Wednesday, 26 March 2014

New Prudential Authorities

Arisyi Fariza Raz
The Jakarta Post
27 March 2014
Available at:

The year 2014 has been an important one for Indonesia’s financial system. On Jan. 1 Bank Indonesia (BI), the central bank, transferred its banking supervisory role to the Financial Services Authority (OJK).

Both of these institutions have been given new mandates: To maintain the country’s financial system stability through the implementation of prudential policies, which consist of macro-prudential and micro-prudential policies. After the hand over, Bank Indonesia, which is already charged with price stability, has been given a mandate to take charge of macro-prudential policy. The OJK, meanwhile, is in charge of micro-prudential policy and will focus on individual financial institutions.

According to the Bank for International Settlements, the distinction between macro- and micro-prudential regimes is best drawn in terms of the policy objective and of the conception of the processes influencing economic outcomes.

Simply put, macro-prudential policy aims at limiting the “systemic risk” or the costs to the economy from financial distress. On the other hand, micro-prudential policy works toward minimizing the possibility of failure of individual institutions, which is often referred to as limiting “idiosyncratic risk”.

In terms of conceptions of the mechanisms affecting the economy, a macro-prudential regime is viewed as “endogenous” since it views the system outcome to be determined by the collective behavior of individual institutions. Meanwhile, a micro-prudential regime views those outcomes as related to individual firms and is “exogenous”.

In terms of policy applications, theoretically, macro-prudential and micro-prudential policies should be complimentary and reinforce each other in achieving their respective policy objectives.

For instance, sound individual institutions contribute to system-wide financial stability, while a stable system with minimized systemic risk influences the soundness of individual institutions.

However, a paper by the International Monetary Fund (IMF) in 2013 also notes that conflicts may occur in certain situations due to different policy applications and overlapping policy mandates. By nature, macro-prudential policies are usually counter-cyclical, while micro-prudential policies are pro-cyclical.

Hence, when the financial system is under pressure, micro-prudential policy usually raises its standards to anticipate the shock, while macro-prudential policy tends to loosen its policy, thus increasing the tensions between the two policy regimes.

Even though tensions may arise during a downturn phase or at crucial turning points, the IMF suggests that these can be prevented or, at least, minimized, by conducting information sharing, inter-institution dialogue and joint-risk analysis between macro- and micro-prudential authorities.

In addition, the IMF also recommends both authorities form a jointly coordinated strategy that can be communicated to the market and the public to enhance understanding and policy transparency.

Fortunately, prudential authorities, i.e. BI and the OJK, and the government have realized the importance of establishing close communications to reduce the possibility of differences of opinion between the two institutions.

One notable example is the establishment of the Financial System Stability Coordination Forum (FKSSK). This forum consists of the Finance Ministry, BI, the OJK and the Deposit Insurance Corporation (LPS), which are in charge of fiscal policy; monetary and macro-prudential policy; micro-prudential policy; and deposit insurance respectively. 

This forum consists of multi-level meetings held regularly, whether monthly or quarterly and discusses the country’s economic resilience, including financial-system stability.

In addition, both authorities also have data and information sharing that is easily accessible to avoid data lags and to support the efficiency of policy implementation.

These examples show that appropriate measures have been taken by macro- and micro-prudential authorities in Indonesia in order to minimize the tensions between the authorities and, accordingly, achieve their respective policy objectives.

However, numerous challenges still exist, particularly due to the dynamics and the transforming financial system. Therefore, tensions between the two authorities can be kept to a minimum if they take a flexible approach toward institutional arrangements. In addition, both authorities should exploit policy complementarities through arrangements in order to create productive collaboration between them.

In short, BI and the OJK have followed contemporary global financial policy trends through the establishment of prudential regimes in order to capture the dynamics of the latest financial system characteristics. In addition, in terms of implementation and policy coordination, both authorities have also followed the available standards in order to optimize policy efficiency.

Nevertheless, since prudential policies are relatively new, there is still a lot to learn and thus many challenges have to be overcome. Therefore, policy flexibility is necessary to keep up with the evolving characteristics of the financial system.

The writer is a graduate of the University of Manchester, UK.

Monday, 6 January 2014

Will US economic recovery harm Indonesia?

Arisyi Fariza Raz
The Jakarta Post
6 January 2014
Available at:
Despite the “dovish” reputation of Janet Yellen, nominated to take over as the US Federal Reserve chair in 2014, the central bank is already committed to reducing its bond-buying program by US$10 billion starting in January this year.

This decision was primarily motivated by the central bank’s confidence in the stability of the US economy. This decision will have a significant impact on the global economy, particularly emerging economies including Indonesia.

Even though the Fed eventually delayed the tapering from its original schedule last September due to less than expected macroeconomic improvements, this signal had led to a global portfolio rebalancing that affected most emerging economies.

In particular, emerging economies that experienced fiscal and current-account deficits, such as Indonesia, were more prone to this shock and thus were affected more severely. As a huge amount of capital was withdrawn from Indonesia, its currency depreciated sharply, resulting in short-term financial instability in August through October.

Hence, considering its existing twin deficits issue, Indonesia will face another wave of threats when the QE tapering really happens next year. From an external balances perspective, the prolonged current-account deficit that has been plaguing Indonesia for five successive quarters will still make the rupiah prone to further undergoing currency

This is exacerbated further by the huge share of foreign funds invested in Indonesian capital markets.

As dollar liquidity tightens, vast funds withdrawal from capital markets will occur, resulting in the plummeting stock index and soaring bond yields.

Then, this fund withdrawal will drain the Indonesian capital account and reduce its ability to finance its current-account deficit. As a consequence, its balance of payment will deteriorate and the rupiah will suffer.
When the tapering occurs, it is also very likely to raise interest rates again to dampen consumption and reduce imports.

Meanwhile, from a fiscal policy perspective, Indonesia will experience another fiscal deficit in the proposed 2014 state budget, which is estimated to reach 2 percent of next year’s gross domestic product (GDP). When QE tapering occurs, the weakening rupiah will cause energy subsidies to swell further and widen the fiscal deficit.

Accordingly, oil and gas imports will increase and undermine the current-account deficit further. Higher oil and gas imports, coupled by rupiah depreciation, will result in higher imported inflation. With more inflationary pressures, consumption will be hampered and economic growth may slow. Therefore, if no concrete actions are taken, this issue could result in a downward spiral, thus adding more pressure to economic stability.

Fortunately, some of Indonesia’s other macroeconomic variables are still relatively strong enough to anticipate QE tapering. From a public finance perspective, government debt as a percentage of the GDP is only around 23 percent. This low government debt, accompanied by sufficient foreign reserves, may minimize additional shock to rupiah’s volatility.

Moreover, Indonesia’s financial sector is still firm enough in facing external shock, such as that caused by QE tapering. Thanks to the adoption of BASEL II and the implementation of macro-prudential policies to preserve financial stability, Indonesian banks have healthy liquidity position and good capital management. When the tapering occurs, this prudent financial sector will prevent, or at least, minimize the magnitude of adverse shock transmission from the financial sector to the real sector.

In addition, the delay of QE tapering also gave Indonesia more time to improve its macroeconomic fundamentals. To reduce financial volatility, the central bank has made some attempts to narrow Indonesia’s current deficits by tightening its monetary policy, i.e. rising its benchmark policy rate. When the tapering occurs, it is also very likely to raise interest rates again to dampen consumption and reduce imports, thus minimizing the impact of additional inflationary pressures and improving the trade balance.

Furthermore, it has been sustaining its foreign reserves amount to maintain rupiah liquidity. It also established and increased bilateral swap agreements with Japan, China and South Korea to maintain its foreign reserves. To some extent, these central bank policies are expected to be able to narrow Indonesia’s current-account deficit and reduce the impact of QE tapering on financial stability.

Bank Indonesia also cooperates with the government in facing QE tapering, which is mainly aimed at managing its twin deficits issue. For instance, the government launched the first and second rescue packages, increased the investment limits in certain industries, eased investment regulations and announced tax incentives for investments in agriculture and metal to promote exports. It will also reduce luxury car imports, control the subsidized oil usage and mandate higher biodiesel usage to cut oil imports.

Ultimately, QE tapering will still have adverse effects on the Indonesian economy, particularly considering its unsolved twin deficits issue. Once the tapering starts, dollar liquidity will tighten and Indonesian economy will face huge funds withdrawals. This will lead to currency depreciation and financial instability, thus undermining overall macroeconomic performance.

However, the exact severity of the impact is very difficult to measure since such phenomenon has never happened before. In addition, different timing and bond-buying reduction amount may result in different impacts on the Indonesian economy.

To conclude, even though QE tapering is expected to undermine the Indonesian economy severely, its impact is expected to be less significant than the 1997-scale financial crisis vis-à-vis macroeconomic performance and financial stability.
The writer, a graduate of the University of Manchester, is a research analyst at a multinational bank. The views expressed are his own.

Tuesday, 17 September 2013

Will the fiscal stimulus work?

Arisyi Fariza Raz
The Jakarta Post
17 September 2013

Available at:

The government recently announced a fiscal stimulus through four packages to deal with the deteriorating economy.

The first package deals with the current deficit account. This will be achieved by: promoting exports through tax deductions for value-added goods, reducing fuel imports and levying luxury taxes on imported brand-name goods. The second stimulus aims to nurture domestic purchasing power and economic growth through maintaining budget deficit and providing incentives for value-added industries. The third stimulus is to maintain price stability. This stimulus will be carried out through close cooperation with Bank Indonesia (the central bank) by prioritizing food prices.

The government also intends on improving bureaucracy efficiency to promote investment and business.

Unfortunately, analysts and industry players reacted to the announcement of these packages with scepticism. Supposedly, these policies are needed to boost economic growth. However, many believe that these policies should have been implemented when market conditions were better to improve structural conditions and not when the country is facing economic turbulence.

The main reservation behind these packages is their long-term orientation; they cannot solve Indonesia’s economic issues immediately. Theoretically, assuming Indonesia has an efficient bureaucracy, good infrastructure and negligible corruption issues, these packages may help boost the economy significantly after at least six months of being implemented.

However, considering today’s rampant corruption, perplexed bureaucracy and poor infrastructure, it might take years for these stimulus packages to have positive effects.

Therefore, instead of poorly applying textbook-oriented fiscal policy, the government should make bolder moves that could improve the economy immediately.

One of the most feasible policies is by promoting public spending through infrastructure investment. According to Keynesian economics, an economic school of thought, a government should boost its spending when its economy is facing a crisis. When a government does not have enough money to spend, then it can fund spending by obtaining debts. The logic is, at the onset of the crisis, the government should solve problems in the short run rather than waiting for market forces to do it in the long-run.

Admittedly, this policy may sound too risky since it involves public debts in promoting economic growth. Meanwhile, public debt has become a sensitive issue since the 1997 Asian Financial Crisis as it brought our country to the brink of bankruptcy.

However, it is necessary to understand that debt is not always bad, as long as it is not excessive. Indeed, over financing may result in fragile economic conditions, leaving it inflexible and exposed too many risks. However, debt is still necessary to finance an economy, particularly during a crisis.

As an example, fiscal austerity in Europe, which resulted in economic contraction, has become clear evidence of how sometimes debt is necessary to boost economic growth.

Looking at Indonesia’s case, currently the share of debt in terms of total gross domestic product (GDP) is still relatively low compared to its regional peers. Statistically speaking, data released by the International Monetary Fund (IMF) shows that Indonesia’s public debts only accounted for 24 percent of its GDP in 2012. Meanwhile, Thailand’s, Malaysia’s and Singapore’s figures were 46 percent, 56 percent and 108 percent, respectively.

In short, Indonesia’s low public debts position gives a lot of fiscal space for the government to manoeuvre. If the government obtains more public debts and invests in the right sector, i.e. infrastructure, then it will not harm the economy. In fact, infrastructure spending is very much needed in a country such as Indonesia where poor infrastructure has left the country with expensive production costs.

In the short-run, it will create new jobs and projects that will stimulate the economy through increased demand and higher purchasing power. Consequently, economic growth can be created. In addition, the impact of infrastructure spending will last in the long-run as completed infrastructure projects will lower production costs and increase the competitiveness of local products.

As for the debts, if infrastructure spending can foster economic growth faster than debt growth, then the size of public debts in terms of total GDP will shrink by itself in the long-run, even if the government does not pay it off. This method is suggested by Paul Krugman in his book End This Depression Now!

In conclusion, debt-financed infrastructure investments will create sustainable economic growth since the impact of the investments will last in the long-run and create multiplier effects in the economy.

The writer, a graduate of the University of Manchester, UK, is a research analyst at a multinational bank. The opinions expressed are his own.

Monday, 9 September 2013

Book Review: End This Depression Now!

Sebenarnya sudah lama saya ingin menulis review tentang buku ini. Namun apa daya, baru sekarang saya sempat menulisnya hingga selesai..

Well, seperti yang tertulis di judul, di dalam buku ini Paul Krugman membahas keadaan krisis di Amerika dan Eropa pada saat ini yang sedang mengalami liquidity trap (di mana pemerintah tidak dapat lagi menurunkan suku bunga yang sudah mendekati nol untuk menstimulus perekonomian). Lalu, dia juga memberikan resep Neo-Keynessian mengenai penanganan krisis di Amerika dan Eropa. Menurut Krugman, cara untuk mengatasi krisis di negara yang mengalami liquidity trap adalah mendorong pemerintah untuk memberikan stimulus secara terus menerus agar dapat menciptakan demand atau permintaan. Dengan terciptanya demand, maka lapangan kerja baru akan tercipta dan akhirnya ekonomi bisa kembali tumbuh. 

Ia juga menkritisi bagaimana fiscal austerity di Eropa malah membuat perekonomian pinggiran (peripheral economies) di Uni Eropa semakin terjerumus ke krisis yang lebih dalam. Fiscal austerity, yang berarti pengetatan fiskal, membuat pemerintah memangkas pengeluaran yang akhirnya menggerus demand dan malah menghilangkan lapangan pekerjaan. Permasalahannya adalah, ketika terjadi krisis lapangan pekerjaan, pengangguran muda (young employment) terkena dampaknya tidak hanya di jangka pendek, tetapi juga di jangka panjang, i.e. berdampak terhadap seluruh karir mereka.

Selain itu Krugman juga membahas mengenai ketakutan terhadap inflasi yang sangat berlebihan. Padahal, menurutnya inflasi terkadang diperlukan dalam situasi tertentu. Terutama ketika perekonomian itu mengalami deflationary issues. Menurutnya inflasi, dengan batas tertentu, mengindikasikan berjalannya perekonomian dan berputarnya uang. Dan hal ini diperlukan jika suatu ekonomi harus tumbuh. Yang penting, selama inflasi itu belum melewati batas tertentu, maka financial stability masih tetap bisa terjaga.

Di bagian lain di buku, ada juga dibahas tentang perang filosofi ekonomi antara freshwater economics dan saltwater economics. Freshwater economics adalah ajaran yang lebih konservatif, yang percaya bahwa perekonomian akan kembali menjadi normal dan pulih dari krisis dengan sendirinya tanpa ata campur tangan pemerintah. Sementara itu, Saltwater economics percaya bahwa ada lagging effect yang membuat private sector tidak bisa langsung kembali ke equilibrium, sehingga perekonomian baru akan pulih di jangka panjang. Oleh karena itu, campur tangan pemerintah diperlukan di jangka pendek untuk mempercepat pemulihan perekonomian. Konsep ini didasari oleh ajaran Keynesian yang mengatakan bahwa "In the long-run, we are all dead". Dalam hal ini, Krugman mengkritisi freshwater economics yang bisa memperparah dan memperpanjang krisis.

Intinya, buku ini menjelaskan bagaimana opini atau resep Neo-Keynesian dalam menangani krisis yang sedang terjadi di Amerika dan Eropa saat ini. Dibandingkan buku sebelumnya, The Return of Depression Economics, buku ini lebih banyak memberikan solusi-solusi mengenai permasalahan perekonomian yang ada. Karena buku ini memberikan banyak insight menarik dengan kata-kata yang tidak teknikal, buku ini sangat disarankan untuk dibaca semua kalangan, baik awam maupun akademisi, pro Keynesian ataupun pro Neo-Classical.

Thursday, 22 August 2013

In search of better industrial policy in Indonesia

Arisyi Fariza Raz
The Jakarta Post
13 August 2013

Available at:

Recently, Indonesia’s economic indicators show some signs of moderation. For instance, the economy only grew by 6 percent during quarter 1 (Q1) 2013, down from 6.2 percent in quarter 4 (Q4) 2012. This figure was slightly lower than the government’s initial projection.

One of the factors of this economic moderation is Indonesia’s high dependence on commodity exports.

During the commodities boom in the 2000s, Indonesia has been exporting commodities such as coal and crude palm oil on a massive scale to meet demands from emerging economies such as China and India.

Since mid 2012, however, sluggish global economic conditions resulted in declining commodity prices and affected Indonesia’s export performance. In the end, this resulted in slower economic growth.

In short, this condition shows that Indonesia’s current economic model of commodity-propelled economic growth is not sustainable and very vulnerable to commodity price volatility.

Meanwhile, the industrial sector is usually a better propeller for economic growth, since it is a relatively less volatile sector. In addition, it creates huge employment opportunities (particularly that with labor-intensive approach), which is good for Indonesia’s enormous population size. It also brings more value-added and positive externalities to the economy.

Unfortunately, Indonesia’s industrial sector has not been performing well in the recent quarters.

Based on data released by Statistics Indonesia, Indonesia’s manufacturing industry shrunk by 1.7 percent in Q1 2013 compared to Q4 2012. Moreover, manufacturing industry share in terms of total gross domestic product (GDP) was only around 24 percent in Q1 2013, fell slightly from 25 percent in Q4 2012. In terms of productivity, industrial production index has also declined slightly in Q1 2013 to 113.8 from 114.12 in Q4 2012.

These statistics, even though not conclusive, show a tendency of industrial stagnation. If this occurs in the long run, Indonesia might experience early “de-industrialization”, which is highly undesirable.

Fortunately, the government has realized this issue and has been trying to promote industrialization once again. It has implemented several policies such as restrictions on exports of mining products and anti-dumping duty on steel imports. These restrictions are expected to give incentives to local manufacturers to substitute imports and bring more value added to the output by recreating the whole production chain locally.

However, if we look at these policies closely, it seems like the government is adopting an import-substitution industrialization (ISI) strategy considering its main aim is to try to replace foreign imports with domestic products.

An ISI strategy, which is to some extent, theoretically justified, has several drawbacks. Replacing imported goods with domestic production takes some time to fully work. It is also very costly and may create inefficient and obsolete industries since they are not exposed to internationally competitive industries.

More importantly, this strategy is considered “outdated” considering current global trends that focus on production efficiency. Hence, by implementing an ISI strategy too deeply, Indonesia will lose its attractiveness, which might reduce foreign direct investment (FDI) in Indonesia.

Meanwhile, a study by Meixell and Gargeya (2005) suggests that current international manufacturers are more interested in reducing cost, increasing revenue, and improving reliability. This paradigm shift has made “global production chain” manufacturing a more desirable and cost efficient manufacturing model.

In the global production chain model, each country focuses on a particular production chain in order to maximize productivity and improve cost efficiency. Then, this production is integrated globally in order to produce a complete product.

Therefore, instead of trying to focus too much on creating the whole production chain for one particular product, Indonesia’s government should pay more attention on product specialisation and production efficiency in order to take part in the global production chain.

Product specialization does not necessarily lead to less value added in the production process. A traditional measurement of value added usually estimates per-unit difference between revenues and costs related to production. The government’s current industrial policy is too focused on this traditional measurement.

However, as suggested by Lejour et al. (2012), new arrangements in international production have changed the rational of measuring production value added. As an alternative of the traditional measurement, value added can be measured by estimating total value added of production activity.

In other words, even though the government focuses on the specialization of one particular production chain instead of producing the whole manufacturing process, it does not necessarily lead to lower value added. In fact, efficient product specialization might lead to the same or higher amount of total value added.

The government can enhance this industrialization model by creating and directing one particular industry, which is relatively more efficient with lower cost , to be more specialized in one particular production chain in order to integrate it into global production chains.

In addition, this should be supported by adequate infrastructure, encouraging investment and favorable industrial regulations. Through these efforts, hopefully this model of industrialization will be able to revive Indonesia’s stagnating industrial sector and create more sustainable economic growth.

The writer is a research analyst at a multinational bank. The opinions expressed are his own.

Monday, 6 May 2013

Can Indonesia maintain its economic momentum in 2013?

In 2012, Indonesia deserved some credits in terms of economic performance. Almost all of the economic indicators remained steady, if not improved, despite deepening recession in Euro Zone and stagnation in US and Japan.

Indonesia’s annual GDP growth reached 6.2 percent, slightly lower than initial target of 6.5 percent. In spite of this, Indonesia still relatively fared better in South East Asian region. Its growth rate is higher than most of its neighbouring countries such as Malaysia, Thailand, Singapore and Philippines.
Indonesia’s remarkable growth was mainly underpinned by firm domestic demand (or private consumption). In 2012, private consumption grew by 5.3 percent, accounting around 55 percent of GDP, which made it the biggest contributor to economic growth.

Even though there were still some concerns regarding current account deficit that, to some extents, pressured Indonesian rupiah, most of other economic indicators performed relatively well.
For instance, inflation in 2012 was recorded at 4.3 percent (Year on Year), the lowest in 12 years. Manufacturing and services sectors also continued its rapid growth, giving higher contribution to GDP. In addition, real investment grew by 9.8 percent in 2012, higher than 2011 figure of 8.8 percent.

Even though Indonesia recorded relatively good performance in 2012, it has to face challenges and pressures to continue its rapid economic growth in 2013.
For instance, inflation has surged to 5.9 percent (Year on Year) in March 2013, pushed by higher food prices and electricity costs. Moreover, Statistics Indonesia (BPS) reveals that up to February 2013, Indonesia was still unable to lift its exports due to slow global economic recovery, which resulted in prolonged trade deficit. This problem will put further pressures on Indonesian rupiah, which has been depreciating against US dollar since mid 2012.

In spite of these escalating pressures, however, there is still a possibility for Indonesia’s to grow above 6 percent in 2013. The most important thing is to know how to face the challenges and tackle the obstacles that threaten the economy.

One of Indonesia’s biggest economic challenges is to improve its inadequate infrastructure.  Currently, Indonesia’s infrastructure condition is one of the worst in South East Asia. Moreover, infrastructure investment in Indonesia is also relatively low compared to its neighbours and has not shown any significant improvements in the recent years. For instance, World Bank’s Indonesia Economic Quarterly Report in QI 2013 suggests that infrastructure investment in Indonesia as a share of GDP is lower during the post-crisis era compared to the pre-crisis era.

In 2011, the government already established MP3EI (Master Plan to Accelerate and Expand Economic Development in Indonesia) to encourage increased investment in infrastructure projects. Nevertheless, so far this master plan has not been going very effectively due to several problems such as overlapping regulations and land clearing issues.

Hence, the government should confront these issues so that MP3EI can achieve its objectives effectively in lifting Indonesia’s infrastructure investment in the upcoming years.
In addition to improving infrastructure investment, it is also necessary to increase the quality of infrastructure through adequate budget to sustain operational and regular maintenance.

More adequate infrastructure will reduce logistic costs and, thus, minimize production costs. With low logistic costs Indonesia will able to attract more investment. In the end, this will increase productivity and create new job opportunities that can improve gross output and increase overall income level.

Unfortunately, currently many investors are concerned about Indonesia’s poor logistic condition, which increases the cost of running business. If this issue is prolonged, there will be a possibility that investors will shift its business to other countries that can provide cheaper logistic cost.

Better infrastructure also reinforces the process of urbanization in Indonesia that, if supported by sufficient employment opportunities, will create new households and drive demand up. In the end, this will ameliorate welfare and trigger economic growth.

Beside infrastructure issue, another important issue that needs to be handled is the perplexed bureaucracy. Indonesia’s complicated bureaucracy system is one of its major competitive disadvantages that discourage investors to start new businesses in Indonesia.

A study by Kaufman, Kraay and Mastruzzi in 2010 shows that the effectiveness of Indonesian government is one of the lowest in South East Asia, below Singapore, Malaysia, Brunei, Thailand and Philippines.

If this issue continues, then investors will be more reluctance in investing in Indonesia. In the long run, this may lead to capital flight, which will undermine the economy.

Therefore, the government needs to address this issue as soon as possible. Indonesia has much potential as one of the main investment destinations. By improving bureaucracy efficiency through bureaucracy reform, it will be able to realize this potential and propel economic growth.

In summary, out of several major obstacles that can harm Indonesia’s economy, infrastructure and bureaucracy issues are among the most urgent things that have to be addressed immediately. Improved infrastructure will be able to create multiplier effects that can benefit all economic sectors, promote exports, attract investments and increase productivity. More efficient bureaucracy will push investments even further; creating economic leap that can result in sustainable economic growth.

In other words, these improvements will not only help Indonesia to continue its rapid economic growth in 2013, but also improve the quality of economic growth itself.

Saturday, 13 April 2013

Commercializing Agriculture

Arisyi Fariza Raz
The Jakarta Post
10 January 2013

Available at:

Indonesia has emerged as one of the fastest growing economies in Asia amid the global economic slowdown. Strong domestic demand, accompanied by structural reform of the financial sector, has formed the foundation of Indonesia’s economic resilience.

Despite the success story of its overall macroeconomic performance, Indonesia’s agriculture sector, once renowned for being Indonesia’s main engine of growth, is facing various challenges to survive.

Statistically speaking, the World Bank’s world development indicators show that the share of Indonesia’s agriculture sector in terms of gross domestic product (GDP) declined from 17 percent in 2000 to 15 percent in 2011.

During the same period, the sector’s average annual growth was less than 3 percent, lower than the country’s average real GDP growth of around 5 percent. Moreover, around 60 percent of the poorest Indonesians are smallholders who live on small farms with poor productivity.

A report by Rabobank in 2011, titled Indonesia Food and Agribusiness Outlook suggested that the challenges in agribusiness development included low-yielding smallholder crop systems, underdeveloped agricultural practices, low-quality crops and underinvestment.

One way of tackling these issues is by introducing agricultural commercialization in Indonesia. By definition, agricultural commercialization is an agricultural growth process that links smallholders in the agriculture sector into commodity value chains.

Currently, the agriculture sector in Indonesia is dominated by smallholders who have limited access to capital and, more importantly, technical expertise. Moreover, these smallholders have little, if any, entrepreneurial skill. As a consequence, farming is carried out on a small-scale basis with low yields and insubstantial profitability.

Through commercialization, smallholders in the agriculture sector are encouraged to be more profit-oriented since production is more focused on sales. In addition, they are also introduced to the agribusiness concept, which leads to entrepreneurial farming.

To achieve commercialization, both government and private sectors have to play their roles effectively. First, the government has to introduce agronomic and farm managerial skills to farmers. By introducing these skills, smallholders are educated to generate more cash in order to improve farming profitability and agribusiness sustainability.

Second, it also needs to provide adequate rural infrastructure, including improved road and irrigation systems. Moreover, crop improvement research is also necessary to create high-yield corps. This will enable smallholders to reduce farming costs while maximizing productivity.

Third, the government can also act as a bridge between smallholders and the private sector to facilitate the transfer of capital and know-how to these smallholders. With adequate capital and sufficient technological capability provided by the private sector, smallholders can increase the value-added of their products, resulting in higher profit margins.

For instance, capital investment in smallholder’s agribusinesses focused on the agricultural processing industry can be stimulated to increase the value-added of agricultural products. Another example is by improving agricultural marketing and distribution flows through government and private sector-led market research and market information systems.

In addition, the government and private sector can also support agribusiness by providing rural credit facilities through state-owned or private commercial banks at market interest rates.

Last but not least, agriculture policy is also crucial since it can create an enabling environment for smallholders if imposed in the right direction. For instance, currently the government imposes several export taxes on various agricultural products. These taxes are levied in order to encourage value addition in farming products, leading to higher employment and better value to smallholders.

By implementing all of these steps, smallholders are facilitated with the knowledge of entrepreneurial farming and profit orientation. Technological and capital supports also help them in conducting agribusiness on a bigger-scale and with greater production efficiency. In addition, smallholders are given easy access to credit facilities at reasonable interest rates, thus allowing them more space to grow.

In the bigger scope, agriculture commercialization can reinforce the overall development of the agriculture sector in Indonesia in several ways.

First, it increases agricultural productivity through agribusiness skills, adequate infrastructure and high-yielding crops. Second, it improves crop marketing and distribution flows, which underpin further the output of the agriculture sector. Third, it creates value addition for agricultural products that will increase their competitiveness in export markets.

In terms of empirical evidence, many countries in the developing world have shown the positive impact of agricultural commercialization. For instance, a report by Michigan State University in 1999 showed, based on a study case in Kenya, that agricultural commercialization at household level improves food crop fertility and productivity. Meanwhile research by Pingali and Rosegrant suggests that appropriate government policies can create a smooth and effective process of agricultural commercialization.

In short, agricultural commercialization is a method that can be used, not only to revive the agriculture sector in Indonesia, but also to reduce the poverty that prevails in the rural sector.

Through profit-oriented farming, smallholders will be able to gain more cash to improve their welfare. Meanwhile, managerial skills will allow them to manage their assets more efficiently that can then result in bigger-scale farming through economies of scale.

In the process, the growing smallholders’ agribusiness can promote the development of the agriculture sector in Indonesia in a sustainable way. 

The writer is a graduate of the University of Manchester, UK.