The Commodities Price Collapse and Indonesia’s Economy

It has been, since the early days of colonialism, a land of bountiful natural beauty and resources. Today, Indonesia is as dependent on its abundant natural resources as it was back then, especially for government spending. Last month, the public learned that the country’s largest taxpayer is none other than United States mining giant Freeport McMoRan, which paid a massive bill of $1.5 billion in 2014, according to Vice President Yusuf Kalla. However, with the recent rapid drop in prices for some of Indonesia’s top exports, including coal, nickel and gold, there are fears that the country’s economic growth could be derailed, and that future payments from mining exports may be far less than anticipated.

Resource Dependence

Indonesia’s dependence on resource exports is clear at the national level, but more so in the country’s myriad districts and provinces. Decentralization, a policy pushed by former President BJ Habibie in 1999, placed greater control of natural resources with regional governments, which depend on resource development to fund local projects. This has led, during times when prices were high, to a large number of “white elephant” projects in resource-rich regions, such as the mostly unused, 60,000 seat Utama Kaltim stadium in Samarinda, Indonesia, capital of coal and timber rich East Kalimantan.

“Political decentralization facilitated speedy resource extraction throughout the country,” said Dr. Zulfan Tadjoeddin, a Indonesia expert and Senior Lecturer in Development Studies at the University of Western Sydney.

That is in jeopardy now, as many of Indonesia’s top exports 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 $1921.50 an ounce, has been falling precipitously ever since, hitting a four-year low of $1100 late last year. Dutch-based ABN Amro NV bank believes that 2015 will be another hard year for the metal, given the strong dollar and weakness in Japan and China, two of the top gold markets. They expect the price to fall to $800 an ounce by the end of this year.

The outlook is no better for Indonesia’s biggest mining export, coal. In 2012, the country overtook Australia to become the world’s top coal exporter, shipping a staggering 383 metric tons of “black gold” primarily to China and India. Coal prices have fallen 52 percent since 2011, and there’s more to come. According to a recently released Deutsche Bank report, this year “[g]lobal supply for coal will exceed demand by 30 million tons, compared with 9 million tons in 2014.” The main cause: rapidly falling demand from China.

None of this bodes well for Indonesia. Though there are hopes that other emerging markets, such as Vietnam or India, will step in to fill the gap, this is unlikely. India is ramping up its own domestic production, while Vietnam is just too small to fill the China-sized gap.

Diversifying Strategies

There are several paths Indonesia can take to mitigate the impact of lower global commodity prices. One strategy is to hyperproduce. Because Indonesia is a low-cost producer of most resources, the country can, theoretically, increase exports and equalize revenue by increasing quantity, with the goal of forcing higher cost producers in countries like the United States to shut down, eliminating the global glut and allowing prices to rebound.

Producers, however, only want to export resources when they are highly profitable, and margins are already thin in the coal industry, where this strategy is currently being pushed. This is creating tension between industry and government.

“Coal producers are reducing production due to lower coal prices. However, the Indonesian Government is saying ‘increase production.’ It is unclear where things will go,” said Aviva Imhof, Pacific Coal Network Coordinator at The Sunrise Project. The government has countered by raising royalties by between 2.5 and 6 percent for certain license holders (about 25 percent of mining operations) – but it is doubtful that this will offset the drop in exports.

Another idea is to focus on the few commodities that have not seen prices collapse, such as palm oil. During his first overseas tour, Indonesian 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 United States and Europe.

The challenges are that palm oil production has huge environmental impacts, including deforestation, species extinction, and carbon emissions due to burning of forests and peat lands. This is why countries are placing greater restrictions on its use and that consumers are demanding palm-oil free products. Moreover, even under the best-case scenarios, palm oil cannot match the high-profit margins that minerals once enjoyed, and increased dependency on a single resource only leaves the country more, not less, vulnerable to global price shifts.

That is why most economists and resource experts 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 provide a reduced proportion of tax revenue for the Government, and building value-added services to its existing resource exports.

Unfortunately, according to Dr. Krystof Obidzinski, a scientist and resource governance expert at the Bogor, Indonesia based Center for International Forestry Research, this process has only just begun in Indonesia.

“In my sense – the economy is diversifying, but it is still dependent on key natural resource sectors – minerals, commodity plantations, pulp and paper,” said Dr. Obidzinski.

In fact, resource exports in the past decade may have had a negative effect, not only for diversification, but also inequality. The copper and coal boom, fueled by China’s rise during the 2000s, helped Indonesia’s economy grow during the early years of its democracy, but the wealth was never spread equally. In 2002, Indonesia’s GINI coefficient, a measure of income distribution in which lower values demonstrate greater equality, was 29.57. By 2011, the coefficient had risen to 38.14, a dramatic shift of wealth to the rich. This was to be expected, as analysis of GINI data shows that countries with more natural resources tend to have greater levels of inequality, and Indonesia is no exception. Resource exports, controlled by the few, stunted opportunities for the many.

“Relative to the pre-1997 crisis period, the Indonesian economy since the 2000s has been more resource dependent, fueled by increasing global commodity demand,” said Zulfan. “During the resource boom, the growth in investment and skill-based manufacturing stagnated, resulting in de-facto de-industrialization.”

That was one of the reasons that Joko made diversification of Indonesia’s economy and the expansion of education opportunities for citizens a cornerstone of his historic Presidential campaign last year. He has, thus far, made few moves to make Indonesia less resource-dependent. One step in the right direction – late last year, he strengthened government revenues streams by reducing subsidies for oil – which had accounted for an estimated 15 percent of the state budget. Lower gas prices globally have helped blunt the impact of this on consumers. However, he has much more to do to truly de-couple the Indonesian economy from natural resources.

“Solving the problem will be determined by how wise the government is in spending revenue from resources towards infrastructure and skill-development, which will help economic diversification,” said Zulfan.

Moving Forward (or not)

In 2015, Indonesia can expect to be getting a lot less from Freeport McMoRan than the $1.5 billion the company paid last year. This will turn out to be a lost opportunity – the failure to use the funds from the past decade’s global resource boom to build a diverse, sustainable economy. The money will not be there in 2015, and it is unsure when prices will – if ever – scale their previous heights again.

At the same time, in some ways, the global commodity price drops may be a blessing in disguise. Without them, Indonesia could never have discarded inefficient gasoline subsidies so painlessly, and they are already reducing pressure on its overburdened natural landscapes. Now, lower prices will also provide more incentives for the government to push for economic diversification. Whether or not Indonesia takes advantage of this opportunity, or merely tries to wring more funds out of resources while it can, will show if it is truly ready to become a 21st century economic power.