Following the collapse of the financial sectors in the U.S. and Europe, fear of a global economic slowdown has begun to spread. In spite of measures taken by the U.S. and European governments to help their financial sectors, the threat of a global recession remains prominent.
This will result in the continued decline of prices of oil and other commodities due to slower demand.
The commodity bulls at the beginning of the year made many believe Asia could decouple itself from the U.S. slowdown, propelled by China and India. China's strong GDP growth, which has been consistently in the double digits since the beginning of 2006, supported the theory.
However, the train of thought was derailed when China reported a decline in growth this year.
China has strong ties to the U.S. and EU economies as both account for approximately 40 percent of China's total exports. An economic slowdown in both regions will undoubtedly negatively impact the Chinese economy.
China's GDP growth declined from its peak of 12.6 percent recorded in the second quarter 2007 to 9.5 percent in the third quarter of this year, the worst fall since 2004.
China's economic slowdown will damage Indonesian exports, which account for some 28 percent of our national GDP. The slowdown will more significantly impact Indonesia's listed plantation and metal mining companies, because they produce CPO, nickel and tin.
Indonesia exports two thirds of its CPO production, and nearly almost all of its nickel ore and tin output.
It is worth noting that China is not only the world's biggest importer of CPO, tin and nickel but also Indonesia's major export destination for those commodities.
A Chinese slowdown will be a key factor in further pressuring CPO prices as the country is the largest importer of CPO (6.2 million tons), or 19 percent of the world's CPO imports.
For most Indonesian publicly listed plantation companies, their exports as a percentage of total sales declined significantly to below 10 percent in the first half of this year from more than 25 percent in 2007.
This was a result of the increased export tax coupled with lower demand.
However, good weather thus far this year has resulted in high CPO output, creating an oversupply situation. Supply from Malaysia and Indonesia has been reported to be higher than expected, at more than 2 million tons.
Subsequently, the price of CPO has declined 41 percent from last year and more than 70 percent from its peak of US$1,400 per ton in March this year.
Nickel's astonishing growth in 2006 and 2007 has pared off from its peak of $54,000 per ton in mid 2007, which coincided with China's peak economic growth. Indonesia exported more than 60 percent of its nickel ore to China last year.
The boom in the price of nickel is considered a result of the industrial growth in China, which was partly driven by the country's Olympic Games projects.
Demand for nickel has dissipated of late as many stainless steel firms are reducing their output due to diminishing demand.
We believe the London Olympics will not prove a main driver for nickel and other metals.
China spent a record $44 billion on the Beijing Olympics, while London already has much of the necessary infrastructure in place.
A decline in Indonesia's tin production is in the offing in our view given that 95 percent of the country's output is exported to China and Japan. China is the world's biggest consumer of tin, accounting for some 36 percent of the world's consumption.
Tin solders are widely used to join electrical circuits for swiftly developing consumer electronic goods, such as TVs, cameras, mobile phones and computers.
The global economic slowdown will definitively reduce consumer spending on discretionary products such as electronic goods.
This would lead to lower demand for electronics, which will in turn lower demand for tin as 52 percent of total tin consumption is used for soldering.
Anticipating lower demand from China and other export markets, Indonesia must focus on fully utilizing its domestic demand consumption capability. For CPO, both the Malaysian and Indonesian governments have joined forces to increase biodiesel production and usage.
Indonesia has mandated industrial users to ensure that 2.5 percent of the fuel they consume is biodiesel. This policy is expected to increase demand for CPO amid lower demand from the overseas market.
However, the situation for the metal market is different. It is not that easy to increase domestic consumption of nickel and tin since we do not have a strong metal manufacturing base that can consume excess output.
Therefore, it may be the right time for the government to build a downstream industry for both metals, allowing Indonesia to increase profit margin for export of the commodity compared to exporting the metal in block or ore form.
In conclusion, Indonesia should be able to maximize its domestic potential and find solutions to alleviate lower export demand amid the current global financial crisis and liquidity crunch.
The writer is a research analyst at Bahana Securities
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