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Indonesia: Selected Issues

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International Monetary Fund
Published Date:
September 2012
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III. China’s Growth Pattern: Implications for Indonesia1

China’s rapid growth in recent years has contributed to changes in global trade patterns as well as global commodity demand. China has become an important part of the global supply chain in many manufacturing goods such as electronics (see IMF, 2012a, and IMF, 2011, for example). Moreover, strong domestic growth in China, together with its shift in composition toward investment, has played an important role in the global commodity boom, affecting both price and volume, as well as capital goods imports. This chapter considers the implications for Indonesia.

A. Context

1. While others in the Asian region have benefited more from vertical integration in manufacturing with China, Indonesia has emerged as the top regional resource supplier. Indonesia has not become a significant part of the regional Asian manufacturing chains, which involve the more advanced economies of Japan, Korea, and Taiwan Province of China and, to a lesser extent, the other ASEAN countries. This, for example, is evident in the increases in intermediate goods trade between these economies and China. The more advanced Asian countries have also experienced a boost in their capital goods exports to China. In contrast, Indonesia has responded to rapid growth in China by positioning itself as one of the main suppliers of commodities in the region.

2. A slowdown in China could have significant implications for the Asian region, including Indonesia.2 A slower rate of growth in China could translate to a more sluggish demand for commodities, implying lower world market prices and slower pace of export volume growth. Over the medium term, China’s rebalancing of growth away from investment toward consumption could also have significant implications on the composition of Chinese import demands, and hence Indonesian exports. This chapter examines (i) how the rise of China has impacted Indonesia so far; and (ii) the implications, going forward, for Indonesia of any changes in China’s growth.

Selected Asia: Change in Intermediate Goods Flows

Sources: Institute of Development Economics, Japan External Trade Research Organization, Asian Input Output Tables, 2000; United Nations, Comtrade database; and IMF staff calculations.

B. Indonesia’s Major Commodity Exports and the China Factor

3. China’s rapid growth in recent years has contributed to robust demand for raw materials. In reflection of the rapid expansion of Chinese exports and investment, the growth of China’s commodity consumption has been very high. China’s rising contribution to global demand of many commodities has been well documented (see for example Coates and Luu, 2012; Roach, 2012; and World Bank, 2009). This includes rapid increase in demand for fuels and many metals. China is now accounting for about 20 percent of global oil consumption and has recently become the world’s largest oil importer. On the metal side, China’s metal demand sharply outpaced GDP growth over the years and China has become the largest consumer of steel, aluminum, and copper, accounting for about 40 percent of global consumption for each metal. The rising demand has coincided with increases in global commodity prices.

4. Indonesia has benefited from China’s rise mostly through commodity trade. With increasing global prices and demand, Indonesia’s commodity exports now account for 55 percent of its total export value, up by about 10 percentage points since the mid-2000s. Three commodities—coal, palm oil, and rubber—have particularly gained prominence. In contrast, Indonesia’s mineral exports (copper, tin, and bauxite) only account for about 4–5 percent of total export value.

Indonesia: Exports by Sector

(In percent of GDP)

Sources: Indonesian authorities; and IMF staff estimates.

  • China is now a top global importer of coal (about 16 percent of global imports), palm oil (25 percent) and rubber (30 percent). Since 2009, China’s contribution to global import growth in these commodities has been very high. It is also among the top importers of these commodities from Indonesia.

  • For Indonesia, the three commodities together account for about 30 percent of total export value in 2011, ahead of oil and gas (at about 20 percent). The share was only 13 percent in 2005. Global prices of these commodities have increased markedly in recent years. At the same time, investment has increased capacity and led to greater production and export volumes. As a result, Indonesia has already surpassed Australia as the top global exporter of coal, Thailand as the top exporter of rubber, and Malaysia as the top exporter of palm oil (data from U.S. Energy Information Administration and FAO).

Indonesia: Key Commodity Prices

(Index, 2005=100)

Sources: Commodity Price System database; and IMF staff estimates.

5. China’s demand for coal grew rapidly in recent years. China is by far the biggest consumer and producer of coal in the world. Its share of coal consumption almost doubled over the decade and reached almost half of global consumption in 2010. Coal still accounts for the majority of China’s total energy consumption with oil being the second largest. About half of the coal usage goes toward electricity generation. Domestic production and transport infrastructure expansion has not kept up with the pace of consumption.3 As the cost of importing coal became more competitive, China became a net coal importer in 2009 and by 2010, its import share rose to 16 percent of global imports. Especially in 2009–10 when the investment boom was in place, China was the main contributor to global coal import volume growth.

6. Responding to this strong demand, Indonesia’s coal production quadrupled over the decade. With production outstripping domestic consumption, Indonesia was by far the largest contributor to global coal export volume growth in recent years. Average coal export volumes increased at about 20 percent per year from 2005 to 2010. Around the mid-2000s, its exports mainly went to Japan (20 percent), Taiwan POC (15 percent), Korea, and India (10 percent each). China only accounted for about 3 percent at the time. By 2011, however, China had taken over as the top destination for Indonesia’s coal (30 percent), followed by India (17 percent) and Japan (14 percent).

Global Coal Import Volume: Country Share in 2010

(In percent of total)

Source: U.S. Energy Information Administration (EIA).

Global Coal Import Volume: Contribution to Growth

(In percent)

Source: U.S. Energy Information Administration (EIA).

China's Coal Sector

(In billion of short tons)

Source: U.S. Energy Information Administration (EIA).

Global Coal Export Volume: Contribution to Growth

(In percent)

Source: U.S. Energy Information Administration (EIA).

7. Demand for palm oil mainly comes from income growth in the developing world, including China. As one of the edible oils widely used in the food industry, palm oil consumption growth has gone hand in hand with improved income per capita in populous developing countries like China and India. Palm oil today represents about one-third of global consumption of edible oil, followed by soy bean oil at about 23 percent.4 Beyond its main use for food consumption (about 80 percent) and chemical industry (about 10 percent), demand for palm oil for biofuels has also recently increased and now represents about 10 percent of total palm oil usage. In the last decade, China’s import volume growth averaged around 20 percent, while India’s growth averaged around 10 percent. Today, China and India together import about half of the world’s palm oil.

8. Indonesia and Malaysia have dominated as palm oil suppliers. Indonesia is currently the largest producer and exporter of palm oil, having about half of the global export market share. Indonesia’s main market traditionally has been India, but it has recently increased exports to China. China’s imports are now mainly from Malaysia (60 percent) and Indonesia (40 percent).

Palm Oil Volume: Share of Top 20 World Imports

(In percent)

Source: FAO.

Palm Oil Volume: Share of Top 20 World Exports

(In percent)

Source: FAO.

China's Palm Oil Import Volume by Exporting Country

(In percent of total)

Sources: FAO.

Indonesia's Palm Oil Exports by Importing Country

(In percent of total)

Sources: FAO.

9. China has also become the biggest importer of rubber. Natural rubber is an important raw material for many household and for industrial goods manufacturing. The automotive industry is one significant user of rubber products. With large increases in automobile production, China has become the largest global consumer as well as importer of natural rubber. Its share of global imports almost doubled over the last decade.

10. Indonesia has long been one of the top global exporters of natural rubber. Rubber exports have long been dominated by Thailand, Indonesia, and Malaysia. According to FAO data, Indonesia overtook Thailand in 2006 to become the largest global exporter of natural rubber. By 2009, its share in world exports rose to almost 40 percent. Its traditional export market has been the United States, while China had been relying on imports from Thailand. However, over the last decade, Indonesia’s rubber exports to China rose from only 3 percent of its total export volume to about a quarter. Indonesia grew quickly to become the second largest exporter of rubber to China after Thailand. China’s average rubber import volume growth over 2000–09 was around 7 percent and about half of that was contributed by Indonesian suppliers.

Rubber Volume: Share of Top 20 World Imports

(In percent)

Source: FAO.

Rubber Volume: Share of Top 20 World Exports

(In percent)

Source: FAO.

China’s Rubber Import Volume by Exporting Country

(In percent of total)

Sources: FAO.

Indonesia’s Rubber Export Volume by Importing Country

(In percent of total)

Sources: FAO.

C. Implications for Indonesia of China’s Change in Growth Pattern

11. Going forward, a change in China’s growth rate could have significant implications for Indonesia. A slowdown in China’s growth would impact on Indonesia through both direct trade and commodity price effects. Given the importance of commodity exports to China in recent years, lower commodity earnings could significantly influence companies’ investment decisions and possibly Indonesia’s own aggregate consumption through income effects. A slowdown in China would also have an impact on Indonesia’s other major trading partners, adding to the export volume effects for Indonesia.

12. As regards the direct trade channel, previous studies have identified a significant relationship between Indonesian exports and China’s domestic demand. According to IMF (2012), while Chinese exports seem to be a significant determinant of manufacturing export from countries linked closely to the manufacturing chain with China (Japan, Korea and other ASEAN countries), commodity exporters (Australia, Indonesia, and New Zealand) exhibit a more significant relationship to Chinese domestic demand. Estimates from IMF (2012) indicate that a 1 percent increase in Chinese domestic demand translates into 0.7 percent increase in Indonesia’s exports. In other words, the estimated elasticity with respect to Chinese growth of Indonesian exports is about 0.7 percent, lower than for Australia and New Zealand (around 1.7–1.8 percent).

13. China also has an impact on Indonesia indirectly through the global commodity price channel. Recent papers have provided empirical evidence of the relationship between China’s growth and some commodity prices. Yu (2011) documents the demand for metals and emphasizes the importance of high investment growth in China. Using VARs, Roach (2012) shows that a shock to real activity in China has a large and statistically significant impact on global oil and copper prices, with less of an effect for other metals. A one-time 1 percentage point shock to the real month-on-month growth rate of China’s industrial production leads to an increase in the real price of oil and copper by about 2.5 and 2.25 percent respectively after four quarters.

14. More recent studies also suggest that slower Chinese investment could have some impact on Indonesia, although the exact magnitude remains uncertain. Using a factor augmented VAR, Ahuja and Myrvoda (forthcoming) suggest that a 10 percent decline in China’s real estate investment would shave about 1 percent off Chinese growth. They, however, find a negligible impact on Indonesia’s growth (similar to Australia) while they find some impact on other G-20 emerging market commodity producers such as Argentina (1 percent), Brazil (0.5 percent) and South Africa (0.4 percent). Another analysis employing panel data (Nabar and Ahuja, forthcoming) suggests that a 4 percent slowdown in China’s fixed investment (which would be equivalent to a 10 percent decline in China’s real estate investment according to Ahuja and Myrvoda) would lead to a 0.4 percentage point decline in Indonesia’s growth.

15. Ahuja and Myrvoda (forthcoming) also find a significant impact of China’s real estate investment on many commodity prices. They find that a 10 percent decline in China’s real estate investment would bring down world prices of metals (14 percent), nonfueled primary commodities (7 percent), and rubber (8 percent). They do not find significant impacts on oil or coal prices, however. It is likely that as China has only started to affect the global coal market in the last three–four years, the VARs—which are based on longer-term historical relationships—may not pick up this latest trend.

16. Using current trade projections and assuming similar global price effects on coal and other commodities, as well as spillovers to other trading partners’ demand as in Ahuja and Myrvoda (forthcoming), suggest significant effects on Indonesia’s growth. This exercise aims to present an alternative partial equilibrium analysis of the possible effects assuming price impacts on all of Indonesia’s important commodities, including, in particular, coal. It also aims to complement the FAVAR and panel data analysis. The total effects are computed as the sum of individual effects on exports, consumption, investment and imports:

  • Main assumptions: The exercise assumes a 10 percent decline in China’s real estate investment; this is equivalent to 1 percent decline in China’s growth. Derived from Ahuja and Myrvoda (forthcoming), it assumes estimated price impacts of aluminum (11 percent), nickel (19 percent), copper (16 percent), and rubber (8 percent). The exercise also assumes a price impact on coal and palm oil of 7 percent (average impact on nonfuel primary commodities in Ahuja and Myrvoda’s study); and also includes the estimated growth impact on Indonesia’s main trading partners (including China) to take into account both the direct and indirect external demand effects on Indonesia. The price changes result in a deterioration of the terms of trade (TOT) (from 1.4 percent in the baseline to -0.2 percent).5

  • Exports. Using the team’s export projection framework, Indonesia’s export earnings as well as real exports would fall by 0.4 percentage point of GDP as a result of lower commodity prices and lower trading partners’ demand (from China and others).

  • Investment. The effects on Indonesia’s investment are estimated using a linear relationship between the TOT and investment, using an investment regression for Indonesia. A simple bilateral estimate using annual data suggests that the impact on investment of the change in the TOT could be around 0.3 percent of GDP. However, the effects seem to be much more diluted once other variables are controlled and quarterly data are used (see short-run aggregate investment equation in Chapter II). It appears that short-run dynamics of investment growth are mainly governed by momentum (lag investment) and the deviation from its long-run relationship. However, the longer-term effects on investment are persistent as shown by the annual data. The effects on investment therefore could be between 0–0.3 percent of GDP.

Investment and Terms of Trade

Sources: BPS; and IMF staff estimates.

  • Consumption. The estimates of the effects on Indonesia’s consumption are based on a simple regression (an error correction model, similar to the investment regression).6 Assuming a one-to-one relationship between export decline and the decline in real income, the effect of China’s slowdown (through the income effect of lower exports) on consumption is estimated at 0.2 percent.

Private Consumption Growth Determinants
Real GDP growth0.9115***
Real lending rate-0.0002
Error correction term (-1)‒0.7206***
Adjusted R-squared = 0.63
Source: IMF staff estimates.
1/ Error correction term =
Log (Real private consumption)
- 0.83*Log(Real GDP)
+ 0.0003*Real Lending Rate.
2/ An * indicates significance at 10 percent, ** at 5 percent, and *** at 1 percent.
  • Imports. The effects on imports are also based on an import regression. Short-run dynamics of imports in Indonesia is mainly driven by domestic demand and export dynamics.7 Applying the decline in exports and domestic demand due to a 1 percent decline of Chinese growth (as in the main assumptions above) in the equation and holding everything else constant, imports could fall by about 0.3–0.4 percent of GDP. The range indicates the range of the estimated effects on investment.

Import Growth Determinants
Real domestic demand growth (-1)0.623***
Real export growth0.705***
Real exchange rate change (-1)‒0.125***
Error correction term (-1)‒0.259***
Adjusted R-Squared = 0.63
Source: IMF staff estimates.
1/ Error correction term =
Log (real imports)
- 0.25*Log(real domestic demand)(-1)
- 0.76*Log (real exports)(-1) - 0.27 *Log (real exchange rate)(-1)
2/ An * indicates significance at 10 percent, ** at 5 percent, and *** at 1 percent.
  • Summary. Putting each piece of the estimate together (the sum of the effects on exports, investment, and consumption minus the effect on imports), the exercise suggests that the total impact could be around 0.3–0.5 percentage points of Indonesia’s GDP. The higher estimate reflects the view that the TOT has a stronger relationship with investment (as in the simple linear relationship shown above) while the lower estimate reflects negligible impact of TOT on investment. The estimates could also be higher if the real exchange rates move in response to the change in TOT, leading to lower imports.

17. These estimates are subject to many uncertainties.

  • Permanent versus transitory change. In theory, the impact of lower commodity prices on domestic demands depends on whether consumers and investors believe that the price decline is going to be permanent or not. Transitory price drop may have little impact on investment, for example, if economic agents believe that there is still intrinsic demand for their commodities over the medium- to long-term due to population growth and higher food and energy needs in developing countries.

  • Spillover of commodity sector activities into other sectors. Direct effect on consumer spending of the workers in the coal sector may likely be small as it is not so labor intensive. Plantation (rubber and palm oil), on the other hand, employ more labor.

Employment by Sector, 2011

(In millions of employee)

Source: BPS (National Workforce Survey/SAKERNAS).

  • Policy responses. Policy responses either from China, Indonesia, or the rest of the world, could help cushion the impact. Looser monetary policy at home, for example, would help cushion the impact on domestic demand. At the same time, China’s fiscal stimulus could also help maintain the demand volume for imports.

  • Competitiveness of Indonesian commodity sector. If Indonesia has a cost competitiveness compared to other producers, its producers’ margins may still be high enough to continue investing even when prices have declined from a high level. This seems to be the case for Indonesian coal.

  • Technological changes and substitution. For coal, in the short run, power plants or other coal consumers may not be able to switch out of their specific mix of fuel use, helping to maintain the volume of demand. Therefore, Indonesia’s export volumes may not fall as much. In the medium and long run, however, changes in technology and preference for greener power could be a threat to the coal sector.

18. Over the medium term, if China’s growth pattern becomes more consumption-led, Indonesia with its resource-based exports would likely not gain much benefit from increases in Chinese consumption. IMF (2012) indicates that the benefits to trading partners of China’s rebalancing toward higher consumption may be small as China remains marginal as an importer of consumer goods. Rebalancing toward lower investment-led growth could be thought of as a permanent shift in China’s demand for some of these investment related resources. These include energy fuels and metals. For other more consumption-related commodities, the effects are not clear. Demand for palm oil and rubber, for example, may be supported by growth in consumption of processed food and durable goods (i.e., vehicles).

D. Conclusion

19. A slowdown in China could have a significant impact on Indonesia. The trade relationship between China and Indonesia is dominated by the commodity sector. This development has only been accelerating in the past decade, with China’s rapid increase in commodity demand affecting global prices and import volumes. Given the dominant role of commodities in Indonesia’s export basket, lower commodity prices and demand would have an immediate impact on Indonesia’s export earnings. Subject to many uncertainties, this chapter shows that the impact on domestic demand and imports could also be significant.

References

Prepared by Mali Chivakul.

IMF (2012b), for example, projects China’s growth at 8 percent in 2012 and an average of 8.5 percent growth in the next five years compared with an average of 10.5 percent growth from 2006–11.

Most domestic coal mines are in the inland regions (Inner Mongolia, Ningzia, and Shaanzi) while the demand has been strongest in the industrial coastal regions.

Some of the data quoted in this paragraph are from Citi’s note on vegetable oil industry, June 2012.

The exercise is based on April 2012 WEO baseline.

Consumption regression was run using quarterly seasonal adjusted data from 1997Q4 to 2011Q4.

Import regression was run using quarterly seasonal adjusted data from 1993Q3 to 2011Q4.

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