Indonesia: Time to Diversify Out of Resources
    Category: Column By : Nithin Coca Read : 1295 Date : Tuesday, May 05, 2015 - 11:05:15

    Make no mistake about it—Indonesia is, despite moves to diversify, still a heavily resource export-dependent economy. As one example, Freeport-McMoRan Inc. is Indonesia’s biggest taxpayer in 2014, paying a massive $1.5 billion bill, based on taxes of its mineral business in the country. However, the recent rapid drop in prices for some of Indonesia’s top exports may impact this formally rosy relationship between the government and resource extractors.

    The Indonesian government still depends on partners like Freeport, one of the world’s largest mining companies, which reported $19 billion in revenue in 2013, with nearly $4 billion in profit. Most of its revenue comes from copper and gold, and its Grasberg mine is one of the largest such mines in the world.

    That is all in jeopardy now, as both minerals are fetching lower prices at global markets. Copper demand from China is dropping rapidly and there are fears that there might be a global glut of copper and other metals. Meanwhile gold, which hit a peak price in 2011 at $1,922 an ounce, has been falling precipitously ever since, hitting a four-year low at $1,100 late last year (and now around $1,200). It may be another hard year for the metal, due to the strong dollar and weakness in Japan and China, two of the top gold markets, and gold may hit $800 by the end of the year, according to ABN Amro.

    Indonesia’s other major mining export is coal—it was the world’s top exporter in 2012. Coal’s drop foreshadowed that of oil, having fallen 52% since 2011—with more maybe to come. This year, global supply for coal will exceed demand by 30 million tonnes, compared with 9 million tonnes in 2014, according to Deutsche Bank.

    Though Indonesia hopes that other emerging markets, such as Vietnam or India, will fill in the gap in the demand left by China, that may be a risky bet. India is ramping up its own domestic production, while Vietnamese demand is just too small to fill the China-sized gap.

    One strategy is to hyperproduce. Because Indonesia is a low-cost producer, the country can, theoretically, increase exports to make up for lower prices. The idea is that increased output will force higher cost producers such as the U.S. to cut supply, eliminating the global glut and allowing prices to rebound. Producers, however, want to maximize profits, and with coal margins are already thin, this strategy is creating tension between coal players and the government.

    Another idea is to focus on the few commodities that have not seen prices collapse, such as palm oil. During his first overseas tour, President Joko Widodo called on countries around the world to reduce barriers placed on the imports of palm oil in a quest to increase access to lucrative markets in the U.S. and Europe.

    The challenge is that palm oil production creates environmental problems, which is one of the main reasons that countries are placing greater restrictions on its import. Moreover, even in the best-case scenarios, palm oil cannot match the high-profit margins that minerals once enjoyed, and increased dependency on palm oil only leaves the country more, not less, vulnerable to global price volatility.

    That is why many believe that, if Indonesia is to reach its potential and become the next Asian economic power, it needs to focus on two things—diversifying its economy so that resources play a smaller role, and creating value-added services to its existing resource exports.

    There are several challenges here. One is that diversifying the economy away from resources requires a long-term commitment by the public and private sectors. However, just as the process begins, the commodity cycle can shift, prices rebound, and then reform effort tends to wane as the profits roll in. Then the cycle repeats, prices decline and the same ideas get floated—and everything starts again almost from square one.

    Despite being a huge export and tax generator, the resource sector does not benefit all of Indonesia. For one, it is actually a capital-intensive industry rather than a labor-intensive one, those it doesn’t provide as many jobs per dollar invested as, say, textiles or retail sectors.

    The wealth generated by resources tends also to go into the hands of tycoons and other well-connected individuals. In 2014, the 50 richest Indonesians had a combined net worth over $100 billion, roughly one-tenth of the entire national GDP in a nation of 250 million. In 2002, Indonesia’s GINI coefficient, a measure of income distribution in which higher values demonstrate greater inequality, was 30. In 2013, the coefficient had risen to 38, despite a huge rise in national GDP in that period—meaning the rich got richer and the poor poorer.

    That’s why President Joko Widodo made diversification of the economy and expanding education important cornerstones of his administration. Yet, so far, he has made few moves to make Indonesia less resource-dependent aside from reducing subsidies for oil—which will encourage fuel-efficiency and free up $20 billion, or 15% of the state budget, for other projects. Lower gas prices globally have helped blunt the impact of this on consumers.

    Thus global commodity price drops may be a blessing in disguise. Besides allowing Indonesia to discard inefficient subsidies, they can provide incentive for greater economic diversification while allowing it to spread resource development over a longer time frame. Whether Indonesia takes advantage of this opportunity may show if it is truly ready to become a global economic power.