: Super User; Indonesia; 27 October 2012; Hits: 1247

Keeping Indonesia-Japan Ties Cordial

“JAPAN has not filed an official complaint with us. So we are just going to wait and see.” This comment in July by Trade Ministry director-general for foreign trade Deddy Saleh reflects the increasing confidence of Indonesia these days as it implements nationalistic and protectionist regulations ahead of the 2014 elections.

Mr Deddy was referring to Japanese threats to complain to the World Trade Organisation about changes in Indonesia’s mineral trade policy. Tokyo subsequently accused major Indonesian pulp and paper producers of dumping, and it raised the possibility of banning the import of Indonesian photocopy paper.

Newly appointed Deputy Energy and Mineral Resources Minister Rudi Rubiandini responded with the assertion that Indonesia could easily retaliate by cutting supplies of liquefied natural gas to Japan.

Indonesian economic policy has become markedly protectionist in recent months, annoying several major trade partners in the process. Even so, it is somewhat surprising that Japan is the only country with which Indonesia has unabashedly exchanged threats over its newly announced trade policies.

Japan is Indonesia’s most important foreign investor. It is also the nation’s chief trading partner. In 2008, the two countries signed an Economic Partnership Agreement – Indonesia's first bilateral free trade pact – under which 90 per cent of Indonesian goods entering Japan are free of import duties.

One reason for the acrimony is Japan’s increasing concern about the security of the commodity supplies that sustain its own exports.

In recent months, countries as far apart as Brazil and India have moved to limit the export of raw material in an effort to encourage local processing.

Indonesia, meanwhile, has been gaining confidence. The country was one of the few G-20 member states to register significant growth during the financial crisis of 2008-2009, and its economy has continued to grow strongly ever since.

At the heart of the current dispute with Japan is a regulation issued by the Indonesian government in May that introduces tougher export requirements on raw minerals. A 20 per cent export tax was also introduced. Jakarta wants foreign companies to either build smelters in Indonesia or make other plans to process raw minerals locally.

The move comes ahead of a complete ban on raw mineral exports planned for 2014, when the ruling Democrat Party faces the electorate in national elections.

In more recent weeks, however, the language on both sides has become far less strident. Tokyo, in particular, has had reason to rethink its approach in the wake of an acrimonious territorial dispute with China over a cluster of islands in the East China Sea.

Rising tensions forced Japanese retailers in China to close their stores and manufacturers to suspend production, underlining the need for Japanese firms to diversify their business interests. With its large pool of cheap labour and expanding middle class, Indonesia remains an attractive option.

This is the second time in recent years that international events have conspired to underline the importance of Indonesia for the Japanese. The first was in 2010, when floods in Thailand caused many Japanese factories in the country to close, seriously disrupting supply chains.

The result was a surge in investment into Indonesia. Japanese foreign direct investment totalled US$3.6 billion (S$4.4 billion) last year, up from less than US$500 million the year before.

But while Indonesia is clearly important to Japan, both as a source of raw materials and as an alternative production base, Jakarta also has much to gain from ensuring that the relationship remains cordial.

Cooler heads in Jakarta have been pointing out that strong Japanese FDI helps counterbalance Indonesia’s current account deficit and volatile capital market flows, thus stabilising the nation’s balance of payments. Japan has also made a point of providing Indonesia with soft loans and has been implementing a wide variety of development projects.

Earlier this month, the two governments approved a master plan for Jakarta under which Japan will assist in the construction of 410 trillion rupiah (S$53.3 billion) worth of infrastructure projects.

The projects, including a mass transit railway system, the expansion of the Soekarno-Hatta international airport and the city’s sewerage system, are expected to be completed by 2020.

About a third of the total cost is to be met in the form of a soft loan from Japan.

The announcement came just two weeks after a Japanese employee of Sumitomo Corp, one of the companies involved in the construction of a controversial US$4 billion coal-fired plant in Central Java, was kidnapped and held for five hours by local residents opposed to the project.

Isolated incidents of social unrest, as well as periodic surges in economic nationalism, are common in Indonesia. Such developments may be annoying, but long-term investors like the Japanese have clearly learnt to see them in perspective.

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Key Political Risks

Asia is the fastest growing region in the world, and is likely to remain so in 2013. However, a number of risks cloud the picture.

The good news is that domestic demand in the region remains strong and should continue to cushion the impact of weaker external demand on overall economic growth. The completion of national elections in Japan and South Korea in December 2012 should also help reduce political uncertainties.

But Asian governments will need to guard against the adverse impact of prolonged easy financial conditions on inflation.

Rising inequality also continues to threaten social stability. Ethnic and religious rivalries remain just below the surface in many countries. When combined with government corruption and (in some countries) high youth unemployment, this could become a deadly mix. This seems particularly true of China.

Territorial disputes also require close monitoring. Much diplomatic activity in the new year is likely to be centered on finding ways to reduce tensions over resource-rich islands in the South China Sea, where Beijing's claims overlap with those of Japan, Vietnam and other Southeast Asian states. South Korea and Japan also have rival territorial claims.

North Korea remains the wild card. Inclined to believe its own propaganda, Pyongyang's new leadership could miscalculate, making belligerent moves that plunge the region into a military conflict that nobody wants.