Overview of the Indonesian Economy

Last Friday, August 23, 2013, the Government through the President and related Ministries announced a package of policies to save the economy, including the monetary policy from Bank Indonesia (BI) as a monetary authority, to address the weakening Rupiah that had reached the level of Rp11,000 per U.S. Dollar. When viewed from the policy package name of 'saving the economy', the ultimate goal of this policy package is certainly not merely to avert Rupiah not to fall again, or to address the decline in the stock market (JCI) that occurred lately, but to save the economy of Indonesia as a whole. But it might as well raise the question, what is actually happen with our economy?

The answer to these questions may lead to the Indonesian economy flashback about ten to fifteen years back, precisely after the monetary crisis of 1998. After the crisis, the national economy was stagnant over the next two to three years, until the early 2000s there was an important global event that appears to be an opportunity for Indonesia: The Rise of China. Since the early 2000s, China's economic growth is very high, which is mainly driven by the advancement of a wide variety of manufacturing industries. The country is able to make anything, everything! You name it, hair tongs, motorcycle bolts, until smartphones just like iPhone and Android. The Chinese-made products are then sold dispersed throughout the world, and can be easily found in any country.

Because there are so many kinds of ‘made in China’ products, including imitation products from well-known brands, then there is an anecdotal 'God made Heaven and Earth, and the rest was made in China.'

The growth of industry in China could only be sustained by two things: The supply of iron and steel, and the supply of fuel, in this case coal. Iron and steel and its derivatives are necessary to make industrial machinery, construction, and raw material for electronic goods and automotive. While coal? For power plants, where the electricity itself certainly is necessary for any kind of industry. China actually has its own coal, but as its industries growing faster than the ability of the local mining companies to dig coal, then the nation should also import coal from outside, one of them of course, from Indonesia.

That's why, in Indonesia in the early 2000s, the coal business was booming, where there are people who became very successful from the business. Some of large conglomerate groups, such as Bakrie Group and Saratoga, could rise until today because of their ability to capitalize the opportunity of coal industries, where Bakrie acquired two giant coal company, Arutmin and Kaltim Prima Coal/KPC, which was then placed under Bumi Resources (BUMI), while Saratoga acquired Adaro Energy (ADRO).

The booming of coal immediately bring a positive influence on the growth of the national economy. In 2000, Indonesia recorded a record of trade surplus amounted to almost US$ 3 billion, which was mainly due to increased exports of coal, where the surplus is then continued until subsequent years.

Actually, other than coal, there were other opportunities from the progress of the Chinese economy, which was the growing demand for iron and steel. Unfortunately because there is no company in Indonesia which is able to produce iron and steel in large quantities, then the opportunities are captured by Indians, one of them was the company that later grew into the world's largest steel company, Arcelor Mittal. Thanks to its iron and steel industry, India then also successfully recorded significant economic growth.

Back to Indonesia. If you notice, even though Indonesia and India are both recorded high economic growth in the last ten years, but they never touch a record of 13% growth a year as the record of China. But it was fair, because Indonesia and India were actually just got a nickel from the economic expansion of China, where the industry in these two countries have not really developed, especially in Indonesia where the entrepreneurs were fall asleep as they could easily take advantage from coal (just dig it, then sell), so they ‘forgot’ to develop the real industries.

Actually, when Indonesia was hit by the global crisis in 2008, the awareness that Indonesia's economic growth can not rely forever on exports of natural resources solely, in this case coal, began to arise. The actors of national economy should also encourage the development of downstream industries, to create value-added products. This awareness also later gave birth to the Master Plan for the Acceleration and Expansion of Indonesian Economic Development (MP3EI), with its main purpose is to develop the infrastructure, as the infrastructure, both in physical form as well as government policy, is necessary to develop the industry and ultimately grow the economy. The idea of  MP3EI was first coined by the President Susilo Bambang Yudhoyono in 2008, when the global crisis reached its peak.

Unfortunately, before the MP3EI was actually started, Indonesia had had a ‘bit of luck’ again. In early 2010, the price of crude palm oil (CPO) started to skyrocketed, and it immediately gives a large increase in profits for palm oil plantation companies. Because at the time the coal business had not slowing down, then the Indonesian economic growth had speeding again, even when the government and entrepreneurs almost do nothing.

As a result, after the economic growth had drop to 4.1% in 2009 due to the global financial crisis, in 2010 it was immediately rose again, and reached its peak in early 2011 in which the growth of the national economy had touched a record of 6.9% on year on year basis, thanks to the boom of two commodities, namely coal and CPO. Also in 2011, Indonesia had recorded a surplus of exports over imports of up to US$ 3 billion, thanks to higher export value of coal and CPO. 

But after 2011, as you probably know, the condition was reversed when the world commodity prices, including crude palm oil and coal as the mainstay of Indonesian export, declined. The export value was then depressed, and as augmented by the increasing flow of imports, the national trade balance eventually come into deficit. And it was slowly but surely erode the economic growth until the latter being only 5.8% in First Quarter 2013. Actually at the year of 2011, the draft of MP3EI has finally endorsed, as well as a marker that the Government with the state-owned enterprises and the private sector have started to build infrastructure and others. But before some of the infrastructure was completed and began to make a positive contribution to the development of industry and the economy itself, the economy was already slowing down.

Well, so let's sort what happened. First, our trade balance was deficit as coal and palm oil prices were down. Second, the deficit eventually suppress the economic growth. And third, Rupiah weakened as a reflection of the economic slowdown.     

So when Rupiah weakens (against US Dollar), then it does not impact the economic slowdown or other problems, but rather the economic slowdown was the one, which then causes the weakening of Rupiah. In any country, the weakening of its currency against the 'world currency', namely the U.S. dollar, indeed become a sign that the economy of the country concerned is in trouble. In 2011, when there was Greek crisis and European Union in general, the Euro also weakened against the U.S. Dollar. 

So when the government unveiled a package of measures, the title is the policy of economic rescue package, not the Rupiah rescue package. Because if we want to strengthen the value of Rupiah, then we have to do the economy. It was as if I was Sandiaga Uno, the owner Adaro Energy (ADRO), and I want the stock of ADRO rise, then the way is not to ‘cooking’ its shares in the market (although he may), but should be by way of improving the financial performance of the company, and eventually the stock price will rise by itself.

It is also necessary to remember that the weakening of Rupiah will automatically make the price of imported goods become expensive, so that people will reduce the purchase of imported goods. As a result the value of Indonesia's imports will fall, and if the value of exports remains, then we will arrive at a certain point where our trade balance will be surplus again. So, the weakening rupiah may also be considered as a balancing that are actually beneficial in the long term to grow the economy again. But in the short term, of course, the weakening of Rupiah will give more negative than positive effects, due to the rising price of imported goods that obviously would hurt some companies, especially import-based companies such as mobile phone distributors, pharmaceutical, animal feed (because they must import corn and soybeans), and general industries.

So what’s next?

As already mentioned above, today’s weakening of Rupiah was first caused by the falling prices of two commodities, namely crude palm oil and coal, so that Indonesia had suddenly run out of things to sell out. Because at the same time, various types of infrastructure and industry that is being built is not ready to contribute to the economy, including not yet ready to produce quality added-value goods for export, to keep the export value remained high.

On the other hand, the imported goods is continue to coming into Indonesia, so eventually our trade balance becoming deficit. The deficit then suppress the growth of our economy, because the expenditure is greater than income. This deficit looks bad because since the 70s, we always had a surplus and there were only three years of deficit, ie the year of 1983, 2008, and today. Yes, believe it or not, even though it seems that our homes (here in Indonesia) are surrounded by imported goods, but our export almost always far greater, especially for the export of natural resources. We were the exporter of oil, while since the 2000s, we are the exporter of coal and various metal ores. We are also one of the world’s largest producers of crude palm oil, paper, cocoa, and rubber.

Back again to the matter of the deficit. The bottom line here is, the trade deficit was due to the huge increase of volume (and value) of imports, which latter cannot be offset by the exports. Ten years ago, ie in 2003, the value of imports we are still in the range of US$ 3 - 3.5 billion per month. Now? Latest data was US$ 15.6 billion in July 2013, down from a peak at US$ 17.2 billion in October 2012. Let say we take the figure of US$ 15 billion alone, so in the last ten years we have increased the value of imports between 4 - 5 times! 

While in the same period, our exports also increased from an average of US$ 5.0 billion per month in 2003 and had a record of more than US$ 18.6 billion in 2011 (when the boom of CPO and coal reached its peak), before being dropped to the current level of US$ 14.7 billion. Now we suppose, if in the last ten it was export value that increase, while imports were stagnant, then how much the economic growth we have now? Well, it might be higher than China.

So what causes the ‘over-increase’ in the import value? Laypeople may pointed imports of beef, soy, onion, until the products of smartphones and tablet PCs, as they are the goods which normaly used in daily life. But the real value of imports of goods mentioned above is small. Based on data from the Central Statistics Agency (Badan Pusat Statistik/BPS), Indonesian largest import (excluding imports of oil and gas, as it will always be the biggest imports) currently is the import of machinery and mechanical equipments. No no no, we are not talking about Ace Hardware products here, but about heavy machinery and equipments for industrial engineering, including the large industry. After mechanical machinery, we are also imported (in huge value) electrical machinery, iron and steel, motorcycles and its parts, plastics, organic chemicals, and products of iron and steel, with the value of imports during the first semester of 2013 amounted to between US$ 2.5 billion (products of iron and steel), up to US$ 13.3 billion (mechanical machinery). After the category of products of iron and steel, there are no imports of other goods worth more than US$ 2 billion.

The seven categories of the above items, ranging from mechanical machines to products of iron and steel, accounted for 58.7% of non-oil imports, or quite large.

Then if you are observant, you will be able to see that our imports are mainly iron and steel. Mechanical machine, for example, it is made of iron or steel, right? Similarly, the electrical machinery, that is made of derivative products of steel, the stainless steel. This is because these machines are needed for the industry. After there are many companies that build factory in Cikarang and other Industrial Zone, they then immediately import the machines because there are not many engineering companies in Indonesia which could make similar machines. Also, because the volume of local production of iron and steel are still small, then we have to buy it from overseas, aka import again.

But as well as the Chinese who need a lot of iron and steel to build their industry in the early 2000s (to the extent that they must be import steel from India, while they have a lot of steel companies themselves), which eventually led to an extraordinary economic growth, especially since In 2004, then maybe we're also going to there. If Indonesia's efforts to move up from the class of developing into the industrial country are successful, including Krakatau Steel and the others are also capable to producing iron and steel in massive quantities so that we do not have to import again, then maybe we will overtake China as the country that is able to make anything.

Because if we look at history, a superpower country like the United States can be stand as a very highly developed country as it is today, is because of its remarkable industrial development in the early 20th century, where they could make cars, electronic goods, building skyscrapers in New York, railroads, military equipments, to the aircraft. And the whole industry becomes possible to built after earlier, namely in 1901, a well-known businessman named Andrew Carnegie founded the U.S. Steel, a giant iron and steel enterprise, and is known as the first company in the world that has a value of more than U.S. $ 1 billion. The U.S. Steel would later supply the needs of the iron and steel for all types of industries that thrive in America.

Back to Indonesia. In conclusion, although we are at this moment, this day, having the trade deficit, slowing economic growth, until the weakening of Rupiah, but hopefully it is a square off for us to jump higher in the future. One day later, we do not need to export coal as the PLN (the state electric company) is large enough to absorb all of the coal, and converts it into electricity that is needed by the industry, and then the industry will produce export quality goods. Someday, we do not need to export crude palm oil, but exporting its derivatives such as margarine, oleochemicals, and cosmetics and pharmaceutical raw materials, at the much higher selling price. And so on.

However, all that vision requires a long time to achieve, and the fact that at this time, our country's economy was a bit problematic, where many analysts predicted that Rupiah in the short-term will weaken further. This article is also does not answer many questions, such as how are the property sector's contribution to the economy, how the progress of infrastructure development, how the influence of the Bank Indonesia rate if it later raised again, how about the benefits that could result from the government's policy package announced yesterday, and so on.

Well, but since this article is already quite long, then the rest will be discussed next time.

Original article was written in August 26, 2013

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