Weaker trade prospects for 2006: Is oil to be blamed?

Puspa Delima Amri Jakarta

Reading the performance of the Indonesian economy this year can be compared to a parent's reaction when the children bring home a fantastic mid-year report card: A mixture of pride, optimism and also anxiety. Will the brilliant performance be sustainable throughout the year?

The first six months of the year provided plenty of reasons to be optimistic: GDP grew by an encouraging rate of 5.9 percent, macroeconomic fundamentals were favorable and confidence in the government was reasonably strong. More importantly, the economy was finally beginning to shift away from heavy dependence on private consumption to investment and foreign trade as sources of growth.

But apparently it was too early to expect that the perfect weather was here to stay. In the third quarter of 2005, the upbeat sentiment was brought to a standstill as GDP growth went down to 5.3 percent (year-on-year). Fuel price hikes pushed October's annual inflation to a six-year high of 17.89 percent while the exchange rate depreciated by around 8 percent and passed the psychological level of 10,000 Rp/$ in August. Exports slowed down in the third quarter, while imports soared due to higher oil prices and a weaker rupiah, resulting in a negative current account balance.

What went wrong? There seems to be an easy scapegoat for this unfortunate situation: Swiveling world oil prices. With world oil prices hitting over 60 US$/barrel, the government was forced to cut off significant chunks of its oil subsidies and initiated two rounds of fuel price hikes, in March and October. The Oct. 1 package, which included a dramatic increase in domestic fuel prices by 126 percent, delivered the harder blow of the two.

As with most unpopular policies, the package triggered negative market sentiment, particularly from the business sector. The main concern is that the move would cause prices of other goods and services to rise and hence this would subsequently lead to an erosion of the competitiveness of our exports in the international market.

Traders and investors have had a myriad of reasons to be doubtful and skeptical about the prospect of conducting business in Indonesia. Excessive red tape, high transaction costs, legal uncertainties, cost of compliance with complex regulations, security issues and labor disputes have long been burdening the business community. Is this gloomy attitude necessary? Or has the impact of volatile oil prices been overblown?

The appropriate answer lies between the two extremes: The prospects are neither rosy nor gloomy. There are reasons to believe that the weakening or slowdown of exports was temporary.

A closer look at the figures suggests that Indonesia's export performance is still pretty encouraging. On a quarterly basis, third-quarter exports dropped by 1.86 percent, but cumulative exports up to the third quarter of 2005 increased by 21.1 percent (year-on-year) compared to the same period of 2004. This is a noteworthy progress, considering that 2004 exports only increased by 11.5 percent.

Non-oil and gas exports are on the rise by 15.5 percent, driven by the manufacturing sector, which accounted for 65.2 percent of total exports. Machinery and electrical tools, fats and palm oils, and mechanical tools were Indonesia's top three non-oil and gas exports for the period comprising 10.9, 6.8 and 6.5 percent of total exports respectively. Products such as clothing, wood products and furniture and lightings are also among the stars of our exports, and the trend is expected to remain throughout the coming year.

The U.S. remains Indonesia's largest export destination, followed closely by Japan and then Singapore. China is still in fourth place, but is gradually gaining importance. The European Union is also a potentially significant market, Indonesian exports to the 25 EU countries from January to October 2005 increased by 12.8 percent compared to the previous year.

The above suggests that there is little evidence to expect a sudden erosion of competitiveness. Nonetheless, the negative current account balance in the third quarter is still worrying; this is mainly attributed to the weaker rupiah and the sharp increase in oil prices. But if we look closely, the rise in imports was dominated by intermediate and capital goods, a sign of investment and a potential rise in productivity in the coming quarters.

Trade prospects are hardly gloomy, but it could certainly be better. There is plenty of room to improve our competitiveness, in particular the investment climate. The cost of doing business remains significantly high and not enough efforts have been put in place to handle the issue.

There is little progress on efforts to revise the investment law, a necessary first step to cutting red tape and there have been no significant results with regards "the war against smuggling." In fact, the World Bank, in their October edition of Social and Economic Update of Indonesia noted that some frustrations about in-adequate progress on investment climate reforms.

Moderate trade prospect would have been tolerable a couple of years ago, but it is high time that Indonesia enters the age of progressive growth and strong exports and investment. In order to enable this, the government's "To-Do List" for next year needs to incorporate the following aspects.

In addition to spur further growth, the government needs to initiate breakthrough policies in the real sector, emphasizing particularly on how to encourage labor-intensive export-oriented manufacturing sectors. A continued effort to scrap unnecessary taxes, duties and illegal fees that only hamper export activities and a quick clearance of an investment bill would send out a strong and highly visible signal to investors. Finally, a robust monetary policy to ensure a stable rupiah would be in order, given the inflationary pressures in the next few months to come.

A tall order? Indeed it is, but in this case, there can be no compromise. After all, we cannot keep looking for scapegoats and blame oil for deficiencies in our housekeeping.

The writer is a researcher at the Economics Unit with the Centre for Strategic and International Studies (CSIS), Jakarta and a graduate student at the School of Advanced International Studies, Johns Hopkins University, Washington D.C.