Indonesian Strategy:Turning inwards

Event

    The Indonesian government has announced a sweeping array of higherimport taxes on a variety of consumer goods. The move appears to be thelatest in a broader push towards an import substitution-based industrial policy.While we are not as ideologically opposed to barriers to free trade as some,and believe that if well executed, import substitution policies could in theorywork and provide a beneficial multiplier effect to the domestic economy, inpractice we believe the strategy is risky, given the experience of othereconomies that have attempted import substitution development approachesin the past (e.g. Brazil and other Latin American countries). The policy alsointroduces the risk of opening the door to renewed rent-seeking practices.

    Impact

    Turning inwards: Far from moving towards free trade and economicliberalisation, Indonesia is pursuing a strategy of increased governmentregulation/micromanagement of the economy in an effort to force domesticindustrialisation and restimulate the flagging manufacturing sector. While weagree that industrialisation ought to be an important development priority forIndonesia, the approach of attempting to simply mandate higher domesticmanufacturing, instead of focusing on resolving the various competitivenessissues that have held back a free-market based resurgence, is arguably amisguided approach. Some successes are likely in time, but in the short tomedium term, the measures risk being destabilising at a time whenIndonesia’s economic fundamentals are already showing growing fragility.

    Inflation/rupiah weakness the short-term risk; rent seeking longer term:The immediate risk of such policies is that they will exacerbate recent trendstowards rising inflation, which have not been simply a function of higherdomestic fuel prices, but have instead been driven primarily by rising foodprices following the implementation of import restrictions earlier this year. Theannouncement of the above tariff measures has already taken a toll on thecurrency (which fell to 13,470 from 13,400 in today’s trading), and risinginflation could place further downward pressure on the rupiah and upwardpressure on bond yields in coming months. In the medium term, risks relate tothe policies catalysing a new round of rent seeking practices, which couldresult in both reduced efficiency and rising costs/prices. The policies are alsolikely to result in the increased prevalence of smuggled goods.

    Action

    The government’s growing hostility to imported products has negativeimplications for Indonesian retailers who rely heavily on imported products,such as ACES and MAPI (although the latter sources a surprisingly-highc50% of products from domestic producers). However, retailers that relyalmost exclusively on domestically-produced products (such as LPPF) standto benefit from reduced competition from imported products. MLBI is also abeneficiary of significantly-increased import tariffs on alcoholic products.

    Meanwhile, the short-term downside risks the measures impose to the rupiah,by increasing upside risks to inflation, argue for the favouring of USD-earners/exporters (e.g. CPO companies and textile exporters). Meanwhile, theimplications for interest rate-sensitive sectors (like property) are negative, asgrowing inflationary pressures will likely reduce scope for interest rate cuts.