Wed, 09 Jul 2003

Unasked questions in Sukhoi countertrade controversy

Mari Pangestu Center for Strategic and International Studies (CSIS)

Countertrade, as its name suggests, is the international exchange of goods and services based on barter or some form of reciprocity. Countertrade undertaken in the private sector is easily understood as taking place directly between buyers and sellers, or more usually through a third party, which earns margins as the intermediary between buyers and sellers. The third party is often a trading company specializing in countertrade and in markets of countries with limited foreign exchange.

The buyers could be from countries with limited foreign exchange and thus pay for the goods purchased with other goods. The third party could use its own funds or borrow from the bank for bridging funds. Countertrade practice is also accepted for exporting companies.

For instance, in Indonesia, foreign investment companies in bonded areas or export-processing zones can use countertrade arrangements (with their parent companies) for the duty- or tax- free importation of equipment or inputs for production against the exportation of their final product (World Trade Organization, Trade Policy Review of Indonesia, 2003).

The usual rationale for governments to enter into a countertrade agreement is to leverage against importation of goods and services from a foreign supplier as direct purchase or as part of government projects.

There are several types of common countertrade agreements, such as counterpurchase or counterexport, whereby foreign suppliers commit to purchasing goods and/or services from the country to which they are supplying goods or services. Conversely, foreign suppliers can commit to invest, undertake technology transfer or skills training, or research and development in the buying country. Product buyback involves the foreign supplier of machinery or equipment buying back the final goods manufactured from the machinery or equipment. Some countries have also paid their debt with goods or services.

The main motivations for governments to use countertrade as an instrument are to save foreign exchange, to obtain higher prices for products that are in surplus (often primary products) and as an instrument to promote or market their products.

On paper, Indonesia's current policy (introduced in 1982) is to link imports related to purchase by government institutions and state-owned enterprises to the purchase of non-oil exports. The foreign supplier is required to import a certain percentage of any import of goods or services by the government greater than Rp 500 million in value.

The trade is to be undertaken through one of the approved Indonesian trading companies. There are exceptions to this rule such as imports through a soft loan from one of the international financial institutions or imports for a joint venture between a foreign company and a state-owned company.

There appears to be no explicit percentage requirement set and it is not clear how much of the policy has been implemented, given that such countertrade does not seem to have been significant in value. In 1997 the value of countertrade was US$379 million and in 1998 it was $195 million. Since then, amounts dropped off to only $3.2 million in 2000 and $17 million in 2001 (U.S. Commercial Service, 2002).

Therefore, countertrade has not been an important element of Indonesian trade policy and also not important in most other countries, as only an estimated 4 percent to 5 percent of world trade is accounted for by countertrade (including that conducted by the private sector). Obviously, it is important for a subset of countries that face large foreign exchange constraints.

In the light of this information, what can be said about the current interest in countertrade policy related to the purchase of Sukhoi aircraft from Russia, from a purely economic perspective? Two main economic arguments have been put forward regarding the use of countertrade, although some of the detail has not been clearly articulated.

First, it appears to have been intended to save the government foreign exchange and outlay. However, the government still had to purchase the goods to be exchanged for the purchase of the aircraft. Therefore, budgetary funds were still needed by the State Logistics Agency (Bulog) to purchase the goods.

As for saving foreign exchange, whilst the countertrade arrangement meant that there was no foreign exchange outlay related to the purchase, it is not known whether there were other foreign exchange requirements, such as the need to have spare parts and servicing contracts, which may not necessarily have been offset by purchase of goods from Indonesia. Rather than a one-off saving of foreign exchange, would not a better strategy have been to earn foreign exchange in a more sustained way?

The second argument was the promotion of Indonesian exports in nontraditional markets such as Russia and to market products that were in surplus, which seems to have been part of the rationale for the inclusion of palm oil as one of the products for the countertrade. This approach was only efficient and beneficial if the foreign supplier in question was a sufficiently large or diversified company so that it was in a position to effectively find markets for our goods. This would normally be large, specialized trading agencies, and it was possible that the Russian government would have subcontracted the sale of our goods in Russia to such a company.

If, indeed, the objective was to promote sales of our goods in the most effective way, then would it not have been more efficient for Indonesia to directly contract such a company for more market-based countertrade arrangements, rather than go through a countertrade arrangement? The effort could then have been supplemented with a concerted trade promotion program.

A final problem is the lack of transparency in the pricing and margins on both sides, as the deals were neither subject to market pricing, nor the selection of products to be sold under the agreement based on market demand and pricing.

In conclusion, while countertrade is a valid instrument, if indeed our objective is to promote our exports in a sustained way, does countertrade deserve the resources and attention it has now? Would not limited resources be better used to specifically focus on the issues of marketing and promoting our products in these nontraditional markets in a sustained way, or even using the services of specialized trading companies, rather than a one- off sale under countertrade?

The focus has been on saving foreign exchange -- instead of earning foreign exchange, through a longer-term strategy of addressing the structural weaknesses and problems of a high-cost economy, which are affecting the competitiveness of our exports.