RS21753 -- Indonesia-U.S. Economic Relations March 2, 2004 Indonesia, like many East Asian economies, suffered a severe economic shock when the "Asian Financial Crisis" struck the country in mid-1997. Prior to thisperiod, Indonesia had enjoyed relatively healthy economic growth: from 1980-1989, real GDP growth averaged5.5%, and from 1990 to 1996, it averaged 8.0%(one of the highest GDP growth rates in the world). According to the World Bank, the proportion of people livingbelow poverty declined from 60% in 1970 toan estimated 11% by mid-1997. (3) The 1997 economic crisis (which began in Thailand and quickly spread to Indonesia and several other East Asian economies), (4) resulted in a sharp depreciationof Indonesia's currency (the rupiah), (5) large-scalecapital flight, high inflation, widespread corporate bankruptcies (caused in part by large short-term debt ofmany companies and corrupt business practices), and a near collapse of the banking system. (6) In 1998, real GDP plunged by 13.2%; exports andimports fell by 8.6% and 34.5%, respectively, and living standards (per capita GDP on a purchasing power parity basis) droppedby nearly 13% (see Table 1 ). Finally , thepoverty rate doubled between mid-August 1997 (pre-crisis) and late 1998/early 1999. (7) Political unrest followed the economic crisis, eventually leading to the resignation in May 1998 of President Suharto (or Soeharto) who had ruled the countrysince 1967. The collapse of the Suharto regime helped usher in a new era of democratic political reforms inIndonesia, although the transition to democracy hasnot been easy and political instability remains a problem. Indonesia's near economic meltdown forced it to turn tointernational lending institutions, such as theInternational Monetary Fund, the World Bank, the Asian Development Bank, and foreign governments for billionsof dollars in loans, debt rescheduling, andeconomic aid. Indonesia has been somewhat successful in bringing the economy back to at least pre-crisis levels, but several problems remain. On the positive side, real GDPfrom 2000-2003 grew at a relatively healthy pace, averaging 4.0% (although it was half the average level of realGDP growth during the early 1990s). Inaddition, Indonesia's living standards (measured according to per capita GDP in purchasing power parity) finallyreached and exceeded pre-crisis levels in 2002($3,320 in 2002 versus $3,201 in 1997). Living standards improved by 12.7% in 2003. Finally, Indonesian exports (in dollar terms) in 2003 were 6.6% higherthan 1997 levels. On the negative side, Indonesian imports in 2003 were 21.1% lower than pre-crisis levels,reflecting the effects of the sharp devaluation of therupiah. In addition, the stock of foreign direct investment (FDI) in Indonesia dropped each year from 1997-2002. While the stock of FDI is estimated to haverisen slightly in 2003, it is $14.8 billion (or 20.3%) lower than what it was in 1997. (8) Finally, the rate of unemployment in Indonesia has steadily risen over thepast few years, from 6.1% in 2000 to 8.7% in 2003. Table 1. Selected Economic Indicators for Indonesia's Economy: 1997-2003 Source: Economist Intelligence Unit and government of Indonesia. Data for 2003 are estimates. *PPP data are measurements of foreign data in national currencies converted into U.S. dollars based on a comparable level of purchasing power these datawould have in the United States. The short-term economic prospects for Indonesia are relatively positive. For example, Global Insight , an international forecasting firm, predicts thatIndonesia's real GDP will rise by 4.6% in 2004 and 5.0% in 2005. (9) However, Indonesia faces a number of challenges that threaten to undermine long-termgrowth prospects. These include widespread government corruption and a weak legal system, (10) large public debt, extensive government controlof keyeconomic sectors (such as oil and gas), a high level of corporate non-performing loans, a weak banking system,uncertainties surrounding the centralgovernment's efforts to decentralize fiscal and political authority to local governments, and failure by thegovernment to provide adequate protection ofintellectual property rights (IPR). In addition, the existence and activities of several separatist movements andterrorist groups in Indonesia constitute majorthreats to political and economic stability. (11) InOctober 2002, terrorists with reported links to Al Qaeda bombed a club in Bali frequented by western tourists,killing over 200 people (including seven Americans) and wounding hundreds more. (12) In August 2003, terrorists bombed a U.S.-run hotel in Jakarta , killing12 people and wounding 150. The bombings have had a chilling effect on Indonesia's tourism industry and raisedmajor concerns over the safety of foreigntourists and businesspeople in Indonesia. Ethnic, religious, and separatist violence in the country has displaced 1.3million Indonesians. (13) According to the World Trade Organization, Indonesia was the world's 28th largest exporter and the 39th largest importer in 2002. Indonesian trade data indicatethat Japan was its largest trading partner in 2002, followed by the United States, Singapore, South Korea, and China(see Table 2 ). The United States wasIndonesia's second largest export market and its third largest source of imports. Major Indonesian exports includedpetroleum and petroleum products, naturalgas, and clothing and accessories. Its major imports were petroleum and petroleum products, organic chemicals,and general industrial machinery. (14) According to Indonesian investment statistics (which record approved investment, as opposed to actual investment),the top five foreign investors in Indonesiaare the United Kingdom, Japan, Singapore, China, and Malaysia. Major sectors for FDI in Indonesia includechemicals, pharmaceuticals, paper; metal goods,transportation, and real estate. (15) Table 2. Indonesia's Major Trading Partner's: 2002 ($billions) Source: United Nations Conference on Trade and Development U.S. data indicate that Indonesia is not a large U.S. trading partner. In 2003, U.S. exports to, and imports, from Indonesia were $2.5 billion and $9.5 billion,respectively, making Indonesia the 37th largest U.S. export market and its 26th largestsource of imports. As indicated in Table 3 and figure 1 , U.S. exports toIndonesia declined sharply in 1998 and 1999 and have been relatively flat since. Overall, U.S. exports to Indonesiain 2003 were 44.4% lower than 1997 levels. U.S. imports from Indonesia grew slightly from 1997-2000, but have been relatively flat since. U.S. imports fromIndonesia in 2003 were only 3.6% higherthan 1997 levels. The top three U.S. exports to Indonesia in 2003 were soybeans, textile fibers, and animal feed,while the top U.S. imports from Indonesiawere clothing and apparel, telecommunications equipment (mainly audio and video equipment), and crude rubber. According to U.S. investment data (whichlists the value of U.S. FDI on a historical cost basis, i.e., the cumulative book value of investment), U.S. FDI inIndonesia stood at $7.5 billion at year-end 2002,down by $700 million from 2001 and by $1.4 billion from its peak in ($8.9 billion) in 2000. Currently, 77% of U.S.FDI in Indonesia is in the mining sector(mainly oil and gas). (16) Because Indonesia is a developing country and meets other criteria set in U.S. law, $1.3 billion worth of its exports entered the United States duty-free under theGeneralized System of Preferences (GSP). In an effort to boost U.S.-Indonesian commercial relations, promotepolitical stability in Indonesia, and combatterrorism, the Bush Administration on September 19, 2001 announced that the United States would add 11 productsimported from Indonesia (valued at about$100 million) that would be eligible for GSP treatment and pledged that the United States would provide up to $400million in financial aid and loan guaranteesunder U.S. trade programs operated by the Overseas Private Investment Corporation (OPIC), the Export-ImportBank (Eximbank), and the Trade andDevelopment Agency (TDA), largely targeted at Indonesia's oil and gas sector. Indonesia has gradually reformed its trade regime over the past 10 years, reducing its average un-weighted tariff from 20.0% in 1994 to 7.3% in 2003. In 1999,Indonesia agreed to eliminate various discriminatory trade policies on auto trade after it lost a case in the WTOdispute brought mainly by the United States andEuropean Union. Indonesia's enforcement of U.S. IPR has been a major issue of concern for U.S. firms. Accordingto the International Intellectual PropertyAlliance (IIPA), piracy levels in Indonesia are "among the highest in the world," rivaling those of China andVietnam. IIPA estimates that IPR piracy inIndonesia cost U.S. firms $260 million in lost trade in 2002. (17) Table 3. U.S. Trade With Indonesia: Selected Years ($millions) Source: U.S. International Trade Commission Dataweb. PDF version

Summary: Indonesia's economy continues to struggle against the lasting effects of the 1997-1998Asian financial crisis and thepolitical instability that resulted. Indonesia was one of the hardest hit economies in Asia; real GDP fell by 13.2 %in 1998. Indonesian-U.S. commercial tieswere sharply diminished as well, caused in part by declining Indonesia living standards and a loss of foreign investorconfidence in Indonesia (due largely topolitical instability). The Indonesian economy has improved over the past few years, however, recent activities ofterrorist elements in Indonesia and the rise ofseparatist movements threaten to undermine further an already fragile economy. This report will be updated asevents warrant.