Indonesia and the rise and fall of commodity prices

By webadmin on 08:59 pm Jun 03, 2012
Category Archive

Wijayanto

Over the last few months we’ve witnessed interesting developments in Indonesian business. After a long period of good performance, in the first quarter of 2012 several mining companies booked lower revenues and profitability. Similar cases appeared in the agriculture sector; stock prices of some major players, especially crude palm oil (CPO) producers, decreased as a result of lower profitability due to the decrease in global CPO prices.

We’ve also noticed some alarming signs in our international trade. Export growth is slowing down, while imports are growing at a faster rate. As a result, net exports shrank and reached Rp1.2 trillion in the first quarter of 2012; this was much lower than the figures from the first and fourth quarters of last year of Rp3.41 trillion and Rp4.7 trillion respectively. If the trend continues, we could end this year with a trade deficit.

As a net producer of commodities, Indonesia’s economy is influenced by the global commodity market. The decrease in prices poses a challenge for the government, corporates and farmers. Exports account for around 25% of Indonesia’s GDP; approximately 50% of these exports are commodities such as coal, oil, natural gas, copper, CPO, coffee, rubber, cocoa and tea.

The decrease in commodity prices would reduce government revenue significantly, since around 40% of revenue comes from commodity royalties and taxes. It will also reduce corporate profitability en route to a decrease in investment. Unfortunately this is happening at a time when we are expecting more investment to support economic growth.

This phenomenon also has a severe impact on farmers’ livelihoods. In terms of value, 50% of our CPO is produced by small farmers; the proportion is even higher for coffee (92%) and cocoa (87%). Data on poverty shows that the decrease in our poverty rate over the last few years was driven not by provinces in Java, but by the performance of commodity-producing provinces in Sumatra, Kalimantan and Sulawesi. Consequently, the decrease in commodity prices might worsen the national poverty rate.

Beginning of a downward trend

Over the past decade, the commodities index has shown some interesting, never-before-seen behavior. First, it has shown a growing volatility, triggered in part by the volatility of the energy (oil) index. This instability in price in turn means volatility in revenue for commodity-producing countries. Without the existence of a responsive countercyclical economic policy, economic instability is the consequence.

Second, commodity indexes show an increasing correlation to each other. In the past, exporting various types of commodities provided stable revenue for a country, since a fall in the price of one commodity could be offset by an increase in another. This era seems to have come to an end. Information technology advancements, a more efficient global transportation system and the growing importance of the commodity futures market are the three most important factors behind this new phenomenon.

Third, commodity prices have a long-term cycle, ebbing and flowing every 25 to 30 years. According to the International Monetary Fund, we just passed a peak in the years between 2008 and 2011. It is very possible that we will witness a decrease in commodity prices in the near future. Bleak economic progress in the world’s main commodity consumers such as the United States, Europe, India, China and Japan seems to justify the IMF’s forecast.

Minimizing the impact

Indonesia is only one of many countries which rely on commodities. In Southeast Asia, Malaysia and Thailand will also face challenges since commodity exports account for around 30% and 11% of their GDP respectively. Australia, the world’s major producer of coal and minerals, will also feel the impact. The BRICS countries – particularly Russia, Brazil and South Africa, which are large net exporters of commodities – will also have to swallow the bitter pill.

Fortunately, according to the IMF forecast, the price decline will not happen abruptly, giving commodities-producing countries ample time to respond. In the context of Indonesia, responses should be able to address concerns at the central government, corporate and small-farmer levels.

The government needs to cut the “fat” in the state budget, to prepare for the possible decrease of future tax income from commodities-related businesses. Inefficient spending on personnel, energy subsidies and various government consumption items should be reallocated to other productive expenditures such as infrastructure, health and education, as well as incentive programs for small and medium enterprises. 

At the corporate level, the decrease in commodity prices would squeeze corporate profitability. In this context, reducing the high-cost economy by minimizing red tape and rent-seeking activities as well as ensuring security at sites are key. In addition to that, the government should not introduce excessive taxes – including export tax. In the short term it may increase government revenue, but in the mid and long term it will not, since this will discourage the industry from growing at its optimal level. 

Small farmers are those who will face the worst impact of all. At the moment, close to 40% of Indonesians make a living from agriculture, but it accounts for less than 15% of the national economy. Most of those who live below and slightly above the poverty line are small farmers. A decrease in commodity prices will force many farmers below the poverty line.

Fertilizer subsidies and various programs to increase agricultural yield and quality will certainly help. Reducing information asymmetry by providing access of information about commodity prices to farmers will strengthen their bargaining position with traders, who have traditionally enjoyed the largest portion of profits. In the mid and long term, farmers need to be empowered to be able to produce beyond raw materials: in other words, create more value. Improving transportation efficiency constitutes more mid-term homework for the government. 
The government has ample time to respond since a decline in commodity prices will not happen overnight. However, if it fails to take well-coordinated action as with the oil subsidy debacle, no matter how much time we have, it will not be sufficient.

Wijayanto is the vice rector of Paramadina University, and is the co-founder and managing director of Paramadina Public Policy Institute. He can be reached at wijayanto@paramadina.ac.id.