Towards a Liberalized Trade Regime: Indonesia Trade Policies Review

CSIS WORKING PAPER SERIES

WPE 060

Towards a Liberalized Trade Regime: Indonesia Trade Policies Review Haryo Aswicahyono Titik Anas September 2001 Economics Working Paper Series http://www.csis.or.id/papers/wpe060

The CSIS Working Paper Series is a means by which members of the Centre for Strategic and International Studies (CSIS) research community can quickly disseminate their research findings and encourage exchanges of ideas. The author(s) welcome comments on the present form of this Working Paper. The views expressed here are those of the author(s) and should not be attributed to CSIS Jakarta. © 2004 Centre for Strategic and International Studies, Jakarta

Towards a Liberalized Trade Regime: Indonesia Trade Policies Review Haryo Aswicahyono Titik Anas CSIS Working Paper Series WPE 060 September 2001 ABSTRACT An assessment of the evolution of Indonesia’s trade policies, commencing with an analysis of trade policies prior the crisis. The paper highlights trade policy shifts and their impacts on the real sectors, and analyses the significant economic reforms undertaken as part of the IMF standby agreement in 1997, focusing on trade reforms agreed in the letters of intent and implementation to date. Specifically, it examines post-crisis trade-related regulations and assesses their impacts on trade. It also analyses recent developments in regional cooperation and global free trade, including regional free trade arrangements and the status of Indonesia’s commitments under the WTO, AFTA and APEC.

Keywords: Indonesia, trade, structural adjustment, International Monetary Fund (IMF), World Trade Organization (WTO), Asia-Pacific Economic Cooperation (APEC), ASEAN Free Trade Area (AFTA), economic crisis

Haryo Aswicahyono [email protected] Department of Economics CSIS Jakarta

Titik Anas [email protected] Department of Economics CSIS Jakarta

TOWARDS A LIBERALIZED TRADE REGIME: INDONESIA TRADE POLICIES REVIEW Haryo Aswicahyono and Titik Anas September 2001 Although Indonesia has consistently committed to trade reform since the 1960s, the pace of liberalisation has varied over the years. After some initial trade reform in the late 1960s, by the 1970s the oil boom financed a swing to intervention. Falling oil prices in the early 1980s stimulated a swing back to a more open and international trade policy orientation. By the mid 1990s rampant corruption, rapidly rising short-term external debt, and some reversion to interventionist policies threatened to undo the gains from earlier reforms and made the Indonesian economy vulnerable to external shocks. This chapter briefly assesses the evolution of Indonesia’s trade policies, commencing with an analysis of trade policies prior the crisis. It highlights trade policy shifts and their impacts on the real sectors. It then analyses the significant economic reforms undertaken as part of the IMF standby agreement in 1997, focussing on trade reforms agreed in the letter of intents and implementation to date. It assesses some observations on post-crisis trade-related regulations and assesses their impacts on trade. Finally, the chapter analyses recent of regional cooperation and the global free trade development, including regional free trade arrangements and the status of Indonesia’s commitments under the WTO, AFTA and APEC. Trade reforms prior the crisis 1982-1985: early signs of trade liberalisation Falling oil prices, gradually in 1982-3 then abruptly in 1985-6, produced an immediate and effective macroeconomic policy response, resulting in fiscal contraction and devaluation. To ameliorate the balance of payments deficit due to declining terms of trade, the Government took various measures. The first was the devaluation of the Rupiah by 27.5 per cent on March 19831. Second, an ambitious

1

There were at least three reasons for the devaluation. First, to discourage anticipatory capital outflow. Second, to retain the nominal value of government oil revenues. Third, to increase nonpetroleum exports. However the third purported objective could not be achieved because the devaluation was not accompanied by microeconomic reform.

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1

plan to develop various capital-intensive industries was rescheduled (Arndt, 1983)2. Other tight fiscal measures, such as freezing the public service wage, and reducing or removing subsidies on domestic fuel, agriculture and state-enterprises, were also introduced. However, on the microeconomic side, economic reform was undertaken at a slower pace and was more visibly protectionist, especially in trade and industrial policies. In 1982, the Government introduced a system called the approved importers system (Tata Niaga Impor),3 the official argument for which was to increase the professionalism of importers and streamline imports. However, because the system is less visible than a tariff, it was captured by vested interests and became an instrument for quantitative restrictions on imports. This was particularly so for the license, which was discretionary and firm specific in nature. Under this system, the NTB became built into the import system and the Government had discretionary power to specify a zero amount or to disallow an import license.4 Another important development in protectionism during this period, was the creation of the Junior Minister for Promotion of the Use of Domestic Products (headed then by Ginanjar Kartasasmita). Despite the protectionist tendency, several reforms were still undertaken during this period. In June, the Government announced major banking reforms. With the stroke of a pen, interest rate controls on state banks and credit ceilings were removed and liquidity credit was reduced and the tax system was simplified. Tariff ceilings of 60 per cent were introduced in March 1985 and resulted in an across-theboard reduction in the range and level of nominal tariffs. The range was reduced from 0-225 per cent to 0-60 per cent and most tariff rates ranged from 15-25 per cent. The number of tariff levels was also reduced from 25 to 11 (Pangestu, 1996 p16). Nevertheless, critical intellectuals, press, and even technocrats within the Government felt that the reforms were not sufficient in alleviating the economic problems during the period, and created a heated public debate on the ‘high-cost 2

Major projects that were rescheduled were the $1.35 billion Musi oil refinery in South Sumatra, the $0.6 billion Bintang alumina project, and two petrochemical projects, the $1.5 billion Pertamina aromatic plant in Plaju and the $1.6 billion olefin complex in Aceh. Other projects, such as, integrated sea communication, a mass transit railway system for Jakarta, telecommunication projects, coal projects and various large hydroelectric schemes, were all under review (Arndt, 1983) 3 The system has been discussed at length in Pangestu (1996) 4 It was estimated that in 1986, 28 per cent of the total number of items imported, 26 per cent of the total import value, and 31 per cent of value added were restricted under the approved importer system.

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economy’.5 For example, it was believed that the complex procedures in the customs department were the major source of Indonesia’s high cost economy, and hence should be streamlined and simplified. Another often criticised source of ‘high cost economy’ was the regulation banning imports of new ships and the obligation that domestic shipping industry use domestically produced vessels. In response to this critique, the Government gradually began to take bold reforms in customs as well as partially deregulating domestic and foreign shipping. In April 1985, the Government issued Inpres-4 (presidential instruction/decree no 4) that handed substantial responsibilities of the customs service over to the Swiss Surveyor SGS.6 With this reform, the custom procedures were streamlined and simplified. All estimation of the duty rate and value of imports were to be done at the point of origin of the goods, and the importers paying the duty to the Government directly through banks.7 1986-1990: swift and effective liberalisation It took a recession in 1985 and a plunge in oil prices in 1986, to halt protectionist trends and begin substantive trade reform. In May 1986, the 1978 export certificate scheme that was subject to abuse8 was replaced with a new, improved, duty drawback system. This new export facilitation measure, known as the BAPEKSTA scheme, was more precise because it was based on the calculation of input/output ratios in production. Under the new system, exporters also could bypass the import monopolies. Administration of the new system was also less prone to corruption.9 Many believed the scheme was one of the important policy changes that underpinned the export boom, 1987-92. However, since 1992 long delays and other administrative problems have undermined the effectiveness of the scheme. The Rupiah was again devalued in September 1986, followed by a series of substantive trade reforms: October 1986, January 1987, November 1988, and May 5

For discussion of the political economy of reforms, and the role of academic, media, and technocrats in pressing the reform see Soesatro (1989) 6 The custom administration has been reverted back to Indonesian Custom Services on 31 March 1997 7 The inspection was later handed over from SGS to a newly formed company PT Surveyor Indonesia, and as of April 1, 1997 it reverted back to Customs. 8 The system also created an implicit subsidy; hence violating the GATT Code on Subsidies and Countervailing Duties to which Indonesia became a signatory in 1985. 9 For example, the applicants were not allowed to meet the official who administered the scheme. All procedures were organised through mail.

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1990. This might explain why this devaluation was more effective, in terms of increasing non-petroleum exports, than the devaluation of 1978 and 1983. The devaluation, combined with tight macroeconomic management, maintained the competitiveness of real effective exchange rates, while the substantive deregulation tackled the ‘high cost economy’. In contrast, the effectiveness of the 1978 devaluation in promoting exports was eroded by appreciation of the Rupiah, due to the oil boom, and the high cost economy discussed above. It was mentioned earlier that, in 1982, the Government introduced a system called approved importers system (Tata Niaga Impor), which became a non-tariff barrier, conferring discretionary power on the Government. Many approved import licenses, which at the peak covered some 43 per cent of tariff lines (Soesastro, 1996), were eliminated and converted into tariff equivalents in the October 1986 package and subsequent deregulation packages. The November 1988 deregulation was particularly important, since it removed import monopolies for plastic and steel; this had a strong psychological effect in business circles, increasing their confidence in the seriousness of the Government’s commitment to deregulation. Considering the importance of textile exports, the Government undertook several reforms targeted specifically at this sector. A more transparent quota allocation system for textile was introduced in 1987 and the import monopoly for cotton, an important raw material input for textile industry, was removed in 1989. Further removal of NTBs took place in May 1990, which among other things, allowed consumer electronics and electronics components to be imported under the non-restrictive general importer license. Long awaited financial reform was announced in October 1988. The reform increased competition among banks, which, in turn, increased mobilisation of public monetary assets and reduced interest rates.10 Foreign and domestic investment was gradually deregulated during 1986-94, especially for export oriented FDI. This included allowing 95 per cent foreign ownership and domestic distribution of export oriented FDI, introducing a positive list of restricted sectors in place of opaque sectoral restrictions, and opening previously closed sectors. The conducive domestic and foreign investment climates resulted in a private investment boom, and a surge in foreign direct investment especially in export oriented industry.

10

See Gultom (1995) for the effect of the financial deregulation on the real sector

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1991-1997: deregulation fatigue The first major trade and investment reforms during this period occurred with a June 1991 deregulation package. These reforms further reduced NTBs and replaced them with tariff and export taxes, reduced general tariff levels, and reopened several sectors previously included in the negative lists closed to foreign investment, to new domestic and foreign investment. The removal of NTBs included the abolition of import bans on cold-rolled steel and sheets and tin plates. The reforms also abolished export bans on copra and palm oil as well as the exclusive rights of several companies to export palm oil based products. These major reforms were followed by a series of other trade and investment reforms in July 1992, June and October 1993, June 1994, May 1995, and June 1996. These reforms reduced many tariffs, removed NTBs for certain commodities, improved trade facilitation measures such as duty draw back schemes and procedures for bonded zones and shortened lists of activities closed to domestic and/or foreign investment. As a result of these trade reforms, average tariffs declined significantly during 1986-1995, (Figure 2.1). The largest tariff falls were during 1986-91 periods, when the Government undertook significant deregulation. From 1991 to 1994 the average tariff reduction was minimal and import weighted tariffs actually rose. NTBs also fell significantly during 1986-91 followed by minimal reduction during 1991-94. The 1995 package significant reduced average tariff rates but had little impact on NTB coverage. The June 1996 package further reduced unweighted average tariff level to 12 per cent. Figure 2.1 Average tariffs, 1994-1999

25 20 15 10 5 0 1994

May95

Aug95

Dec95

Draft, not to be quoted

Jan96

Jun96

Sep97

Feb98

Dec98

Dec99

5

Table 1 Average Nominal Tariff and Non Tariff Reductions, 1986-1995 1986 1988 1990 1991 1992 1993 1994 1995 Unweighted Average 27 24 22 20 20 19.7 19.5 15 Weighted Average* 13 14 12 11.9 11.9 13.7 12.5 9.5 NTB as percentage of CCCN 32 16 HS 17 10 Value of Imports 43 21 17 13 Notes:*weighted by the value of imports in 1992 Surce: (Pangestu, 1995)

5 13

3.5 12

3.5 12

3 n.a.

Figure 2.2. Average Nominal Tariff and Non Tariff Reductions, 1986-1995 50

45

40

35

30

25

20

15

10

5

0 1986

1988

1990

1991

1992

1993

1994

1995

Per cent Unweighted average tariffs

Weighted average tariffs*

NTBs as % of CCCN/HS

NTBs as % of value of imports

Source: (Pangestu, 1995)

From 1991 to 1995, many economists worried the country was experiencing ‘deregulation fatigue.’ They argued the reforms during this period were to slow, much less comprehensive than they had hoped,11 and did not include various sensitive agricultural commodities such as sugar, wheat flour, soybeans, garlic, cloves, milk and dairy products, and several manufacturing commodities such as the automotives, propylene and cement. Moreover, several policy aberrations emerged during this

11

The exception was June 1994 investment deregulation package, the main element of which was a substantial relaxation of the divestment requirements for foreign investors,

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period. Among the controversial cases were the clove monopoly and the restrictions on inter-island trade of oranges from West Kalimantan in 1991, the increase of tariff surcharge on propylene and ethylene imports in 1993, and exemptions from 35 per cent luxury taxes for the national car, the Timor. All of these cases were related to President’s family and/or cronies. But, the optimists pointed to large coverage of tariff reductions (64 per cent of tariff lines) in the May 1995 package and the fact that this package, for the first time, contained schedule for tariff reduction for the 1995-2003 period (Table 2.2). By the year 2003, the Government announced all tariffs, except those on automotive components and products, would be set at a maximum of 10 per cent, with most falling in the 0-5 per cent range. Table 2.2. Schedule of Tariff Reductions, 1995-2003 Tariff before 23 May 1995

1995

1996

1997

1998

1999

2000

5

5

5

5

5

5

max 5

2001

2002

2003

10

5

5

5

5

5

max 5

15

10

10

5

5

5

max 5

20

15

15

10

10

5

max 5

25

20

15

15

10

10

10

10

10

max 10

30

25

20

20

15

15

10

10

10

max 10

35

30

25

25

20

20

15

15

10

max 10

40

30

25

25

20

20

15

15

10

max 10

Source: MOTI

By the mid 1990s, rampant corruption and rapidly rising short-term external debt threatened to undo the gains from these reforms exposed the Indonesian economy and led to the current economic crisis. Current trade reforms: forced reforms in adversity? Because of these weaknesses in the Indonesian economy, currency speculation against the baht in July 1997 quickly spread to Malaysia, Philippines, and Indonesia. Currency depreciation rapidly sparked a financial crisis. After the Indonesian Government failed to stabilise the rupiah in August and September 1997, it sought IMF assistance. The first agreement with IMF signed in late October 1997 enabled Indonesia to draw on up to US$43 billion to stabilise the currency. The agreement outlined macroeconomic policies and structural reforms to restore economic stability which the Government would implement over the following three years. These measures failed to reassure markets and were followed

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by a second letter of intent signed on January 15 1998, outlining a more comprehensive reform program. This included measures to restore the health of the financial sector, tighten fiscal and monetary policy, and undertake structural adjustment by extending and deepening deregulation. The second letter of intent also included trade liberalisation measures. As a result of these and subsequent letters of intent, Indonesia finally undertook substantial trade and investment reform. Its commitment covered tariff reductions as well as many non-tariff and trade facilitation measures. A large number of import-licensing requirement and export restrictions, which was untouched during the mid 1990s, were removed by the end of 1997, in accordance with the first letter of intent. Indonesia also committed to remove all non-tariff measures and export restrictions, which are not justified by health, safety and environmental standards, by the end of the four-year IMF program. The IMF package liberalised the most sensitive sectors left untouched by the previous deregulation packages. These included trade deregulation in most of agriculture commodities, removal of production and trade monopolies in several intermediate industries (cement, plywood and rattan), and reduction in export taxes on key commodities (Table 2.3). By the end of the IMF program period, Indonesia should have one of the most liberal trade-regime in a developing country, equivalent to Singapore and Hong Kong in the 1960s and 1970s.

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Box 1. LOI January and May 2000 on Trade Policy Reforms th

LOI No. 12 January 2000: Trade Policy Reforms 33. We reaffirm our commitment to maintain a liberal trade regime, avoid introducing any new trade barriers, and remove remaining distortionary elements in the trade structure. As part of the 1995 tariff reduction plan, we recently reduced the import tariff on a number of items from 10 percent to 5 percent and, by end-2003, we will establish a three-tiered tariff structure (0, 5, and 10 percent) for all goods except alcohol and automobiles. During the program period, we will eliminate all exemptions to import tariffs (except those which are part of international agreements), and remove all existing non-tariff barriers (except those for health and safety reasons). As a step toward replacing all export taxes and levies by resource rent taxes, the maximum export tax on logs, sawn timber, and minerals was reduced to 15 percent by end-December 2000. This will be followed by a review of forestry sector taxation policy starting January 200O, in consultation with the World Bank. At the same time we will ensure that the forest resource royalty rate (PSDH) captures at least 60 percent of the economic rent from logs and, thereby, protect Indonesia's forests. Finally, we will eliminate all other export restrictions (e.g., licensing requirements or government approval on logs, coffee, and wood products), by end-2000, with the exception of those needed under the multi-fiber agreement. LOI, May 2000: Trade Policy Reforms 6. The fiscal reform agenda is being implemented as envisaged. Consistent with the approved budget, we expect Parliament to approve the amendments to the VAT law, the Tax Procedure law, and certain other tax laws by July 2000. Other tax reforms affecting the tax privileges for the Integrated Economic Development Zones (KAPETs); the rationalization of import tariffs on capital goods; and the imposition of a flat 5 percent duty on all exempted goods with non-zero rates have been implemented. Regarding the collection of VAT from Batam island, we have deferred its implementation to ensure that the necessary institutional framework for tax collection is in place, and to secure a wide consensus for this measure.

Tariffs In July 1997, just before the “contagion” from baht depreciation reached Indonesia, the Government announced a deregulation package as part of its commitment to WTO and APEC goals. It consisted of tariff reductions affecting 1 600 items: 1 461 manufacturing products, 136 agricultural products and three health products. As a result, over 50 per cent of Indonesia tariff codes were lowered to 0 to 5 per cent and over 60 per cent of the tariff lines had duties of 10 per cent or less. The simple average applied MFN tariff rate was about 11.7 per cent. The Government's trade policy commitments to the IMF complemented Indonesia’s WTO and APEC commitments. Overall, the four-year program committed to achieving a three-tier tariff structure by the end of 2003, with rates of 0, 5 and 10 per cent for all items except automobiles and alcohol. In the first and second LOIs, Indonesia committed to reduce tariffs on items currently subject to tariff of 15 to 25 per cent by 5 per cent point, including iron and steel. It also committed to reduce tariffs on chemical, steel/metal and fishery products to 5 to 10 per cent by 2003. As a result, by mid 2000, 60 per cent of tariff lines have

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duties of 0 to 5 per cent, more than 70 per cent of tariff lines have duties of 10 per cent or less and 97 per cent of tariff lines have duties 20 per cent or less (Table 2.4). Hence, by 2000 the simple average applied MFN tariff rate had fallen to about 9.5 per cent. Table 2.4 Indonesia: Import Tariff Structures

tariff

0-5% 0-10% 0-20% 25-35% >=40% total tariff lines

Jul-97 Total tariff lines percentage

3688 51%

4563 63%

6151 85%

1032 14%

80 1%

7263 100%

1998 Total tariff lines percentage

4266 59%

5188 71%

6973 96%

167 2%

72 1%

7212 99%

1999 Total tariff lines percentage

4289 59%

5226 72%

7055 97%

135 2%

69 1%

7259 100%

Source: Indonesia Individual Action Plan as of Agust 1999 Figure 2.3: Tariff by Classification (1997-1999) 100% 90% 80% 70%

July, 1997 1998 1999

60% 50% 40% 30% 20% 10% 0%

0-5%

0-10%

0-20%

25-35%

>=40%

Tariff Classification

The Government also made a commitment to undertake bold agricultural import liberalisation by reducing all food tariffs to 0-5 per cent and non-food agricultural tariffs by 5 percentage points from the prevailing tariff level. At the end of the IMF program period, maximum tariffs on non-food agricultural products will be 10 per cent. For agricultural products (HS 1-24), the 1998 simple average applied tariff rate was 8.6 per cent compare to around 19 per cent in 1995.

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Under the 1995 national car program, the Timor car was exempted from 35 per cent luxury taxes. This program and the 1993 local content requirements violated WTO non-discrimination principles. In July 1998, the Dispute Settlement Body of the WTO ruled the national car program and the local content scheme must be abolished by July 1999.12 Faced with possible WTO sanctions, at the IMF's request the Government announced an automotive deregulation package in June 1999. It substantially cut tariffs on completely knocked down, CKD, and completely built up autos, CBUs and abolished the local content scheme and the national car program (Table 2.5). Table 5. June 1999 Deregulation Package: Changes in Automotive Tariffs

Tariff Rates Type of Vehicles Old Sedan less than 1500 cc Sedan 1500 cc - 3000 cc Sedan higher than 3000 cc Minibus Jeep Bus Truck with GVW less than 24 tones Truck with GVW higher than 24 tones

CBU New 200 200 200 105 105 70 70 5

Old 65 70 80 45 45 40 40 5

CKD New 65 65 65 25 25 25 25 0

35 40 50 25 45 25 25 0

Source: Ministry of Trade and Industry

As a result of the trade reforms since the mid 1980s and culminating in the post crisis reforms, the trade regime is now much more open. The highest tariff rate, which applies to only 45 tariff lines, mainly in the steel and chemical sectors, is now 25 per cent. Nevertheless, Indonesia has fallen behind the target set in the May 1995 trade liberalisation package. The latest package of trade reforms announced on 31 December 1999 reduced the rates of 232 tariff lines, but still left 2 142 lines above the 1995 target. Non tariffs Barriers Import bans and import restrictions In July 1997, one of the most serious NTBs, importing used trawlers and merchant ships was liberalised when the ban on importing new and used ships was 12

Previously, Indonesia was exempted from the WTO provision related to the TRIMs agreement until year 2000

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abolished in accordance with the IMF program. The Government also committed to phase out remaining quantitative import restrictions and other non-tariff barriers so only import bans related to health and environmental concerns will remain.

Licensing requirement Non-automatic import licensing, which is complex and non-transparent was one of the major trade impediments in Indonesia. The system classified licenses according to the type of operator: importer-producer, IP, registered importer, IT, and agent or sole importer, AT licenses. Importer producer (IP) is import license that is granted to producer who needs raw materials or intermediate goods. Registered importer (IT) is import licenses granted to importers who are approved by the government. For example plastic raw materials such as polyesterene and polyethelene, was designated to one or a number of the state trading companies. Agent or sole importer (AT) is that the import license granted to an agent of certain commodities, such as the case of automobile. In the past, only company that had agency arrangement with the brand holder that can import automobile. In addition to these licenses, some products only could be imported by designated state-owned enterprises, such as BULOG, the national logistic agency, Pertamina, the national oil company and Badan Penyangga dan Pemasaran Cengkeh (BPPC), the clove marketing agency. All other products are unrestricted and classified in the general importer (IU, automatic licensing) category. In accordance to the IMF letter of intent no 2, the Government committed to remove these licenses, particularly those that were not covered by the WTO commitments. Early in the first letter of intent, its also committed to take effective action to allow free competition for importers of wheat, wheat flour, soybeans and garlic, for the sale or distribution of flour and importation and marketing of sugar, all of which were previously a BULOG monopolies. The Government also intended to phase out import, marketing monopolies and price controls on other agriculture commodities. In November 1997, import-licensing requirements on commodities controlled by BULOG were removed, with rice the only remaining commodity still controlled by BULOG.

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The initial step that the Government took was to replace with tariffs the nontariff barriers on soybean and dried garlic (20 per cent) and wheat flour (10 per cent). These tariffs will be reduced to maximum of 5 per cent by 2003. The importation of rice was opened late 1998. In the sixth letter of intent signed on 11 September 1998, to secure domestic rice supply, the IMF and the Government of Indonesia agreed that trade in rice is now open to all general importers and exporters. However, as the price of rice in the world market decreased substantially, the Government asked IMF to put an import duty on the importation of rice as a protection for local rice farmer. In the twelfth letter of intent, signed on January 20, 2000 the Government announce that the importation of rice is subject to Rp. 430 per kg import duty. The import duty will apply only till August 2000 and its necessity then will be reviewed. Prior to the crisis, sugar importation was the exclusive preserve of selected traders. However, the twelfth letter of intent announced that by end of January 2000, the Government would replace this system with a 25 per cent tariff to be phased down over three years and open sugar trading to all general importers. On 30 June 1998, the Government also disbanded Badan Penyangga dan Pemasaran Cengkeh (BPPC), the clove marketing agency, that held monopoly power over domestic marketing and distribution and international trade in cloves. Control of wood panel product export and shipment was dismantled in January 1998 and the import of dairy products was freed up in January 1998. As part of the June 1999 automotive deregulation package, the Government also permitted general importers to import completely build-up vehicles. Local content requirements In the second letter of intent, the Government announced that it would discontinue immediately any special tax, customs, or credit privileges granted to the National Car project and implement ahead of schedule the WTO panel ruling on this case. In addition, the Government announced it would phase out by year 2000 the motor vehicle local content program giving preferential tariff rates to manufacturers using a high percentage of local parts. As discussed earlier the national car program and local content scheme for automotive were abolished in June 1999.

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The second letter of intent also announced the phasing out local content requirements for dairy products; this was implemented in February 1998 (Presidential Instruction No 4/1998) much earlier than Indonesia’s Uruguay Round commitment. Export Restrictions Another distinction between the IMF trade liberalisation commitments and prior deregulation packages was the substantial deregulation of exports. In the second letter of intent the Government announced by the end of 2001 it would phase out punitive export taxes and eliminate all other types of export restrictions, such as quotas and provincial taxes levied on inter-provincial and inter-district trade. The only exceptions will be for export restrictions imposed for health and security reasons, as well as time-bound, temporary, measures introduced in the event of occasional domestic shortages – such as the export ban on palm oil. As a step toward replacing all export taxes and levies by resource rent taxes, export taxes on logs, sawn timber, rattan and minerals were scheduled to be no more than 30 per cent by April 15, 1998, 20 per cent by end December 1998, 15 per cent by end December 1999 and 10 per cent by end December 2000 (LOI 2, see table in Appendix1). The 12th LOI revised the maximum export tax on logs, sawn timber, and minerals for the end-December 2000 target to 15ually. At the end of the IMF program period, the remaining export taxes and levies will be replaced by resource rent taxes as appropriate . This plan has been implemented in several areas. For example, on February 1, 1998, the Government abolished export taxes on leather, cork, ores and waste aluminium products. In April 1998, bans on palm oil exports were lifted and replaced by an export tax of 40 per cent. The Government announced it would review this export tax to consider a possible reduction, based on market prices and exchange rates and expected to reduce it to 10 per cent by end December 1999. In early 1998, the Government also significantly reformed the export licensing system removing from the regulated export list many agricultural products (live cattle, wheat and wheat flour, and sugar), mining products (silver, gold and tin), gas products (liquefied natural gas, butane, propane) and some chemicals. In April 1998, the Government reduced the list of regulated exports to a small range of products (manioc, coffee, textiles and textiles products under Multi Fibre Agreement

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arrangements and plywood products).13 In addition, the Government also allowed cement producers to export with general export licenses. Export bans remain on live fishery products, wildlife, hides and shins of certain animals such as reptiles, some rubber material (notably in blocks) and many waste and scrap products. These restrictions aim to protect endangered species and prevent the exportation of dangerous materials. Export and trade finance Since 1993, the Government had granted “special exporters” access to a rediscounted post-shipment trade finance facility for their exports at the Singapore inter-bank rate (SIBOR) plus 3 per cent, while general exporters’ credits are rediscounted at SIBOR plus 4 per cent. In 1997, the Government increased the number of industries eligible for special exporter status, from five to 18 and then to 27 in 1998, to include textiles and clothing, leather, electronics, shoes, rattan, rubber, pulp and paper and crude palm oil. Bank Indonesia also introduced a pre-shipment rediscount facility for exporters. However, beginning April 1, 2000, all tax and banking facilities for these special exporters are removed. Due to the difficulties in trade financing faced by most exporters during the crisis, the Government and Bank Indonesia had launched a number of trade-financing programs, and several trading partners, including Australia introduced bilateral tradefinance programs. However, donors’ funds were underutilised and were low due to the malfunctioning banking system’s inability to issue letters of credit and take on default risk for Indonesian borrowers. Export oriented zones, duty drawbacks and exemptions In the eleventh and twelfth Letters of Intent signed July 22, 1999 and January 20, 2000, the Government announced it would commission a comprehensive study to review the tax free status of Batam, Rempang and Galang islands. The Government initially also planned to commence collecting value-added tax from Batam Island but recently announced it would postpone tax collections due to strong objections by

13

Until the crisis, up to 50% of Indonesia’s exports of agricultural products, and significant share of mining products, petroleum products and certain manufactured products (essentially textiles and clothing) were regulated by the Government and could only be exported through approved and registered exporters (WTO, Trade Policy Review, 1998).

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Batam residents and businesses. In the twelfth Letter of Intent, the Government also announced it would review the effectiveness of policies for the Integrated Economic Development Zones, KAPET, especially their income and indirect tax concessions. To promote exports, the government granted export-oriented companies duty exemption and drawback. Eligible exporters operating in export processing zones or export oriented manufacturing entreports are eligible for tariff exemptions for all capital equipment, machinery and raw materials needed for initial investments and production. Exporters can also obtain a refund on the duty paid out on imports used in production for exports and are also allowed to bypass the import monopolies as long as the import is used in export production. Duty exemption scheme was based on selfassessment of import values and inputs used in exported products, and subjected to ex-post audits. On December 1997, ex-post audit responsibility was transferred from BAPEKSTA to the Directorate General for Customs and Excise, which is considered more flexible (WTO, Trade Policy Review, 1998). On the other hand, duty drawback required a more precise calculation based on the input and output ratios involved in production. In practice, even though the government gave two different concessions: duty exemptions and duty drawback, it seems that exporters used duty exemption facility more widely than the drawback system as they considered the drawback scheme was too complicated. The IMF has asked the government of Indonesia to remove all import duty exemptions. The twelfth letter of intent contained a commitment to remove all import duty exemptions. Since such exemptions currently apply to about half of imports and are used widely by exporters and investors who need access to world priced inputs to be competitive, some argue this proposal may injure non-oil exports. However, the LOI signed May 2000 indicated that the government has already imposed a flat 5 percent duty on all exempted goods with non-zero rates. Towards A Liberalized World Economy Regional Economic Cooperation: AFTA Indonesia joined ASEAN in 1967 and since 1976 has actively participated in its economic cooperation. In 1992, at the fourth ASEAN summit in Singapore the six ASEAN countries, Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand, agreed to establish the ASEAN Free Trade Area, AFTA, by 2008. The ultimate Draft, not to be quoted

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objective was free trade among the ASEAN countries, defined as tariffs of 0 to 5 per cent and no non-tariff barriers. The original ASEAN members perceived AFTA as a training ground to force the pace of trade and investment liberalisation within the ASEAN members, helping ASEAN achieve their APEC and WTO commitments. Since this process commenced, Vietnam, Laos, Cambodia and Myanmar have joined ASEAN and AFTA. At the sixth ASEAN summit in 1998, member countries decided to accelerate AFTA’s establishment by achieving free internal ASEAN trade by 1 January 2002. New members’ AFTA free trade deadlines were extended: for Vietnam to 2006, Laos and Myanmar, 2008 and Cambodia, 2010. The main method of achieving the AFTA free trade objective was to reduce tariffs on all included tariff items until they reached 0 to 5 per cent. When it was first initiated, the Inclusion List of the common economic preferential tariff, CEPT, scheme contained 41 147 tariff lines. Some 3 321 tariff lines were placed on a Temporary Exclusion List while another 523 tariff lines were permanently excluded from tariff reductions (on the General Exception List). Since then, the inclusion list of CEPT has expanded to 53 144 tariff lines (83 per cent of tariff lines). When the CEPT scheme was initiated, agricultural products and services were excluded but in 1994, the 26th AEM agreed to include all unprocessed agricultural products. As a result of the regional integration brought about by AFTA, intra ASEAN trade has increased. In 1992, intra ASEAN trade was only 19 per cent of ASEAN trade but by 1997, it had increased to 25 per cent. The success of AFTA has inspired ASEAN member countries to expand the areas of cooperation beyond the elimination of tariff and non-tariff barriers (AFTA plus) to include efforts to strengthen, streamline or harmonise non-border measures with the objective of facilitating intra-ASEAN and inter-regional trade and investment. For example, the Bangkok Summit Declaration in 1995 agreed to enhance cooperation and freer trade in services. This was followed by several rounds of negotiations of specific commitments to market access, national treatment and additional commitments covering all services sectors and all modes of supply, including financial services, maritime transport, telecommunications, air transport, construction and business services. In fact, the ambition was to liberalise trade and services beyond those undertaken under the GATS.

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AFTA-CER FTA updates Trade between Australia and New Zealand, which have a operate the Closer Economic Relations, CER, trade agreement, and ASEAN has been increasing for many years. In 1980, trade between these two regional trading arrangements was only 7 per cent of ASEAN trade but by 1997, had increased to 10 per cent of ASEAN trade. In February, 2000, exploring the gains from free trade between the two regional trading arrangements, a high level task force of ASEAN, Australia and New Zealand representatives met in Jakarta to study the feasibility of establishing an AFTA-CER free trade area by 2010. They looked at the potential benefits and cost of establishing an AFTA-CER free trade area as well as its potential scope and coverage. The task force met again in New Zealand in April 2000, to further discuss the establishment of AFTA-CER free trade area. WTO, AFTA and APEC Commitments Indonesia has been a GATT member since 1947, but like other developing countries, was not actively involved in GATT negotiations until 1986. In the Uruguay Round, Indonesia offered trade liberalisation commitments including new tariff binding (Table 2.6). It included 6714 tariff lines or 71.6 per cent of all tariff lines in the manufacturing industries and elimination of quantitative restrictions, trade in services and in foreign direct investment by applying the national treatment principle by the year 2000.

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Table 2.6. Indonesia’s Uruguay Round Market Access Offer Tariff lines No. A. TARIFF BINDING 1. Total Bound Manufactures Existing bindings New Bidings 2. Total Agriculture (all bound) 3. Exceptions TOTAL

7537 823 6714 1341 504 9382

%

80.3 8.8 71.6 14.3 5.4 100

B. AGRICULTURE 1. Tarification and biding of all items 2. Duty reduction of 10 % by tariff line over 10 years 3. Elimination of local content requirement for milk products 4.Agreed access of 70000 tons of rice imports annually C. REMOVAL OF NON TARIFF BARRIERS ON BOUND TARIFF ITEMS NTBs on 98 industrial tariff lines affecting $358 millions of imports to be removed within 10 years D. ELIMINATION OF IMPORT SURCHARGES ON BOUND TARIFF ITEMS Surcharges varying between 5-25 percent on 159 tariff lines affecting $838 million of imports to be removed within 10 years Source: MOTI, quoted from Tarmidi 2000

Indonesia has implemented Uruguay Round tariff commitments reducing general tariff reduction schedules in June 1996. With some exceptions these reductions are still valid in 2000. For example, several agricultural products as have been submitted to the GATT/WTO (337 tariff lines), automotive products (145 tariff lines), chemical, plastic, metal products (125 tariff lines), alcohol and alcoholic drinks (27 tariff lines). Based on its Uruguay Round commitments, in 2000 the maximum applied tariff is 15 per cent (Table 2.2). Indonesia also committed to remove 96 non-tariff barrier measures by the year 2004(Table 2.7). By April 1996, Indonesia had eliminated 75 NTB’s, 77 per cent of its Uruguay Round commitments and by June 1996, 83 NTBs were abolished, over 80 per cent of its commitments. Indonesia will continue to reduce export taxes on logs, sawn timber, rattan and minerals to achieve APEC goals. Indonesia also has made a commitment to eliminate the remaining NTBs that are part of its Uruguay Round

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commitments by 2004, simplify import licensing and gradually eliminate producerimporter and trade-importer licensing. Table 2.7 Indonesia’s Non-tariff Barrier Commitments 1. In Uruguay Round, Indonesia committed to eliminate 98 NTBs by 2004 2. By April 1996, Indonesia has already eliminated 75 NTBs, which is 77% of the UR commitments 3. By June 1996, an additional 8 NTBs covered by Indonesia’s UR commitments were eliminated in addition, on other NTB that was not covered by Indonesia’s UR commitment was eliminated. 4. In July 1997, Indonesia removed restrictions on the imports of used fishing vessels. This policy is further expanded in 1998 to include all new and used ships. 5. April 22, 1998, export taxes on logs, sawn timber, rattan and minerals were reduced. 6. February 1998, Export taxes on leather cork, ore, and waste aluminium products had been abolished. 7. On 1 Dec 1998, Indonesia eliminated subsidy on fertilizers. 8. In 1998, Indonesia abolished restrictions, allowing free competition in: Import and marketing of wheat, wheat flour, soybean and garlic, and Sale and distribution of four. 9. In March 1999, Indonesia further reduced export taxes on log, sawn timbers, rattan and mineral to a maximum of 20%. 10. On 1 February 1999, Indonesia eliminated subsidy on aviation fuel. 11. In June 1999, Indonesia relaxed 47 import licensing requirements on motor vehicles.

By January 2000, Indonesia had placed 7 173 tariff lines in the CEPT inclusion list, leaving 21 tariff lines in the temporary exclusion list and 4 on the sensitive list (mostly unprocessed agricultural products, such as rice, sugar, tobacco and meat products) and 68 on the general exception list. The latter mainly are excluded for of national security and public morality reasons or to protect human, animal or plant life or artistic, historical or archaeological values. (Examples include arms and ammunition and narcotics products). Indonesia’s original CEPT-AFTA schedule is similar to its Uruguay commitments. Based on its CEPT commitments, beginning the year of 1998, ASEAN countries are not allowed to apply tariffs higher than 20 per cent for all products that each country has already put in the Inclusion List14, based on which is higher than Indonesia’s Uruguay Round commitment (Appendix Table 2.8). However, based on 14

There are four categories of products under AFTA. Firstly, Inclusion List (IL) which includes products that are subject to preferential tariff reduction to reach 0-5 percent in year 2002. Secondly, Temporary Exclusion List (TEL) includes products that are temporarily excluded from tariff reductions schedule. Temporary Exclusion List might differ across member countries. Items under TEL should be phased into the IL in five instalments. Thirdly, Sensitive List (SL) includes products which are declared sensitive, mainly unprocessed agriculture products such as rice, sugar, tobacco and meat products. These items will have a longer time frame to be phase into the IL. Fourthly, General Exception (GE) are products that

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the 1998 CEPT package (the tariff reduction schedule for all ASEAN member countries), it was shown that in 2000 Indonesia average CEPT tariff was already below 5 per cent, possibly indicating accelerated tariff reductions to achieve free trade in 2003. Table 2.8. CEPT-AFTA Tariff Reduction Schedule, 1995-2003 (percent) Tariff before 23 May 1995

5 10 15 20 25 30 35 40

1995 5 5 10 15 20 25 30 30

1998

2000

2003

max 5 max 5 max 5 max 5

max 5 max 5 max 5 max 5 max 10 max 10 max 10 max 10

max 20 max 20 max 20 max 20

AVERAGE CEPT TARIFF (2000-2003) INDONESIA

2000 4.77

2001 4.36

2002 3.73

2003 2.16

The APEC goal is to achieve free and open trade and investment among member developed member economies by 2010 for and by 2020 for the developing member economies. In contrast to WTO and AFTA agreements, which are legally binding, APEC agreements are based on consensus and hence are not legally binding. As summarised in its individual action plan Indonesia committed to continue its deregulation efforts to further liberalise trade and investment by progressively reducing its tariffs to reach APEC goal of 2020 (Table 2.9). It also committed to progressively reduce non-tariff measures and simplify import licensing.

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Table 2.9. Indonesia’s APEC Individual Action Plan: Summary AREA

CURRENT STATUS

SHORT TERM

Indonesia has • Indonesia will announced a schedule continue to reduce of tariff reduction on an its tariffs on an MFN MFN basis for each year basis until the year between 1995-2001 2001, in line with its schedule of tariff • Tariff of 20 percent reduction or less in 1995 will be reduced in stages to 0-5 % by the year • Indonesia will 2000 actively participate

Tariffs

•

Non Tariff measures

Indonesia will continue its deregulation efforts to further liberalise trade and investment by progressively reducing its tariffs

LONG TERM Tariff will be progressively reduced to reach APEC goal of 2010/2020

in the APECI Tariff database and regularly update Indonesia’s tariff data

Tariff of more than 20 percent in 1995 will be reduced in stages to 0-20 % by 1998 and to 0-10 % by the year 2001

Indonesia has already eliminated 75 NTB’s which are 77 % of its Uruguay Round commitments. In June 1996, an additional 9 NTBs, 8 belongs to the Uruguay Round commitments were eliminated

MEDIUM TERM

•

Indonesia will continued to reduce export taxes on logs, sawn timber, rattan and minerals to achieve APEC goals. • Indonesia will continue to eliminate the remaining NTBs that are part of its Uruguay Round commitments by 2004 • Indonesia will continuously update its non-tariff measures data in the APEC Tariff Database

Indonesia will progressively reduce nontariff measures. Import licensing has been simplified and will continue to be further simplified Indonesia will gradually eliminate producer-importer and trade-importer licensing except where there are justified grounds to keep it in place

Political Assessment Political risk and threat to liberalization Political risk and threat to liberalisation can be observed at three levels: First, the sentiment among the population to liberalisation which can be described by the level of activism on this issue. Second, the nature of the government and to what extent it can provide consistent policies. Third, the risks associated with the

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decentralisation process, as the extent to which regions can manage their resources independently will also impact future investment policies in Indonesia. Activism against liberalisation Generally, the recent crisis has not led to a dramatic switch towards protectionist and inward-looking policies in Indonesia. As Fane (2000) notes, although the trade liberalisation efforts have fallen behind the targets of the 1995 liberalisation package, the current trade regime is much more open compared to the situation in the 1980s. The IMF programme also puts pressure on the government to further liberalise the economy. However, negative sentiments and activism against further liberalisation of the Indonesian economy certainly do exist within certain layers of society, as the recent cases discussed further below will show. Under the New Order regime, formal trade policies were largely determined by a few key actors, among them the Tariff Committee under the Ministry of Finance, the Ministry of Trade and the responsible line Ministry and other government institutions. For instance, tariff policies for rice involved the Tariff Committee, the Ministry of Trade, BULOG, the Ministry for Food and the Ministry of Agriculture. In several industries (such as petrochemicals, automotive industries) lobbying for protectionism proceeded along paths outside the formal institutions. Here the government provided special treatment to businesses linked to the Soeharto family. Nowadays, the political economy of trade protection has become more complex, as Indonesia is moving towards a democratic system. Protectionist interests are more institutionalised in the sense that politicians – both outside and within the government - respond to various protectionist – minded constituencies within a democratic system. Business associations, farmer lobbies and grassroots – based organisations play a more significant role now. One can distinguish between two groups who oppose liberalisation: vested interest groups trying to protect their industries and social movements who fear negative social and environmental impacts of liberalisation. Together with politicians within or outside the government they form alliances to press their case for more protection. The discussion on increasing tariffs on rice is a case in point. Public sensitivity towards import penetration is very high in the rice sector, as the livelihood of millions of farmers depend on the price developments of the commodity. Despite a

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tariff rate of 30%, rice prices fell below the set floor target price for rice. In April this year the newly appointed director of BULOG, Rizal Ramli, a former government critic, demanded an import stop of rice and also asked for a firm stance of the government and NGOs in insisting on higher tariff rates for imported rice in the range between 90 and 120 percent. Tariff policies on rice imports should not be subjected to IMF policies, as , so his argument goes, the Fund does not have the expertise in managing agricultural policies. Instead the Fund should only focus on monetary policy (Media Indonesia, 6 May, 2000, Asian Wall Street Journal, 9 May, 2000). Tariffs on sugar imports are another example for recent increased protection efforts. The prevailing 20-25% import tariffs for sugar are deemed as too low by the sugar industry and farmers. For instance, four Java – based sugar cane farmer associations under APTR (Asosiasi Petani Tebu Rakyat) demanded to meet IMF representatives to challenge prevailing tariff policies in early May 2000. Their argument is that in developed countries import tariffs are much higher, amounting to 140–240 percent (Bisnis Indonesia, 30 May 2000). However, the plan of the government of banning import of raw sugar to protect domestic farmers was rejected by the IMF (Republika 4 May, 2000). Efforts to gather support for more protectionism on a regional level could also be observed. In April the Asian Farmers Group for Cooperation held a meeting in which demands for protection in the agricultural sectors were addressed to the WTO. Specific agricultural commodities like rice should not be included in the fast track liberalisation programme (Suara Karya, 19 April, 2000). Interests to maintain the current high tariff rates of 25% (currently the highest tariff rates) are also evident in the steel industry, in which the state-owned Krakatau Steel is the major player (Fane 2000:27). Associations like the Indonesian Association of Steel Pipe Producers (GAPIPA) pushed for anti-dumping duty on steel pipe imports from Japan, China and Korea to protect domestic production (The Jakarta Post, 5 April, 2000). Petrochemical industries also belong to the highest tariff (25%) sectors with the Chandra Asri company as the country’s largest ethylene producer being the largest player. IBRA took over the company after it failed to repay debts to several domestic banks. In May, negotiations resulted in the government taking over 80% of the shares in the company, while the remaining 20% will remain with the

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Japanese Marubeni Corporation. This means that the government may have to pay the company’s remaining debt to Japanese lenders (Jakarta Post, 10 May, 2000). Another recent case is the Indonesian Footwear Association’s (APRISINDO) demand to impose countervailing duties on import of Chinese footwear because of suspected dumping practices. The Association asked the Indonesian Antidumping Committee (KADI) to investigate this issue. According to the Footwear Association’s secretary general, prices for Chinese footwear are 25 percent lower than domestic ones, thus threatening to increase unemployment in the industry. Minister of Industry and Trade Luhut Pandjaitan announced that his ministry will seek ways to curb importation of Chinese products, citing unfair business practices or smuggling. At the same time he emphasised that any measures must not disturb bilateral relations between the two countries (Jakarta Post, 29 June 2000). IBRA’s management of the banking restructuring process has also become a playing ground for nationalist sentiments. Approximately 70% of corporate assets are now in the hands of the government. Managing the privatisation of state companies means that a choice has to be made between maximising the value of assets or proceeding quickly with the asset sales. In this context, the IMF has been accused of acting on behalf of international investors who are interested in purchasing Indonesian assets as cheaply as possible (Bisnis Indonesia, 23 April, 2000). The case of Bank Bali in August – September 1999 is one example for resistance towards foreign investment. In this case, the old management resisted Standard and Poor’s audit, which later resulted in the cancellation of the sale of Bank Bali. Political risks to liberalisation are evident in environmental disputes involving international mining companies. One case is the tax dispute between US mining company Newmont Mining and the district court of Tondano, Sulawesi. The court ordered the temporary closure of the company’s mine in Minahasa, after it ruled that the company had to pay 8 billion US$ in back taxes in relation to the sale of waste rock and soil removed from the mine site. The central government supported the company’s position arguing that Newmont’s contract of work excluded it from paying taxes on these items (Asian Wall Street Journal, 11 April 2000). The Supreme Court then overturned the district court’s rule on the closing. Eventually, an out-of-court settlement was reached in which Newmont agreed to pay about 500,000 US$ in taxes on 379,000 tons of waste material (Asian Wall Street Journal, 20-22 April, 2000). Draft, not to be quoted

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Another case involved Australian’s Rio Tinto facing land right activists at its PT Kelian Equatorial Mining site in East Kalimantan. Local residents demanded compensation for land lost due to the construction of the mining site. They are represented by two local groups in negotiations with the conpany to assess the claims. As by mid-May, talks have not produced an agreement (Asian Wall Street Journal, 11 May 2000). WALHI, the vocal environmental advocacy group has been involved in this case since 1998 in the mediating the land dispute. The NGO’s approach to other foreign mines and resource-based was more aggressive, particularly in the case Freeport’s mining operations in West Papua province. In this case, the bureaucracy and NGOs formed an effective alliance, when the Minister for the Environment Soni Keraf announced the government’s order to Freeport to scale back its mining operations at its Grasberg mining site.15 However, the government does not intend to shut down Freeport’s operations, but considered to restructure the contract (Asian Wall Street Journal, 24 May 2000). Finally, a prominent case is also the closure of Indorayon, a pulp and paper company, in which foreign interests have a 86% share. Indorayon’s operations have been suspended in mid-1998 as a result of protests by citizens and environmental groups who claimed that the company polluted North Sumatra province’s Lake Toba. The company claims to have passed an environmental audit and annual inspections by Indonesia’s Environmental Protection Agency. An environmental audit will determine the fate of Indorayon (Suara Karya, 17 May, 2000). Recent labour disputes and activism have also contributed to political uncertainties with regard to the tolerance in Indonesia to liberalisation process. Recent labour unrests include: a strike by workers of Gudang Garam (Indonesia’s largest cigarette prodcer) in Kediri, East Java; a strike at PT Sony Electronics Indonesia in May; and several cases of worker unrests in the industrial areas of Bekasi around Jakarta. In all cases, workers demanded wage rises and an improvement in working conditions. In general, NGOs support the worker’s demands. For instance, the Legal Aid Institute (LBH) recommended to workers to reject newly drafted minimum wage regulations in April 2000, as they are deemed not to meet worker’s daily requirements. 15 This decision followed after long-standing disputes with local residents over the company’s environmental record and a recent accident in which the company’s waste-rock facility collapsed, causing an adjoining water basin to overflow. Four workers were left dead

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Fragile government To what extent can the government resist populist demands? This clearly depends on a stable government. However, the nature of Abdurrahman Wahid’s cabinet as a loose coalition of major political groupings raises questions about the durability of the government, as the president has to accommodate various interests. Unless the president violates the constitution of Indonesia (UUD 1945) and other basic policies of the state (MPR’s Decrees), his legitimacy cannot be challenged and withdrawn by the People’s Consultative Assembly. So far, there were no indications that President Wahid could be removed from office on grounds of violating the constitution. However, the recent perception is that the president does not perform well in managing his government. The nature of the cabinet as a loose coalition of major political groupings has put the president into a politically uncomfortable position to really control and coordinate members of his Government. The latest case of the replacement of Laksamana Sukardi (PDI-P) as State Minister of Investment and State Enterprises, and Yusuf Kalla (Golkar) as Minister of Trade and Industry with respectively Rozy Munir (formerly Secretary of the State Ministry for Investment and State Enterprises) and Lt. Gen. Luhut Binsar Panjaitan (formerly Indonesia’s Ambassador to Singapore) was another indication of Gus Dur’s efforts to re-shape his cabinet to his own liking. Previously, there had been three replacements of cabinet ministers.16 Although each replacement was accompanied by different official reasons, the new appointees all were recruited from Gus Dur’s close aides. This indicates clearly that the president is trying to remove personnel from his cabinet who are not under his control. This means that as long as the president has not consolidated his power within the cabinet, changes in the government will continue to be an issue and a source for uncertainty. Under such conditions, President Wahid is taking a risk of loosing political support from the major political groupings. By changing the political power constellation, the President invites strong reactions from the major political groupings. The latest issue of a formation of new political coalition of PDIP, Golkar and Fraksi

16

The first was Hamzah Haz as Coordinating Minister for Social Affairs. The second was Gen. Wiranto as Coordinating Minister for Political and Security Affairs, and the third was Ali Rachman as the State Secretary.

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Reformasi in the DPR was a first sign of challenge to the President from the major political parties that were disadvantaged by the President’s recent moves. Meanwhile, the new cabinet appointments have met with negative responses from the public. Increasingly, people suspect Gus Dur is practicing collusion and nepotism: things that the new government was supposed to eradicate. Declining political support and increasing public suspicion of collusion, nepotism and corruption in the cabinet, are two factors that challenge the stability of the government. As a result, the government is still not in the position to make politically difficult economic decisions. The delay of fuel price increase scheduled to be implemented on April 1, 2000 was a case in point. This has negatively affected the international community’s perceptions of Indonesia’s commitment to economic reforms and liberalisation. Decentralisation The previously mentioned cases of environmental disputes show how the delegation of powers from Jakarta to the regions within the decentralisation programme can affect investors. In essence, the government is caught between honouring long – term contracts with foreign business and meeting outer provinces demands for an increased share of revenues of locally exploited resources. Thus, the decentralisation agenda will have to strike a balance between the two objectives. The future direction of investment policies in Indonesia will heavily depend on to what extent regions can determine their own policies. Thus, a basic understanding of the current status of the decentralisation process is important. Two decentralisation laws were enacted in April 1999: Law No.22/1999 on regional government, and the Law No.25/1999 on the financial balance between central and regional governments. However, these laws are by no means a perfect legal basis for regional autonomy. The laws have complicated rather than simplified and resolved problems of regional autonomy and centre-regional relations. The first major problem is the decision to confer full autonomy at the district level (Kabupaten/Kotamadya) without taking account of the existence of provincial governments that still hold authority over district governments. Duplication and conflict of authority (and interest) between these two levels of government is unavoidable.

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Secondly, the transfer of authority from the central to district governments will create problems. None of the technical ministries of the central government want to transfer their authority to district governments, primarily because this will create corresponding cuts in their budgets. This has resulted in conflict between the State Minister for Regional Autonomy Affairs and the line Ministries. The third problem refers to the ancillary legislation and government regulations needed to implement the two new Laws. The legislation and regulations deriving from the two regional autonomy laws must be completed by April 2001, but mid-May 2000 the government had completed only one government regulation on central and provincial authorisation. Given this slow pace, it is unlikely the new laws will be implemented in April 2001, as planned. Finally, there is the problem of regional incapacity at both the provincial and district levels to manage autonomy. No evidence exists to show how regional authorities or local communities systematically pursued capacity-building to manage autonomy. Regions perceive merely that regional autonomy should be implemented now no matter whether they are ready to manage it or not. The above problems suggest two options. The first is to postpone the implementation of the laws in order to provide the government with enough time to review them and to prepare other regulations for a comprehensive legal basis for local autonomy. This option, however, might not be popular with local communities in particular who would be suspicious about the government’s commitment to reform and democratisation. In addition, it has the potential to increase regional instability. The second option is to implement the laws as scheduled on April 2001. But the process of implementation could be frustrating and may create a lot of tension between the centre and the regions, a situation that the laws aimed to avoid in the first place. It is likely that Gus Dur’s administration will chose the second option. This is a popular decision, but it is by no means a decision that will be easily realised. An overall assessment of the political threats to liberalisation would emphasise the following: the consensus on the need to liberalise the economy and to follow the IMF- prescribed policies to restore investor confidence has so far prevented a more inward-looking trade policy. However, the longer it takes Indonesia to recover and enter a high growth path again, the more likely protectionist and nationalist

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sentiments will grow. As the government’s capacity to manage the economy efficiently erodes, the more likely it will respond towards protectionist – minded constituencies, as the previous examples have shown. Thus, very much depends on how rapidly the government can restructure the badly damaged financial sector in order to revitalise the real sector and rekindle economic growth.

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APPENDIX. TRADE-RELATED POLICY ACTIONS UNDER THE IMF PROGRAM Policy Action

Target Date

TARIFFS Reduce by 5 percentage point tariffs on items currently subject to tariffs of 15 to 25 31-Mar-98 per cent. Cut tariffs on all food items to a maximum of 5 per cent. 1-Feb-98 Reduce tariffs on non-food agricultural products by 5 percentage points.

1-Feb-98

Gradually reduce tariffs on non-food agricultural products to a maximum of 10 percentage points. Reduce by 5 percentage point tariffs on chemical products.

2003 1-Jan-98

Reduce tariffs on steel/metal products by 5 percentage points.

1-Jan-98

Reduce tariffs on chemical, steel/metal and fishery products to 5-10 per cent.

2003

IMPORT RESTRICTIONS Abolish import restrictions on all new and used ships.

1-Feb-98

Phase out remaining quantitative import restrictions and other non-tariff barriers.

End-program

EXPORT RESTRICTIONS Abolish export taxes on leather, cork, ores and waste aluminium products.

1-Feb-98

Reduce export taxes on logs, sawn timber, rattan and minerals to a maximum of 30 First Step by April 22, per cent by April 15, 1998; 20 per cent by end December 1998, 15 per cent by end 1998 December 1999 and 10 per cent by end December 2000

Phase in resource rent taxes on logs sawn timber and minerals.

First Step by April 22, 1998

Replace remaining export taxes and levies by resource rent taxes as appropriate.

Over program period

Eliminate all other export restrictions

Over program period

Remove ban on palm oil exports and replace by export tax of 40 per cent. The level 22-Apr-98 of the export tax will be reviewed for possible reduction, based on market prices and exchange rate and reduced to 10 per cent by end December 1999.

OTHER MEASURES Local Contents Abolish local content regulations on motor vehicles

2000

Abolish local content regulations on dairy products.

1-Feb-98

Free Trade Zone Review the tax free status of the islands of Batam, Rempang & Galang, based on Based on feasibility the comprehensive feasibility study being undertaken. Defer any plans pending the study to be completed completion of the study by August 31, 1999. 12: Immediate. Review the effectiveness of policies for the Integrated Economic Development Zones (KAPETS), especially the fiscal concessions.

Based on study to be completed by December 31, 1999.

Start collecting value added tax from Batam island

April 1, 2000.

Review the desirability of maintaining the income tax facilities and abolishing the indirect tax facilities for the Integrated Economic Development Zones (KAPETS). Complete review

Complete review: Feb. 1, 2000, Implement measures: April 1, 2000

Value Added Tax Limit VAT zero-rating of domestically supplied goods to businesses in proportion to Upon implementation of their exports. the new VAT Law

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Review VAT exemptions on specified goods (capital goods, agricultural inputs & public services), & identify those that should be revoked, avoiding cascading.

30-Sep-99

Prepare draft amendments to the VAT law to provide prompt refunds for all excess 1-Mar-00 credits of exporters and enterprises purchasing large amounts of capital goods Eliminate VAT exemptions on capital goods

Upon implementation of the new VAT Law

Custom Administration Prepare draft amendments to the law on customs and issue implementation regulations to provide for penalties & interest on unpaid duties & implementing short, issue oriented audits. Develop & implement the plan to combat valuation fraud by (i) strengthening physical inspections; (ii) establishing special valuation units in the regions;(iii) undertaking special valuation audits; and (iv) developing a valuation database to help detect Reduce exemptions to import tariffs on capital goods, rationalize & make tranparent the remaining exemptions. Dissolve restrictive marketing arrangements for cement, paper and plywood.

31-Oct-99

1-Feb-98

Eliminate price controls on cement.

3-Nov-97

Allow cement producers to export with only a general export license.

1-Feb-98

Free traders to buy, sell and transfer all commodities across district and provincial boundaries, including cloves, cashew nuts, and vanilla.

1-Feb-98

31-Oct-99

April 1, 2000.

Eliminate BPPC (Clove Marketing Board).

30-Jun-98

Abolish quotas limiting the sale of livestock.

30-Sep-98

Prohibit provincial governments from restricting trade within and between provinces. Enforce prohibition of provincial and local-export taxes. Take effective action to allow free competition in: (i) importation of wheat, wheat flour, soybeans, and garlic; (ii) sale or distribution of flour; and (iii) importation and marketing of sugar. (iv) importation of rice

1-Feb-98

1 = MEFP October 31, 1997

*structural benchmark

Jan-98

2 = MEFP January 15, 1998 3 = SMEFP April 10, 1998 4 = SMEFP June 24, 1998 5 = MEFP July 29, 1998 6 = SMEFP September 11, 1998 7 = MEFP October 19,1998 8 = SMEFP November 13, 1998 9 = SMEFP March 16, 1999 10 = MEFP May 14,1999 11 = SMEFP July 22, 1999 12 = MEFP January 20, 2000. MEFP is Memorandum of Economic and Financial Policies SMEFP is Supplement to Memorandum of Economic and Financial Policies Source: IMF website

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REFERENCES: Basri, Chatib, Indonesia’s Manufacturing Protection: How to Protect Crony Capitalists, 1999, paper presented at The Conference on The Economic Issues Facing the New Government. WTO, Trade Policy Review: Indonesia, 1998 APEC, Indonesia Individual Action Plan 1999 Yamazawa, Ippei, APEC’s Progress towards the Bogor Target: A Quantitative Assessment of Individual Action Plans. 1997

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