Indonesia’s Strategy in Rising US-China Trade Tension

While there has been rising uncertainty due the recent escalating tension in US-China’s trade, Indonesia will maintain its neutral position and keep positive engagements.

Before we discuss how this will affect Indonesia’s trade and the overall Indonesian economy, let’s begin by understanding the main issue that the US economy is now facing. The US economy has been facing a “twin deficits” of budget and trade deficits. In Q4-2017, US recorded a budget deficit of 3.4% of GDP and a current account deficit of 2.1% of GDP. With the current scenario of tax cut and budget spending, JP Morgan even estimates the budget deficit will reach 5.4% in 2019.

How could the US manage its twin deficits?

At the monetary front, the US is projected to increase its 10 year-bond interest rates to 3.25% by the year end. As of July 5th, it reached 2.86%. This increase is expected to escalate the Fed interest rates, which results in strengthened US Dollar against the world’s major currencies.

At the real sector front, ideally, the US should go through the long pain process which is improving its productivity and labor skills, by all means “working and learning harder and saving more”. Productivity is not everything, but in the long rung it is almost everything (Paul Krugman, 1994). But improving productivity is taking at least one and half decades to enjoy the benefit from the efforts made today, as for now it is neither selling to the society nor gaining more votes.

The shortcuts to its twin deficits will be: (i) to cut income and business taxes in order to elevate investment and (ii) to raise import tariffs.

Every pill has its own efficacies as well as effects.

What will be the Consequences of the US imposing tariffs?

China and Mexico will be the ones who targeted the most by the US increased tariffs.  The impact of these tariffs on Indonesia’s trade will be largely coming from US trade links with China. 99% of tariffs on USD 50 billion out of USD 450 billion of China’s exports to the US, which will be executed into two terms: tariffs on USD 34 billion will be in effect on Friday July 6th, and those on another USD 16 billion will be in effect in the next round.

In responding to these increased tariffs, China has its stance to raise tariffs on 128 products of US’s exports to China ranging from soybeans, corn, wheat, rice, sorghum, beef, pork, poultry, fish, dairy products, nuts and vegetables, and autos, which totaled USD 3.5 billion. This will be in effect as soon as the US implement its increased tariffs. Lately, Beijing states that she will retaliate at the level of ‘same scale, same intensity’. But Beijing ensures domestic players that it will not affect US exports on manufactures to China as China aims to realize its strategic plan of “China manufacturing 2025”.

In a study by Mc McKibbin and Stoeckel (2017), if the US levied a 40% tariff on all imports, US GDP would fall 1.2%. If all countries retaliated, US GDP would fall 5.2% and thus enter a deep recession. Recently, Nicholas Lardy, an expert on the Chinese economy at the Peterson Institute for International Economics, claims that everyone will lose in absolute term in a trade war.

While China has sought the European Union’ support to issue a joint statement against US President Donald Trump’s trade policies, however until now the EU has maintained not taking sides.
China has two strengths to retaliate the US tariff increases.  First is the US dependency on China in the US bond market. As of May 2018, the US owes China USD 1.19 trillion or about 19% of USD 6.29 trillion bond owned by foreigners. China has been the largest foreign holder of USD bond. While USD 21 trillion of bond are still owned by the US domestic investors. Moreover, China’s dependency on US exports and FDI are relatively very small.

Second, China has political asset to manage its market. While Trump faces a review in every two year and will face an election in 2020, Xin Jin Ping who has been appointed as the President of China since March 2013 will be reappointed, and now without term limits. The strong political asset enables China to have one voice in responding to the escalating tariffs and managing its domestic market.

 

How should Indonesia stand?

While, the America-First trade policy will hit China’s exports to the US. Goods from China that accounted for 22 percent of total US imports in 2017, its imports from Indonesia only accounted for 0.9 percent in the same year.

Indonesia’s exports of goods to the US increased from USD 8 billion in 2001 to USD 18.5 billion in 2017, the US’ share of the country’s total exports declined from 14 percent in 2001 percent to 11 percent in 2017.

Indonesia’s exports to the US have been largely dominated by apparel, which contributed about 22 percent of the total exports to the country from 2001 to 2017. The other main Indonesia’s exports to the US are rubber (11 percent), electrical machinery (7 percent) and footwear (7 percent), which the US needs for its direct consumption enjoying low-priced-products or as components to support US domestic automotive and machinery industry. Simultaneously, US exports to Indonesia, largely in the form of machinery and electrical equipment, contributed about 14 percent of its total imports.

All in all, Indonesia should not be a target of US increased tariffs. In fact, Indonesia’s exports to the US are largely contributed by apparel and footwear as well as components to support the US domestic industry.

Indonesia aims to achieve 5.4% export and investment led growth. Indonesia will continue its domestic reforms in lowering tariffs on capital goods and inputs, streamlining export and import licensing, and improving access in investment.

Indonesia’s trade strategy is clear. As stated in Minister Lukita’s speech at Fes Meknes Forum in Morocco on June 27th, with Africa, Indonesia’s main potential trading and investment partners, Indonesia will not to over-power, but to grow together. With China, Japan, and Korea, Indonesia will not to be a subordinate, but to cooperate. With the US, Indonesia will not to retaliate, but to negotiate.

Indonesia has vowed to uphold ‘fair and non-discriminative treatment’ to all countries. But if Indonesia’s exports are treated unfair and discriminative, Indonesia has no choice, but take necessary actions.

Trade war will not benefit anyone. Not now, not then.

Lili Yan Ing*
Lead advisor, the Ministry of Trade of Indonesia
*views expressed here are personal

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