia's Long-Term Economic Health.

Tables

35. The Data in the following tables were obtained from Indonesia's Central Bureau of Statistics. Detailed country breakdowns are available only through September 1998. Preliminary aggregated data through November 1998 indicate a slowdown in exports toward the end of 1998.

Table 1
Total Indonesian Exports to the 10 top markets (million US$)

Table 2
Indonesian oil, gas, and petroleum product exports by country
(million US$)

table 3
Indonesian Non-Oil Merchandise Exports by Country (million US$)

/1 note: trade statistics between Indonesia and Singapore are notoriously unreliable. The Indicated increase in exports to Singapore more likely reflects an increasing reliance on Singapore--instead of Jakarta or Surabaya--as a transshipment point.

Table 4
Indonesian Exports by SITC Code (million US$)
Jan-Sep 1998

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