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Indonesia's next juncture: Facing China's decline

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Jakarta Post - October 4, 2024

Ibrahim Kholilul Rohman and Fadli Jihad Dahana Setiawan, Jakarta – As China's economic engine begins to sputter, Indonesia finds itself at a critical juncture. The intricate economic relationship between these two nations, characterized by substantial trade and investment flows, now presents both challenges and opportunities.

With the global economic landscape shifting, it is imperative for Indonesia to reassess its strategies and navigate these uncertain waters with caution.

For decades, China has been the world's fastest-growing major economy, driving global growth and providing a significant boost to fellow emerging countries like Indonesia. However, recent forecasts paint a starkly different picture.

The International Monetary Fund (IMF) projects that China's GDP growth will dwindle to just 3.3 percent by 2029, a sharp decline from the double-digit growth rates that once characterized its economic rise. This deceleration is not a temporary blip but a reflection of numerous deep-seated issues, an ongoing property crisis, a staggering debt burden, increasing government control and a rapidly aging population.

These developments will inevitably affect Indonesia, which has China as its largest trading partner and is a major recipient of Chinese foreign direct investment (FDI). In 2023 alone, China accounted for over 25 percent of Indonesia's exports and contributed to more than 14 percent of its total FDI inflows. An analysis of GDP growth from 1961 to 2023 reveals a significant alignment between the economic performances of Indonesia and China, particularly after 1998, when both countries embarked on transformative economic reforms.

A recent study by IFG Progress on the Indonesia-China economic interrelationship suggests that a one-percentage-point increase in China's GDP growth has historically led to a 0.247 percentage-point increase in Indonesia's growth rate, a clear indication of how closely these economies are linked.

Over the past decade, Indonesia actually has made strides in its trade relationship with China, but challenges remain. Indonesia's exports to China over the past 10 years (2014-2023) grew by 15.61 percent compound annual growth rate (CAGR), nearly twice the growth rate of Indonesia's imports from China, which stands at 8.32 percent CAGR.

This rapid growth in exports is a positive sign, but the trade dynamic still reflects an imbalance. Indonesia primarily exports raw materials to China, such as iron and steel, mineral fuels and vegetable oils, while importing higher-value intermediate and final goods, including machinery and electronics. This disparity highlights the ongoing obstacle for Indonesia to move up the value chain in its trade with China.

The challenges facing China itself are multifaceted and profound. Once a pillar of China's economic growth, the property sector is now becoming a significant drag, with plummeting sales and financial instability among developers like Evergrande, whose liabilities at one point exceeded US$300 billion. The broader real estate crisis is underscored by a sharp decline in residential property sales, which dropped by around 12 percent year-on-year in 2022.

China's staggering debt burden is compounding these issues, with the real total (approximated) debt-to-GDP ratio soaring to 300 percent. The heavy hand of government regulation further stifles economic activity, while an aging population poses long-term challenges to growth and productivity.

For Indonesia, the risks associated with China's economic malaise are considerable. A prolonged slowdown in Chinese demand could lead to reduced exports and FDI inflows, dampening Indonesia's economic prospects. Yet, within this challenge lies an opportunity for Indonesia to rethink its economic strategy and reduce its dependency on China.

Diversification is the key to mitigating the risks posed by China's slowdown. Indonesia must broaden its export markets to reduce its vulnerability to idiosyncratic economic shocks from any single country. Current data indicates that Indonesia's export market concentration index has been slightly higher than the ASEAN average since 2021 (0.084 versus 0.08), underscoring the urgency of reducing reliance on a few key markets, particularly China. Although Indonesia engages with more markets than some of its ASEAN counterparts, the concentration of exports to China remains a significant vulnerability.

To secure its economic future, Indonesia's strategic response should involve leveraging international trade agreements to open new avenues for trade and investment. The country is already negotiating several new significant free trade agreements (FTAs), including the Indonesia-EU Comprehensive Economic Partnership Agreement and the ASEAN-Canada FTA. Accelerating these negotiations and securing new trade deals will be essential in reducing Indonesia's economic dependence on China and positioning the country as a more globally integrated economy.

In this context, Indonesia's participation in the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) could be a game changer. The CPTPP is a trade pact that includes key economies like Japan, Canada, the United Kingdom and Australia, collectively representing about 13.4 percent of global GDP.

For Indonesia, joining the CPTPP would not only provide better market access to these major economies but also push for higher standards in domestic regulations, particularly in challenging areas such as environmental and labor standards. This is due to the "regulatory harmony" requirement with other CPTPP members. Regarding this, the Office of Coordinating Economic Minister estimates that Indonesia's current domestic regulations are already 70 percent aligned with the CPTPP requirements.

As the global economic landscape continues to evolve, Indonesia's ability to adapt and respond to these changes will be crucial. The country's interconnectedness with China has served it well during periods of rapid Chinese growth. However, given the dim forecasts, Indonesia must look to the future and chart a new course.

By attracting a broader range of investors and capitalizing on new trade opportunities, Indonesia can navigate the challenges posed by China's economic descent and emerge stronger on the other side.

Source: https://asianews.network/indonesias-next-juncture-facing-chinas-decline

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